PAGE 1
Prospectus for the T. Rowe Price California Tax-Free Income
Trust, dated July 1, 1997.
<PAGE>
PROSPECTUS
July 1, 1997
California Tax-Free Funds
A long-term bond fund and a money market fund for investors seeking income that
is exempt from federal and California state income taxes.
T. ROWE PRICE RAM LOGO
<PAGE>
FACTS AT A GLANCE
California Tax-Free Funds
Investment Goal
The highest level of income exempt from federal and California state income
taxes consistent with each fund's prescribed investment program.
As with all mutual funds, these funds may not meet their goal.
Strategy and Risk/Reward
California Tax-Free Money Fund Invests in high-quality, short-term municipal
securities, and its average maturity will not exceed 90 days. Your investment
in the fund is neither insured nor guaranteed by the U.S. government, and there
is no assurance that the fund will be able to maintain a stable net asset value
of $1.00 per share. Because the fund concentrates its investments in securities
of California issuers, an investment in this fund may be riskier than an
investment in more broadly diversified money funds.
Risk/Reward: Lowest potential risk and reward.
California Tax-Free Bond Fund Invests primarily in investment-grade municipal
bonds. The fund's average maturity is expected to exceed 15 years.
Risk/Reward: Significantly higher income than the money fund and greater
potential price fluctuation than a shorter-term bond fund.
Investor Profile
California taxpayers who, because of their tax bracket, can benefit from income
that is exempt from federal and California state income taxes. Not appropriate
for tax-deferred retirement plans, such as IRAs.
Fees and Charges
100% no load. No fees or charges to buy or sell shares or to reinvest
dividends; no 12b-1 marketing fees; free telephone exchange.
Investment Manager
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates,
Inc. ("T. Rowe Price") and its affiliates managed approximately $103 billion,
including over $6.1 billion in municipal bond assets, for more than five
million individual and institutional investor accounts as of March 31, 1997.
<PAGE>
T. Rowe Price California Tax-Free Income Trust
Prospectus
July 1, 1997
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<PAGE>
T. ROWE PRICE 2
CONTENTS
1
ABOUT THE FUNDS
Transaction and Fund Expenses 2
Financial Highlights 4
Fund, Market, and Risk Characteristics 6
2
ABOUT YOUR ACCOUNT
Pricing Shares and Receiving Sale Proceeds 15
Distributions and Taxes 16
Transaction Procedures and Special Requirements 19
3
MORE ABOUT THE FUNDS
Organization and Management 22
Understanding Performance Information 24
Investment Policies and Practices 25
4
INVESTING WITH T. ROWE PRICE
Account Requirements and Transaction Information 34
Opening a New Account 34
Purchasing Additional Shares 35
Exchanging and Redeeming 36
Shareholder Services 37
Discount Brokerage 40
Investment Information 40
This prospectus contains information you should know before investing. Please
keep it for future reference. A Statement of Additional Information about the
funds, dated July 1, 1997, has been filed with the Securities and Exchange
Commission and is incorporated by reference in this prospectus. To obtain a free
copy, call 1-800-638-5660.
<PAGE>
3
ABOUT THE FUNDS
1
TRANSACTION AND FUND EXPENSES
----------------------------------------------------------
o Like all T. Rowe Price funds, these funds are 100% no load.
These tables should help you understand the kinds of expenses you will bear
directly or indirectly as a fund shareholder.
Shareholder Transaction Expenses in Table 1 shows that you pay no sales
charges. All the money you invest in a fund goes to work for you, subject to
the fees explained below. Annual Fund Expenses shows how much it will cost to
operate each fund for a year, based on 1997 fiscal year expenses (and any
applicable expense limitations). These are costs you pay indirectly, because
they are deducted from each fund's total assets before the daily share price
is calculated and before dividends and other distributions are made. In other
words, you will not see these expenses on your account statement.
<TABLE>
Table 1
<CAPTION>
<S> <C> <C> <C>
Shareholder Transaction
Expenses
Money Fund Bond Fund
Sales charge "load" on
purchases None None
Sales charge "load" on
reinvested distributions None None
Redemption fees None None
Exchange fees None None
Annual Fund Expenses Percentage of Fiscal 1997 Average Net Assets
Management fee 0.26/a/% 0.43%
Marketing fees (12b-1) None None
Total other (shareholder
servicing, custodial,
auditing, etc.) 0.29% 0.19%
Total fund expenses 0.55/a/% 0.62%
- -------------------------------------------------------------------------------
</TABLE>
/a/
The money fund's management fee and its total expenses ratio would have been
0.43% and 0.72%, respectively, had T. Rowe Price not agreed to reduce
management fees in accordance with the expense limitation described in Table
3.
Note:
The funds charge a $5 fee for wire redemptions under $5,000, subject to change
without notice, and a $10 fee is charged for small accounts when applicable
(see Small Account Fee under Transaction Procedures and Special Requirements).
The main types of expenses, which all mutual funds may charge against fund
assets, are:
<PAGE>
T. ROWE PRICE 4
o A management fee The percent of fund assets paid to the fund's investment
manager. Each fund's fee comprises a group fee, 0.33% as of February 28,
1997, and an individual fund fee of 0.10%.
o "Other" administrative expenses Primarily the servicing of shareholder
accounts, such as providing statements and reports, disbursing dividends, and
providing custodial services.
o Marketing or distribution fees An annual charge ("12b-1") to existing
shareholders to defray the cost of selling shares to new shareholders. T.
Rowe Price funds do not levy 12b-1 fees.
For further details on fund expenses, please see Organization and Management.
o Hypothetical example Assume you invest $1,000, the fund returns 5% annually,
expense ratios remain as listed previously, and you close your account at the
end of the time periods shown. Your expenses would be:
<TABLE>
Table 2
<CAPTION>
<S> <C> <C> <C> <C> <C>
Hypothetical Fund Expenses
Fund 1 year 3 years 5 years 10 years
Money $6 $18 $31 $69
Bond $6 $20 $35 $77
- ----------------------------------------------------------
</TABLE>
o Table 2 is just an example; actual expenses can be higher or lower than
those shown.
Table 3 sets forth expense ratio limitations and the periods for which they
are effective. For each, T. Rowe Price has agreed to waive its fees and bear
any expenses to the extent such fees or expenses would cause the funds' ratio
of expenses to average net assets to exceed the indicated percentage
limitations. Subject to shareholder approval, fees waived or expenses paid or
assumed are subject to reimbursement to T. Rowe Price by each fund through
the indicated reimbursement date, but no reimbursement will be made if it
would result in the funds' expense ratio exceeding its specified limit.
<TABLE>
Table 3
<CAPTION>
<S> <C> <C> <C> <C>
Expense Ratio Limitations
Expense Ratio
Limitation Period Limitation Reimbursement Date
Money/a/ 3/1/97-2/28/99 0.55% 2/28/01
Bond/b/ 3/1/95-2/28/97 0.65% 2/28/99
- ---------------------------------------------------------------------------------
</TABLE>
/a/The money fund previously operated under a 0.55% limitation that expired
February 28, 1995. Effective March 1, 1997, T. Rowe Price agreed to extend
the existing expense limitation of 0.55%, for a period of two years from
March 1, 1997, through February 28, 1999. Subject to shareholder approval,
fees waived or expenses paid or assumed under these agreements are subject to
reimbursement to T. Rowe Price by the
<PAGE>
ABOUT THE FUNDS 5
fund whenever the expense ratio is below 0.55%; however, no reimbursement
will be made after February 28, 1997 (for the first agreement), or February
28, 1999 (for the second agreement), or if it would result in the expense
ratio exceeding 0.55%. Any amounts reimbursed will have the effect of
increasing fees otherwise paid by the fund.
/b/The bond fund previously operated under a 0.60% limitation that expired
February 28, 1995. Effective March 1, 1995, T. Rowe Price agreed to increase
the existing expense limitation of 0.60% to 0.65%, for the period indicated.
Subject to shareholder approval, fees waived or expenses paid or assumed
under these agreements are subject to reimbursement to T. Rowe Price by the
fund whenever the expense ratio is below 0.60% for the previous agreement or
0.65% for the current agreement; however, no reimbursement will be made after
February 28, 1997 for the previous agreement or February 28, 1999 for the
current agreement, or if it would result in the expense ratio exceeding 0.60%
for the previous agreement or 0.65% for the current agreement. Any amounts
reimbursed will have the effect of increasing fees otherwise paid by the
fund.
FINANCIAL HIGHLIGHTS
----------------------------------------------------------
Table 4, which provides information about each fund's financial history, is
based on a single share outstanding throughout each fiscal year. Each fund's
section of the table is part of the financial statements which are included
in its annual report and are incorporated by reference into the Statement of
Additional Information (available upon request). The financial statements in
the funds' annual report were audited by Coopers & Lybrand L.L.P., the funds'
independent accountants.
<TABLE>
Table 4 Financial Highlights
<CAPTION> Income From Investment Activities Less Distributions Net Asset
Value
Period Net Asset Net Net Realized Total From Net Net Realized Total Net Asset
Ended Value, Investment & Unrealized Investment Investment Gain (Loss) Distributions Value, End
Beginning Income (Loss) Gain (Loss) on Activities Income (Loss) of Period
of Period Investments
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Money Fund
1988/d/ $ 1.000 $0.41/a/ -- $ 0.041 $(0.041) -- $(0.041) $ 1.000
-- --
1989 1.000 0.47/a/ -- 0.047 (0.047) -- (0.047) 1.000
-- --
1990 1.000 0.53 -- 0.053 (0.053) -- (0.053) 1.000
-- --
1991 1.000 0.46/b/ -- 0.046 (0.046) -- (0.046) 1.000
-- --
1992/d/ 1.000 0.35/b/ -- 0.035 (0.035) -- (0.035) 1.000
-- --
1993 1.000 0.23/b/ -- 0.023 (0.023) -- (0.023) 1.000
-- --
1994 1.000 0.19/b/ -- 0.019 (0.019) -- (0.019) 1.000
-- --
1995 1.000 0.25/b/ -- 0.025 (0.025) -- (0.025) 1.000
-- --
1996/d/ 1.000 0.32/b/ -- 0.032 (0.032) -- (0.032) 1.000
-- --
1997 1.000 0.28/b/ -- 0.028 (0.028) -- (0.028) 1.000
- ----------------------------------------------------------------------------------------------------------------------------------
Footnotes appear on page 6. (continued on next page)
Bond Fund
1988/d/ $10.48 $0.57/a/ $(1.04) $ (0.47) $(0.57) -- $(0.57) $ 9.44
--
1989 9.44 0.57/a/ (0.13) 0.44 (0.57) -- (0.57) 9.31
--
1990 9.31 0.59/c/ 0.08 0.67 (0.59) -- (0.59) 9.39
--
1991 9.39 0.58/c/ 0.12 0.70 (0.58) -- (0.58) 9.51
--
1992/d/ 9.51 0.59/c/ 0.34 0.93 (0.59) -- (0.59) 9.85
--
1993 9.85 0.57/c/ 0.80 1.37 (0.57) -- (0.57) 10.65
1994 10.65 0.56/c/ 0.01 0.57 (0.56) $(0.23) (0.79) 10.43
1995 10.43 0.55/c/ (0.41) 0.14 (0.55) (0.02) (0.57) 10.00
1996/d/ 10.00 0.55 0.45 1.00 (0.55) -- (0.55) 10.45
--
1997 10.45 0.55 0.02 0.57 (0.55) -- (0.55) 10.47
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
T. ROWE PRICE 6
<TABLE>
Table 4 Financial Highlights (continued)
<CAPTION>
Returns, Ratios, and Supplemental Data
Total Return Ratio of Ratio of Net
Period (Includes Net Assets Expenses to Investment Portfolio
Ended Reinvested ($ Thousands) Average Net Income to Turnover
Distributions) Assets Average Net Rate
Assets
<S> <C> <C> <C> <C> <C> <C>
Money Fund
1988/d/ 4.17 %/a/ $ 59,673 0.80 %/a/ 4.18 %/a/ --
--
1989 4.76/a/ 75,180 0.80/a/ 4.69/a/ --
--
1990 5.40 87,270 0.80 5.28 --
--
1991 4.73/b/ 82,408 0.71/b/ 4.64/b/ --
--
1992/d/ 3.55/b/ 70,302 0.55/b/ 3.50/b/ --
--
1993 2.31/b/ 66,617 0.55/b/ 2.29/b/ --
--
1994 1.92/b/ 74,016 0.55/b/ 1.90/b/ --
--
1995 2.55/b/ 76,289 0.55/b/ 2.51/b/ --
--
1996/d/ 3.24/b/ 72,739 0.55/b/ 3.20/b/ --
--
1997 2.87/b/ 82,210 0.55/b/ 2.82/b/ --
- ---------------------------------------------------------------------------------------
Footnotes appear on page 6. (continued on next page)
Bond Fund
1988/d/ (4.17 )%/a/ $ 36,379 1.00 %/a/ 6.19 %/a/ 152.4%
1989 4.93/a/ 42,902 1.00///a/ 6.23/a/ 77.0
1990 7.35/c/ 65,056 0.93/c/ 6.25/c/ 88.4
1991 7.84/c/ 84,375 0.73/c/ 6.29/c/ 192.7
1992/d/ 10.05/c/ 108,494 0.60/c/ 6.07/c/ 80.3
1993 14.41/c/ 143,973 0.60/c/ 5.69/c/ 57.5
1994 5.37/c/ 151,936 0.60/c/ 5.19/c/ 73.4
1995 1.60/c/ 131,953 0.60/c/ 5.60/c/ 78.0
1996/d/ 10.28 146,194 0.63 5.40 61.9
1997 5.64 160,813 0.62 5.29 47.3
- ---------------------------------------------------------------------------------------
</TABLE>
<PAGE>
ABOUT THE FUNDS 7
/a/
Excludes expenses in excess of a 0.80% voluntary expense limitation in effect
through February 28, 1989.
/b/
Excludes expenses in excess of a 0.55% voluntary expense limitation in effect
November 7, 1990, through February 28, 1999.
/c/
Excludes expenses in excess of a 0.60% voluntary expense limitation in effect
November 7, 1990, through February 28, 1995, and an 0.80% voluntary expense
limitation in effect November 1, 1989, through November 6, 1990, and a 1.00%
voluntary expense limitation in effect during the year ended February 29,
1988.
/d/ Fiscal year ended February 29.
FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT
----------------------------------------------------------
To help you decide whether the funds are appropriate for you, this section
takes a closer look at their investment objectives and approaches.
o Income from California municipal securities is exempt from federal and
California state income taxes.
<TABLE>
Table 5
<CAPTION>
<S> <C> <C> <C> <C> <C>
Funds Comparison Guide
Credit-Quality Expected Share Expected Average
Fund Categories Income Price Fluctuation Maturity
Money Two highest Lowest Stable 90 days or less
Bond Primarily four highest High High 15+ years
- ----------------------------------------------------------------------------------------
</TABLE>
What are the funds' objectives and investment programs?
o The California Tax-Free Money Fund's objective is preservation of capital,
liquidity, and, consistent with these objectives, the highest current income
exempt from federal and California state income taxes. The fund invests in
<PAGE>
T. ROWE PRICE 8
municipal securities that mature in 397 days or less, and its dollar-weighted
average maturity will not exceed 90 days. The fund's yield will fluctuate in
response to changes in interest rates, but the share price is managed to
remain stable at $1.00. Although the fund has maintained a constant share
price since its inception, and fund managers will make every effort to
continue to meet this objective in the future, the price could drop below
$1.00 under certain circumstances, such as a major change in interest rates
or default on one or more fund holdings. Unlike most bank accounts or
certificates of deposit, your investment in the fund is not insured or
guaranteed by the U.S. government.
o The California Tax-Free Bond Fund's investment objective is, consistent with
prudent portfolio management, the highest level of income exempt from federal
and California state income taxes by investing primarily in investment-grade
California municipal bonds. The fund's dollar-weighted average maturity is
expected to exceed 15 years.
o Each fund will invest at least 65% of its total assets in California
municipal securities. However, due to seasonal variations or shortages in the
supply of suitable short-term California securities, each fund may invest
periodically in municipals whose interest is exempt from federal but not
California state income taxes. Every effort will be made to minimize such
investments, but they could compose up to 10% of each fund's annual income.
What are the funds' credit-quality guidelines?
o The money fund will generally purchase securities rated within the two
highest money market rating categories assigned by established rating
agencies, or, if not rated, of equivalent investment quality as determined by
T. Rowe Price. All securities purchased by the fund will present minimal
credit risks in the opinion of T. Rowe Price.
o The bond fund will generally purchase investment-grade securities, which
means their ratings are within the four highest credit categories (AAA, AA,
A, BBB) as determined by a national rating organization or, if unrated, by T.
Rowe Price. The fund may occasionally purchase below investment-grade
securities (including those with the lowest or no rating), but no such
purchase will be made if it would cause the fund's noninvestment-grade bonds
to exceed 5% of its net assets. Unrated bonds may be less liquid than rated
bonds.
Investment-grade securities include a range from the highest rated to medium
quality. Securities in the BBB category may be more susceptible to adverse
economic conditions or changing circumstances, and the securities at the
lower end of the BBB category have certain speculative characteristics.
o At its discretion, the bond fund may retain a security whose credit quality
is downgraded after purchase. The money fund may also do so, but only in
accordance with Rule 2a-7 under the Investment Company Act of 1940.
<PAGE>
ABOUT THE FUNDS 9
What are the main risks of investing in municipal bond and money market funds?
Since they are managed to maintain a $1.00 share price, money market funds
should have little risk of principal loss. However, the potential for
realizing a loss of principal in a bond or money market fund could derive
from:
o Interest rate or market risk The decline in the price of bonds and bond
funds that may accompany a rise in the overall level of interest rates
(please see Table 5). A sharp and unexpected rise in interest rates could
cause a money fund's price to drop below one dollar. However, the very
short-term securities held in money market portfolios-a means of achieving an
overall fund objective of principal safety-reduces their potential for price
fluctuation.
o Credit risk The chance that any of a fund's holdings will have its credit
rating downgraded or will default (fail to make scheduled interest and
principal payments), potentially reducing a fund's income level and share
price. Money funds invest in very high-rated securities, thus reducing this
risk.
o Political risk The chance that a significant restructuring of federal income
tax rates, or even serious discussion on the topic in Congress, could cause
municipal bond prices to fall. The demand for municipal bonds is strongly
influenced by the value of tax-exempt income to investors. Broadly lower tax
rates could reduce the advantage of owning municipal bonds.
o Geographical risk The chance of price declines resulting from developments
in a single state.
o A more detailed discussion of these and other risk considerations is
contained in the funds' Statement of Additional Information.
What are the particular risks associated with single-state funds versus those
that invest nationally?
A fund investing within a single state is, by definition, less diversified
geographically than one investing across many states. The risk arises from
the fund's greater exposure to that state's economy and politics, factors
that loom large in establishing the credit quality of bonds issued by the
state and its political subdivisions. For example, general obligation bonds
of a state or locality that has a high income level, reasonable debt levels,
and a positive long-term outlook should have a higher credit rating than
those of a state without those attributes.
Of course, many municipal bonds are not general obligations backed by the
state's "full faith and credit" (its full taxing and revenue raising
resources) and may not rely on any government for money to service their
debt. Bonds issued by governmental authorities may depend wholly on revenues
generated by the project they financed or on other dedicated revenue streams.
The credit quality of these "revenue" bonds may vary significantly from that
of the state's general obligations.
<PAGE>
T. ROWE PRICE 10
o Significant political and economic developments within a state may have
direct and indirect repercussions on virtually all municipal bonds issued in
the state.
How does the portfolio manager try to reduce risk?
Consistent with each fund's objective, the portfolio manager actively seeks
to reduce risk and increase total return. Risk management tools include:
o Diversification of assets to reduce the impact of a single holding on the
funds' net asset value.
o Thorough credit research by our own analysts.
o Adjustment of fund duration to try to reduce the negative impact of rising
interest rates or take advantage of the benefits of falling rates. (Duration
is a more accurate measure than maturity of a fund's sensitivity to interest
rate changes.)
What is the credit quality of California general obligations?
As of June 1, 1997, the state was rated A1 by Moody's, A+ by Standard &
Poor's, and A+ (with a positive outlook) by Fitch. These ratings were most
recently changed in 1996 when both Standard & Poor's and Fitch upgraded the
state's general obligation bonds from A. The revisions were in response to
improvements in the state's economic and financial posture following a period
of stress experienced during the recession of the early 1990's.
Restrictions on taxes and spending, such as Proposition 13 and Article XIIIB
of the constitution, have resulted in a broad shift by state and local
governments away from general obligation debt toward lease revenue financing,
which is subject to annual appropriation and generally does not require voter
approval. Lease-backed debt is generally viewed as a less secure form of
borrowing and therefore entails more credit risk than general obligation
borrowing. California will continue to be exposed to similar initiatives
which could put pressure on the expenditures of the state and local
governments and restrict their ability to raise revenues.
o Credit ratings and the financial and economic conditions of the state, local
governments, public authorities, and others in which the funds may invest are
subject to change at any time.
What about the quality of the funds' other holdings?
In addition to the state's general obligations, the funds will invest a
portion of their assets in securities that are rated according to the
issuer's individual creditworthiness, such as bonds of local governments and
public authorities. While local governments in California depend principally
on their own revenue sources, they could experience budget shortfalls due to
reallocations of tax revenues or responsibilities by the state.
<PAGE>
ABOUT THE FUNDS 11
This was the case in the early 1990's as the state struggled to achieve
fiscal balance during the recession. The combination of increasing
responsibilities and declining resources resulted in the downgrades of many
large counties and other local governments during the last six years.
Orange County filed a petition in bankruptcy in 1994. The county emerged from
bankruptcy on June 12, 1996, when the proceeds of a recovery financing
provided funds for it to repay the majority of its remaining claims. However,
the long-term consequences of the bankruptcy are unknown.
The funds may invest in certain sectors with special risks, for example
health care, which could be affected by federal or state legislation,
electric utilities with exposure to nuclear power plants, and private
activity bonds without government backing.
The funds sometimes invest in obligations of the Commonwealth of Puerto Rico
and its public corporations (as well as U.S. territories of Guam and the
Virgin Islands) that are exempt from federal and California state income
taxes. These investments require careful assessment of certain risk factors,
including reliance on substantial federal assistance and favorable tax
programs that have recently become subject to phaseout by Congress. As of
June 1, 1997, Puerto Rico's general obligations were rated Baa1 by Moody's
and A by Standard & Poor's.
o The yield of each fund will fluctuate with changing market conditions and
interest rate levels. The share price of the bond fund will also fluctuate;
when you sell your shares, you may lose money.
What are derivatives and can the funds invest in them?
The term derivative is used to describe financial instruments whose value is
derived from an underlying security (e.g., a stock or bond) or a market
benchmark (e.g., an interest rate index). Many types of investments
representing a wide range of potential risks and rewards fall under the
"derivatives" umbrella- from conventional instruments, such as callable
bonds, futures, and options to more exotic investments, such as stripped
mortgage securities and structured notes. While the term "derivative" only
recently became widely known among the investing public, derivatives have in
fact been employed by investment managers for many years.
The money fund does not invest in high-risk, highly leveraged derivatives.
The bond fund will invest in derivatives only if the expected risks and
rewards are consistent with its objective, policies, and overall risk profile
as described in this prospectus. The bond fund limits its use of derivatives
to situations in which they may enable the fund to accomplish the following:
increase yield;
<PAGE>
T. ROWE PRICE 12
hedge against a decline in principal value; invest in eligible asset classes
with greater efficiency and lower cost than is possible through direct
investment; or adjust the fund's duration.
The bond fund will not invest in any high-risk, highly leveraged derivative
instrument that is expected to cause the price volatility of the portfolio to
be meaningfully different from that of a long-term, investment-grade bond.
The following are some characteristics of municipal securities.
Who issues municipal securities?
State and local governments and governmental authorities sell notes and bonds
(usually called "municipals") to pay for public projects and services.
Who buys municipal securities?
Individuals are the primary investors, and a principal way they invest is
through mutual funds. Prices of municipals may be affected by major changes
in cash flows of money into or out of municipal funds. For example,
substantial and sustained redemptions from municipal bond funds could result
in lower prices for these securities.
Is interest income from municipal issues always exempt from federal taxes?
No. Since 1986 income from so-called "private activity" municipals has been
subject to the federal alternative minimum tax (AMT). For instance, some
bonds financing airports, stadiums, and student loan programs fall into this
category. Shareholders subject to the AMT must include income derived from
private activity bonds in their AMT calculation. Relatively few taxpayers are
required to pay the tax. Normally, the funds will not purchase any security
if, as a result, more than 20% of the fund's income would be subject to the
AMT. The funds will report annually to shareholders the portion of income, if
any, subject to the AMT. (Please see Distributions and Taxes -Taxes on Fund
Distributions.)
o Municipal securities are also called "tax-exempts" because the interest
income they provide is usually exempt from federal income taxes.
Why are yields on municipals usually below those on otherwise comparable
taxable securities?
Since the income provided by most municipals is exempt from federal taxation,
investors are willing to accept lower yields on a municipal bond than on an
otherwise similar (in quality and maturity) taxable bond.
Why are yields on California bonds often below those of comparable issues from
other states?
Strong demand for California securities, due to a relatively high state
income tax rate tends to push their prices up and yields down.
<PAGE>
ABOUT THE FUNDS 13
Is there an easy way to compare after-tax yields on a California fund with a
similar tax-exempt fund that invests nationally?
Subtract your state tax rate from 1 and multiply this number times the yield
on the national fund. The result is the yield to you on the national fund
after paying California income tax. Compare this with the California fund's
yield.
What are the major differences between money market and bond funds?
o Price Bond funds have fluctuating share prices. Money market funds are
managed to maintain a stable share price.
o Maturity Short- and intermediate-term bond funds have longer average
maturities (from one to 10 years) than money market funds (90 days or less).
Longer-term bond funds have the longest average maturities (10 years or
more).
o Income Limited-term bond funds typically offer more income than money market
funds and less income than longer-term bond funds.
You may want to review some fundamentals that apply to all fixed income
investments.
Is a fund's yield fixed or will it vary?
It will vary. The yield is calculated every day by dividing a fund's net
income per share, expressed at annual rates, by the share price. Since both
income and share price will fluctuate, a fund's yield will also vary.
(Although money fund prices are stable, income is variable.)
Is a fund's "yield" the same thing as the "total return"?
Not for bond funds. The total return reported for a fund is the result of
reinvested distributions (income and capital gains) and the change in share
price for a given time period. Income is always a positive contributor to
total return and can enhance a rise in share price or serve as an offset to a
drop in share price. Since money funds are managed to maintain a stable share
price, their yield and total return should be the same.
What is "credit quality" and how does it affect a fund's yield?
Credit quality refers to a bond issuer's expected ability to make all
required interest and principal payments in a timely manner. Because highly
rated issuers represent less risk, they can borrow at lower interest rates
than less creditworthy issuers. Therefore, a fund investing in high-quality
securities should have a lower yield than an otherwise comparable fund
investing in lower credit-quality securities.
<PAGE>
T. ROWE PRICE 14
What is meant by a bond fund's "maturity"?
Every bond has a stated maturity date when the issuer must repay the
security's entire principal value to the investor. However, many bonds are
"callable," meaning their principal can be repaid before their stated
maturity dates on (or after) specified call dates. Bonds are most likely to
be called when interest rates are falling, because the issuer can refinance
at a lower rate, just as a homeowner refinances a mortgage. In such an
environment, a bond's "effective maturity" is calculated using its nearest
call date.
A bond mutual fund has no maturity in the strict sense of the word, but it
does have an average maturity and an average effective maturity. This number
is an average of the stated or effective maturities of the underlying bonds,
with each bond's maturity "weighted" by the percentage of fund assets it
represents. Funds that target effective maturities would use the effective
(rather than stated) maturities of the underlying instruments when computing
the average. Targeting effective maturity provides additional flexibility in
portfolio management but, all else being equal, could result in higher
volatility than a fund targeting a stated maturity or maturity range.
What is meant by a bond fund's "duration"?
Duration is a calculation that seeks to measure the price sensitivity of a
bond or a bond fund to changes in interest rates. It measures bond price
sensitivity to interest rate changes more accurately than maturity because it
takes into account the time value of cash flows generated over the bond's
life. Future interest and principal payments are discounted to reflect their
present value and then are multiplied by the number of years they will be
received to produce a value that is expressed in years, i.e., the duration.
Effective duration takes into account call features and sinking fund payments
that may shorten a bond's life.
Since duration can also be computed for bond funds, you can estimate the
effect of interest rates on a fund's share price. Simply multiply the fund's
duration (available for T. Rowe Price bond funds in our shareholder reports)
by an expected change in interest rates. For example, the price of a bond
fund with a duration of five years would be expected to fall approximately 5%
if rates rose by one percentage point.
How is a municipal's price affected by changes in interest rates?
When interest rates rise, a bond's price usually falls, and vice versa. In
general, the longer a bond's maturity, the greater the price increase or
decrease in response to a given change in interest rates, as shown in Table
6.
<PAGE>
ABOUT THE FUNDS 15
<TABLE>
Table 6
<CAPTION>
How Interest Rates Affect Bond Prices
Price per $1,000 of a Municipal Bond if Interest Rates:
Increase Decrease
Bond Maturity Coupon 1 Point 2 Points 1 Point 2 Points
<S> <S> <C> <C> <C> <C> <C>
1 year 3.75% $990 $981 $1,010 $1,020
5 years 4.55% 957 916 1,045 1,093
10 years 4.90% 925 857 1,082 1,173
20 years 5.45% 889 794 1,132 1,287
30 years 5.50% 869 763 1,164 1,370
- ----------------------------------------------------------------------------------------
</TABLE>
Coupons reflect yields on AAA-rated municipals as of May 31, 1997. This is an
illustration and does not represent expected yields or share price changes of
any T. Rowe Price fund.
Do money market securities react to changes in interest rates?
Yes. As interest rates change, the prices of some money market securities
fluctuate, but changes are usually small because of their very short
maturities. Investments are typically held until maturity in a money fund to
help it maintain a $1.00 share price.
How can I decide which California fund is most appropriate for me?
Review your own financial objectives, time horizon, and risk tolerance. Use
Table 5, which summarizes each fund's main characteristics, to help choose a
fund (or funds) suitable for your particular needs. For example, only the
money fund is designed to provide principal stability, which makes it a good
choice for money you may need for occasional or unexpected expenses. However,
if you are investing for the highest possible income and can tolerate some
price volatility, you should consider a longer-term bond fund.
o Neither fund should be relied upon as a complete investment program nor be
used for short-term trading purposes.
Is there other information I need to review before making a decision?
Be sure to read Investment Policies and Practices in Section 3, which
discusses the principal types of portfolio securities that the funds may
purchase as well as the types of management practices that the funds may use.
<PAGE>
T. ROWE PRICE 16
ABOUT YOUR ACCOUNT
2
PRICING SHARES AND RECEIVING SALE PROCEEDS
----------------------------------------------------------
Here are some procedures you should know when investing in a T. Rowe Price
tax-free fund.
How and when shares are priced
Bond and money funds
The share price (also called "net asset value" or NAV per share) for each
fund is calculated at 4 p.m. ET each day the New York Stock Exchange is open
for business. To calculate the NAV, a fund's assets are valued and totaled,
liabilities are subtracted, and the balance, called net assets, is divided by
the number of shares outstanding. Amortized cost is used to value money fund
securities.
o The various ways you can buy, sell, and exchange shares are explained at the
end of this prospectus and on the New Account Form. These procedures may
differ for institutional accounts.
How your purchase, sale, or exchange price is determined
If we receive your request in correct form by 4 p.m. ET, your transaction
will be priced at that day's NAV. If we receive it after 4 p.m., it will be
priced at the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Note: The time at which transactions and shares are priced and the time until
which orders are accepted may be changed in case of an emergency or if the
New York Stock Exchange closes at a time other than 4 p.m. ET.
How you can receive the proceeds from a sale
o When filling out the New Account Form, you may wish to give yourself the
widest range of options for receiving proceeds from a sale.
If your request is received by 4 p.m. ET in correct form, proceeds are
usually sent on the next business day. Proceeds can be sent to you by mail or
to your bank account by Automated Clearing House (ACH) transfer or bank wire.
Proceeds sent by ACH transfer should be credited the second day after the
sale. ACH is an automated method of initiating payments from and receiving
payments in your
<PAGE>
ABOUT YOUR ACCOUNT 17
financial institution account. ACH is a payment system supported by over
20,000 banks, savings banks, and credit unions, which electronically
exchanges the transactions primarily through the Federal Reserve Banks.
Proceeds sent by bank wire should be credited to your account the next
business day.
o Exception: Under certain circumstances and when deemed to be in the fund's
best interests, your proceeds may not be sent for up to five business days
after receiving your sale or exchange request. If you were exchanging into a
bond or money fund, your new investment would not begin to earn dividends
until the sixth business day.
o If for some reason we cannot accept your request to sell shares, we will
contact you.
USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES
----------------------------------------------------------
o All net investment income and realized capital gains are distributed to
shareholders.
Dividends and Other Distributions
Dividend and capital gain distributions are reinvested in additional fund
shares in your account unless you select another option on your New Account
Form. The advantage of reinvesting distributions arises from compounding;
that is, you receive income dividends and capital gain distributions on a
rising number of shares.
Distributions not reinvested are paid by check or transmitted to your bank
account via ACH. If the Post Office cannot deliver your check, or if your
check remains uncashed for six months, the fund reserves the right to
reinvest your distribution check in your account at the NAV on the business
day of the reinvestment and to reinvest all subsequent distributions in
shares of the fund.
Income dividends
o Bond funds declare income dividends daily at 4 p.m. ET to shareholders of
record at that time provided payment has been received on the previous
business day.
o Money funds declare income dividends daily to shareholders of record as of
12:00 noon ET on that day. Wire purchase orders received before 12:00 noon ET
receive the dividend for that day. Other purchase orders receive the dividend
on the next business day after payment has been received.
o Bond and money funds pay dividends on the first business day of each month.
<PAGE>
T. ROWE PRICE 18
o Bond and money fund shares will earn dividends through the date of
redemption; also, shares redeemed on a Friday or prior to a holiday will
continue to earn dividends until the next business day. Generally, if you
redeem all of your shares at any time during the month, you will also receive
all dividends earned through the date of redemption in the same check. When
you redeem only a portion of your shares, all dividends accrued on those
shares will be reinvested, or paid in cash, on the next dividend payment
date.
Capital gains
o Since money funds are managed to maintain a constant share price, they are
not expected to make capital gain distributions.
o A capital gain or loss is the difference between the purchase and sale price
of a security.
o If a fund has net capital gains for the year (after subtracting any capital
losses), they are usually declared and paid in December to shareholders of
record on a specified date that month. If a second distribution is necessary,
it is usually declared and paid during the first quarter of the following
year.
Tax Information
o You will be sent timely information for your tax filing needs.
Although the regular monthly income dividends you receive from the funds are
expected to be exempt from federal income taxes, you need to be aware of the
possible tax consequences when:
o You sell fund shares, including an exchange from one fund to another.
o The fund makes a distribution to your account.
Due to 1993 tax legislation, a portion of the capital gains realized on the
sale of market discount bonds with maturities beyond one year may be treated
as ordinary income and cannot be offset by other capital losses. Therefore,
to the extent the fund invests in these securities, the likelihood of a
taxable gain distribution will be increased.
Note: You must report your total tax-exempt income on IRS Form 1040. The IRS
uses this information to help determine the tax status of any Social Security
payments you may have received during the year.
Taxes on fund redemptions
When you sell shares in any fund, you may realize a gain or loss. An exchange
from one fund to another is still a sale for tax purposes. If you realize a
loss on the sale or exchange of fund shares held six months or less, your
capital loss is reduced by the tax-exempt dividends received on those shares.
<PAGE>
ABOUT YOUR ACCOUNT 19
In January, you will be sent Form 1099-B, indicating the date and amount of
each sale you made in the fund during the prior year. This information will
also be reported to the IRS. For accounts opened new or by exchange in 1983
or later, we will provide you with the gain or loss of the shares you sold
during the year, based on the "average cost" method. This information is not
reported to the IRS, and you do not have to use it. You may calculate the
cost basis using other methods acceptable to the IRS, such as "specific
identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction you make (except for systematic purchases and
redemptions) and a year-end statement detailing all your transactions in each
fund account during the year.
Taxes on fund distributions
In January, the funds will send you Form 1099-DIV indicating the tax status
of any capital gain distribution made to you. This information will also be
reported to the IRS. All capital gain distributions are taxable to you for
the year in which they are paid. The only exception is that dividends
declared during the last three months of the year and paid in January are
taxed as though they were paid by December 31. Dividends are expected to be
tax-exempt.
Short-term capital gains are taxable as ordinary income, and long-term gains
are taxable at the applicable long-term gain rate. The gain is long- or
short-term depending on how long the fund held the securities, not how long
you held shares in the fund. If you realize a loss on the sale or exchange of
fund shares held six months or less, your short-term loss recognized is
reclassified to long-term to the extent of any long-term capital gain
distribution received.
If the funds invest in certain "private activity" bonds, shareholders who are
subject to the alternative minimum tax (AMT) must include income generated by
these bonds in their AMT computation. The portion of your fund's income which
should be included in your AMT calculation, if any, will be reported to you
in January.
o Distributions are taxable whether reinvested in additional shares or
received in cash.
Tax effect of buying shares before a capital gain distribution
If you buy shares shortly before or on the "record date"- the date that
establishes you as the person to receive the upcoming distribution-you will
receive a portion of the money you just invested in the form of a taxable
distribution. Therefore, you may also wish to find out the fund's record date
before investing. Of course, the fund's share price may, at any time, reflect
undistributed capital gains or income and unrealized appreciation. When these
amounts are eventually distributed, they are taxable.
<PAGE>
T. ROWE PRICE 20
Note: For shareholders who receive Social Security benefits, the receipt of
tax-exempt interest may increase the portion of benefits that are subject to
tax.
TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS
----------------------------------------------------------
o Following these procedures helps assure timely and accurate transactions.
Purchase Conditions
Nonpayment
If your payment is not received or you pay with a check or ACH transfer that
does not clear, your purchase will be canceled. You will be responsible for
any losses or expenses incurred by the fund or transfer agent, and the fund
can redeem shares you own in this or another identically registered T. Rowe
Price fund as reimbursement. The fund and its agents have the right to reject
or cancel any purchase, exchange, or redemption due to nonpayment.
U.S. dollars
All purchases must be paid for in U.S. dollars; checks must be drawn on U.S.
banks.
Sale (Redemption) Conditions
10-day hold
If you sell shares that you just purchased and paid for by check or ACH
transfer, the fund will process your redemption, but will generally delay
sending you the proceeds for up to 10 calendar days to allow the check or
transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh calendar day following
receipt unless the check or ACH transfer has not cleared. If, during the
clearing period, we receive a check drawn against your bond or money market
account, it will be returned marked "uncollected." (The 10-day hold does not
apply to the following: purchases paid for by bank wire; cashier's,
certified, or treasurer's checks; or automatic purchases through your
paycheck.)
Telephone, Tele*Access/(R)/, and personal computer transactions
Exchange and redemption services through Telephone and Tele*Access are
established automatically when you sign the New Account Form unless you check
the box which states that you do not want these services. Personal computer
transactions must be authorized separately. Each fund uses reasonable
procedures (including shareholder identity verification) to confirm that
instructions given by telephone are genuine and is not liable for acting on
these instructions. If these procedures are not followed, it is the opinion
of certain
<PAGE>
ABOUT YOUR ACCOUNT 21
regulatory agencies that a fund may be liable for any losses that may result
from acting on the instructions given. A confirmation is sent promptly after
the telephone transaction. All conversations are recorded.
Redemptions over $250,000
Large sales can adversely affect a portfolio manager's ability to implement a
fund's investment strategy by causing the premature sale of securities that
would otherwise be held. If, in any 90-day period, you redeem (sell) more
than $250,000, or your sale amounts to more than 1% of the fund's net assets,
the fund has the right to delay sending your proceeds for up to five business
days after receiving your request, or to pay the difference between the
redemption amount and the lesser of the two previously mentioned figures with
securities from the fund.
Excessive Trading
o T. Rowe Price may bar excessive traders from purchasing shares.
Frequent trades, involving either substantial fund assets or a substantial
portion of your account or accounts controlled by you, can disrupt management
of the fund and raise its expenses. We define "excessive trading" as
exceeding one purchase and sale involving the same fund within any 120-day
period.
For example, you are in fund A. You can move substantial assets from fund A
to fund B and, within the next 120 days, sell your shares in fund B to return
to fund A or move to fund C.
If you exceed the number of trades described above, you may be barred
indefinitely from further purchases of T. Rowe Price funds.
Three types of transactions are exempt from excessive trading guidelines: 1)
trades solely between money market funds; 2) redemptions that are not part of
exchanges; and 3) systematic purchases or redemptions (see Shareholder
Services).
Keeping Your Account Open
Due to the relatively high cost to a fund of maintaining small accounts, we
ask you to maintain an account balance of at least $1,000. If your balance is
below $1,000 for three months or longer, we have the right to close your
account after giving you 60 days in which to increase your balance.
Small Account Fee
Because of the disproportionately high costs of servicing accounts with low
balances, a $10 fee, paid to T. Rowe Price Services, the funds' transfer
agent, will automatically be deducted from nonretirement accounts with
balances falling below a minimum level. The valuation of accounts and the
deduction are expected to take place during the last five business days of
September. The fee
<PAGE>
T. ROWE PRICE 22
will be deducted from accounts with balances below $2,000, except for UGMA/
UTMA accounts, for which the limit is $500. The fee will be waived for any
investor whose aggregate T. Rowe Price mutual fund investments total $25,000
or more. Accounts employing automatic investing (e.g., payroll deduction,
automatic purchase from a bank account, etc.) are also exempt from the
charge. The fee will not apply to IRAs and other retirement plan accounts. (A
separate custodial fee may apply to IRAs and other retirement plan accounts.)
Signature Guarantees
o A signature guarantee is designed to protect you and the T. Rowe Price funds
from fraud by verifying your signature.
You may need to have your signature guaranteed in certain situations, such
as:
o Written requests 1) to redeem over $100,000, or 2) to wire redemption
proceeds.
o Remitting redemption proceeds to any person, address, or bank account not on
record.
o Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration (name or ownership) from yours.
o Establishing certain services after the account is opened.
You can obtain a signature guarantee from most banks, savings institutions,
broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
<PAGE>
ABOUT YOUR ACCOUNT 23
MORE ABOUT THE FUNDS
3
ORGANIZATION AND MANAGEMENT
----------------------------------------------------------
How are the funds organized?
The T. Rowe Price California Tax-Free Income Trust (the "Trust") was
organized in 1986 as a Massachusetts business trust and is a "diversified,
open-end investment company," or mutual fund. Both California funds were
organized in 1986. Mutual funds pool money received from shareholders and
invest it to try to achieve specified objectives.
o Shareholders benefit from T. Rowe Price's 60 years of investment management
experience.
What is meant by "shares"?
As with all mutual funds, investors purchase shares when they put money in a
fund. These shares are part of a fund's authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles the shareholder to:
o Receive a proportional interest in a fund's income and capital gain
distributions.
o Cast one vote per share on certain fund matters, including the election of
fund directors, changes in fundamental policies, or approval of changes in
the fund's management contract.
Do T. Rowe Price funds have annual shareholder meetings?
The funds are not required to hold annual meetings and, in order to avoid
unnecessary costs to fund shareholders, do not intend to do so except when
certain matters, such as a change in a fund's fundamental policies, are to be
decided. In addition, shareholders representing at least 10% of all eligible
votes may call a special meeting, if they wish, for the purpose of voting on
the removal of any fund director or trustee. If a meeting is held and you
cannot attend, you can vote by proxy. Before the meeting, the fund will send
you proxy materials that explain the issues to be decided and include a
voting card for you to mail back.
<PAGE>
T. ROWE PRICE 24
Who runs the funds?
General Oversight
The Trust is governed by a Board of Trustees that elects the Trust's officers
and meets regularly to review the funds' investments, performance, expenses,
and other business affairs. The policy of the Trust is that a majority of
Board members will be independent of T. Rowe Price.
o All decisions regarding the purchase and sale of fund investments are made
by T. Rowe Price-specifically by the funds' portfolio managers.
Portfolio Management
Each fund has an Investment Advisory Committee whose chairman has day-to-day
responsibility for managing the portfolio and works with the committee in
developing and executing the fund's investment programs. The Investment
Advisory Committees are composed of the following members:
Money Fund Patrice L. Berchtenbreiter Ely, Chairman, Jeremy N. Baker, Paul W.
Boltz, Patricia S. Deford, Joseph K. Lynagh, Konstantine B. Mallas, Mary J.
Miller, Theodore E. Robson, and Arthur S. Varnado. Ms. Berchtenbreiter Ely
has been chairman of the fund's committee since 1992. She joined T. Rowe
Price in 1972 and has been managing investments since 1987.
Bond Fund Mary J. Miller, Chairman, Jeremy N. Baker, Paul W. Boltz, Patricia
S. Deford, Patrice L. Berchtenbreiter Ely, Joseph K. Lynagh, Konstantine B.
Mallas, Theodore E. Robson, and Arthur S. Varnado. Mrs. Miller has been
chairman of the fund's committee since 1990. She joined T. Rowe Price in 1983
and has been managing investments since 1987.
Marketing
T. Rowe Price Investment Services, Inc., a wholly owned subsidiary of T. Rowe
Price, distributes (sells) shares of these and all other T. Rowe Price funds.
Shareholder Services
T. Rowe Price Services, Inc., another wholly owned subsidiary, acts as the
funds' transfer and dividend disbursing agent and provides shareholder and
administrative services. The address for T. Rowe Price Investment Services,
Inc., and T. Rowe Price Services, Inc., is 100 East Pratt St., Baltimore, MD
21202.
How are fund expenses determined?
The management agreement spells out the expenses to be paid by each fund. In
addition to the management fee, each fund pays for the following: shareholder
service expenses; custodial, accounting, legal, and audit fees; costs of
preparing and printing prospectuses and reports sent to shareholders;
registration fees and expenses; proxy and annual meeting expenses (if any);
and director/trustee fees and expenses.
<PAGE>
MORE ABOUT THE FUNDS 25
The fund's paid the expenses shown in Table 7 for the fiscal year ended
February 28, 1997.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Fund Transfer Agent Accounting
Money $ 65,000 $ 67,000
Bond 91,000 72,000
- ------------------------------------------------------------
</TABLE>
Table 7 Services Fees Paid
The Management Fee
This fee has two parts-an "individual fund fee" (discussed under Transaction
and Fund Expenses), which reflects a fund's particular investment management
costs, and a "group fee." The group fee, which is designed to reflect the
benefits of the shared resources of the T. Rowe Price investment management
complex, is calculated daily based on the combined net assets of all T. Rowe
Price funds (except Equity Index and the Spectrum Funds and any institutional
or private label mutual funds). The group fee schedule (shown below) is
graduated, declining as the asset total rises, so shareholders benefit from
the overall growth in mutual fund assets.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
0.480% First $1 billion 0.360% Next $2 billion 0.310% Next $16 billion
--------------------------
0.450% Next $1 billion 0.350% Next $2 billion 0.305% Next $30 billion
----------------------------------------------------
0.420% Next $1 billion 0.340% Next $5 billion 0.300% Thereafter
----------------------------------------------------
0.390% Next $1 billion 0.330% Next $10 billion
------------------------------------------------------------------------------
0.370% Next $1 billion 0.320% Next $10 billion
</TABLE>
Each fund's portion of the group fee is determined by the ratio of its daily
net assets to the daily net assets of all the T. Rowe Price funds described
previously. Based on combined Price funds' assets of approximately $63
billion at March 31, 1997, the group fee was 0.33%.
UNDERSTANDING PERFORMANCE INFORMATION
----------------------------------------------------------
This section should help you understand the terms used to describe fund
performance. You will come across them in shareholder reports you receive
from us, in our newsletter, The Price Report, in Insights articles, in T.
Rowe Price advertisements, and in the media.
Total Return
This tells you how much an investment in a fund has changed in value over a
given time period. It reflects any net increase or decrease in the share
price and assumes that all dividends and capital gains (if any) paid during
the period were reinvested in additional shares. Including reinvested
distributions means that total return numbers include the effect of
compounding, i.e., you receive income and capital gain distributions on a
rising number of shares.
<PAGE>
T. ROWE PRICE 26
Advertisements for a fund may include cumulative or compound average annual
total return figures, which may be compared with various indices, other
performance measures, or other mutual funds.
o Total return is the most widely used performance measure. Detailed
performance information is included in each fund's annual and semiannual
shareholder reports and in the quarterly Performance Update, which are all
available without charge.
Cumulative Total Return
This is the actual rate of return on an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated between the beginning and end of the period specified.
Average Annual Total Return
This is always hypothetical. Working backward from the actual cumulative
return, it tells you what constant year-by-year return would have produced
the actual cumulative return. By smoothing out all the variations in annual
performance, it gives you an idea of the investment's annual contribution to
your portfolio, provided you held it for the entire period in question.
Yield
The current or "dividend" yield on a fund or any investment tells you the
relationship between the investment's current level of annual income and its
price on a particular day. The dividend yield reflects the actual income paid
to shareholders for a given period, annualized, and divided by the net asset
value. For example, a fund providing $5 of annual income per share and a
price of $50 has a current yield of 10%. Yields can be calculated for any
time period.
The money fund may advertise a "current" yield, reflecting the latest 7-day
income annualized, or an "effective" yield, which assumes the income has been
reinvested in the fund.
For the bond fund, the advertised or "SEC" yield is found by determining the
net income per share (as defined by the SEC) earned by a fund during a 30-day
base period and dividing this amount by the per share price on the last day
of the base period. The SEC yield may differ from the dividend yield.
o You will see frequent references to a fund's yield in our reports, in
advertisements, in media stories, and so on.
<PAGE>
MORE ABOUT THE FUNDS 27
INVESTMENT POLICIES AND PRACTICES
----------------------------------------------------------
This section takes a detailed look at some of the types of securities the
funds may hold in their portfolios and the various kinds of investment
practices that may be used in day-to-day portfolio management. Each fund's
investment program is subject to further restrictions and risks described in
the Statement of Additional Information.
Shareholder approval is required to substantively change a fund's objective
and certain investment restrictions noted in the following section as
"fundamental policies." The managers also follow certain "operating policies"
which can be changed without shareholder approval. However, significant
changes are discussed with shareholders in fund reports. Each fund adheres to
applicable investment restrictions and policies at the time it makes an
investment. A later change in circumstances will not require the sale of an
investment if it was proper at the time it was made.
The funds' holdings of certain kinds of investments cannot exceed maximum
percentages of total assets, which are set forth herein. For instance, the
bond fund is not permitted to invest more than 10% of total assets in
residual interest bonds. While these restrictions provide a useful level of
detail about the fund's investment programs, investors should not view them
as an accurate gauge of the potential risk of such investments. For example,
in a given period, a 5% investment in residual interest bonds could have
significantly more of an impact on a fund's share price than its weighting in
the portfolio. The net effect of a particular investment depends on its
volatility and the size of its overall return in relation to the performance
of all the funds' other investments.
Changes in the funds' holdings, the funds' performance, and the contribution
of various investments are discussed in the shareholder reports sent to you.
o Fund managers have considerable leeway in choosing investment strategies and
selecting securities they believe will help the funds achieve their
objectives.
Types of Portfolio Securities
In seeking to meet their investment objectives, the funds may invest in any
type of municipal security or instrument (including certain potentially
high-risk derivatives described in this section) whose investment
characteristics are consistent with the funds' investment programs. The
following pages describe the principal types of portfolio securities and
investment management practices of the funds.
Fundamental policy Each fund will not purchase a security if, as a result,
with respect to 75% of its total assets, more than 5% of its total assets
would be invested in securities of a single issuer or more than 10% of the
outstanding
<PAGE>
T. ROWE PRICE 28
voting securities of the issuer would be held by a fund; provided that these
limitations do not apply to a fund's purchase of securities issued or
guaranteed by the U.S. government, its agencies, or instrumentalities.
Operating policy (money fund only) The money fund will not purchase a
security if, as a result, with respect to 75% of its total assets, more than
5% of its total assets would be invested in securities of a single issuer,
provided that this limitation does not apply to purchases of U.S. government
securities or securities subject to certain types of guarantees.
Municipal Securities
Each fund's assets are invested primarily in various tax-free municipal debt
securities. The issuers have a contractual obligation to pay interest at a
stated rate on specific dates and to repay principal (the bond's face value)
on a specified date or dates. An issuer may have the right to redeem or
"call" a bond before maturity, and the funds may have to reinvest the
proceeds at lower rates.
There are two broad categories of municipal bonds. General obligation bonds
are backed by the issuer's "full faith and credit," that is, its full taxing
and revenue raising power. Revenue bonds usually rely exclusively on a
specific revenue source, such as charges for water and sewer service, to
generate money for debt service.
o In purchasing municipals, the funds rely on the opinion of the issuer's bond
counsel regarding the tax-exempt status of the investment.
Private Activity Bonds
While income from most municipals is exempt from federal income taxes, the
income from certain types of so-called private activity bonds (a type of
revenue bond) may be subject to the alternative minimum tax (AMT). However,
only persons subject to the AMT pay this tax. Private activity bonds may be
issued for purposes such as housing or airports or to benefit a private
company. (Being subject to the AMT does not mean the investor necessarily
pays this tax. For further information, please see Distributions and Taxes.)
Fundamental policy Under normal market conditions, the funds will not
purchase any security if, as a result, less than 80% of the funds' income
would be exempt from federal and California state income taxes. The income
included under the 80% test does not include income from securities subject
to the alternative minimum tax.
Operating policy During periods of abnormal market conditions, for temporary
defensive purposes, the funds may invest without limit in high-quality,
short-term securities whose income is subject to federal and California state
income tax.
<PAGE>
MORE ABOUT THE FUNDS 29
In addition to general obligation and revenue bonds, the funds' investments
may include, but are not limited to, the following types of securities:
Municipal Lease Obligations
A lease is not a full faith and credit obligation of the issuer and is
usually backed only by the borrowing government's unsecured pledge to make
annual appropriations for lease payments. There have been challenges to the
legality of lease financing in numerous states and, from time to time,
certain municipalities have considered not appropriating money for lease
payments. In deciding whether to purchase a lease obligation, the funds would
assess the financial condition of the borrower, the merits of the project,
the level of public support for the project, and the legislative history of
lease financing in the state. These securities may be less readily marketable
than other municipals. The funds may also purchase unrated lease obligations.
Municipal Warrants (bond fund)
Municipal warrants are essentially call options on municipal bonds. In
exchange for a premium, they give the purchaser the right, but not the
obligation, to purchase a municipal bond in the future. The bond fund might
purchase a warrant to lock in forward supply in an environment where the
current issuance of bonds is sharply reduced. Like options, warrants may
expire worthless and they may have reduced liquidity.
Operating policy The bond fund will not invest more than 2% of its total
assets in municipal warrants.
Securities With "Puts" or Other Demand Features
Some longer-term municipals give the investor the right to "put" or sell the
security at par (face value) within a specified number of days following the
investor's request-usually one to seven days. This demand feature enhances a
security's liquidity by shortening its effective maturity and enables it to
trade at a price equal to or very close to par. The money fund typically
purchases a significant number of these securities. If a demand feature
terminates prior to being exercised, the funds would hold the longer-term
security, which could experience substantially more volatility.
Securities With Credit Enhancements
o Letters of credit Letters of credit are issued by a third party, usually a
bank, to enhance liquidity and ensure repayment of principal and any accrued
interest if the underlying municipal security should default.
o T. Rowe Price periodically reviews the credit quality of the insurer.
o Municipal Bond Insurance This insurance, which is usually purchased by the
bond issuer from a private, nongovernmental insurance company, provides an
unconditional and irrevocable guarantee that the insured bond's principal and
<PAGE>
T. ROWE PRICE 30
interest will be paid when due. Insurance does not guarantee the price of the
bond or the share price of any fund. The credit rating of an insured bond
reflects the credit rating of the insurer, based on its claims-paying
ability.
The obligation of a municipal bond insurance company to pay a claim extends
over the life of each insured bond. Although defaults on insured municipal
bonds have been low to date and municipal bond insurers have met their
claims, there is no assurance this will continue. A higher-than-expected
default rate could strain the insurer's loss reserves and adversely affect
its ability to pay claims to bondholders, such as the fund. The number of
municipal bond insurers is relatively small, and not all of them have the
highest rating.
o Standby Purchase Agreements A Standby Bond Purchase Agreement (SBPA) is a
liquidity facility provided to pay the purchase price of bonds that cannot be
remarketed. The obligation of the liquidity provider (usually a bank) is only
to advance funds to purchase tendered bonds that cannot be remarketed and
does not cover principal or interest under any other circumstances. The
liquidity provider's obligations under the SBPA are usually subject to
numerous conditions, including the continued creditworthiness of the
underlying borrower.
Synthetic or Derivative Securities
These securities are created from existing municipal bonds:
o Residual Interest Bonds (bond fund) (These are a type of potentially
high-risk derivative.) The income stream provided by an underlying bond is
divided to create two securities, one short term and one long term. The
interest rate on the short-term component is reset by an index or auction
process normally every seven to 35 days. After income is paid on the
short-term securities at current rates, the residual income goes to the
long-term securities. Therefore, rising short-term interest rates result in
lower income for the longer-term portion, and vice versa. The longer-term
bonds can be very volatile and may be less liquid than other municipals of
comparable maturity.
Operating policy The bond fund will not invest more than 10% of its total
assets in residual interest bonds.
o Participation Interests This term covers various types of securities created
by converting fixed rate bonds into short-term, variable rate certificates.
These securities have been developed in the secondary market to meet the
demand for short-term, tax-exempt securities. The funds will invest only in
securities deemed tax-exempt by a nationally recognized bond counsel, but
there is no guarantee the interest will be exempt because the IRS has not
issued a definitive ruling on the matter.
o Embedded Interest Rate Swaps and Caps (bond fund) In a fixed rate, long-term
municipal bond with an interest rate swap attached to it, the bondholder
usually
<PAGE>
MORE ABOUT THE FUNDS 31
receives the bond's fixed coupon payment as well as a variable rate payment
that represents the difference between a fixed rate for the term of the swap
(which is typically shorter than the bond it is attached to) and a variable
rate short-term municipal index. The bondholder receives excess income when
short-term rates remain below the fixed interest rate swap rate. If
short-term rates rise above the fixed income swap rate, the bondholder's
income is reduced. At the end of the interest rate swap term, the bond
reverts to a single fixed coupon payment.
An embedded interest rate cap allows the bondholder to receive payments
whenever short-term rates rise above a level established at the time of
purchase. They normally are used to hedge against rising short-term interest
rates.
Both instruments may be volatile and of limited liquidity, and their use may
adversely affect a fund's total return.
Operating policy The bond fund will not invest more than 10% of its total
assets in embedded interest rate swaps and caps.
Private Placements
The funds may seek to enhance their yield through the purchase of private
placements. These securities are sold through private negotiations, usually
to institutions or mutual funds, and may have resale restrictions. Their
yields are usually higher than comparable public securities to compensate the
investor for their limited marketability.
Operating policy The bond fund may not invest more than 15% (10% for the
money fund) of its net assets in illiquid securities, including unmarketable
private placements.
Types of Management Practices
Cash Position (bond fund)
The fund will hold a portion of its assets in short-term, tax-exempt money
market securities maturing in one year or less. The reserve position
accomplishes the following: provides flexibility in meeting redemptions,
expenses, and the timing of new investments; can help in structuring a fund's
weighted average maturity; and serves as a short-term defense during periods
of unusual market volatility. The fund's cash reserve position will be
comprised of short-term, investment-grade securities including tax-exempt
commercial paper, municipal notes, and short-term maturity bonds. Some of
these securities may have adjustable, variable, or floating rates.
When-Issued Securities (each fund) and Forwards (bond fund)
New issues of municipals are often sold on a "when-issued" basis, that is,
delivery and payment take place 15-45 days after the buyer has agreed to the
purchase. Some bonds, called "forwards," have longer-than-standard settlement
dates, typically six to 24 months. When buying these securities, each fund
will maintain
<PAGE>
T. ROWE PRICE 32
cash or high-grade marketable securities held by its custodian equal in value
to its commitment for these securities. The funds do not earn interest on
when-issued and forward securities until settlement, and the value of the
securities may fluctuate between purchase and settlement. Municipal
"forwards" typically carry a substantial yield premium to compensate the
buyer for their greater interest rate, credit, and liquidity risks.
Interest Rate Futures (bond fund)
Futures (a type of potentially high-risk derivative) are often used to manage
risk because they enable the investor to buy or sell an asset in the future
at an agreed-upon price. Specifically, the fund may use futures (and options
on futures) for any number of reasons, including: to hedge against a
potentially unfavorable change in interest rates and to adjust its exposure
to the municipal bond market; to protect portfolio value; in an effort to
enhance income; and to adjust portfolio duration. The use of futures for
hedging and non-hedging purposes may not always be successful. Their prices
can be highly volatile, using them could lower a fund's total return, and the
potential loss from their use could exceed a fund's initial exposure to such
contracts.
Operating policy Initial margin deposits on futures and premiums on options
used for non-hedging purposes will not equal more than 5% of the bond fund's
net asset value.
Borrowing Money and Transferring Assets
Each fund can borrow money from banks as a temporary measure for emergency
purposes, to facilitate redemption requests, or for other purposes consistent
with each fund's investment objective and program. Such borrowings may be
collateralized with fund assets, subject to restrictions.
Fundamental policy Borrowings may not exceed 33/1//\\/3/\\% of total fund
assets.
Operating policy Each fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33/1//\\/3/\\% of a
fund's total assets. A fund may not purchase additional securities when
borrowings exceed 5% of total assets.
Portfolio Turnover (bond fund)
The fund generally purchases securities with the intention of holding them
for investment; however, when market conditions or other circumstances
warrant, securities may be purchased and sold without regard to the length of
time held. Due to the nature of the fund's investment program, the fund's
portfolio turnover rate may exceed 100%. Although the fund does not expect to
generate any taxable income, a high turnover rate may increase transaction
costs and may affect taxes paid by shareholders to the extent short-term
gains are distributed.
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MORE ABOUT THE FUNDS 33
The bond fund's portfolio turnover rates for the fiscal years ended February
28, 1997, February 29, 1996, and February 28, 1995, were 47.3%, 61.9%, and
78.0%, respectively.
Sector Concentration
It is possible that each fund could have a considerable amount of assets (25%
or more) in securities that would tend to respond similarly to particular
economic or political developments. An example would be securities of issuers
related to a single industry, such as health care or nuclear energy.
Operating policy Each fund will not invest more than 25% of total assets in
industrial development bonds of projects in the same industry (such as solid
waste, nuclear utility, or airlines). Bonds which are refunded with escrowed
U.S. government securities are not subject to the 25% limitation.
Credit-Quality Considerations
The credit quality of most bond issues is evaluated by rating agencies such
as Moody's and Standard & Poor's. Credit quality refers to the issuer's
ability to meet all required interest and principal payments. The highest
ratings are assigned to issuers perceived to be the best credit risks. T.
Rowe Price research analysts also evaluate all portfolio holdings of each
fund, including those rated by outside agencies. The lower the rating on a
bond, the higher the yield, other things being equal.
Table 8 shows the rating scale used by the major rating agencies, and Table 9
provides an explanation of quality ratings. T. Rowe Price considers publicly
available ratings, but emphasizes its own credit analysis when selecting
investments.
<TABLE>
Table 8
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Ratings of Municipal Debt Securities
Moody's Standard & Fitch
Investors Poor's Investors
Service, Inc. Corporation Service, Inc. Definition
Long Term Aaa AAA AAA Highest quality
Aa AA AA High quality
A A A Upper medium grade
Baa BBB BBB Medium grade
Moody's S&P Fitch
SP1+ Very strong quality F-1+ Exceptionally strong quality
Short Term MIG1/VMIG1 Best quality SP1 Strong grade F-1 Very strong quality
C
MIG2/VMIG2 High quality SP2 Satisfactory grade F-2 Good credit quality
C
A-1+ Extremely strong F-1+ Exceptionally strong quality
Commercial Superior A-1 quality F-1 Very strong quality
Paper P-1 quality Strong quality
C
P-2 Strong quality A-2 Satisfactory quality F-2 Good credit quality
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
T. ROWE PRICE 34
<TABLE>
Table 9
<CAPTION>
<S> <C> <C> <C>
Explanation of Quality Ratings
Bond
Rating Explanation
Moody's Investors Aaa Highest quality, smallest degree of
Service, Inc. investment risk.
Aa High quality; together with Aaa bonds, they
compose the high-grade bond group.
A Upper-medium-grade obligations; many
favorable investment attributes.
Baa Medium-grade obligations; neither highly
protected nor poorly secured. Interest and
principal appear adequate for the present,
but certain protective elements may be
lacking or may be unreliable over any great
length of time.
Ba More uncertain with speculative elements.
Protection of interest and principal payments
not well safeguarded in good and bad times.
B Lack characteristics of desirable investment;
potentially low assurance of timely interest
and principal payments or maintenance of
other contract terms over time.
Caa Poor standing, may be in default; elements of
danger with respect to principal or interest
payments.
Ca Speculative in high degree; could be in
default or have other marked
shortcomings.
C Lowest rated. Extremely poor prospects of
ever attaining investment standing.
Standard & Poor's AAA Highest rating; extremely strong capacity to
Corporation pay principal and interest.
AA High quality; very strong capacity to pay
principal and interest.
A Strong capacity to pay principal and
interest; somewhat more susceptible to the
adverse effects of changing circumstances and
economic conditions.
BBB Adequate capacity to pay principal and
interest; normally exhibit adequate
protection parameters, but adverse economic
conditions or changing circumstances more
likely to lead to weakened capacity to pay
principal and interest than for higher-rated
bonds.
BB, B, Predominantly speculative with respect to the
CCC, CC issuer's capacity to meet required interest
and principal payments. BB-lowest degree of
speculation;
CC-the highest degree of speculation. Quality
and protective characteristics outweighed by
large uncertainties or major risk exposure to
adverse conditions.
D In default.
Fitch Investors AAA Highest quality; obligor has exceptionally
Service, Inc. strong ability to pay interest and repay
principal, which is unlikely to be affected
by reasonably foreseeable events.
AA Very high quality; obligor's ability to pay
interest and repay principal is very strong.
Because bonds rated in the AAA and AA
categories are not significantly vulnerable
to foreseeable future developments,
short-term debt of these issuers is generally
rated F-1+.
A High quality; obligor's ability to pay
interest and repay principal is considered to
be strong, but may be more vulnerable to
adverse changes in economic conditions and
circumstances than higher-rated bonds.
BBB Satisfactory credit quality; obligor's
ability to pay interest and repay principal
is considered adequate. Unfavorable changes
in economic conditions and circumstances are
more likely to adversely affect these bonds
and impair timely payment. The likelihood
that the ratings of these bonds will fall
below investment grade is higher than for
higher-rated bonds.
BB, Not investment grade; predominantly
CCC, speculative with respect to the issuer's
CC, C capacity to repay interest and repay
principal in accordance with the terms of the
obligation for bond issues not in default. BB
is the least speculative. C is the most
speculative.
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
MORE ABOUT THE FUNDS 35
INVESTING WITH T. ROWE PRICE
4
ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION
----------------------------------------------------------
Tax Identification Number
We must have your correct Social Security or corporate tax identification number
on a signed New Account Form or W-9 Form. Otherwise, federal law requires the
funds to withhold a percentage (currently 31%) of your dividends, capital gain
distributions, and redemptions, and may subject you to an IRS fine. If this
information is not received within 60 days after your account is established,
your account may be redeemed, priced at the NAV on the date of redemption.
Always verify your transactions by carefully reviewing the confirmation we send
you. Please report any discrepancies to Shareholder Services promptly.
Institutional Accounts
Transaction procedures in the following sections may not apply to institutional
accounts. For procedures regarding institutional accounts, please call your
designated account manager or service representative.
OPENING A NEW ACCOUNT
----------------------------------------------------------
$2,500 minimum initial investment; $1,000 for gifts or transfers to minors
(UGMA/UTMA) accounts
Account Registration
If you own other T. Rowe Price funds, be sure to register any new account just
like your existing accounts so you can exchange among them easily. (The name and
account type would have to be identical.)
By Mail
Please make your check payable to T. Rowe Price Funds (otherwise it will be
returned) and send your check together with the New Account Form to the address
below. We do not accept third party checks to open new accounts.
<PAGE>
T. ROWE PRICE 36
Regular Mail
T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353
Mailgram, Express, Registered, or Certified Mail
T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117
By Wire
Call Investor Services for an account number and give the following wire
information to your bank:
PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account#
1004397951 account name and account number
Complete a New Account Form and mail it to one of the appropriate addresses
listed on the previous page.
Note: No services will be established and IRS penalty withholding may occur
until a signed New Account Form is received.
By Exchange
Call Shareholder Services or use Tele*Access or your personal computer (see
Automated Services under Shareholder Services). The new account will have the
same registration as the account from which you are exchanging. Services for the
new account may be carried over by telephone request if preauthorized on the
existing account. For limitations on exchanging, see explanation of Excessive
Trading under Transaction Procedures and Special Requirements.
In Person
Drop off your New Account Form at any location listed on the cover and obtain a
receipt.
PURCHASING ADDITIONAL SHARES
----------------------------------------------------------
$100 minimum purchase; $50 minimum for Automatic Asset Builder, and gifts or
transfers to minors (UGMA/UTMA) accounts
<PAGE>
INVESTING WITH T. ROWE PRICE 37
By ACH Transfer
Use Tele*Access, your personal computer, or call Investor Services if you have
established electronic transfers using the ACH network.
By Wire
Call Shareholder Services or use the wire address in Opening a New Account.
By Mail
1. Make your check payable to T. Rowe Price Funds (otherwise it may be
returned).
2. Mail the check to us at the address shown below with either a fund
------
reinvestment slip or a note indicating the fund you want to buy and your fund
account number.
3. Remember to provide your account number and the fund name on the memo line
of your check.
Regular Mail
T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500
/(For mailgrams, express, registered, or certified mail, see previous /
/section.)/
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form.
EXCHANGING AND REDEEMING SHARES
----------------------------------------------------------
By Phone
Call Shareholder Services
If you find our phones busy during unusually volatile markets, please consider
placing your order by your personal computer, Tele*Access (if you have
previously authorized telephone services), mailgram, or express mail. For
exchange policies, please see Transaction Procedures and Special Requirements
- -Excessive Trading.
Redemption proceeds can be mailed to your account address, sent by ACH transfer,
or wired to your bank (provided your bank information is already on file). For
charges, see Electronic Transfers -By Wire under Shareholder Services.
<PAGE>
T. ROWE PRICE 38
By Mail
For each account involved, provide the account name, number, fund name, and
exchange or redemption amount. For exchanges, be sure to indicate any fund you
are exchanging out of and the fund or funds you are exchanging into. Please mail
to the appropriate address on the next page. T. Rowe Price requires the
----------------
signatures of all owners exactly as registered, and possibly a signature
guarantee (see Transaction Procedures and Special Requirements-Signature
Guarantees).
Regular Mail
T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220
Mailgram, Express, Registered, or Certified Mail
T. Rowe Price Account Services 10090 Red Run Boulevard Owings Mills, MD 21117
Rights Reserved by the Fund
The fund and its agents reserve the right to waive or lower investment minimums;
to accept initial purchases by telephone or mailgram; to refuse any purchase
order; to cancel or rescind any purchase or exchange (for example, if an account
has been restricted due to excessive trading or fraud) upon notice to the
shareholder within five business days of the trade or if the written
confirmation has not been received by the shareholder, whichever is sooner; to
freeze any account and suspend account services when notice has been received of
a dispute between the registered or beneficial account owners or there is reason
to believe a fraudulent transaction may occur; to otherwise modify the
conditions of purchase and any services at any time; or to act on instructions
believed to be genuine.
<PAGE>
INVESTING WITH T. ROWE PRICE 39
SHAREHOLDER SERVICES
----------------------------------------------------------
Shareholder Services 1-800-225-5132 1-410-625-6500 Investor Services
1-800-638-5660 1-410-547-2308
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically, and others you must authorize on the New Account Form. By
signing up for services on the New Account Form rather than later on, you avoid
having to complete a separate form and obtain a signature guarantee. This
section reviews some of the principal services currently offered. Our Services
Guide contains detailed descriptions of these and other services.
If you are a new T. Rowe Price investor, you will receive a Services Guide with
our Welcome Kit.
Note: Corporate and other institutional accounts require an original or
certified resolution to establish services and to redeem by mail. For more
information, call Investor Services.
Retirement Plans
We offer a wide range of plans for individuals, institutions, and large and
small businesses: IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs (profit sharing, money
purchase pension), 401(k), and 403(b)(7). For information on IRAs, call Investor
Services. For information on all other retirement plans, including our no-load
variable annuity, please call our Trust Company at 1-800-492-7670.
Exchange Service
You can move money from one account to an existing identically registered
account, or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund are
limited to investors living in states where the funds are registered.) Some of
the T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held
for less than six months or one year, as specified in the prospectus. The fee is
paid to the fund.
Automated Services Tele*Access 1-800-638-2587 24 hours, 7 days
Tele*Access
24-hour service via toll-free number enables you to (1) access information on
fund yields, prices, distributions, account balances, and your latest
transaction; (2) request checks, prospectuses, services forms, dupli-
<PAGE>
T. ROWE PRICE 40
cate statements, and tax forms; and (3) initiate purchase, redemption, and
exchange transactions in your accounts (see Electronic Transfers on the next
-----------
page).
- ----
T. Rowe Price OnLine
24-hour service via dial-up modem provides the same services as Tele*Access but
on a personal computer. Please call Investor Services for an information guide.
After obtaining proper authorization, account transactions may also be conducted
on the Internet.
Plan Account Line 1-800-401-3279
Plan Account Line
This 24-hour service is similar to Tele*Access, but is designed specifically to
meet the needs of retirement plan investors.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our investor center locations whose addresses are listed on
the cover.
Electronic Transfers
By ACH
With no charges to pay, you can initiate a purchase or redemption for as little
as $100 or as much as $100,000 between your bank account and fund account using
the ACH network. Enter instructions via Tele*Access or your personal computer,
or call Shareholder Services.
By Wire
Electronic transfers can be conducted via bank wire. There is currently a $5 fee
for wire redemptions under $5,000, and your bank may charge for incoming or
outgoing wire transfers regardless of size.
Checkwriting
(Not available for equity funds, or the High Yield or Emerging Markets Bond
Funds) You may write an unlimited number of free checks on any money market
fund, and most bond funds, with a minimum of $500 per check. Keep in mind,
however, that a check results in a redemption; a check written on a bond fund
will create a taxable event which you and we must report to the IRS.
Automatic Investing
($50 minimum) You can invest automatically in several different ways, including:
<PAGE>
INVESTING WITH T. ROWE PRICE 41
Automatic Asset Builder
You instruct us to move $50 or more from your bank account, or you can instruct
your employer to send all or a portion of your paycheck to the fund or funds you
designate.
Automatic Exchange
You can set up systematic investments from one fund account into another, such
as from a money fund into a stock fund.
DISCOUNT BROKERAGE
----------------------------------------------------------
This additional service gives you the opportunity to easily consolidate all of
your investments with one company. Through our discount brokerage, you can buy
and sell individual securities-stocks, bonds, options, and others - at
commission savings over full-service brokers. We also provide a wide range of
services, including:
To open an account 1-800-638-5660 For existing discount brokerage investors
1-800-225-7720
Automated telephone and on-line services
You can enter trades, access quotes, and review account information 24 hours a
day, seven days a week. Any trades executed through these programs save you an
additional 10% on commissions.
Note: Discount applies to our current commission schedule, subject to our $35
minimum commission.
Investor information
A variety of informative reports, such as our Brokerage Insights series, S&P
Market Month Newsletter, and select stock reports can help you better evaluate
economic trends and investment opportunities.
Dividend Reinvestment Service
Virtually all stocks held in customer accounts are eligible for this
service-free of charge.
/Discount Brokerage is a division of //T. Rowe Price// Investment Services, /
/Inc., Member NASD/SIPC./
<PAGE>
T. ROWE PRICE 42
INVESTMENT INFORMATION
----------------------------------------------------------
To help shareholders monitor their current investments and make decisions that
accurately reflect their financial goals, T. Rowe Price offers a wide variety of
information in addition to account statements.
Shareholder Reports
Fund managers' reviews of their strategies and results. If several members of a
household own the same fund, only one fund report is mailed to that address. To
receive additional copies, please call Shareholder Services or write to us at
100 East Pratt Street, Baltimore, Maryland 21202.
The T. Rowe Price Report
A quarterly investment newsletter discussing markets and financial strategies.
Performance Update
Quarterly review of all T. Rowe Price fund results.
Insights
Educational reports on investment strategies and financial markets.
Investment Guides
Asset Mix Worksheet, College Planning Kit, Personal Strategy Planner, Retirees
Financial Guide, Retirement Planning Kit, Tax Considerations for Investors, and
Diversifying Overseas: A T. Rowe Price Guide to International Investing.
<PAGE>
INVESTING WITH T. ROWE PRICE 43
To help you achieve your financial goals, T. Rowe Price offers a wide range of
stock, bond, and money market investments, as well as convenient services and
timely, informative reports.
To Open a Mutual Fund Account
Investor Services
1-800-638-5660
1-410-547-2308
For Existing Accounts
Shareholder Services
1-800-225-5132
1-410-625-6500
For Yields, Prices, Account Information, or to Conduct Transactions
Tele*Access/(R)/
1-800-638-2587 24 hours, 7 days
To Open a Discount Brokerage Account
1-800-638-5660
Internet Address
www.troweprice.com
Investor Centers
101 East Lombard St.
Baltimore, MD 21202
T. Rowe Price
Financial Center
10090 Red Run Blvd.
Owings Mills, MD 21117
Farragut Square
900 17th Street, N.W.
Washington, D.C. 20006
<PAGE>
T. ROWE PRICE 44
ARCO Tower
31st Floor
515 South Flower St.
Los Angeles, CA 90071
4200 West Cypress St.
10th Floor
Tampa, FL 33607
C05-040 7/1/97
(LOGO)
<PAGE>
PAGE 2
The Statement of Additional Information for the T. Rowe Price
California Tax-Free Income Trust, dated July 1, 1997.
PAGE 1
STATEMENT OF ADDITIONAL INFORMATION
T. Rowe Price State Tax-Free Income Trust
(the "Trust")
New York Tax-Free Money Fund
New York Tax-Free Bond Fund
Maryland Tax-Free Bond Fund
Maryland Short-Term Tax-Free Bond Fund
Virginia Tax-Free Bond Fund
Virginia Short-Term Tax-Free Bond Fund
New Jersey Tax-Free Bond Fund
Georgia Tax-Free Bond Fund
Florida Insured Intermediate Tax-Free Fund
(collectively the "Funds" and individually the "Fund")
T. Rowe Price California Tax-Free Income Trust
(the "Trust")
California Tax-Free Bond Fund
California Tax-Free Money Fund
(collectively the "Funds" and individually the "Fund")
This Statement of Additional Information is not a prospectus
but should be read in conjunction with the appropriate Fund
prospectus dated July 1, 1997, which may be obtained from T. Rowe
Price Investment Services, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202. The purchase or exchange of shares in
any of the above-listed funds is limited to investors residing in
states where the funds are qualified for sale.
If you would like a prospectus for a Fund of which you are
not a shareholder, please call 1-800-638-5660. A prospectus with
more complete information, including management fees and expenses
will be sent to you. Please read it carefully.
The date of this Statement of Additional Information is July
1, 1997.
C23-043 7/1/97
PAGE 2
TABLE OF CONTENTS
Page Page
Code of Ethics . . . . . . . . Pricing of Securities Being
Custodian . . . . . . . . . . . Offered . . . . . . . . . . .
Determination of Maturity of Principal Holders of
Money Market Securities . . . Securities . . . . . . . . .
Distributor for the Trusts . . Ratings of Commercial
Dividends . . . . . . . . . . . Paper . . . . . . . . . . . .
Federal and State Registration Ratings of Municipal
of Shares . . . . . . . . . . Debt Securities . . . . . . .
Forwards . . . . . . . . . . . Ratings of Municipal Notes
Futures Contracts . . . . . . . and Variable Securities . . .
Independent Accountants . . . . Risk Factors . . . . . . . . .
Investment Management Risk Factors Associated with
Services . . . . . . . . . . . a California Portfolio . . .
Investment in Taxable Money Risk Factors Associated with
Market Securities . . . . . . a Florida Portfolio . . . . .
Investment Objectives and Risk Factors Associated with
Policies . . . . . . . . . . . a Georgia Portfolio . . . . .
Investment Performance . . . . Risk Factors Associated with
Investment Programs . . . . . . a Maryland Portfolio . . . .
Investment Restrictions . . . . Risk Factors Associated with
Legal Counsel . . . . . . . . . a New Jersey Portfolio . . .
Management of the Trusts . . . Risk Factors Associated with
Municipal Securities . . . . . a New York Portfolio . . . .
Net Asset Value Per Share . . . Risk Factors Associated with
Options . . . . . . . . . . . . a Virginia Portfolio . . . .
Organization of the Trusts . . Tax-Exempt vs. Taxable
Portfolio Management Yield . . . . . . . . . . . .
Practices . . . . . . . . . . Tax Status . . . . . . . . . .
Portfolio Transactions . . . . When-Issued Securities . . . .
Yield Information . . . . . .
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of each
Fund's investment objectives and policies discussed in each
Fund's prospectus. The Funds will not make a material change in
their investment objectives without obtaining shareholder
approval. Unless otherwise specified, the investment programs
and restrictions of the Funds are not fundamental policies. Each
Fund's operating policies are subject to change by each Trust's
Board of Trustees without shareholder approval. However,
shareholders will be notified of a material change in an
operating policy. The fundamental policies of each Fund may not
be changed without the approval of at least a majority of the
outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the
holders of 50% or more of the shares of the Fund are represented.
PAGE 3
RISK FACTORS
All Funds
The Funds are designed for investors who, because of their
tax bracket, can benefit from investment in municipal bonds whose
income is exempt from federal taxes. The Funds are not
appropriate for qualified retirement plans where income is
already tax deferred.
Municipal Securities
There can be no assurance that the Funds will achieve their
investment objectives. Yields on municipal securities are
dependent on a variety of factors, including the general
conditions of the money market and the municipal bond market, the
size of a particular offering, the maturity of the obligation,
and the rating of the issue. Municipal securities with longer
maturities tend to produce higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter maturities and lower
yields. The market prices of municipal securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio investments, and a
decline in interest rates will generally increase the value of
portfolio investments. The ability of all the Funds to achieve
their investment objectives is also dependent on the continuing
ability of the issuers of municipal securities in which the Funds
invest to meet their obligations for the payment of interest and
principal when due. The ratings of Moody's, S&P, and Fitch
represent their opinions as to the quality of municipal
securities which they undertake to rate. Ratings are not
absolute standards of quality; consequently, municipal securities
with the same maturity, coupon, and rating may have different
yields. There are variations in municipal securities, both
within a particular classification and between classifications,
depending on numerous factors. It should also be pointed out
that, unlike other types of investments, municipal securities
have traditionally not been subject to regulation by, or
registration with, the SEC, although there have been proposals
which would provide for regulation in the future.
The federal bankruptcy statutes relating to the debts of
political subdivisions and authorities of states of the United
States provide that, in certain circumstances, such subdivisions
or authorities may be authorized to initiate bankruptcy
proceedings without prior notice to or consent of creditors,
which proceedings could result in material and adverse changes in
the rights of holders of their obligations.
Proposals have been introduced in Congress to restrict or
eliminate the federal income tax exemption for interest on
municipal securities, and similar proposals may be introduced in
PAGE 4
the future. Proposed "Flat Tax" and "Value Added Tax" proposals
would also have the effect of eliminating the tax preference for
municipal securities. Some of the past proposals would have
applied to interest on municipal securities issued before the
date of enactment, which would have adversely affected their
value to a material degree. If such a proposal were enacted, the
availability of municipal securities for investment by the Funds
and the value of a Fund's portfolio would be affected and, in
such an event, a Fund would reevaluate its investment objectives
and policies.
Although the banks and securities dealers with which the
Fund will transact business will be banks and securities dealers
that T. Rowe Price believes to be financially sound, there can be
no assurance that they will be able to honor their obligations to
the Fund with respect to such securities.
After purchase by a Fund, a security may cease to be rated
or its rating may be reduced below the minimum required for
purchase by the Fund. For the Money Funds, the procedures set
forth in Rule 2a-7, under the Investment Company Act of 1940, may
require the prompt sale of any such security. For the other
Funds, neither event would require a sale of such security by the
Fund. However, T. Rowe Price Associates, Inc. ("T. Rowe Price")
will consider such event in its determination of whether the Fund
should continue to hold the security. To the extent that the
ratings given by Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's Corporation ("S&P"), or Fitch Investors
Service, Inc. ("Fitch") may change as a result of changes in such
organizations or their rating systems, the Fund will attempt to
use comparable ratings as standards for investments in accordance
with the investment policies contained in the prospectus. When
purchasing unrated securities, T. Rowe Price, under the
supervision of the Fund's Board of Trustees, determines whether
the unrated security is of a quality comparable to that which the
Fund is allowed to purchase.
Municipal Bond Insurance. All of the Funds may purchase
insured bonds from time to time. The Florida Insured
Intermediate Tax-Free Fund must purchase such bonds. Municipal
bond insurance provides an unconditional and irrevocable
guarantee that the insured bond's principal and interest will be
paid when due. The guarantee is purchased from a private, non-
governmental insurance company.
There are two types of insured securities that may be
purchased by the Funds, bonds carrying either (1) new issue
insurance or (2) secondary insurance. New issue insurance is
purchased by the issuer of a bond in order to improve the bond's
credit rating. By meeting the insurer's standards and paying an
PAGE 5
insurance premium based on the bond's total debt service, the
issuer is able to obtain a higher credit rating for the bond.
Once purchased, municipal bond insurance cannot be cancelled, and
the protection it affords continues as long as the bonds are
outstanding and the insurer remains solvent.
The Funds may also purchase bonds which carry secondary
insurance purchased by an investor after a bond's original
issuance. Such policies insure a security for the remainder of
its term. Generally, the Funds expect that portfolio bonds
carrying secondary insurance will have been insured by a prior
investor. However, the Funds may, on occasion, purchase
secondary insurance on their own behalf.
Each of the municipal bond insurance companies has
established reserves to cover estimated losses. Both the method
of establishing these reserves and the amount of the reserves
vary from company to company. The obligation of a municipal bond
insurance company to pay a claim extends over the life of each
insured bond. Municipal bond insurance companies are obligated
to pay a bond's interest and principal when due if the issuing
entity defaults on the insured bond. Although defaults on
insured municipal bonds have been low to date and municipal
insurers have met these claims, there is no assurance this low
rate will continue in the future. A higher than expected default
rate could deplete loss reserves and adversely affect the ability
of a municipal bond insurer to pay claims to holders of insured
bonds, such as the Fund.
Money Funds
The Money Funds will limit their purchases of portfolio
instruments to those U.S. dollar-denominated securities which the
Fund's Board of Trustees determines present minimal credit risk,
and which are Eligible Securities as defined in Rule 2a-7 under
the Investment Company Act of 1940 (1940 Act). Eligible
Securities are generally securities which have been rated (or
whose issuer has been rated or whose issuer has comparable
securities rated) in one of the two highest short-term rating
categories by nationally recognized statistical rating
organizations or, in the case of any instrument that is not so
rated, is of comparable high quality as determined by T. Rowe
Price pursuant to written guidelines established under the
supervision of the Fund's Board of Trustees. In addition, the
Funds may treat variable and floating rate instruments with
demand features as short-term securities pursuant to Rule 2a-7
under the 1940 Act.
There can be no assurance that the Money Funds will achieve
their investment objectives or be able to maintain their net
asset value per share at $1.00. The price stability and
PAGE 6
liquidity of the Money Funds may not be equal to that of a
taxable money market fund which exclusively invests in short-term
taxable money market securities. The taxable money market is a
broader and more liquid market with a greater number of
investors, issuers, and market makers than the short-term
municipal securities market. The weighted average maturity of
the Money Funds varies (subject to a 90 day maximum under Rule
2a-7): the shorter the average maturity of a portfolio, the less
its price will be impacted by interest rate fluctuations.
Bond Funds
Because of their investment policies, the Bond Funds may not
be suitable or appropriate for all investors. The Funds are
designed for investors who wish to invest in non-money market
funds for income, and who would benefit, because of their tax
bracket, from receiving income that is exempt from federal income
taxes. The Funds' investment programs permit the purchase of
investment grade securities that do not meet the high quality
standards of the Money Funds. Since investors generally perceive
that there are greater risks associated with investment in lower
quality securities, the yields from such securities normally
exceed those obtainable from higher quality securities. In
addition, the principal value of long term lower-rated securities
generally will fluctuate more widely than higher quality
securities. Lower quality investments entail a higher risk of
default--that is, the nonpayment of interest and principal by the
issuer than higher quality investments. The value of the
portfolio securities of the Bond Funds will fluctuate based upon
market conditions. Although these Funds seek to reduce credit
risk by investing in a diversified portfolio, such
diversification does not eliminate all risk. The Funds are also
not intended to provide a vehicle for short-term trading
purposes.
Special Risks of High Yield Investing
Junk bonds are regarded as predominantly speculative with
respect to the issuer's continuing ability to meet principal and
interest payments. Because investment in low and lower-medium
quality bonds involves greater investment risk, to the extent the
Bond Funds invest in such bonds, achievement of their investment
objectives will be more dependent on T. Rowe Price's credit
analysis than would be the case if the Funds were investing in
higher quality bonds. High yield bonds may be more susceptible
to real or perceived adverse economic conditions than investment
grade bonds. A projection of an economic downturn, or higher
interest rates, for example, could cause a decline in high yield
bond prices because such events could lessen the ability of
highly leveraged issuers to make principal and interest payments
on their debt securities. In addition, the secondary trading
market for high yield bonds may be less liquid than the market
PAGE 7
for higher grade bonds, which can adversely affect the ability of
a Fund to dispose of its portfolio securities. Bonds for which
there is only a "thin" market can be more difficult to
value inasmuch as objective pricing data may be less available
and judgment may play a greater role in the valuation
process.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
of the risks associated with the investments and practices
described therein.
RISK FACTORS ASSOCIATED WITH A CALIFORNIA PORTFOLIO
The Funds' concentration in debt obligations of one state
carries a higher risk than a portfolio that is geographically
diversified. In addition to State general obligations and notes,
the Funds will invest in local bond issues, lease obligations and
revenue bonds, the credit quality and risk of which will vary
according to each security's own structure and underlying
economics.
Debt. The State, its agencies and local governmental
entities issued $24.9 billion in debt in 1996. Approximately 16%
was general obligation debt, backed by the taxing power of the
issuer, and 84% were revenue bonds and lease backed obligations,
issued for a wide variety of purposes, including transportation,
housing, education and healthcare.
As of March 1, 1997, the State of California had
approximately $17.7 billion outstanding general obligation bonds
secured by the State's revenue and taxing power. An additional
$3.3 billion in authorized but unissued state general obligation
debt remains to be issued to comply with voter initiatives and
legislative mandates. Debt service on roughly 21% of the State's
outstanding debt is met from revenue producing projects such as
water, harbor, and housing facilities. As part of its cash
management program, the State regularly issues short-term notes
to meet its disbursement requirements in advance of revenue
collections. During fiscal 1997, the State issued $3.0 billion
in short-term notes for this purpose.
The State also supports $5.5 billion in lease-purchase
obligations attributable to the State Public Works Board. These
obligations are not backed by the full faith and credit of the
State but instead, are subject to annual appropriations from the
State's General Fund.
In addition to the State obligations described above, bonds
have been issued by special public authorities in California that
are not obligations of the State. These include bonds issued by
the California Housing Finance Agency, the Department of Water
PAGE 8
Resources, the Department of Veterans Affairs, California State
University and the California Transportation Commission.
Economy. California's economy is the largest among the 50
states and one of the largest in the world. The 1996 population
of 32 million represents 12% of the U.S. total. The State's per
capita personal income in 1995 exceeded the U.S. average by 4%.
California s economy suffered through a severe recession
during the early 1990 s as the effects of a slowdown in the
national economy were compounded by federal defense spending cuts
and military base closings. Since 1994, the State has been in a
steady recovery, positing significant job growth and gains in
personal income. The level of economic activity within the State
is important as it influences the growth or contraction of State
and local government revenues available for operations and debt
service.
Recessionary influences and the effects of overbuilding in
selected areas have resulted in a contraction in real estate
values in many regions of the State in prior years. Most areas
have begun to show improvement corresponding to gains in the
general economic level. Future declines in property values could
have a negative effect on the ability of certain local
governments to meet their obligations.
As a state, California is more prone to earthquakes than
most other states in the country, creating potential economic
losses from damages. On January 17, 1994, a major earthquake,
measuring 6.8 on the Richter scale, hit Southern California
centered in the area of Northridge. Total damage has been
estimated at $20 billion. Significant federal aid has been
received.
Legislative. Due to the Funds' concentration in California
state and its municipal issuers, the Funds may be affected by
certain amendments to the California constitution and state
statutes which limit the taxing and spending authority of
California governmental entities and may affect their ability to
meet their debt service obligations.
In 1978, California voters approved "Proposition 13" adding
Article XIIIA, to the state constitution which limits ad valorem
taxes on real property to 1% of "full cash value" and restricts
the ability of taxing entities to increase real property taxes.
In subsequent actions, the State substantially increased its
expenditures to provide assistance to its local governments to
offset the losses in revenues and to maintain essential local
services; later the State phased out most local aid in response
to its own fiscal pressures.
Another constitutional amendment, Article XIIIB, was passed
by voters in 1979 prohibiting the State from spending revenues
PAGE 9
beyond its annually adjusted "appropriations limit". Any
revenues exceeding this limit must be returned to the taxpayers
as a revision in the tax rate or fee schedule over the following
two years. Such a refund, in the amount of $1.1 billion,
occurred in fiscal year 1987.
Proposition 218, the "Right to Vote on Taxes Act", was
approved by the voters in 1996. It further restricts the ability
of local governments to levy and collect both existing and future
taxes, assessments and fees. In addition to further limiting the
financial flexibility of local governments in the state, it also
increases the possibility of voter determined tax rollbacks and
repeals. The interpretation and application of this proposition
will ultimately be determined by the courts.
An effect of the tax and spending limitations in California
has been a broad scale shift by local governments away from
general obligation debt that requires voter approval and pledging
future tax revenues, towards lease revenue financing that is
subject to abatement and does not require voter approval. Lease
backed debt is generally viewed as a less secure form of
borrowing and therefore entails greater credit risk. Local
governments also raise capital through the use of Mello-Roos,
1915 Act, and Tax Increment Bonds, all of which are generally
riskier than general obligation debt as they often rely on tax
revenues to be generated by future development for their support.
Proposition 98, enacted in 1988, changed the State's method
of funding education for grades below the university level.
Under this constitutional amendment, the schools are guaranteed a
minimum share of State General Fund revenues. The major effect
of Proposition 98 has been to restrict the State's flexibility to
respond to fiscal stress.
Future initiatives, if proposed and adopted or future court
decisions could create renewed pressure on California governments
and their ability to raise revenues. The State and its
underlying localities have displayed flexibility, however, in
overcoming the negative effects of past initiatives.
Financial. The recession of the early 1990 s placed
California's finances under pressure. From 1991 through 1995,
accumulated deficits were carried over into the following years
and the State s general obligation bonds were downgraded from AAA
to A. Reflecting the recent trend of economic recovery, the
state s financial condition has improved. Fiscal 1997 is
expected to close with a reserve balance of $312 million. The
Governor has proposed a budget for fiscal 1998 which features a
proposed cut in the corporation and bank tax rate and increased
school funding levels, supported by economic growth and health
and welfare savings. The projected surplus will increase the
state s reserve to $580 million (1.1% of expenditures). We are
PAGE 10
unable to predict whether the budget package will be negotiated
in a timely manner by the Governor and the legislature.
As of June 1, 1997, the State's general obligation bonds are
rated A1 by Moody's, A+ by Standard & Poor's and A+ by Fitch.
The consequences of the State's fiscal actions reach beyond its
own general obligation bond ratings. Many state agencies and
local governments which depend upon state appropriations have
realized significant cutbacks in funding in recent years.
Entities which have been forced to make program reductions or to
increase fees or raise special taxes to cover their debt service
and lease obligations may recover somewhat during periods of
economic prosperity.
On December 6, 1994, Orange County filed for protection
under Chapter 9 of the U.S. Bankruptcy Code after reports of
significant losses in its investment pool. Upon restructuring,
the realized losses in the pool were $1.6 billion or 21% of
assets. More than 200 public entities, most of which, but not
all, are located in Orange County were also depositors in the
pool. The County defaulted on a number of its debt obligations.
The County emerged from bankruptcy on June 12, 1996. Through a
series of long-term financings, it repaid most of its obligations
to pool depositors and has become current on its public debt
obligations. The balance of claims against the County are
payable from any proceeds received from litigation against
securities dealers and other parties.
Sectors
Certain areas of potential investment concentration present
unique risks. In 1996, $1.8 billion of tax-exempt debt issued in
California was for public or non-profit hospitals. A significant
portion of the Funds' assets may be invested in health care
issues. For over a decade, the hospital industry has been under
significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial
health of many hospitals. While each hospital bond issue is
separately secured by the individual hospital's revenues, third
party reimbursement sources such as the federal Medicare and
state MediCal programs or private insurers are common to all
hospitals. To the extent these third party payors reduce
reimbursement levels, the individual hospitals may be affected.
In the face of these pressures, the trend of hospital mergers and
acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for
the institutions involved.
The Funds may from time to time invest in electric revenue
issues. The financial performance of these utilities may be
impacted as the industry moves toward deregulation and increased
competition. California s electric utility restructuring plan,
Assembly Bill 1890, permits direct competition to be phased in
PAGE 11
between 1998 and 2002. Municipal utilities, while not subject to
the legislation, will be faced with competitive market forces and
must use the transition period wisely to prepare for
deregulation. In addition, some electric revenue issues have
exposure to or participate in nuclear power plants which could
affect the issuer s financial performance. Risks include
unexpected outages or plant shutdowns, increased Nuclear
Regulatory Commission surveillance or inadequate rate relief.
The Funds may invest in private activity bond issues for
corporate and non-profit borrowers. These issues sold through
various governmental conduits, are backed solely by the revenues
pledged by the respective borrower corporations. No governmental
support is implied.
RISK FACTORS ASSOCIATED WITH A MARYLAND PORTFOLIO
Each Fund's concentration in the debt obligations of one
state carries a higher risk than a portfolio that is
geographically diversified. In addition to State of Maryland
general obligations and state agency issues, the Fund will invest
in local bond issues, lease obligations and revenue bonds, the
credit quality and risk of which will vary according to each
security's own structure and underlying economics.
Debt. The State of Maryland and its local governments issue
three basic types of debt, with varying degrees of credit risk:
general obligation bonds backed by the unlimited taxing power of
the issuer, revenue bonds secured by specific pledged fees or
charges for a related project, and tax-exempt lease obligations,
secured by annual appropriations by the issuer, usually with no
implied tax or specific revenue appropriations by the issuer. In
1996, $3.0 billion in state and local debt was issued in
Maryland, with approximately 47% representing general obligation
debt and 53% revenue bonds and lease backed debt.
The State of Maryland had $2.9 billion in general obligation
bonds outstanding as of December 31, 1996 along with an
additional $1.4 billion in other tax-supported debt. General
obligation debt of the State of Maryland is rated Triple-A by
Moody's, Standard & Poor's and Fitch. There is no general debt
limit imposed by the State Constitution or public general laws.
The State Constitution imposes a 15 year maturity limit on State
general obligation bonds. Although voters approved a
constitutional amendment in 1982 permitting the State to borrow
up to $100 million in short-term notes in anticipation of taxes
and revenues, the State has not made use of this authority.
Many agencies and other instrumentalities of the State
government are authorized to borrow money under legislation which
expressly provides that the loan obligations shall not be deemed
PAGE 12
to constitute a debt or a pledge of the faith and credit of the
State. The Community Development Administration of the
Department of Housing and Community Development, the Maryland
Stadium Authority, the Board of Trustees of St. Mary's College of
Maryland, the Maryland Environmental Service, the Board of
Regents of the University of Maryland System, the Board of
Regents of Morgan State University, the Maryland Food Center
Authority, and the Maryland Water Quality Financing
Administration have issued and have outstanding bonds of this
type. The principal of and interest on bonds issued by these
bodies are payable solely from pledged revenues, principally fees
generated from use of the facilities, enterprises financed by the
bonds, or other dedicated fees. Total outstanding revenue and
enterprise debt of these State units, the Maryland Transportation
Authority, and the Maryland Department of Transportation at
December 31, 1996 was $3.7 billion.
Economy. The economy of the State of Maryland generally
demonstrates strong performance relative to the nation. Per
capita income is 12% above the U.S. average. Unemployment was
4.9% in 1996, compared to a national average of 5.4%. The
State's population in 1996 was 5.0 million, with 87% concentrated
in the Baltimore-Washington corridor.
Financial. To a large degree, the risk of the Funds is
dependent upon the financial strength of the State of Maryland
and its localities. Over the long term, Maryland's financial
condition has been strong; however, in fiscal 1992, the State
experienced unanticipated shortfalls in revenues, as collections
of major taxes fell during the recession. To address this loss,
the governor enacted a series of mid-year reductions in
expenditures, primarily cuts in local aid.
Balancing the state budget for fiscal year 1993 involved a
variety of additional taxes, including a higher income tax on
upper income households and an expanded sales tax. The
legislature also adopted further cuts in State aid to localities,
but this action was offset by the ability of localities to
increase the local "piggyback" tax from 50 percent to 60 percent
of the State rate. These actions were successful in restoring
the State's financial condition and replenishing reserves. In
fiscal 1994 Maryland s economy began to improve, allowing the
state to continue to strengthen its financial condition. The
results of fiscal year 1997 are projected to show a general fund
balance of $489 million (6.5% of revenues). The fiscal 1998
budget enacts a 10% reduction in the personal income tax rate, to
be phased in over five years. Funding the final years of this
plan may require a draw down of the reserve position.
Many local Maryland governments also suffered from fiscal stress
and general declines in financial performance during the
recession. Downturns in real estate related receipts, declines in
the growth of income tax revenues, lower cash positions and
PAGE 13
reduced interest income were common problems. State aid to local
governments was also reduced during that period. Local
governments closed these gaps by increasing property and local
income tax rates, implementing program cuts, and curtailing pay
raises. Certain counties in Maryland are subject to voter
approval limitations on property tax levy increases or on
governmental spending which limits their flexibility in
responding to external changes.
Future voter initiatives, if proposed and adopted, could
create pressure on the counties and other local governments and
their ability to raise revenues. The Funds cannot predict the
impact of any such future tax limitations on debt quality.
Sectors. Certain areas of potential investment
concentration present unique risks. In 1996 $346 million of tax-
exempt debt issued in Maryland was for public or non-profit
hospitals. A significant portion of the Funds' assets may be
invested in health care issues. For over a decade, the hospital
industry has been under significant pressure to reduce expenses
and shorten length of stay, a phenomenon which has negatively
affected the financial health of some hospitals. While each
hospital bond issue is separately secured by the individual
hospital's revenues, third party reimbursement mechanisms are
common to the group. At the present time Maryland hospitals
operate under a system which reimburses hospitals according to a
State administered set of rates and charges rather than the
Federal Diagnosis Related Group (DRG s) system for Medicare
payments. Since 1983, Maryland hospitals, on average over the
trailing three year period, have increased hospital charges at a
level below the national average in terms of Medicare cost
increases, allowing them to continue operating under a Medicare
waiver. Any loss of this waiver in the future may have an
adverse impact upon the credit quality of Maryland hospitals.
The Funds may from time to time invest in electric revenue
issues which have exposure to or participate in nuclear power
plants which could affect the issuers' financial performance.
Such risks include unexpected outages or plant shutdowns,
increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance
of electric utilities may be impacted by increased competition
and deregulation in the industry.
The Funds may invest in private activity bond issues for
corporate and non-profit borrowers. These issues sold through
various governmental conduits, are backed solely by the revenues
pledged by the respective borrowing corporations. No
governmental support is implied.
RISK FACTORS ASSOCIATED WITH A GEORGIA PORTFOLIO
PAGE 14
The Fund's concentration in the debt obligations of one
state carries a higher risk than a portfolio that is
geographically diversified. In addition to State of Georgia
general obligations and state agency issues, the Fund will invest
in local bond issues, lease obligations and revenue bonds, the
credit quality and risk of which will vary according to each
security's own structure and underlying economics.
Debt. The State of Georgia and its local governments issued
$3.5 billion in municipal bonds in 1996, approximately 24%
general obligation debt backed by the unlimited taxing power of
the issuer and 76% revenue bonds secured by specific pledged fees
or charges for an enterprise or project. As of June 1, 1997, the
State was rated Aaa by Moody's, AA+ by Standard & Poor's and AAA
by Fitch.
As of April 30,1997, the State of Georgia had net direct
obligations of $5.0 billion. Since 1973, when a Constitutional
Amendment authorizing the issuance of state general obligation
(GO) bonds was implemented, the State has funded most of its
capital needs through the issuance of general obligation (GO)
bonds. Previously, capital requirements were funded through the
issuance of bonds by ten separate authorities and secured by
lease rental agreements and annual state appropriations. Its
Constitution permits the State to issue bonds for two types of
public purposes: (1) general obligation debt and (2) guaranteed
revenue debt. The Constitution imposes certain debt limits and
controls. GO debt service cannot exceed 10% of total revenue
receipts less refunds of the state treasury. GO bonds have a
maximum maturity of 25 years. Currently, maximum GO debt service
requirements are well below the legal limit at 5.5% of Fiscal
Year 1996 treasury receipts.
In addition to the general obligation and lease backed debt
described above, $198 million bonds have been issued by the
Georgia World Congress Authority and $754 million bonds have been
issued and are outstanding by the Georgia Housing and Finance
Authority, none of which represent direct obligations of the
State.
Economy. The State of Georgia has a population of
approximately 7.4 million, making it the 10th largest state.
Since the 1960s, the State's population has grown at a rate
exceeding the national average, with the growth rate during the
1980s nearly twice that of the entire country. Stable to strong
economic growth during the 1980s was led by the Atlanta
metropolitan statistical area, where approximately 45% of the
State's population is located. This area includes the capital
city of Atlanta, and 18 surrounding counties. The next largest
metropolitan area is the Columbus-Muscogee area followed by the
Macon area.
PAGE 15
The State's economy is well diversified. The current labor
force of 3.6 million is largely concentrated in wholesale/retail
trade and service jobs, followed by lesser amounts in
manufacturing and government. Employment gains have
substantially exceeded the region and the U.S. since 1980. The
State s economy continues to outperform the nation, despite a
slowing after the high level of economic activity resulting from
the 1996 Olympic Games. Georgia's per capita income has steadily
improved against the national average since the 1960s and
currently is 94% of the U.S., ranking it 26th among the states.
Financial. To a large degree, the creditworthiness of the
portfolio is dependent on the financial strength of the State of
Georgia and its localities. During the 1980s, the State's strong
economic performance translated into solid financial performance
and the accumulation of substantial reserves.
During fiscal 1989 to 1991, the State's financial condition
was affected by three years of revenue shortfalls brought on by
recession. During these periods, the Governor called special
legislative sessions to enact sizable spending cuts to achieve
budget balance. Economic conditions improved in 1992, allowing
the State to restore its financial cushion. Results for fiscal
1996 showed a continuation of this positive trend with an ending
unreserved general fund balance of $620 million, or 5.9% of
revenues.
A significant portion of the portfolio's assets is expected
to be invested in the debt obligations of local governments and
public authorities with investment grade ratings of BBB or
higher. While local governments in Georgia are primarily reliant
on independent revenue sources, such as property taxes, they are
not immune to budget shortfalls caused by cutbacks in State aid.
The Fund may purchase obligations issued by public authorities in
Georgia which are not backed by the full faith and credit of the
State and may or may not be subject to annual appropriations from
the State's General Fund. Likewise, certain enterprises such as
water and sewer systems or hospitals may be affected by changes
in economic activity.
Sectors. Certain areas of potential investment
concentration present unique risks. In 1996, $533 million of
tax-exempt debt issued in Georgia was for public or non-profit
hospitals. A significant portion of the Fund's assets may be
invested in health care issues. For over a decade, the hospital
industry has been under significant pressure to reduce expenses
and shorten length of stay, a phenomenon which has negatively
affected the financial health of many hospitals. While each
hospital bond issue is separately secured by the individual
hospital's revenues, third party reimbursement sources such as
the federal Medicare and state Medicaid programs or private
insurers are common to all hospitals. To the extent these payors
reduce reimbursement levels, the individual hospitals may be
PAGE 16
affected. In the face of these pressures, the trend of hospital
mergers and acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for
the institutions involved.
The Fund may from time to time invest in electric revenue
issues which have exposure to or participate in nuclear power
plants which could affect the issuers' financial performance.
Such risks include unexpected outages or plant shutdowns,
increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance
of electric utilities may be impacted by increased competition
and deregulation of the electric utility industry.
The Fund may invest in private activity bond issues for
corporate and non-profit borrowers. These issues sold through
various governmental conduits, are backed solely by the revenues
pledged by the respective borrowing corporations. No
governmental support is implied. This category accounted for
3.4% of the tax-exempt debt issued in Georgia during 1996.
RISK FACTORS ASSOCIATED WITH A FLORIDA PORTFOLIO
The Fund's program of investing primarily in insured, AAA-
rated Florida municipal bonds should significantly lessen the
credit risks which would be associated with a portfolio of
uninsured Florida bonds. Nevertheless, to a certain degree, the
Fund's concentration in securities issued by the State of Florida
and its political subdivisions involves greater risk than a fund
broadly invested in insured bonds across many states and
municipalities. The credit quality of the Fund will depend upon
the continued financial strength of the insurance companies
insuring the bonds purchased by the Fund as well as the State of
Florida and the numerous public bodies, municipalities and other
issuers of debt securities in Florida.
Debt. The State of Florida and its local governments issue
three basic types of debt, with varying degrees of credit risk:
general obligation bonds backed by the unlimited taxing power of
the issuer, revenue bonds secured by specific pledged funds or
charges for a related project, and tax-exempt lease obligations,
supported by annual appropriations from the issuer, usually with
no implied tax or specific revenue pledge. During 1996, $10.2
billion in state and local debt was issued in Florida, with
approximately 14% representing general obligation debt and 86%
representing revenue bonds and lease-backed obligations. Debt
issued in 1996 was for a wide variety of public purposes,
including transportation, housing, education, health care and
industrial development.
As of April 30, 1996, the State of Florida had $7.4 billion
outstanding general obligation bonds secured by the State's full
PAGE 17
faith and credit and taxing power. General bonded debt service
accounted for a modest 2.3% of all governmental expenditures in
fiscal year 1996. An additional $3.3 billion in outstanding
bonds have been issued by the State and secured by limited state
tax and revenue sources. General obligation debt of the State of
Florida is rated Aa2 by Moody's, AA+ by Standard & Poor's and AA
by Fitch as of June 1, 1997. State debt may only be used to fund
capital outlay projects; Florida is not authorized to issue
obligations to fund operations.
Several agencies of the State are also authorized to issue
debt which does not represent a pledge of the state's credit.
The Florida Housing Finance Authority and Florida Board of
Regents are the largest issuers of this type. The principal and
interest on bonds issued by these bodies are payable solely from
specified sources such as mortgage repayments and university
tuition and fees.
Economy. The State of Florida has a population of
approximately 14.4 million, making it the fourth largest state.
Due to immigration, the State's population has grown at a rate
exceeding the nation for four decades. Florida's economy is
broadly based with a large concentration in the service and trade
sectors. Tourism is one of Florida's most important industries.
Rebounding from a decline in 1994, visitor traffic grew by 2.5%
in 1995 and 2.0% to 41.5 million people in 1996.
During most of the 1980's, as Florida's population and
employment base grew, its job growth rate was double that of the
nation. However, beginning in 1988, job growth slowed and
unemployment rates began trending above national levels for a
number of years. During 1995, Florida's unemployment rate was
8.2% versus 7.4% for the U.S. With total non-farm jobs growing
faster than the national average in 1996, Florida s unemployment
rate has improved, coming in at 5.1% versus 5.4% for the U.S.
State per capita income is 99% of the national average, well
above norms for the Southeast.
Legislative. The State of Florida does not have a personal
income tax. A constitutional amendment would be required in
order to implement such a tax. Although the probability appears
very low, the Fund cannot rule out the possibility that a
personal income tax may be implemented at some time in the
future. If such a tax were to be imposed, there is no assurance
that interest earned on Florida Municipal Obligations would be
exempt from this tax.
Under current Florida law, shares of the Fund will be exempt
from the State's intangible personal property tax to the extent
that on the annual assessment date (January 1) its assets are
solely invested in Florida Municipal Obligations and U.S.
government securities, certain short-term cash investments, or
other exempt securities. There can be no assurance that this
PAGE 18
exemption for Florida securities will be maintained. Also, the
constitutionality of the intangibles tax has been challenged in
court.
The Florida Constitution limits the total ad valorem
property tax that may be levied by each county, municipality and
school district to ten mills (1.0% of value). The limit applies
only to taxes levied for operating purposes and excludes taxes
levied for the payment of bonds. This restricts the operating
flexibility of local governments in the State and may result from
time to time in budget deficits for some local units.
Financial. The Florida Constitution and Statutes mandate
that the State budget as a whole, and each separate fund within
the State budget, be kept in balance from currently available
revenues each State fiscal year (July 1 - June 30.) The Governor
and Comptroller are responsible for insuring that sufficient
revenues are collected to meet appropriations and that no deficit
occurs in any State fund.
The State's revenue structure is narrowly based, relying on
the sales and use tax for 70% of its general revenues. This
structure, combined with the effects of the recession and heavy
spending demands, created budget shortfalls in fiscal years 1991
and 1992. Through mid-year spending adjustments and a draw upon
its reserves, the State was able to achieve budget balance for
both fiscal years. The State's finances received a substantial
boost in fiscal 1993 as a result of increased economic activity
associated with rebuilding efforts after Hurricane Andrew, which
hit south Florida on August 24, 1992. At the end of 1996, the
State had reserves of $698 million in the General Revenue Fund
(4.8% of revenues).
In November 1994, State voters passed a proposal to limit
State revenue growth to the average annual growth in personal
income over the previous five years. The cap excludes revenue to
pay certain expenditures, including debt service. The limitation
should no pose an onerous burden on State finance. However, the
demand for governmental services continues to grow because of
above average population growth and demographics.
Sectors. Certain areas of potential investment
concentration present unique risks. In 1996, $1.5 billion of
tax-exempt debt issued in Florida was for public or non-profit
hospitals. A significant portion of the Fund's assets may be
invested in health care issues.
For over a decade, the hospital industry has been under
significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial
health of many hospitals. While each hospital bond issue is
separately secured by the individual hospital's revenues, third
party reimbursement sources such as the federal Medicare and
PAGE 19
state Medicaid programs or private insurers are common to all
hospitals. To the extent these payors reduce reimbursement
levels, the individual hospitals may be affected. In the face of
these pressures, the trend of hospital mergers and acquisitions
has accelerated in recent years. These organizational changes
present both risks and opportunities for the institutions
involved. Due to the high proportion of elderly residents,
Florida hospitals tend to be highly dependent on Medicare. In
addition to the regulations imposed by Medicare, the State also
regulates healthcare. A State board must approve the budgets of
all Florida hospitals; certificates of need are required for all
significant capital expenditures. The primary management
objective is cost control. The inability of some hospitals to
achieve adequate cost control while operating in a competitive
environment has led to a number of hospital bond defaults.
The Fund may from time to time invest in electric revenue
issues which have exposure to or participate in nuclear power
plants which could affect the issuers' financial performance.
Such risks include unexpected outages or plant shutdowns,
increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance
of electric utilities may be impacted by increased competition
and deregulation in the electric utility industry.
The Fund may invest in private activity bond issues for
corporate and non-profit borrowers. These issues, sold through
various governmental conduits, are backed solely by the revenues
pledged by the respective borrowing corporations. No government
support is implied. This category accounted for only 1.4% of the
tax-exempt debt issued in Florida during 1996.
RISK FACTORS ASSOCIATED WITH A NEW YORK PORTFOLIO
The Funds' concentration in the debt obligations of one
state carries a higher risk than a portfolio that is
geographically diversified. In addition to state general
obligation bonds and notes and the debt of various state
agencies, the Fund will invest in local bond issues, lease
obligations and revenue bonds, the credit quality and risk of
which will vary according to each security's own structure and
underlying economics.
The Funds' ability to maintain a high level of "triple-
exempt" income is primarily dependent upon the ability of New
York issuers to continue to meet debt service obligations in a
timely fashion. In 1975 the State, New York City, and other
related issuers experienced serious financial difficulties that
ultimately resulted in much lower credit ratings and loss of
access to the public debt markets. A series of fiscal reforms
and an improved economic climate allowed these entities to return
to financial stability by the early 1980s. Credit ratings were
PAGE 20
reinstated or raised and access to the public credit markets was
restored. During the early 1990s, the State and City confronted
renewed fiscal pressure, as the region suffered moderate economic
decline. Conditions began to improve in 1993, though below
average economic performance and tight budgetary conditions
persist. Both entities experienced financial relief in fiscal
1997 because of the strong national economy, a robust financial
services sector, and vigilant spending control. The State and
City continue to face challenging budgets while they attempt to
adjust spending levels and priorities.
New York State
The State, its agencies, and local governments issued $21.7
billion in long-term municipal bonds in 1996. Approximately 38%
was general obligation debt, backed by the taxing power of the
issuer and 62% were revenue bonds and lease backed obligations,
issued for a wide variety of purposes, including transportation,
housing, education and healthcare.
As of March 31, 1996, total State-related bonded debt was
$37.9 billion, of which $5.0 billion was general obligation debt,
$6.4 billion was State moral obligation debt, and $26.4 billion
was financed under lease-purchase or other contractual
obligations. In addition, the State had $293 million in bond
anticipation notes outstanding. Since 1993, the State has not
issued Tax and Revenue Anticipation Notes (TRANs) terminating the
practice of annual seasonal borrowing which had occurred since
1952. As of June 1, 1997, the State's general obligation bonds
were rated A by Moody's, A- by Standard & Poor's and A+ by Fitch.
All general obligation bonds must be approved by the voters prior
to issuance.
The fiscal stability of the State is also important for
numerous authorities which have responsibilities for financing,
constructing, and operating revenue-producing public benefit
facilities. As of September 30, 1995 there were 17 authorities
that had aggregate debt outstanding, including refunding bonds,
of $73 billion.
The authorities most reliant upon annual direct State
support include the Metropolitan Transit Authority (MTA), the
Urban Development Authority (UDC), and the New York Housing
Finance Agency (HFA). In February 1975, the UDC defaulted on
approximately $1.0 billion of short-term notes. The default was
ultimately cured by the creation of the Project Finance Authority
(PFA), through which the State provided assistance to the UDC,
including support for debt service. Since then, there have been
no additional defaults by State authorities although substantial
annual assistance is required by the MTA and the HFA in
particular.
PAGE 21
Subsequent to the fiscal crisis of the mid-70's, New York
State maintained balanced operations on a cash basis, although by
1992 it had built up an accumulated general fund deficit of over
$6 billion on a "Generally Accepted Accounting Principles" (GAAP)
basis. This deficit consisted mainly of overdue tax refunds and
payments due localities.
To resolve its accumulated general fund deficit the State
established the Local Government Assistance Corporation (LGAC) in
1990. A total of $5.2 billion in LGAC bonds have been issued.
The proceeds of these bonds were used to provide the State's
assistance to localities and school districts, enabling the State
to reduce its accumulated general fund deficit. State short-term
borrowing requirements, which peaked at a record $5.9 billion in
fiscal 1991, have been reduced to zero. Nonetheless, the State
ended fiscal 1996 with a General Fund unreserved deficit balance
of $3.6 billion. The adopted budget for fiscal 1996 included a
multi-year tax reduction plan which lowers the maximum personal
income tax rate from 7.875 to 6.85%. The original budget
proposal for the fiscal year ended March 31,1997 included a
multi-year personal income tax rate cut and emphasized cost
control to balance against the effects of a weak economy.
Because of strong growth in personal income and business taxes,
fiscal year 1997 ended with an estimated operating surplus of
$1.4 billion, which will help smooth budget balancing efforts for
next year. The budget for the fiscal year which began on April
1, 1997 had not been adopted as of June 1, 1997.
New York State has a large, diversified economy which has
witnessed a basic shift away from manufacturing toward service
sector employment. In 1996, per capita income in New York State
was $28,782, 18% above the national average. Like most
northeastern states, New York suffered a population loss during
the 1970s. However, during the 1980s that trend reversed and
population increased slightly, standing at 18,185,000 in 1996.
During 1990-1992, the State experienced a slowing of economic
growth evidenced by the loss of 425,000 jobs. Conditions have
improved with non-farm employment growing by an average of 0.6%
between 1992 and 1996, or by roughly one-fourth of the national
average. Such economic trends are important as they influence
the growth or contraction of State revenues available for
operations and debt service.
New York City
The financial problems of New York City were acute between
1975 and 1979, highlighted by a payment moratorium on the City's
short-term obligations. In the subsequent decade, the City made
a significant recovery. The most important contribution to the
City's fiscal recovery was the creation of the Municipal
PAGE 22
Assistance Corporation for the City of New York (MAC). Backed by
sales, use, stock transfer, and other taxes, MAC issued bonds and
used the proceeds to purchase City bonds and notes. Although the
MAC bonds met with reluctance by investors at first, the program
has proven to be very successful.
Much progress has been made since the fiscal crisis of 1975.
By 1981, the City achieved a budget balanced in accordance with
Generally Accepted Accounting Principles (GAAP) and has continued
to generate small surpluses on an operating basis. By 1983, the
City eliminated its accumulated General Fund deficit and as of
the fiscal year ending June 30, 1996, had a total General Fund
balance of $368 million. Although the City continues to finance
its seasonal cash flow needs through public borrowings, the total
amount of these borrowings has not exceeded 10% of any year's
revenues and all have been repaid by the end of the fiscal year.
As of June 1, 1997 the City's general obligation bonds are
rated Baa1 by Moody's, BBB+ by Standard & Poor's and A- by Fitch
with a Stable credit trend.
While New York City sustained a decade long record of
relative financial stability, during the 1990's budgetary
pressures have been evident. Its major revenue sources, income
and sales taxes, were slowed and a downturn in the real estate
market reduced property tax revenues. Nonetheless, the City
concluded the 1996 fiscal year with an operating surplus of $229
million. Revenues and expenditures for the 1996 fiscal year were
balanced in accordance with GAAP for the sixteenth consecutive
year. New York City will require some combination of cuts in
expenditures and state approval of new revenue sources to achieve
permanent fiscal balance in future fiscal years.
Long Island and LILCO
The Long Island Lighting Company (LILCO) is the single
largest property taxpayer in both Nassau and Suffolk Counties.
LILCO has experienced substantial financial difficulty primarily
arising from problems related to its completed but unlicensed 809
megawatt Shoreham Nuclear Power Facility located in Suffolk
County. In 1987, the State Legislature created the Long Island
Power Authority (LIPA). In February, 1989, an agreement was
reached with the state of New York to transfer ownership of the
Shoreham Plant to LIPA for one dollar in exchange for certain
rate benefits to LILCO.
LILCO has challenged various property tax assessments levied
in Suffolk County on its facilities and seeks substantial
refunds. An $81 million refund was made to LILCO in January 1996
for Phase I of this tax litigation. In November, 1996, the New
York State Supreme Court ruled in the company s favor for Phase
II, equating to a $1.16 billion refund, including interest, to
LILCO.
PAGE 23
As requested by the Governor, LIPA has proposed a plan to
restructure LILCO, reduce rates on Long Island and provide a
framework for long-term competition in power production.
Included in the plan would be a settlement of the Suffolk County
tax liability. Certain of LILCO s assets would be purchased by
LIPA with the issuance of approximately $7.3 billion of tax-
exempt debt. Numerous approvals are required, including an IRS
ruling exempting the deal from capital gains taxes. In addition,
a merger agreement between LILCO and Brooklyn Union Gas Company
was announced at year end 1996, providing another positive
development for the company. The merger is subject to various
federal and state approvals.
Sectors
Certain areas of potential investment concentration present
unique risks. In 1996, $1.8 billion of tax-exempt debt issued in
New York was for public or non-profit hospitals. A significant
portion of the Fund's assets may be invested in health care
issues. For over a decade, the hospital industry has been under
significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial
health of many hospitals. While each hospital bond issue is
separately secured by the individual hospital's revenues, third
party reimbursement sources such as the federal Medicare and
state Medicaid programs or private insurers are common to all
hospitals. To the extent these third party payors reduce
reimbursement levels, the individual hospitals may be affected.
The proposed fiscal 1997 State budget calls for sizable
reductions in the state's support of Medicaid and health
services. In the face of these pressures, the trend of hospital
mergers and acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for
the institutions.
The Funds may from time to time invest in electric revenue
issues which have exposure to or participate in nuclear power
plants which could affect the issuers' financial performance.
Such risks include unexpected outages or plan shutdowns,
increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance
of electric utilities may be impacted by increased competition
and deregulation in the industry.
The Funds may invest in private activity bond issues for
corporate and non-profit borrowers. These issues sold through
various governmental conduits, are backed solely by the revenues
pledged by the respective borrowing corporations. No
governmental support is implied. This category accounted for
6.6% of the tax-exempt debt issued in New York during 1996.
RISK FACTORS ASSOCIATED WITH A VIRGINIA PORTFOLIO
PAGE 24
The Funds concentration in the debt obligations of one
state carries a higher risk than a portfolio that is
geographically diversified. In addition to State of Virginia
general obligations and state agency issues, the Fund will invest
in local bond issues, lease obligations and revenue bonds, the
credit quality and risk of which will vary according to each
security's own structure and underlying economics.
Debt. The State of Virginia and its local governments
issued $3.9 billion municipal bonds in 1996, approximately 31%
general obligation debt backed by the unlimited taxing power of
the issuer and 69% revenue bonds secured by specific pledged fees
or charges for an enterprise or project. Included within the
revenue bond category are tax-exempt lease obligations that are
subject to annual appropriations of a governmental body to meet
debt service, usually with no implied tax or specific revenue
pledge. Debt issued in 1996 was for a wide variety of public
purposes, including transportation, housing, education, health
care, and industrial development.
As of June 30, 1996 the State of Virginia had $1.0 billion
outstanding general obligation bonds secured by the State's
revenue and taxing power, a modest amount compared to many other
states. Under state law, general obligation debt is limited to
1.15 times the average of the preceding three years' income tax
and sales and use tax collections. The State's outstanding
general obligation debt is well below that limit and over 90% of
the debt service is actually met from revenue producing capital
projects such as universities and toll roads.
The State also supports $1.5 billion in debt issued by the
Virginia Public Building Authority, the Virginia College Building
Authority, the Virginia Port Authority, the Innovative Technology
Authority and for transportation purposes. These bonds are not
backed by the full faith and credit of the State but instead, are
subject to annual appropriations from the State's General Fund.
In addition to the State and public authorities described
above, an additional $6.5 billion bonds have been issued by
special public authorities in Virginia that are not obligations
of the State. These bonds include debt issued by the Virginia
Education Loan Authority, the Virginia Public School Authority,
the Virginia Resources Authority, and the Virginia Housing
Development Authority.
Economy. The State of Virginia has a population of
approximately 6.6 million, making it the twelfth largest state.
Since the 1930s the State's population has grown at a rate near
or exceeding the national average. Stable to strong economic
growth during the 1980s was led by the northern Virginia area
outside of Washington, D.C. where approximately 25% of the
State's population is concentrated. The next largest
metropolitan area is the Norfolk-Virginia Beach-Newport News
PAGE 25
area, followed by the Richmond-Petersburg area, including the
State's capital of Richmond. The State's economy is broadly
based, with a large concentration in service and governmental
jobs, followed by manufacturing. Virginia has significant
concentrations of high technology employers, with nearly 150,000
people employed in 3,900 establishments. Per capita income
exceeds national averages while unemployment figures have
consistently tracked below national averages.
Financial. To a large degree, the risk of the portfolio is
dependent on the financial strength of the State of Virginia and
its localities. As of June 1, 1997, the State was rated Triple-A
by Moody's, Standard & Poor's and Fitch. The State's budget is
prepared on a biennial basis. From 1970 through 1996 the State's
General Fund showed a positive balance for all of its two year
budgetary periods. The national recession and its negative
effects on State personal income tax collections did, however,
force the State to draw down its General Fund balances to a
deficit position in 1992. Spending cuts and improved economic
conditions allowed for positive operations in 1993-1995. The
State posted a budgetary surplus for fiscal years 1995 and 1996
despite federal retiree settlements and other transfers. On June
30, 1996, the unreserved general fund balance, including a
revenue stabilization account, totaled $148 million.
A significant portion of the Funds assets is expected to be
invested in the debt obligations of local governments and public
authorities with investment grade ratings of BBB or higher.
While local governments in Virginia are primarily reliant on
independent revenue sources, such as property taxes, they are not
immune to budget shortfalls caused by cutbacks in State aid.
Likewise, certain enterprises such as toll roads or hospitals may
be affected by changes in economic activity.
Sectors. Certain areas of potential investment
concentration present unique risks. In 1996, $487 million of
tax-exempt debt issued in Virginia was for public or non-profit
hospitals. A significant portion of the Fund's assets may be
invested in health care issues. For over a decade, the hospital
industry has been under significant pressure to reduce expenses
and shorten length of stay, a phenomenon which has negatively
affected the financial health of many hospitals. While each
hospital bond issue is separately secured by the individual
hospital's revenues, third party reimbursement sources such as
the federal Medicare and state Medicaid programs or private
insurers are common to all hospitals. To the extent these payors
reduce reimbursement levels, the individual hospitals may be
affected. In the face of these pressures, the trend of hospital
mergers and acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for
the institutions involved.
PAGE 26
The Funds may from time to time invest in electric revenue
issues which have exposure to or participate in nuclear power
plants which could affect the issuers' financial performance.
Such risks include unexpected outages or plant shutdowns,
increased Nuclear Regulatory Commission surveillance or
inadequate rate relief.
The Funds may invest in private activity bond issues for
corporate and non-profit borrowers. These issues sold through
various governmental conduits, are backed solely by the revenues
pledged by the respective borrowing corporations. No
governmental support is implied.
RISK FACTORS ASSOCIATED WITH A NEW JERSEY PORTFOLIO
The Fund's concentration in the debt obligations of one
state carries a higher risk than a portfolio that is
geographically diversified. In addition to State of New Jersey
general obligation bonds, notes and state agency issues, the Fund
will invest in local bond issues, lease obligations and revenue
bonds, the credit quality and risk of which will vary according
to each security's own structure and underlying economics.
Debt. The State of New Jersey and its local governments
issued $5.7 billion of municipal bonds in 1996. Of this amount,
approximately 42% was general obligation debt backed by the
unlimited taxing power of the issuer and 58% were revenue bonds
secured by specific pledged fees or charges for an enterprise or
project. Included within the revenue bond sector are tax-exempt
lease obligations that are subject to annual appropriations of a
governmental body, usually with no implied tax or specific
revenue pledge. Debt issued in 1996 was for a wide array of
public purposes, including water and sewer projects, health care,
housing, education, transportation, and pollution control.
The State of New Jersey has approximately $3.6 billion
outstanding general obligation bonds secured by the State's
revenue and taxing power. As of June 1, 1997, its general
obligation bonds were rated Aa1 by Moody's, AA+ by Standard &
Poor's and AA+ by Fitch. In addition to the State's direct debt,
it is obligated for certain lease backed debt issued through the
Mercer County Improvement Authority, the New Jersey Economic
Development Authority, the New Jersey Building Authority, the
Educational Facilities Authority and the Transportation Trust
Fund Authority. Under State law, the obligations of certain
local school districts and county college districts have been
supported by State appropriations. The State has also entered
into a "moral obligation" (as opposed to a legal commitment) to
make up debt service shortfalls for the New Jersey Housing and
Mortgage Finance Agency as well as the South Jersey Port
Corporation. While no assistance has ever been required for the
New Jersey Housing and Mortgage Finance Agency, from time to
PAGE 27
time, the State has supported the operations and debt service of
the South Jersey Port Corporation. The State has also guaranteed
bonds issued by the Sports and Exposition Authority. The related
obligations of the State described in this paragraph total an
additional $6.0 billion.
A number of other state-created agencies issue tax-exempt
revenue bonds that are not a debt or liability of the State. The
largest such entities include the New Jersey Turnpike Authority,
the New Jersey Educational Facilities Authority and the New
Jersey Health Care Facilities Financing Authority.
A significant portion of the portfolio's assets is expected
to be invested in the debt obligations of local governments and
public authorities with investment grade ratings of BBB or
higher. While local governments in New Jersey are primarily
reliant on independent revenue sources, such as property taxes,
they are not immune to budget shortfalls caused by economic
downturns or cutbacks in State aid. Likewise, certain
enterprises such as toll roads or hospitals may be affected by
changes in economic activity. Under the New Jersey Local Budget
Law, the State oversees the budget preparation of local
governments and has certain powers to enforce balanced budgets,
limit short term borrowing and regulate overall debt limits.
Economy. New Jersey is the ninth largest and most densely
populated state with 7.9 million residents. The economic base is
diversified among manufacturing, construction, services, and
agricultural uses. The per capita personal income of $31,053
ranks the State as the second highest in the United States. Over
the long term, the State's economy has been a strong performer,
with unemployment levels generally below national averages;
however, since the recession of 1991-92, the State's growth rate
has lagged the nation.
Financial. To a large degree, the risk of the portfolio is
dependent on the financial strength of the State of New Jersey
and its localities. Characteristically, the State has
demonstrated solid financial performance, but operations suffered
as the State's economy stagnated during the recession of the
early 1990's. In fiscal 1990 through 1994 New Jersey utilized
non-recurring revenues and expenditure deferrals and a tax
increase to achieve balance. An environment of cost controls and
a slightly improved economy allowed the State to conclude fiscal
year 1996 with an undesignated general fund balance of $442
million (2.5% of general fund revenues). Effective January 1996,
the State completed the last stage of a 30% reduction in personal
income tax rates which was accommodated for in the budget for
fiscal year 1997. The proposed budget for fiscal 1998 evidences
initial signs of fiscal pressure. The budget plan relies on
savings from a controversial pension financing and is complicated
by a recent State court ruling which mandates additional funding
for certain school districts.
PAGE 28
Sectors. Certain areas of potential investment
concentration present unique risks. In 1996, 7% of tax-exempt
debt issued in New Jersey was for public or non-profit hospitals.
A significant portion of the Fund's assets may be invested in
health care issues. For over a decade, the hospital industry has
been under significant pressure to reduce expenses and shorten
length of stay, a phenomenon which has negatively affected the
financial health of many hospitals. While each hospital bond
issue is separately secured by the individual hospital's
revenues, third party reimbursement sources such as the federal
Medicare and state Medicaid programs or private insurers are
common to all hospitals. To the extent these payors reduce
reimbursement levels, the individual hospitals may be affected.
In the face of these pressures, the trend of hospital mergers and
a acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for
the institutions involved. In May 1996, the State of New Jersey
reauthorized the funding of charity care subsidies to eligible
hospitals. The new authorization runs through December 31, 1997.
The failure of the State to renew this program or put in place a
permanent funding mechanism may affect the financial performance
of certain New Jersey hospitals in future years.
The Fund may from time to time invest in electric revenue
issues which have exposure to or participate in nuclear power
plants which could affect the issuers' financial performance.
Such risks include delay in construction and operation due to
increased regulation, unexpected outages or plant shutdowns,
increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance
of electric utilities may be impacted by increased competition
and deregulation in the industry.
The Fund may invest in private activity bond issues for
corporate and non-profit borrowers. These issues sold through
governmental conduits, such as the New Jersey Economic
Development Authority and various local issuers, are backed
solely by the revenues pledged by the respective borrowing
corporations. No governmental support is implied. This category
accounted for 6.6% of the tax-exempt debt issued in New Jersey
during 1996. In the past, a number of New Jersey Economic
Development Authority issues have defaulted as a result of
borrower financial difficulties. A number of counties and
utility authorities in the state have issued several billion
dollars of bonds to fund incinerator projects and solid waste
projects. A recent federal court decision striking down New
Jersey s system of solid waste flow control increases the
potential risk of default absent a successful appeal, legislative
solution, or some form of subsidy by local or State governments.
All Funds
Puerto Rico
PAGE 29
From time to time the Fund invests in obligations of the
Commonwealth of Puerto Rico and its public corporations which are
exempt from federal, state and city or local income taxes. The
majority of the Commonwealth's debt is issued by the major public
agencies that are responsible for many of the islands' public
functions, such as water, wastewater, highways,
telecommunications, education, and public construction. As of
December 31, 1996, public sector debt issued by the Commonwealth
and its public corporations totaled $18.4 billion.
Since the 1980s, Puerto Rico's economy and financial
operations have paralleled the economic cycles of the United
States. The island's economy, particularly the manufacturing
sector, has experienced substantial gains in employment. Much of
these economic gains are attributable in part to favorable
treatment under Section 936 of the Federal Internal Revenue Code
for United States corporations doing business in Puerto Rico.
The number of persons employed in Puerto Rico during fiscal 1994
averaged 1 million persons -- a record level. Unemployment,
however, still remains high at 13.8 percent.
Debt ratios for the Commonwealth are high as it assumes much
of the responsibility for local infrastructure. Sizable
infrastructure programs are ongoing to upgrade the island's
water, sewer, and road systems. The Commonwealth's general
obligation debt is secured by a first lien on all available
revenues. The Commonwealth has maintained a fiscal policy which
seeks to correlate the growth in public sector debt to the growth
of the economic base available to service that debt. Between
fiscal years 1992 and 1996, debt increased 27.5% while gross
product rose 27.7%. Short term debt remains a modest 13% of total
debt outstanding as of December 31, 1996. The maximum annual
debt service requirement on Commonwealth general obligation debt
totaled 8.7% of governmental revenues for fiscal 1997. This is
well below the 15% limit imposed by the Constitution of Puerto
Rico.
After recording 3 years of positive operating results in the
1989 to 1991 period, the Commonwealth's General Fund moved into a
deficit position, with a $62 million cash deficit for fiscal 1992
and a $116 million deficit for fiscal 1993. The fiscal 1994
budget was balanced with an increase in the "tollgate" tax on
Section 936 companies and improved revenue collections, which
enabled the Commonwealth to record a strong turnaround in the
General Fund balance to $309 million (6.8% of general fund
expenses). A General Fund unreserved balance of $171 million was
recorded for the end of fiscal year 1996.
The Commonwealth's economy remains vulnerable to changes in
oil prices, American trade, foreign policy, and levels of federal
assistance. Per capita income levels, while being the highest in
the Caribbean, lag far behind the United States. In November
1993, the voters of Puerto Rico were asked in a non-binding
PAGE 30
referendum to consider the options of statehood, continued
Commonwealth status, or independence. 48.4% of the voters
favored continuation of Commonwealth status, 46.2% were for
statehood, and 4.4% were for independence. In February 1997,
legislation was introduced in Congress proposing a mechanism to
permanently settle the political relationship with the United
States.
For many years U.S. companies operating in Puerto Rico were
eligible to receive a special tax credit available under Section
936 of the federal tax code, which helped spur significant
expansion in capital intensive manufacturing activity. Federal
tax legislation was passed in 1993 which revised the tax benefits
received by U.S. corporations (Section 936 firms) that operate
manufacturing facilities in Puerto Rico. The legislation provides
these firms with two options: a 5 year phased reduction of the
income based tax credit to 40% of the previously allowable credit
or the conversion to a wage based standard, allowing a tax credit
for the first 60% of qualified compensation paid to employees as
defined in the IRS Code. Studies indicate that there have been
no reductions in the economic growth rate or employment in
industries which were expected to be impacted by the 1993
amendments. In 1996, amendments were signed into law to phase
out the tax credit over a ten year period for existing claimants
and to eliminate it for corporations without established
operations after October 1995. At present, it is difficult to
forecast what the short and long term effects of a phase-out of
the Section 936 credit would have on the economy of Puerto Rico.
A final risk factor with the Commonwealth is the large
amount of unfunded pension liabilities. The two main public
pension systems are largely underfunded. The employees
retirement system has a funded ratio of 19% and an unfunded
liability of $5.0 billion. The teachers retirement system has a
funded ratio of 56% and an unfunded liability of $1.1 billion. A
measure enacted by the legislature in 1990 is designed to address
the solvency of the plans over a 50 year period.
INVESTMENT PROGRAMS
(Throughout the discussion on Investments, the term "the Fund" is
intended to refer to each of the Funds eligible to invest in the
security or engage in the practice being described.)
Municipal Securities
All Funds
Subject to the investment objective and program described in
the prospectus and the additional investment restrictions
described in this Statement of Additional Information, each
PAGE 31
Fund's portfolio may consist of any combination of the various
types of municipal securities described below or others that may
be developed. The amount of each Fund's assets invested in any
particular type of municipal security can be expected to vary.
The term "municipal securities" means obligations issued by
or on behalf of states, territories, and possessions of the
United States and the District of Columbia and their political
subdivisions, agencies and instrumentalities, as well as certain
other persons and entities, the interest from which is exempt
from federal, state, and/or city or local, if applicable, income
tax. In determining the tax-exempt status of a municipal
security, the Funds rely on the opinion of the issuer's bond
counsel at the time of the issuance of the security. However, it
is possible this opinion could be overturned, and as a result,
the interest received by the Funds from such a security might not
be exempt from federal, state, and/or city or local income tax.
Municipal securities are classified by maturity as notes,
bonds, or adjustable rate securities.
Municipal Notes. Municipal notes generally are used to
provide for short-term operating or capital needs and generally
have maturities of one year or less. Municipal notes include:
Tax Anticipation Notes. Tax anticipation notes are
issued to finance working capital needs of
municipalities. Generally, they are issued in
anticipation of various seasonal tax revenue, such as
income, property, use and business taxes, and are
payable from these specific future taxes.
Revenue Anticipation Notes. Revenue anticipation
notes are issued in expectation of receipt of other
types of revenue, such as federal or state revenues
available under the revenue sharing or grant programs.
Bond Anticipation Notes. Bond anticipation notes are
issued to provide interim financing until long-term
financing can be arranged. In most cases, the
long-term bonds then provide the money for the
repayment of the notes.
Tax-Exempt Commercial Paper. Tax-exempt commercial
paper is a short-term obligation with a stated
maturity of 270 days or less. It is issued by state
and local governments or their agencies to finance
seasonal working capital needs or as short-term
financing in anticipation of longer term financing.
Municipal Bonds. Municipal bonds, which meet longer
term capital needs and generally have maturities of
more than one year when issued, have two principal
PAGE 32
classifications: general obligation bonds and revenue
bonds. Two additional categories of potential
purchases are lease revenue bonds and
pre-refunded/escrowed to maturity bonds. Another type
of municipal bond is referred to as an Industrial
Development Bond.
General Obligation Bonds. Issuers of general
obligation bonds include states, counties, cities,
towns, and special districts. The proceeds of these
obligations are used to fund a wide range of public
projects, including construction or improvement of
schools, public buildings, highways and roads, and
general projects not supported by user fees or
specifically identified revenues. The basic security
behind general obligation bonds is the issuer's pledge
of its full faith and credit and taxing power for the
payment of principal and interest. The taxes that can
be levied for the payment of debt service may be
limited or unlimited as to the rate or amount of
special assessments. In many cases voter approval is
required before an issuer may sell this type of bond.
Revenue Bonds. The principal security for a revenue
bond is generally the net revenues derived from a
particular facility, or enterprise, or in some cases,
the proceeds of a special charge or other pledged
revenue source. Revenue bonds are issued to finance a
wide variety of capital projects including: electric,
gas, water and sewer systems; highways, bridges, and
tunnels; port and airport facilities; colleges and
universities; and hospitals. Revenue bonds are
sometimes used to finance various privately operated
facilities provided they meet certain tests
established for tax-exempt status.
Although the principal security behind these bonds may
vary, many provide additional security in the form of
a mortgage or debt service reserve fund. Some
authorities provide further security in the form of
the state's ability (without obligation) to make up
deficiencies in the debt service reserve fund.
Revenue bonds usually do not require prior voter
approval before they may be issued.
Lease Revenue Bonds. Municipal borrowers may also
finance capital improvements or purchases with
tax-exempt leases. The security for a lease is
generally the borrower's pledge to make annual
appropriations for lease payments. The lease payment
is treated as an operating expense subject to
appropriation risk and not a full faith and credit
obligation of the issuer. Lease revenue bonds are
PAGE 33
generally considered less secure than a general
obligation or revenue bond and often do not include a
debt service reserve fund. To the extent the Board
determines such securities are illiquid, they will be
subject to the Funds' 15% limit on illiquid securities
(10% limit for the Money Funds). There have also been
certain legal challenges to the use of lease revenue
bonds in various states.
The liquidity of such securities will be determined
based on a variety of factors which may include, among
others: (1) the frequency of trades and quotes for the
obligation; (2) the number of dealers willing to
purchase or sell the security and the number of other
potential buyers; (3) the willingness of dealers to
undertake to make a market in the security; (4) the
nature of the marketplace trades, including, the time
needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer; and
(5) the rating assigned to the obligation by an
established rating agency or T. Rowe Price.
Pre-refunded/Escrowed to Maturity Bonds. Certain
municipal bonds have been refunded with a later bond
issue from the same issuer. The proceeds from the
later issue are used to defease the original issue.
In many cases the original issue cannot be redeemed or
repaid until the first call date or original maturity
date. In these cases, the refunding bond proceeds
typically are used to buy U.S. Treasury securities
that are held in an escrow account until the original
call date or maturity date. The original bonds then
become "pre-refunded" or "escrowed to maturity" and
are considered as high quality investments. While
still tax-exempt, the security is the proceeds of the
escrow account. To the extent permitted by the
Securities and Exchange Commission and the Internal
Revenue Service, a Fund's investment in such
securities refunded with U.S. Treasury securities
will, for purposes of diversification rules applicable
to the Fund, be considered as an investment in the
U.S. Treasury securities.
Private Activity Bonds. Under current tax law all
municipal debt is divided broadly into two groups:
governmental purpose bonds and private activity bonds.
Governmental purpose bonds are issued to finance
traditional public purpose projects such as public
buildings and roads. Private activity bonds may be
issued by a state or local government or public
authority but principally benefit private users and
are considered taxable unless a specific exemption is
provided.
PAGE 34
The tax code currently provides exemptions for certain
private activity bonds such as not-for-profit hospital
bonds, small-issue industrial development revenue
bonds and mortgage subsidy bonds, which may still be
issued as tax-exempt bonds. Some, but not all,
private activity bonds are subject to alternative
minimum tax.
Industrial Development Bonds. Industrial development
bonds are considered Municipal Bonds if the interest
paid is exempt from federal income tax. They are
issued by or on behalf of public authorities to raise
money to finance various privately operated facilities
for business and manufacturing, housing, sports, and
pollution control. These bonds are also used to
finance public facilities such as airports, mass
transit systems, ports, and parking. The payment of
the principal and interest on such bonds is dependent
solely on the ability of the facility's user to meet
its financial obligations and the pledge, if any, of
real and personal property so financed as security for
such payment.
Adjustable Rate Securities. Municipal securities may
be issued with adjustable interest rates that are
reset periodically by pre-determined formulas or
indexes in an effort to minimize movements in the
principal value of the investment. For example, the
interest rate on a bond could be indexed to the
consumer price index. Such securities may have
long-term maturities, but may be treated as a
short-term investment under certain conditions.
Generally, as interest rates decrease or increase, the
potential for capital appreciation or depreciation on
these securities is less than for fixed-rate
obligations. These securities may take a variety of
forms including the following:
Variable Rate Securities. Variable rate securities
are those whose terms provide for the adjustment of
their interest rates on set dates and which, upon each
adjustment until the final maturity of the instrument
or the period remaining until the principal amount can
be recovered through demand, can reasonably be
expected to have a market value that approximates its
amortized cost. Subject to the provisions of Rule 2a-
7 under the Investment Company Act of 1940 (1940 Act):
(1) a variable rate security, the principal amount of
which is scheduled to be paid in 397 calendar days or
less, is deemed to have a maturity equal to the
earlier of the period remaining until the next
readjustment of the interest rate or the period
remaining until the principal amount can be recovered
PAGE 35
through demand; (2) a variable rate security, the
principal amount of which is scheduled to be paid in
more than 397 calendar days, which is subject to a
demand feature, as defined in Rule 2a-7, is deemed to
have a maturity equal to the longer of the period
remaining until the next readjustment of the interest
rate or the period remaining until the principal
amount can be recovered through demand; and (3) a
security that is issued or guaranteed by the U.S.
Government or any agency thereof which has a variable
rate of interest readjusted no less frequently than
every 762 calendar days may be deemed to have a
maturity equal to the period remaining until the next
readjustment of the interest rate. Should the
provisions of Rule 2a-7 change, the Fund will
determine the maturity of these securities in
accordance with the amended provisions of such Rule.
Floating Rate Securities. Floating rate securities
are those whose terms provide for the adjustment of
their interest rates whenever a specified interest
rate changes and which, at any time until the final
maturity of the instrument or the period remaining
until the principal amount can be recovered through
demand, can reasonably be expected to have a market
value that approximates its amoritized cost. Subject
to the provisions of Rule 2a-7 under the 1940 Act: (1)
the maturity of a floating rate security, the
principal amount of which must be unconditionally paid
in 397 calendar days or less, is deemed to be one day;
and (2) a floating rate security, the principal amount
of which is scheduled to be paid in more than 397
calendar days, that is subject to a demand feature, is
deemed to have a maturity equal to the period
remaining until the principal amount can be recovered
through demand. Should the provisions of Rule 2a-7
change, the Fund will determine the maturity of these
securities in accordance with the amended provisions
of such Rule.
Put Option Bonds. Long-term obligations with
maturities longer than one year may provide purchasers
an optional or mandatory tender of the security at par
value at predetermined intervals, often ranging from
one month to several years (e.g., a 30-year bond with
a five-year tender period). These instruments are
deemed to have a maturity equal to the period
remaining to the put date.
Residual Interest Bonds (Bond Funds only)(These are a
type of potentially high-risk derivative). The Funds
may purchase municipal bond issues that are structured
as two-part, residual interest bond and variable rate
PAGE 36
security offerings. The issuer is obligated only to
pay a fixed amount of tax-free income that is to be
divided among the holders of the two securities. The
interest rate for the holders of the variable rate
securities will be determined by an auction process
held approximately every 35 days while the bond
holders will receive all interest paid by the issuer
minus the amount given to the variable rate security
holders and a nominal auction fee. Therefore, the
coupon of the residual interest bonds, and thus the
income received, will move inversely with respect to
short-term, 35 day tax-exempt interest
rates. There is no assurance that the auction will be
successful and that the variable rate security will
provide short-term liquidity. The issuer is not
obligated to provide such liquidity. In general,
these securities offer a significant yield advantage
over standard municipal securities, due to the
uncertainty of the shape of the yield curve (i.e.,
short-term versus long-term rates)and consequent
income flows. Unlike many adjustable rate securities,
residual interest bonds are not necessarily expected
to trade at par and in fact present significant market
risks. In certain market environments, residual
interest bonds may carry substantial premiums or be at
deep discounts. This is a relatively new product in
the municipal market with limited liquidity to date.
Participation Interests. The Funds may purchase, from
third parties, participation interests in all or part
of specific holdings of municipal securities. The
purchase may take different forms: in the case of
short-term securities, the participation may be backed
by a liquidity facility that allows the interest to be
sold back to the third party (such as a trust, broker
or bank) for a predetermined price of par at stated
intervals. The seller may receive a fee from the
Funds in connection with the arrangement.
In the case of longer-term bonds, the Funds may
purchase interests in a pool of municipal bonds or a
single municipal bond or lease without the right to
sell the interest back to the third party.
The Funds will not purchase participation interests
unless a satisfactory opinion of counsel or ruling of
the Internal Revenue Service has been issued that the
interest earned from the municipal securities on which
the Funds holds participation interests is exempt from
federal, state, and/or city or local income tax to the
Funds. However, there is no guarantee the IRS would
treat such interest income as tax-exempt.
PAGE 37
Embedded Interest Rate Swaps and Caps (Bond Funds).
In a fixed-rate, long-term municipal bond with an
interest rate swap attached to it, the bondholder
usually receives the bond's fixed-coupon payment as
well as a variable rate payment that represents the
difference between a fixed rate for the term of the
swap (which is typically shorter than the bond it is
attached to) and a variable rate short-term municipal
index. The bondholder receives excess income when
short-term rates remain below the fixed interest rate
swap rate. If short-term rates rise above the fixed-
income swap rate, the bondholder's income is reduced.
At the end of the interest rate swap term, the bond
reverts to a single fixed-coupon payment. Embedded
interest rate swaps enhance yields, but also increase
interest rate risk.
An embedded interest rate cap allows the bondholder to
receive payments whenever short-term rates rise above
a level established at the time of purchase. They
normally are used to hedge against rising short-term
interest rates.
Both instruments may be volatile and of limited
liquidity and their use may adversely affect a Fund's
total return.
The Funds may invest in other types of derivative
instruments as they become available.
There are, of course, other types of municipal
securities that are, or may become, available, and the
Funds reserve the right to invest in them.
For the purpose of the Funds' investment restrictions,
the identification of the "issuer" of municipal
securities which are not general obligation bonds is
made by the Funds' investment manager, T. Rowe Price,
on the basis of the characteristics of the obligation
as described above, the most significant of which is
the source of funds for the payment of principal and
interest on such securities.
When-Issued Securities
All Funds
New issues of municipal securities are often offered on a
when-issued basis; that is, delivery and payment for the
securities normally takes place 15 to 45 days or more after the
date of the commitment to purchase. The payment obligation and
the interest rate that will be received on the securities are
each fixed at the time the buyer enters into the commitment. A
PAGE 38
Fund will only make a commitment to purchase such securities with
the intention of actually acquiring the securities. However, a
Fund may sell these securities before the settlement date if it
is deemed advisable as a matter of investment strategy. Each
Fund will establish a segregated account in which it will
maintain cash and high-grade marketable debt securities equal in
value to commitments for when-issued securities. Such segregated
securities either will mature or, if necessary, be sold on or
before the settlement date. Securities purchased on a
when-issued basis and the securities held in a Fund's portfolio
are subject to changes in market value based upon the public
perception of the creditworthiness of the issuer and changes in
the level of interest rates (which will generally result in
similar changes in value; i.e., both experiencing appreciation
when interest rates decline and depreciation when interest rates
rise). Therefore, to the extent a Fund remains substantially
fully invested at the same time that it has purchased securities
on a when-issued basis, there will be greater fluctuations in its
net asset value than if it solely set aside cash to pay for
when-issued securities. In the case of the Money Funds, this
could increase the possibility that the market value of a Fund's
assets could vary from $1.00 per share.
In addition, there will be a greater potential for the
realization of capital gains, which are not exempt from federal,
state and/or city or local income tax. When the time comes to
pay for when-issued securities, a Fund will meet its obligations
from then-available cash flow, sale of securities or, although it
would not normally expect to do so, from sale of the when-issued
securities themselves (which may have a value greater or less
than the payment obligation). The policies described in this
paragraph are not fundamental and may be changed by a Fund upon
notice to its shareholders.
Forwards
Bond Funds
The Funds also may purchase bonds on a when-issued basis
with longer than standard settlement dates, in some cases
exceeding one to two years. In such cases, the Funds must
execute a receipt evidencing the obligation to purchase the bond
on the specified issue date, and must segregate cash internally
to meet that forward commitment. Municipal "forwards" typically
carry a substantial yield premium to compensate the buyer for the
risks associated with a long when-issued period, including:
shifts in market interest rates that could materially impact the
principal value of the bond, deterioration in the credit quality
of the issuer, loss of alternative investment options during the
when-issued period, changes in tax law or issuer actions that
would affect the exempt interest status of the bonds and prevent
delivery, failure of the issuer to complete various steps
required to issue the bonds, and limited liquidity for the buyer
PAGE 39
to sell the escrow receipts during the when-issued period. Each
Fund will not invest more than 10% of its total assets in
forwards.
Investment in Taxable Money Market Securities
Although the Funds expect to be invested solely in municipal
securities, it is anticipated that, when it is deemed to be in
the best interests of each Fund's shareholders to do so, the
Funds may also invest a portion of their respective assets on a
temporary basis, in the taxable money market instruments set
forth below. The interest earned on these money market
securities is not exempt from federal, state, and/or city or
local income tax and may be taxable to shareholders as ordinary
income.
U.S. Government Obligations - direct obligations of the
government and its agencies and instrumentalities;
U.S. Government Agency Securities - obligations issued or
guaranteed by U.S. government sponsored enterprises, federal
agencies and international institutions. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; others are supported by the right of the issuer; and
the remainder are supported only by the credit of the
instrumentality;
Bank Obligations - certificates of deposit, bankers'
acceptances, and other short-term obligations of U.S. and
Canadian banks and their foreign branches;
Commercial Paper - paper rated A-2 or better by S&P, Prime-2
or better by Moody's, or F-2 or better by Fitch or, if not rated,
is issued by a corporation having an outstanding debt
issue rated A or better by Moody's, S&P or Fitch, and, with
respect to the Money Funds, is of equivalent investment quality
as determined by the Board of Trustees; and
Short-Term Corporate Debt Securities - short-term corporate
debt securities rated at least AA by S&P, Moody's or Fitch.
Determination of Maturity of Money Market Securities
The Money Funds may only purchase securities which at the
time of investment have remaining maturities of 397 calendar days
or less. The Bond Funds may also purchase money-market
securities. In determining the maturity of money market
securities, the Funds will follow the provisions of Rule 2a-7
under the 1940 Act.
PORTFOLIO MANAGEMENT PRACTICES
PAGE 40
Futures Contracts (Bond Funds only)
Futures are a type of potentially high-risk derivative.
Transactions in Futures
The Fund may enter into interest rate futures contracts
("futures" or "futures contracts"). Interest rate futures
contracts may be used as a hedge against changes in prevailing
levels of interest rates in order to establish more definitely
the effective return on securities held or intended to be
acquired by the Fund. The Fund could sell interest rate futures
as an offset against the effect of expected increases in interest
rates and purchase such futures as an offset against the effect
of expected declines in interest rates. Futures can also be used
as an efficient means of regulating a Fund's exposure to the
market.
The Fund will enter into futures contracts which are traded
on national futures exchanges and are standardized as to maturity
date and underlying financial instrument. A public market exists
in futures contracts covering various taxable fixed income
securities as well as municipal bonds. Futures exchanges and
trading in the United States are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission
("CFTC"). Although techniques other than the sale and purchase
of futures contracts could be used for the above-referenced
purposes, futures contracts offer an effective and relatively low
cost means of implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC.
The Fund may not purchase or sell futures contracts or
related options if, with respect to positions which do not
quality as bona fide hedging under applicable CFTC rules, the sum
of the amounts of initial margin deposits and premiums paid on
those positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized
losses on any such contracts it has entered into; provided,
however, that in the case of an option that is in-the-money at
the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation. For purposes of this policy,
options on futures contracts and options traded on a commodities
exchange will be considered "related options." This policy may
be modified by the Board of Trustees without a shareholder vote
and does not limit the percentage of the Fund's assets at risk to
5%.
PAGE 41
The Fund's use of futures will not result in leverage.
Therefore, to the extent necessary, in instances involving the
purchase of futures contracts or the writing of calls or put
options thereon by the Fund, an amount of cash, U.S. government
securities or other liquid, high-grade debt obligations, equal to
the market value of the futures contracts and options thereon
(less any related margin deposits), will be identified in an
account with the Fund's custodian to cover the position, or
alternative cover (such as owning an offsetting position) will be
employed. Assets used as cover or held in an identified account
cannot be sold while the position in the corresponding option or
future is open, unless they are replaced with similar assets. As
a result, the commitment of a large portion of a Fund's assets to
cover or identified accounts could impede portfolio management or
the Fund's ability to meet redemption requests or other current
obligations.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a debt security) for a
specified price, date, time and place designated at the time the
contract is made. Brokerage fees are incurred when a futures
contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
It is possible that the Fund's hedging activities will occur
primarily through the use of municipal bond index futures
contracts since the uniqueness of that index contract should
better correlate with the Fund's portfolio and thereby be more
effective. However, there may be times when it is deemed in the
best interest of shareholders to engage in the use of Treasury
bond futures, and the Fund reserves to right to use Treasury bond
futures at any time. Use of these futures could occur, as an
example, when both the Treasury bond contract and municipal bond
index futures contract are correlating well with municipal bond
prices, but the Treasury bond contract is trading at a more
advantageous price making the hedge less expensive with the
Treasury bond contract than would be obtained with the municipal
bond index futures contract. The Fund's activity in futures
contracts generally will be limited to municipal bond index
futures contracts and Treasury bond and note contracts.
PAGE 42
Unlike when the Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." 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. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments, in practice most futures contracts are usually
closed out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures 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 futures
contract.
PAGE 43
As an example of an offsetting transaction in which the
underlying instrument is not delivered, the contractual
obligations arising from the sale of one contract of September
municipal bond index futures 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 municipal bond index
futures 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.
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and monetary policies and national
and international political and economic events.
Most United States 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 futures 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.
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
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
PAGE 44
purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of its
futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or short futures positions. The Fund may close its
positions by taking opposite positions which would operate to
terminate the Fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional
cash would be required to be paid by or released to the Fund, and
the Fund would realize a loss or a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Fund intends to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, the
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate trends. There are several
risks in connection with the use by the Fund of futures contracts
as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying
instruments which are the subject of the hedge. T. Rowe Price
will, however, attempt to reduce this risk by entering into
futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the
Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly
PAGE 45
predict movements in the direction of the market. It is possible
that, when the Fund has sold futures to hedge its portfolio
against a decline in the market, the index, indices, or
instruments underlying futures are written might advance and the
value of the underlying instruments held in the Fund's portfolio
might decline. If this were to occur, the Fund would lose money
on the futures and also would experience a decline in value in
its underlying instruments. However, while this might occur to a
certain degree, T. Rowe Price believes that over time the value
of the Fund's portfolio will tend to move in the same direction
as the market indices used to hedge the portfolio. It is also
possible that if the Fund were to hedge against the possibility
of a decline in the market (adversely affecting the underlying
instruments held in its portfolio) and prices instead increased,
the Fund would lose part or all of the benefit of increased value
of those underlying instruments that it has hedged, because it
would have offsetting losses in its futures positions. In
addition, in such situations, if the Fund had insufficient cash,
it might have to sell underlying instruments to meet daily
variation margin requirements. Such sales of underlying
instruments might be, but would not necessarily be, at increased
prices (which would reflect the rising market). The Fund might
have to sell underlying instruments at a time when it would be
disadvantageous to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions, which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by T.
Rowe Price might not result in a successful hedging transaction
over a very short time period.
Options on Futures Contracts
The Fund might trade in municipal bond index option futures
or similar options on futures developed in the future. In
PAGE 46
addition, the Fund may also trade in options on futures contracts
on U.S. government securities and any U.S. government securities
futures index contract which might be developed. In the opinion
of T. Rowe Price, there is a high degree of correlation in the
interest rate, and price movements of U.S. government securities
and municipal securities. However, the U.S. government
securities market and municipal securities markets are
independent and may not move in tandem at any point in time.
The Fund will purchase put options on futures contracts to
hedge its portfolio of municipal securities against the risk of
rising interest rates, and the consequent decline in the prices
of the municipal securities it owns. The Funds will also write
call options on futures contracts as a hedge against a modest
decline in prices of the municipal securities held in the Fund's
portfolio. If the futures price at expiration of a written call
option is below the exercise price, the Fund will retain the full
amount of the option premium, thereby partially hedging against
any decline that may have occurred in the Fund's holdings of debt
securities. If the futures price when the option is exercised is
above the exercise price, however, the Fund will incur a loss,
which may be wholly or partially offset by the increase of the
value of the securities in the Fund's portfolio which were being
hedged.
Writing a put option on a futures contract serves as a
partial hedge against an increase in the value of securities the
Fund intends to acquire. If the futures price at expiration of
the option is above the exercise price, the Fund will retain the
full amount of the option premium which provides a partial hedge
against any increase that may have occurred in the price of the
debt securities the Fund intends to acquire. If the futures
price when the option is exercised is below the exercise price,
however, the Fund will incur a loss, which may be wholly or
partially offset by the decrease in the price of the securities
the Fund intends to acquire.
Options on futures are similar to options on underlying
instruments except that options on futures give 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 the futures contract, 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 which 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. Purchasers of
options who fail to exercise their options prior to the exercise
date suffer a loss of the premium paid.
PAGE 47
From time to time a single order to purchase or sell futures
contracts (or options thereon) may be made on behalf of the Fund
and other T. Rowe Price Funds. Such aggregated orders would be
allocated among the Fund and the other T. Rowe Price Funds in a
fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of Transactions on
Futures Contracts" are substantially the same as the risks of
using options on futures. In addition, where the Fund seeks to
close out an option position by writing or buying an offsetting
option covering the same index, underlying instrument or contract
and having the same exercise price and expiration date, its
ability to establish and close out positions on such options will
be subject to the maintenance of a liquid secondary market.
Reasons for the absence of a liquid secondary market on an
exchange include the following: (i) there may be insufficient
trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or
series of options, or underlying instruments; (iv) unusual or
unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic
or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that
exchange (or in the class or series of options) would cease to
exist, although outstanding options on the exchange that had been
issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with
their terms. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times,
render certain of the facilities of any of the clearing
corporations inadequate, and thereby result in the institution by
an exchange of special procedures which may interfere with the
timely execution of customers' orders. In the event no such
market exists for a particular contract in which the Fund
maintains a position, in the case of a written option, the Fund
would have to wait to sell the underlying securities or futures
positions until the option expires or is exercised. The Fund
would be required to maintain margin deposits on payments until
the contract is closed. Options on futures are treated for
accounting purposes in the same way as the analogous option on
securities are treated.
In addition, the correlation between movements in the price
of options on futures contracts and movements in the price of the
securities hedged can only be approximate. This risk is
PAGE 48
significantly increased when an option on a U.S. government
securities future or an option on a municipal securities index
future is used to hedge a municipal bond portfolio. Another risk
is that the movements in the price of options on futures
contracts may not move inversely with changes in interest rates.
If the Fund has written a call option on a futures contract and
the value of the call increases by more than the increase in the
value of the securities held as cover, the Fund may realize a
loss on the call which is not completely offset by the
appreciation in the price of the securities held as cover and the
premium received for writing the call.
The successful use of options on futures contracts requires
special expertise and techniques different from those involved in
portfolio securities transactions. A decision of whether, when
and how to hedge involves skill and judgment, and even a well-
conceived hedge may be unsuccessful to some degree because of
unexpected market behavior or interest rate trends. During
periods when municipal securities market prices are appreciating,
the Fund may experience poorer overall performance than if it had
not entered into any options on futures contracts.
General Considerations
Transactions by the Fund in options on futures will be
subject to limitations established by each of the exchanges,
boards of trade or other trading facilities governing the maximum
number of options in each class which may be written or purchased
by a single investor or group of investors acting in concert,
regardless of whether the options are written on the same or
different exchanges, boards of trade or other trading facilities
or are held or written in one or more accounts or through one or
more brokers. Thus, the number of contracts which the Fund may
write or purchase may be affected by contracts written or
purchased by other investment advisory clients of T. Rowe Price.
An exchange, board of trade or other trading facility may order
the liquidations of positions found to be in excess of these
limits, and it may impose certain other sanctions.
Additional Futures and Options Contracts
Although the Funds have no current intention of engaging in
futures and options on futures transactions other than those
described above, they reserve the right to do so. Such futures
and options trading might involve risks which differ from those
involved in the futures and options described above.
Federal Tax Treatment of Futures Contracts
Although the Fund invests almost exclusively in securities
which generate income which is exempt from federal income taxes,
the instruments described above are not exempt from such taxes.
PAGE 49
Therefore, use of the investment techniques described above could
result in taxable income to shareholders of the Fund.
Generally, the Fund is required, for federal income tax
purposes, 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.
Gain or loss recognized with respect to a futures contract will
generally be 60% long-term capital gain or loss and 40% short-
term capital gain or loss, without regard to the holding period
of the contract.
Futures contracts which are intended to hedge against a
change in the value of securities may be classified as "mixed
straddles," in which case the recognition of losses may be
deferred to a later year. In addition, sales of such futures
contracts on securities may affect the holding period of the
hedged security and, consequently, the nature of the gain or loss
on such security on disposition.
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; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities.
Gains realized on the sale or other disposition of securities,
including futures contracts on securities held for less than
three months, must be limited to less than 30% of the Fund's
annual gross income. In order to avoid realizing excessive gains
on securities held less than three months, the Fund may be
required to defer the closing out of futures contracts beyond the
time when it would otherwise be advantageous to do so. It is
anticipated that unrealized gains on futures contracts, which
have been open for less than three months as of the end of the
Fund's fiscal year and which are recognized for tax purposes,
will not be considered gains on securities held less than three
months for purposes of the 30% test.
The Fund will distribute to shareholders annually any net
gains which have been recognized for federal income tax purposes
from futures transactions (including unrealized gains at the end
of the Fund's fiscal year). Such distributions will be combined
with distributions of ordinary income or capital gains realized
on the Fund's other investments. Shareholders will be advised of
the nature of the payments. The Fund's ability to enter into
transactions in options on futures contracts may be limited by
the Internal Revenue Code's requirements for qualification as a
regulated investment company.
Options on Securities
Options are another type of potentially high-risk
derivative.
PAGE 50
Bond Funds
The Funds have no current intention of investing in options
on securities, although they reserve the right to do so.
Appropriate disclosure would be added to the Funds' prospectus
and Statement of Additional Information when and if the Funds
decide to invest in options.
INVESTMENT RESTRICTIONS
Fundamental policies of the Funds may not be changed without
the approval of the lesser of (1) 67% of a Fund's shares present
at a meeting of shareholders if the holders of more than 50% of
the outstanding shares are present in person or by proxy or (2)
more than 50% of a Fund's outstanding shares. Other
restrictions, in the form of operating policies, are subject to
change by the Trusts' Board of Trustees without shareholder
approval. Any investment restriction which involves a maximum
percentage of securities or assets shall not be considered to be
violated unless an excess over the percentage occurs immediately
after, and is caused by, an acquisition of securities or assets
of, or borrowings by, a Fund.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money except that the Fund may (i)
borrow for non-leveraging, temporary or emergency
purposes and (ii) engage in reverse repurchase
agreements and make other investments or engage in
other transactions, which may involve a borrowing, in a
manner consistent with the Fund's investment objective
and program, provided that the combination of (i) and
(ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed)
less liabilities (other than borrowings) or such other
percentage permitted by law. Any borrowings which come
to exceed this amount will be reduced in accordance
with applicable law. The Fund may borrow from banks,
other Price Funds or other persons to the extent
permitted by applicable law.
(2) Commodities. Purchase or sell physical commodities;
except that the Fund (other than the Money Funds) may
enter into futures contracts and options thereon;
(3) Industry Concentration. Purchase the securities of any
issuer if, as a result, more than 25% of the value of
the Fund's total assets would be invested in the
securities of issuers having their principal business
activities in the same industry;
PAGE 51
(4) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an interfund
lending program with other Price Funds provided that no
such loan may be made if, as a result, the aggregate of
such loans would exceed 33 1/3% of the value of the
Fund's total assets; (ii) purchase money market
securities and enter into repurchase agreements; and
(iii) acquire publicly-distributed or privately-placed
debt securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer
(California Funds only). Purchase a security if, as a
result, with respect to 75% of the value of its total
assets, more than 5% of the value of the Fund's total
assets would be invested in the securities of a single
issuer, except securities issued or guaranteed by the
U.S. Government or any of its agencies or
instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer
(California Funds only). Purchase a security if, as a
result, with respect to 75% of the value of the Fund's
total assets, more than 10% of the outstanding voting
securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by the
U.S. Government, its agencies or instrumentalities);
(7) Real Estate. Purchase or sell real estate, including
limited partnership interests therein, unless acquired
as a result of ownership of securities or other
instruments (but this shall not prevent the Fund from
investing in securities or other instruments backed by
real estate or securities of companies engaged in the
real estate business);
(8) Senior Securities. Issue senior securities except in
compliance with the Investment Company Act of 1940;
(9) Taxable Securities. During periods of normal market
conditions, purchase any security if, as a result, less
than 80% of the Fund's income would be exempt from
federal and, if applicable, state, city or local income
tax. The income included under the 80% test does not
include income from securities subject to the
alternative minimum tax (AMT); or
(10) Underwriting. Underwrite securities issued by other
persons, except to the extent that the Fund may be
deemed to be an underwriter within the meaning of the
Securities Act of 1933 in connection with the purchase
and sale of its portfolio securities in the ordinary
course of pursuing its investment program.
PAGE 52
NOTES
The following Notes should be read in connection with
the above-described fundamental policies. The Notes
are not fundamental policies.
With respect to investment restrictions (1) and (4) the
Fund will not borrow from or lend to any other T. Rowe
Price Fund unless they apply for and receive an
exemptive order from the SEC or the SEC issues rules
permitting such transactions. The Fund has no current
intention of engaging in any such activity and there is
no assurance the SEC would grant any order requested by
the Fund or promulgate any rules allowing the
transactions.
With respect to investment restriction (1), the Money
Funds have no current intention of engaging in any
borrowing transactions. With respect to investment
restriction (2), the Fund does not consider hybrid
instruments to be commodities.
For purposes of investment restriction (3), U.S., state
or local governments, or related agencies or
instrumentalities, are not considered an industry.
Industrial development bonds issued by nongovernmental
users are subject to the restriction on concentration.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional
securities when money borrowed exceeds 5% of its total
assets.
(2) Control of Portfolio Companies. Invest in companies
for the purpose of exercising management or control;
(3) Equity Securities. Purchase any equity security or
security convertible into an equity security provided
that the Fund (other than the Money Funds) may invest
up to 10% of its total assets in equity securities
which pay tax-exempt dividends and which are otherwise
consistent with the Fund's investment objective and,
further provided, that the Money Funds may invest up to
10% of their total assets in equity securities of other
tax-free open-end money market funds;
(4) Futures Contracts. Purchase a futures contract or an
option thereon if, with respect to positions in futures
or options on futures which do not represent bona fide
hedging, the aggregate initial margin and premiums on
PAGE 53
such positions would exceed 5% of the Fund's net asset
value.
(5) Illiquid Securities. Purchase illiquid securities if,
as a result, more than 15% (10% for the Money Funds) of
its net assets would be invested in such securities;
(6) Investment Companies. Purchase securities of open-end
or closed-end investment companies except in compliance
with the Investment Company Act of 1940 provided that,
the Money Funds may only purchase the securities of
other tax-free open-end money market investment
companies;
(7) Margin. Purchase securities on margin, except (i) for
use of short-term credit necessary for clearance of
purchases of portfolio securities and (ii) it may make
margin deposits in connection with futures contracts or
other permissible investments;
(8) Mortgaging. Mortgage, pledge, hypothecate or, in any
manner, transfer any security owned by the Fund as
security for indebtedness except as may be necessary in
connection with permissible borrowings or investments
and then such mortgaging, pledging or hypothecating may
not exceed 33 1/3% of the Fund's total assets at the
time of borrowing or investment;
(9) Oil and Gas Programs. Purchase participations or other
direct interests or enter into leases with respect to,
oil, gas, or other mineral exploration or development
programs if, as a result therof, more than 5% of the
value of the total assets of the fund would be invested
in such programs;
(10) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement of
Additional Information;
(11) Short Sales. Effect short sales of securities;
(12) Warrants. Invest in warrants if, as a result thereof,
more than 2% of the value of the net assets of the Fund
would be invested in warrants.
For purposes of investment restriction (6), the Fund has no
current intention of purchasing the securities of other
PAGE 54
investment companies. Duplicate fees could result from any
such purchases.
RATINGS OF MUNICIPAL DEBT SECURITIES
Moody's Investors Service, Inc.
Aaa - Bonds 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."
Aa - Bonds 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.
A - Bonds rated A possess many favorable investment
attributes and are to be considered as upper medium grade
obligations.
Baa - Bonds 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.
Ba - Bonds rated Ba are judged to have speculative elements:
their futures 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 characterize
bonds in this class.
B - Bonds rated B generally lack the characteristics of a
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.
Caa - Bonds 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.
Ca - Bonds rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default
or have other marked short-comings.
C - Lowest-rated; extremely poor prospects of ever attaining
investment standing.
PAGE 55
Standard & Poor's Corporation
AAA - This is the highest rating assigned by Standard &
Poor's to a debt obligation and indicates an extremely strong
capacity to pay principal and interest.
AA - Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is very
strong.
A - Bonds rated A have a strong capacity to pay principal
and interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
BBB - Bonds rated BBB are regarded as having an adequate
capacity to pay principal and interest. Whereas they normally
exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, C, CCC, CC - Bonds rated BB, B, CCC, and CC are regarded
on balance, as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal. BB
indicates the lowest degree of speculation and CC the highest
degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse
conditions.
D - In default.
Fitch Investors Service, Inc.
AAA - Bonds rated AAA are considered to be investment grade and
of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and repay principal, which is
unlikely to be affected by reasonably foreseeable events.
AA - Bonds rated AA are considered to be investment grade and of
very high credit quality. The obligor's ability to pay interest
and repay principal is very strong, although not quite as strong
as bonds rated AAA. Because bonds rated in the AAA and AA
categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rate
F-1+.
A - Bonds rated A are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest and
repay principal is considered to be strong, but may be more
vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB - Bonds rated BBB are considered to be investment grade and
of satisfactory credit quality. The obligor's ability to pay
PAGE 56
interest and repay principal is considered to be adequate.
Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds,
and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
BB, B, CCC, CC, and C are regarded on balance as predominantly
speculative with respect to the issuer's capacity to repay
interest and repay principal in accordance with the terms of the
obligation for bond issues not in default. BB indicates the
lowest degree of speculation and C the highest degree of
speculation. The rating takes into consideration special
features of the issue, its relationship to other obligations of
the issuer, and the current and prospective financial condition
and operating performance of the issuer.
RATINGS OF MUNICIPAL NOTES AND VARIABLE SECURITIES
Moody's Investors Services, Inc.
VMIG-1/MIG-1: the best quality. VMIG-2/MIG-2: high quality,
with margins of protection ample though not so large as in the
preceding group.
VMIG-3/MIG-3: favorable quality, with all security elements
accounted for, but lacking the undeniable strength of the
preceding grades. Market access for refinancing, in particular,
is likely to be less well established. VMIG-4/MIG-4: adequate
quality but there is specific risk.
Standard & Poor's Corporation
SP-1: very strong or strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety
characteristics will be given a plus (+) designation. SP-2:
satisfactory capacity to pay principal and interest.
SP-3: speculative capacity to pay principal and interest.
Fitch Investors Service, Inc.
F-1+: exceptionally strong credit quality, strongest degree of
assurance for timely payment. F-1: very strong credit quality.
F-2: good credit quality, having a satisfactory degree of
assurance for timely payment. F-3: fair credit quality,
assurance for timely payment is adequate but adverse changes
could cause the securities to be rated below investment grade.
F-S: weak credit quality, having characteristics suggesting a
minimal degree of assurance for timely payment.
PAGE 57
RATINGS OF COMMERCIAL PAPER
Moody's Investors Service, Inc.
P-1: Superior capacity for repayment. P-2: strong capacity for
repayment.
P-3: acceptable capacity for repayment of short-term promissory
obligations.
Standard & Poor's Corporation
A-1: highest category, degree of safety regarding timely payment
is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+)
designation. A-2: satisfactory capacity to pay principal and
interest.
A-3: adequate capacity for timely payment, but are vulnerable to
adverse effects of changes in circumstances than higher rated
issues. B, and C: speculative capacity to pay principal and
interest.
Fitch Investors Service, Inc.
F-1+: exceptionally strong credit quality, strongest degree of
assurance for timely payment. F-1: very strong credit quality.
F-2: good credit quality, having a satisfactory degree of
assurance for timely payment. F-3: fair credit quality,
assurance for timely payment is adequate but adverse changes
could cause the securities to be rated below investment grade.
F-5: weak credit quality, having characteristics suggesting a
minimal degree of assurance for timely payment.
MANAGEMENT OF THE TRUSTS
The officers and trustees of each Trust are listed below.
Unless otherwise noted, the address of each is 100 East Pratt
Street, Baltimore, Maryland 21202. Except as indicated, each has
been an employee of T. Rowe Price for more than five years. In
the list below, the trustees who are considered "interested
persons" of T. Rowe Price or the Funds as defined under Section
2(a)(19) of the Investment Company Act of 1940 are noted with an
asterisk (*). These trustees are referred to as inside trustees
by virtue of their officership, directorship, and/or employment
with T. Rowe Price.
ROBERT P. BLACK, Trustee--Retired; formerly President, Federal
Reserve Bank of Richmond; Address: 10 Dahlgren Road, Richmond,
Virginia 23233
PAGE 58
CALVIN W. BURNETT, PH.D., Trustee--President, Coppin State
College; Board of Directors, McDonogh School, Inc. and Provident
Bank of Maryland; Past President, Baltimore Area Council Boy
Scouts of America; Vice President, Board of Directors, The
Walters Art Gallery; Address: 2000 North Warwick Avenue,
Baltimore, Maryland 21216
ANTHONY W. DEERING, Trustee--Director, President and Chief
Executive Officer, The Rouse Company, real estate developers,
Columbia, Maryland; Advisory Director, Kleinwort, Benson (North
America) Corporation, a registered broker-dealer; Address: 10275
Little Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, Trustee--President, F. Pierce Linaweaver &
Associates, Inc., Consulting Environmental & Civil Engineer(s);
formerly (1987-1991) Executive Vice President, EA Engineering,
Science, and Technology, Inc., and (1987-1990) President, EA
Engineering, Inc., Baltimore, Maryland; Address: The Legg Mason
Tower, 111 South Calvert Street, Suite 2700, Baltimore, Maryland
21202
*WILLIAM T. REYNOLDS, Chairman of the Board--Managing Director,
T. Rowe Price
*JAMES S. RIEPE, Vice President and Trustee--Vice Chairman of
the Board and Managing Director, T. Rowe Price; Chairman of the
Board, T. Rowe Price Services, Inc., T. Rowe Price Retirement
Plan Services, Inc., and T. Rowe Price Investment Services, Inc;
President and Trust Officer, T. Rowe Price Trust Company;
Director, Rowe Price-Fleming International, Inc. and Rhone-
Poulenc Rorer, Inc.
JOHN G. SCHREIBER, Trustee--President, Schreiber Investments,
Inc., a real estate investment company; Director and formerly
(1/80-12/90) Executive Vice President, JMB Realty Corporation, a
national real estate investment manager and developer; Address:
1115 East Illinois Road, Lake Forest, Illinois 60045
M. DAVID TESTA, Trustee--Chairman of the Board, Price-Fleming;
Vice Chairman of the Board, Chief Investment Officer, and
Managing Director, T. Rowe Price; Vice President and Director, T.
Rowe Price Trust Company; Chartered Financial Analyst, Chartered
Investment Counselor
MARY J. MILLER, President--Managing Director, T. Rowe Price
JANET G. ALBRIGHT, Vice President--Vice President, T. Rowe Price
PATRICE L. BERCHTENBREITER ELY, Vice President--Vice
President, T. Rowe Price
A. GENE CAPONI, Vice President--Vice President and Analyst, T.
Rowe Price
PATRICIA S. DEFORD, Vice President--Vice President, T. Rowe Price
CHARLES B. HILL, Vice President--Assistant Vice President, T.
Rowe Price; formerly (9/86-11/91) managed municipal bonds at
Riggs National Bank, Washington, D.C.
CHARLES O. HOLLAND(a), Vice President--Vice President, T. Rowe
Price
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
PAGE 59
Trust Company; Vice President, Price-Fleming and T. Rowe Price
Retirement Plan Services, Inc.
JOSEPH LYNAGH, Vice President--Assistant Vice President, T.
Rowe Price
KONSTANTINE B. MALLAS, Vice President--Assistant Vice President,
T. Rowe Price
LAURA MCAREE, Vice President--Assistant Vice President, T. Rowe
Price; formerly (4/90-11/90) trader, Boeing Company, Seattle,
Washington and (8/87-3/90) financial analyst, Harvard Management
Company, Boston, Massachusetts
HUGH D. MCGUIRK(a), Vice President--Vice President, T. Rowe
Price; formerly (1991-1993) municipal underwriter, Alex. Brown &
Sons, Inc., Baltimore, Maryland
ALAN P. RICHMAN, Vice President--Vice President, T. Rowe Price;
formerly (10/89-6/91) Manager, Public Finance, Credit Local de
France, New York, New York and Public Finance, Tokai Bank, New
York, New York
THEODORE E. ROBSON(a), Vice President--Employee, T. Rowe Price
WILLIAM F. SNIDER(c), Vice President--Vice President, T. Rowe
Price
GWENDOLYN G. WAGNER(a), Vice President--Vice President and
Economist, T. Rowe Price
C. STEPHEN WOLFE II, Vice President--Vice President, T. Rowe
Price
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
JEREMY N. BAKER(b), Assistant Vice President--Employee, T.
Rowe Price
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President,
T. Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T.
Rowe Price
(a) Messrs. Holland, McGuirk, and Robson and Ms. Wagner are only
officers for the State Tax-Free Income Trust.
(b) Mr. Baker is only an officer of the California Tax-Free
Income Trust.
Each Trust's Executive Committee, comprised of Messrs.
Collins, Reynolds, and Riepe, has been authorized by its Board of
Trustees to exercise all powers of the Board to manage the Funds
in the intervals between meetings of the Board, except the powers
prohibited by statute from being delegated.
PAGE 60
COMPENSATION TABLE
The Funds do not pay pension or retirement benefits to their
officers or directors/trustees. Also, any director/trustee of a
Fund who is an officer or employee of T. Rowe Price does not
receive any remuneration from a Fund.
_________________________________________________________________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Complex
Person, from Paid to
Position Fund(a) Trustees(b)
_________________________________________________________________
California Tax-Free Bond Fund
Robert P. Black,
Trustee $1,261 $56,917
Calvin W. Burnett,
Trustee 1,261 56,917
Anthony W. Deering,
Trustee 1,092 70,667
F. Pierce Linaweaver,
Trustee 1,261 56,917
John Schreiber,
Trustee 1,261 56,917
_________________________________________________________________
California Tax-Free Money Fund
Robert P. Black,
Trustee $1,130 $56,917
Calvin W. Burnett,
Trustee 1,130 56,917
Anthony W. Deering,
Trustee 1,050 70,667
F. Pierce Linaweaver,
Trustee 1,130 56,917
John Schreiber,
Trustee 1,130 56,917
_________________________________________________________________
Florida Insured Intermediate Tax-Free Fund
Robert P. Black,
Trustee $1,121 $56,917
Calvin W. Burnett,
PAGE 61
Trustee 1,121 56,917
Anthony W. Deering,
Trustee 1,047 70,667
F. Pierce Linaweaver,
Trustee 1,121 56,917
John Schreiber,
Trustee 1,121 56,917
_________________________________________________________________
Georgia Tax-Free Bond Fund
Robert P. Black,
Trustee $1,054 $56,917
Calvin W. Burnett,
Trustee 1,054 56,917
Anthony W. Deering,
Trustee 1,018 70,667
F. Pierce Linaweaver,
Trustee 1,054 56,917
John Schreiber,
Trustee 1,054 56,917
_________________________________________________________________
Maryland Tax-Free Bond Fund
Robert P. Black,
Trustee $2,404 $56,917
Calvin W. Burnett,
Trustee 2,404 56,917
Anthony W. Deering,
Trustee 1,564 70,667
F. Pierce Linaweaver,
Trustee 2,404 56,917
John Schreiber,
Trustee 2,404 56,917
_________________________________________________________________
Maryland Short-Term Tax-Free Bond Fund
Robert P. Black,
Trustee $1,161 $56,917
Calvin W. Burnett,
Trustee 1,161 56,917
PAGE 62
Anthony W. Deering,
Trustee 1,062 70,667
F. Pierce Linaweaver,
Trustee 1,161 56,917
John Schreiber,
Trustee 1,161 56,917
_________________________________________________________________
New Jersey Tax-Free Bond Fund
Robert P. Black,
Trustee $1,125 $56,917
Calvin W. Burnett,
Trustee 1,125 56,917
Anthony W. Deering,
Trustee 1,050 70,667
F. Pierce Linaweaver,
Trustee 1,125 56,917
John Schreiber,
Trustee 1,125 56,917
_________________________________________________________________
New York Tax-Free Bond Fund
Robert P. Black,
Trustee $1,237 $56,917
Calvin W. Burnett,
Trustee 1,237 56,917
Anthony W. Deering,
Trustee 1,093 70,667
F. Pierce Linaweaver,
Trustee 1,237 56,917
John Schreiber,
Trustee 1,237 56,917
_________________________________________________________________
New York Tax-Free Money Fund
Robert P. Black,
Trustee $1,133 $56,917
Calvin W. Burnett,
Trustee 1,133 56,917
Anthony W. Deering,
Trustee 1,050 70,667
PAGE 63
F. Pierce Linaweaver,
Trustee 1,133 56,917
John Schreiber,
Trustee 1,133 56,917
_________________________________________________________________
Virginia Tax-Free Bond Fund
Robert P. Black,
Trustee $1,320 $56,917
Calvin W. Burnett,
Trustee 1,320 56,917
Anthony W. Deering,
Trustee 1,126 70,667
F. Pierce Linaweaver,
Trustee 1,320 56,917
John Schreiber,
Trustee 1,320 56,917
_________________________________________________________________
Virginia Short-Term Tax-Free Bond Fund
Robert P. Black,
Trustee $1,137 $56,917
Calvin W. Burnett,
Trustee 1,137 56,917
Anthony W. Deering,
Trustee 1,055 70,667
F. Pierce Linaweaver,
Trustee 1,137 56,917
John Schreiber,
Trustee 1,137 56,917
(a) Amounts in this Column are based on accrued compensation from
March 1, 1996 to February 28, 1997.
(b) Amounts in this column are based on compensation received
from January 1, 1996 to December 31, 1996. The T. Rowe Price
complex included 76 funds as of February 28, 1997.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and trustees
of the Funds, as a group, owned less than 1% of the outstanding
shares of each Fund.
PAGE 64
As of May 30, 1997, the following shareholder of the New
York Tax-Free Money Fund beneficially owned more than 5% of the
outstanding shares of beneficial interest of the Fund:
Coleman M. Brandt and Grace L. Brandt JT TEN, 330 West 72nd
Street, Apt. 10A, New York, New York 10023-2649.
INVESTMENT MANAGEMENT SERVICES
Services
Under the Management Agreement with each Trust relating to
its Funds, T. Rowe Price provides each Fund with discretionary
investment services. Specifically, T. Rowe Price is responsible
for supervising and directing the investments of each Fund in
accordance with each Fund's investment objective, program, and
restrictions as provided in its prospectus and this Statement of
Additional Information. T. Rowe Price is also responsible for
effecting all security transactions on behalf of each Fund,
including the allocation of principal business and portfolio
brokerage and the negotiation of commissions. In addition to
these services, T. Rowe Price provides each Fund with certain
administrative services, including: maintaining each Trust's
existence and records; registering and qualifying each Fund's
shares of beneficial interest under federal and state laws;
monitoring the financial, accounting, and administrative
functions of each Fund; maintaining liaison with the agents
employed by each Trust such as the Funds' custodian and transfer
agent; assisting the Funds in the coordination of such agents'
activities; and permitting T. Rowe Price employees to serve as
officers, trustees, and committee members of the Funds without
cost to the Funds.
The Management Agreements also provide that T. Rowe Price,
its directors, officers, employees, and certain other persons
performing specific functions for the Funds will only be liable
to the Funds for losses resulting from willful misfeasance, bad
faith, gross negligence, or reckless disregard of duty.
Management Fee
Each Fund pays T. Rowe Price a fee ("Fee") which consists of
two components: a Group Management Fee ("Group Fee") and an
Individual Fund Fee ("Fund Fee"). The Fee is paid monthly to T.
Rowe Price on the first business day of the next succeeding
calendar month and is calculated as described below.
The monthly Group Fee ("Monthly Group Fee") is the sum of
the daily Group Fee accruals ("Daily Group Fee Accruals") for
each month. The Daily Group Fee Accrual for any particular day
is computed by multiplying the Price Funds' group fee accrual as
PAGE 65
determined below ("Daily Price Funds' Group Fee Accrual") by the
ratio of each Fund's net assets for that day to the sum of the
aggregate net assets of the Price Funds for that day. The Daily
Price Funds' Group Fee Accrual for any particular day is
calculated by multiplying the fraction of one (1) over the number
of calendar days in the year by the annualized Daily Price Funds'
Group Fee Accrual for that day as determined in accordance with
the following schedule:
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
_____________________________
0.480% First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Next $16 billion
0.305% Next $30 billion
0.300% Thereafter
For the purpose of calculating the Group Fee, the Price
Funds include all the mutual funds distributed by T. Rowe Price
Investment Services, Inc. (excluding T. Rowe Price Spectrum Fund,
Inc. and Equity Index Fund and any institutional or private label
mutual funds). For the purpose of calculating the Daily Price
Funds' Group Fee Accrual for any particular day, the net assets
of each Price Fund are determined in accordance with each Fund's
prospectus as of the close of business on the previous business
day on which the Fund was open for business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the
daily Fund Fee accruals ("Daily Fund Fee Accruals") for each
month. The Daily Fund Fee Accrual for any particular day is
computed by multiplying the fraction of one (1) over the number
of calendar days in the year by the Individual Fund Fee Rate of
0.10% (0.05% for the Florida Insured Intermediate Fund) and
multiplying this product by the net assets of each Fund for that
day, as determined in accordance with each Fund's prospectus as
of the close of business on the previous business day on which
the Funds were open for business.
The following chart sets forth the total management fees, if
any, paid to T. Rowe Price by the Funds for each of the last
three fiscal years:
PAGE 66
New York Money New York Bond
1997 $205,000 1997 $582,000
1996 172,000 1996 550,000
1995 122,000 1995 392,000
California Money California Bond
1997 $195,000 1997 $644,000
1996 175,000 1996 609,000
1995 169,000 1995 492,000
Maryland Bond Maryland Short-Term Bond
1997 $3,398,000 1997 $378,000
1996 3,352,000 1996 326,000
1995 3,243,000 1995 242,000
Virginia Bond Virginia Short-Term Bond
1997 $829,000 1997 $0+
1996 770,000 1996 0+
1995 611,000 1995 +
Florida Tax-Free Georgia Bond
1997 $211,000 1997 $41,000
1996 153,000 1996 13,000
1995 13,000 1995 +
New Jersey Bond
1997 $244,000
1996 206,000
1995 135,000
+ Due to effect of expense limitation discussed below, the
Virginia Short-Term and Georgia Bond Funds did not pay T. Rowe
Price an investment management fee.
Limitation on Fund Expenses
All Funds
The Management Agreements between each Fund and T. Rowe
Price provides that each Fund will bear all expenses of its
operations not specifically assumed by T. Rowe Price.
For the purpose of determining whether a Fund is entitled to
reimbursement, the expenses of the Fund are calculated on a
monthly basis. If a Fund is entitled to reimbursement, that
month's management fee will be reduced or postponed, with any
adjustment made after the end of the year.
PAGE 67
New York Funds and California Tax-Free Money Fund
Pursuant to its present expense limitation, $130,000, of
management fees were not accrued for the year ended February 28,
1997 and $141,000 remains unaccrued from prior periods for the
California Money Fund. Pursuant to these present expense
limitations, $3,000 and $127,000 of management fees for the New
York Bond and Money Funds, respectively, were not accrued for the
year ended February 28, 1997 and $5,000 and $131,000 remain
unaccrued from prior periods for the New York Bond and Money
Funds, respectively. Subject to shareholder approval, these
expenses may be reimbursed to T. Rowe Price, provided that the
recapture of fees would not cause the ratio of expenses to
average net assets to exceed the above-mentioned ratios.
Maryland Short-Term Tax-Free Bond Fund
Pursuant to its present expense limitation, $19,000 of
management fees were not accrued by the Maryland Short-Term Fund
for the year ended February 28, 1997, and $33,000 remains
unaccrued from the prior period.
New Jersey Fund
Pursuant to the present expense limitation, $74,000 of
management fees were not accrued by the New Jersey Fund for the
year ended February 28, 1997, and $77,000 remains unaccrued from
the prior period.
Georgia Fund
Pursuant to the present expense limitations, $108,000 of
management fees for the Georgia Bond Fund were not accrued for
the year ended February 28, 1997, and $108,000 remains unaccrued
from the prior period.
Florida Insured Intermediate Fund
Pursuant to the present expense limitation, $53,000 of
management fees for the Florida Insured Fund were not accrued for
the year ended February 28, 1997, and $70,000 remains unaccrued
from the prior period.
Virginia Short-Term Bond Fund
Pursuant to the present expense limitation, $61,000 of
management fees for the Virginia Short-Term Bond Fund were not
accrued for the year ended February 28, 1997, and $41,000 of
other Fund expenses for the Virginia Short-Term Bond Fund were
borne by T. Rowe Price and are subject to future reimbursement.
Additionally, $138,000 of unaccrued fees and expenses remain
subject to future reimbursement.
PAGE 68
DISTRIBUTOR FOR THE TRUSTS
T. Rowe Price Investment Services, Inc. (Investment
Services), a Maryland corporation formed in 1980 as a
wholly-owned subsidiary of T. Rowe Price, serves as the
distributor of each Trust. Investment Services is registered as
a broker-dealer under the Securities Exchange Act of 1934 and is
a member of the National Association of Securities Dealers, Inc.
The offering of shares of beneficial interest pertaining to each
Fund is continuous.
Investment Services is located at the same address as the
Trusts and T. Rowe Price Associates -- 100 East Pratt Street,
Baltimore, Maryland 21202.
Investment Services serves as distributor to the Trusts
pursuant to an Underwriting Agreement ("Underwriting Agreement"),
which provides that each Fund will pay all fees and expenses in
connection with: necessary state filings; preparing, setting in
type, printing, and mailing its prospectuses and reports to
shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services
will pay all fees and expenses in connection with: printing and
distributing prospectuses and reports for use in offering and
selling Fund shares; preparing, setting in type, printing, and
mailing all sales literature and advertising; Investment
Services' federal and state registrations as a broker-dealer; and
offering and selling Fund shares, except for those fees and
expenses specifically assumed by the Funds. Investment Services'
expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the Trusts in
connection with the sale of the Funds' shares in the various
states in which Investment Services is qualified as a
broker-dealer. Under the Underwriting Agreement, Investment
Services accepts orders for Fund shares at net asset value. No
sales charges are paid by investors or the Funds.
CUSTODIAN
State Street Bank and Trust Company (the "Bank") is the
custodian for each Fund's securities and cash, but it does not
participate in the Funds' investment decisions. Each Trust, on
behalf of the Funds, has authorized the Bank to deposit certain
portfolio securities in central depository systems as allowed by
Federal law. In addition, the Funds are authorized to maintain
certain of its securities, in particular variable rate demand
notes, in uncertificated form in the proprietary deposit systems
of various dealers in municipal securities. State Street Bank's
main office is 225 Franklin Street, Boston, Massachusetts 02110.
PAGE 69
SHAREHOLDER SERVICES
The Fund from time to time may enter into agreements with
outside parties through which shareholders hold Fund shares. The
shares would be held by such parties in omnibus accounts. The
agreements would provide for payments by the Fund to the outside
party for shareholder services provided to shareholders in the
omnibus accounts.
CODE OF ETHICS
The Fund's investment adviser (T. Rowe Price) has a written
Code of Ethics which requires all employees to obtain prior
clearance before engaging in personal securities transactions.
Transactions must be executed within three business days of their
clearance. In addition, all employees must report their personal
securities transactions within ten days of their execution.
Employees will not be permitted to effect transactions in a
security: If there are pending client orders in the security; the
security has been purchased or sold by a client within seven
calendar days; the security is being considered for purchase for
a client; a change has occurred in T. Rowe Price's rating of the
security within seven calendar days prior to the date of the
proposed transaction; or the security is subject to internal
trading restrictions. In addition, employees are prohibited from
profiting from short-term trading (e.g., purchases and sales
involving the same security within 60 days). Any material
violation of the Code of Ethics is reported to the Board of the
Fund. The Board also reviews the administration of the Code of
Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T.
Rowe Price is also responsible for implementing these decisions,
including the negotiation of commissions and the allocation of
portfolio brokerage and principal business. The Fund's purchases
and sales of portfolio securities are normally done on a
principal basis and do not involve the payment of a commission
although they may involve the designation of selling concessions.
That part of the discussion below relating solely to brokerage
commissions would not normally apply to the Funds. However, it
is included because T. Rowe Price does manage a significant
number of common stock portfolios which do engage in agency
transactions and pay commissions and because some research and
services resulting from the payment of such commissions may
benefit the Fund.
PAGE 70
How Brokers and Dealers are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
T. Rowe Price may effect principal transactions on behalf of
the Fund with a broker or dealer who furnishes brokerage and/or
research services, designate any such broker or dealer to receive
selling concessions, discounts or other allowances, or otherwise
deal with any such broker or dealer in connection with the
acquisition of securities in underwritings. T. Rowe Price may
receive brokerage and research services in connection with such
designations in fixed price underwritings.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Fund. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research services
from brokers and dealers. These services include information on
the economy, industries, groups of securities, individual
companies, statistical information, accounting and tax law
interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis and analysis of corporate
responsibility issues. These services provide both domestic and
international perspective. Research services are received
PAGE 71
primarily in the form of written reports, computer generated
services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form
of meetings arranged with corporate and industry spokespersons,
economists, academicians and government representatives. In some
cases, research services are generated by third parties but are
provided to T. Rowe Price by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price to
generate all of the information presently provided by brokers and
dealers. T. Rowe Price pays cash for certain research services
received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash.
While receipt of research services from brokerage firms has not
reduced T. Rowe Price's normal research activities, the expenses
of T. Rowe Price could be materially increased if it attempted to
generate such additional information through its own staff. To
the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses
which it might otherwise bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
Commissions to Brokers who Furnish Research Services
Certain brokers and dealers who provide quality brokerage
and execution services also furnish research services to T. Rowe
Price. With regard to the payment of brokerage commissions, T.
Rowe Price has adopted a brokerage allocation policy embodying
the concepts of Section 28(e) of the Securities Exchange Act of
1934, which permits an investment adviser to cause an account to
pay commission rates in excess of those another broker or dealer
would have charged for effecting the same transaction, if the
adviser determines in good faith that the commission paid is
reasonable in relation to the value of the brokerage and research
services provided. The determination may be viewed in terms of
either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over
which it exercises investment discretion. Accordingly, while T.
Rowe Price cannot readily determine the extent to which
commission rates or net prices charged by broker-dealers reflect
PAGE 72
the value of their research services, T. Rowe Price would expect
to assess the reasonableness of commissions in light of the total
brokerage and research services provided by each particular
broker. T. Rowe Price may receive research, as defined in
Section 28(e), in connection with selling concessions and
designations in fixed price offerings in which the Funds
participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage business where
special needs do not exist, or where the business may be
allocated among several brokers or dealers which are able to meet
the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers or dealers,
and attempts to allocate a portion of its brokerage business in
response to these assessments. Research analysts, counselors,
various investment committees, and the Trading Department each
seek to evaluate the brokerage and research services they receive
from brokers or dealers and make judgments as to the level of
business which would recognize such services. In addition,
brokers or dealers sometimes suggest a level of business they
would like to receive in return for the various brokerage and
research services they provide. Actual brokerage received by any
firm may be less than the suggested allocations but can, and
often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above.
In no case is a broker or dealer excluded from receiving business
from T. Rowe Price because it has not been identified as
providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers or dealers through which T. Rowe
Price effects securities transactions may be used in servicing
all accounts (including non-Fund accounts) managed by T. Rowe
Price. Conversely, research services received from brokers or
dealers which execute transactions for the Fund are not
necessarily used by T. Rowe Price exclusively in connection with
the management of the Fund.
PAGE 73
From time to time, orders for clients may be placed through
a computerized transaction network. The Fund does not allocate
business to any broker-dealer on the basis of its sales of the
Fund's shares. However, this does not mean that broker-dealers
who purchase Fund shares for their clients will not receive
business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Fund. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if,
as a result of such purchases, 10% or more of the outstanding
common stock of such company would be held by its clients in the
aggregate.
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
Other
The Funds engaged in portfolio transactions involving
broker-dealers in the following amounts for the fiscal years
ended February 28, 1997, February 29, 1996, and February 28,
1995:
1997 1996 1995
New York Tax-Free
Money Fund $451,170,000 $323,642,000 $318,998,000
New York Tax-Free
PAGE 74
Bond Fund 432,992,000 479,720,000 523,495,000
California Tax-Free
Money Fund 474,186,000 451,803,000 531,661,000
California Tax-Free
Bond Fund 286,416,000 321,786,000 360,305,000
Maryland Tax-Free
Bond Fund 775,356,000 608,562,000 1,004,363,000
Maryland Short-Term
Tax-Free Bond 112,384,000 181,246,000 318,873,000
Virginia Tax-Free
Bond Fund 508,640,000 586,982,000 513,098,000
New Jersey Tax-Free
Bond Fund 238,572,000 244,765,000 295,898,000
Georgia Tax-Free
Bond Fund 104,491,000 101,969,000 117,380,000
Florida Insured
Intermediate
Tax-Free Fund 244,915,000 244,903,000 116,527,000
Virginia Short-Term
Tax-Free Bond Fund 35,817,000 33,183,000 10,600,000
The following amounts consisted of principal transactions as
to which the Funds have no knowledge of the profits or losses
realized by the respective broker-dealers for the fiscal years
ended February 28, 1997, February 29, 1996, and February 28,
1995:
1997 1996 1995
New York Tax-Free
Money Fund $451,170,000 $323,642,000 $318,998,000
New York Tax-Free
Bond Fund 394,711,000 465,446,000 510,410,000
California Tax-Free
Money Fund 472,277,000 449,790,000 531,661,000
California Tax-Free
Bond Fund 260,704,000 298,191,000 351,902,000
Maryland Tax-Free
Bond Fund 680,479,000 530,615,000 969,185,000
Maryland Short-Term
Tax-Free Bond Fund 108,581,000 178,280,000 313,554,000
Virginia Tax-Free
Bond Fund 483,074,000 550,422,000 484,867,000
New Jersey Tax-Free
Bond Fund 225,435,000 232,059,000 288,542,000
Georgia Tax-Free
Bond Fund 98,598,000 95,309,000 109,324,000
Florida Insured
Intermediate
Tax-Free Fund 229,787,000 234,913,000 114,179,000
Virginia Short-Term
Tax-Free Bond Fund 34,013,000 32,888,000 10,550,000
PAGE 75
The following amounts involved trades with brokers
acting as agents or underwriters for the fiscal years ended
February 28, 1997, February 29, 1996, and February 28, 1995:
1997 1996 1995
New York Tax-Free
Money Fund $ 0 $ 0 $ 0
New York Tax-Free
Bond Fund 38,281,000 14,274,000 13,085,000
California Tax-Free
Money Fund 1,909,000 2,013,000 0
California Tax-Free
Bond Fund 25,712,000 23,595,000 8,403,000
Maryland Tax-Free
Bond Fund 94,877,000 77,947,000 35,178,000
Maryland Short-Term
Tax-Free Bond Fund 3,803,000 2,966,000 5,319,000
Virginia Tax-Free
Bond Fund 25,566,000 36,560,000 28,231,000
New Jersey Tax-Free
Bond Fund 13,137,000 12,706,000 7,356,000
Georgia Tax-Free
Bond Fund 5,893,000 6,660,000 8,056,000
Florida Insured
Intermediate
Tax-Free Fund 15,128,000 9,990,000 2,348,000
Virginia Short-Term
Tax-Free Bond Fund 1,804,000 295,000 50,000
The following amounts involved trades with brokers acting as
agents or underwriters, in which such brokers received total
commissions, including discounts received in connection with
underwritings for the fiscal years ended February 28, 1997,
February 29, 1996, and February 28, 1995:
1997 1996 1995
New York Tax-Free Money Fund $ 0 $ 0 $ 0
New York Tax-Free Bond Fund 251,000 92,000 51,875
California Tax-Free Money Fund 1,000 6,000 0
California Tax-Free Bond Fund 111,000 152,000 43,750
Maryland Tax-Free Bond Fund 371,000 243,000 204,475
Maryland Short-Term Tax-Free
Bond Fund 12,000 10,000 17,620
Virginia Tax-Free Bond Fund 121,000 188,000 38,201
New Jersey Tax-Free Bond Fund 75,000 62,000 43,375
Georgia Tax-Free Bond Fund 30,000 30,000 52,475
Florida Insured Intermediate
Tax-Free Fund 85,000 42,000 11,625
Virginia Short-Term Tax-Free
Bond Fund 4,000 1,000 188
PAGE 76
Of all such portfolio transactions, none were placed with
firms which provided research, statistical, or other services to
T. Rowe Price in connection with the management of the Funds, or
in some cases, to the Funds.
The portfolio turnover rates of the Funds for the fiscal
years ended February 28, 1997, February 29, 1996, and February
28, 1995, have been as follows:
1997 1996 1995
New York Tax-Free Money Fund N/A N/A N/A
New York Tax-Free Bond Fund 96.9% 116.0% 134.3%
California Tax-Free Money Fund N/A N/A N/A
California Tax-Free Bond Fund 47.3% 61.9% 78.0%
Maryland Tax-Free Bond Fund 26.2% 23.9% 28.9%
Maryland Short-Term
Tax-Free Bond Fund 21.4% 39.3% 105.3%
Virginia Tax-Free Bond Fund 66.2% 93.7% 89.1%
New Jersey Tax-Free Bond Fund 78.9% 98.4% 139.1%
Georgia Tax-Free Bond Fund 71.1% 71.5% 170.2%
Florida Insured Intermediate
Tax-Free Fund 75.8% 98.7% 140.5%
Virginia Short-Term Tax-Free
Bond Fund 32.5% 36.4% 14.8%
PRICING OF SECURITIES BEING OFFERED
Fixed income securities are generally traded in the over-
the-counter market. With the exception of the Money Market Funds,
investments in securities are stated at fair value using a bid-
side valuation as furnished by dealers who make markets in such
securities or by an independent pricing service, which considers
yield or price of bonds of comparable quality, coupon, maturity,
and type, as well as prices quoted by dealers who make markets in
such securities. Securities held by the Money Market Funds are
valued at amortized cost.
There are a number of pricing services available, and the
Directors of the Funds, on the basis of ongoing evaluation of
these services, may use or may discontinue the use of any pricing
service in whole or in part.
Securities or other assets for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value will be appraised at prices deemed best to reflect their
fair value. Such determinations will be made in good faith by or
under the supervision of officers of each Fund, as authorized by
the Board of Directors.
Maintenance of New York and California Money Funds' Net Asset
Value Per Share at $1.00
PAGE 77
It is the policy of the Funds to attempt to maintain a net
asset value of $1.00 per share by using the amortized cost method
of valuation permitted by Rule 2a-7 under the Investment Company
Act of 1940. Under this method, securities are valued by
reference to the Fund's acquisition cost as adjusted for
amortization of premium or accumulation of discount rather than
by reference to their market value. Under Rule 2a-7:
(a) The Board of Trustees must establish written procedures
reasonably designed, taking into account current market
conditions and the fund's investment objectives, to stabilize
the fund's net asset value per share, as computed for the
purpose of distribution, redemption and repurchase, at a
single value;
(b) Each Fund must (i) maintain a dollar-weighted average
portfolio maturity appropriate to its objective of
maintaining a stable price per share, (ii) not purchase any
instrument with a remaining maturity greater than 397 days,
and (iii) maintain a dollar-weighted average portfolio
maturity of 90 days or less;
(c) Each Fund must limit its purchase of portfolio
instruments, including repurchase agreements, to those U.S.
dollar-denominated instruments which a Fund's Board of
Trustees determines present minimal credit risks, and which
are eligible securities as defined by Rule 2a-7. Eligible
securities are generally securities which have been rated (or
whose issuer has been rated or whose issuer has comparable
securities rated) in or of the two highest rating categories
by nationally recognized statistical rating organizations or,
in the case of any instrument that is not so rated, is of
comparable quality as determined by procedures adopted by the
Funds' Board of Trustees; and
(d) Each Board of Trustees must determine that (i) it is in
the best interest of a Fund and its shareholders to maintain
a stable net asset value per share under the amortized cost
method; and (ii) a Fund will continue to use the amortized
cost method only so long as each Board of Trustees believes
that it fairly reflects the Fund's market based net asset
value per share.
Although the Funds believe that it will be able to maintain
its net asset value at $1.00 per share under most conditions,
there can be no absolute assurance that it will be able to do so
on a continuous basis. If a Fund's net asset value per share
declined, or was expected to decline, below $1.00 (rounded to the
nearest one cent), the Board of Trustees of a Fund might
temporarily reduce or suspend dividend payments in an effort to
maintain the net asset value at $1.00 per share. As a result of
such reduction or suspension of dividends, an investor would
receive less income during a given period than if such a
PAGE 78
reduction or suspension had not taken place. Such action could
result in an investor receiving no dividend for the period during
which he holds his shares and in his receiving, upon redemption,
a price per share lower than that which he paid. On the other
hand, if a Fund's net asset value per share were to increase, or
were anticipated to increase above $1.00 (rounded to the nearest
one cent), the Board of Trustees of a Fund might supplement
dividends in an effort to maintain the net asset value at $1.00
per share.
NET ASSET VALUE PER SHARE
The purchase and redemption price of each Fund's shares is
equal to that Fund's net asset value per share (or share price).
Each Fund determines its net asset value per share by subtracting
its liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities a Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of each Fund is calculated as of the close of trading on
the New York Stock Exchange ("NYSE") every day the NYSE is open
for trading. The NYSE is closed on the following days: New
Year's Day, Washington's Birthday, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering, sale,
redemption and repurchase of shares) for a Fund may be suspended
at times (a) during which the NYSE is closed, other than
customary weekend and holiday closings, (b) during which trading
on the NYSE is restricted (c) during which an emergency exists as
a result of which disposal by a Fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable
for a Fund fairly to determine the value of its net assets, or
(d) during which a governmental body having jurisdiction over the
Funds may by order permit such a suspension for the protection of
the Funds' shareholders; provided that applicable rules and
regulations of the Securities and Exchange Commission (or any
succeeding governmental authority) shall govern as to whether the
conditions prescribed in (b), (c), or (d) exist.
DIVIDENDS
Unless you elect otherwise, each Fund's annual capital gain
distribution, if any, will be reinvested on the reinvestment date
using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
PAGE 79
Each Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
Dividends and distributions paid by the Funds are not
eligible for the dividends-received deduction for corporate
shareholders. For tax purposes, it does not make any difference
whether dividends and capital gain distributions are paid in cash
or in additional shares. Each Fund must declare by its year end
dividends equal to at least 90% of net tax-exempt income (as of
its tax year-end) to permit the pass-through of tax-exempt income
to shareholders, and declare by December 31, 98% of capital gains
(as of October 31) in order to avoid a federal excise tax and
distribute within 12 months, 100% of capital gains (as of its tax
year-end) to avoid federal income tax.
At the time of your purchase, each Fund's net asset value may
reflect undistributed capital gains or net unrealized
appreciation of securities held by the Funds. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Funds are
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains. On May 31, 1997, the books of each Fund
indicated that the Fund's aggregate net assets included:
Realized Capital Unrealized
Gains/(Losses) Appreciation
(Depreciation)
________________ ____________
New York Tax-Money Fund $ (3,180) $ 0
New York Tax-Free Bond Fund (958,541) 7,070,413
California Tax-Free Money Fund (104,891) 0
California Tax-Free Bond Fund (1,060,456) 8,564,287
Maryland Tax-Free Bond Fund (3,707,072) 43,836,833
Maryland Short-Term Tax-Free
Bond Fund (801,298) 776,063
Virginia Tax-Free Bond Fund (1,641,717) 7,276,802
New Jersey Tax-Free Bond Fund (1,911,909) 3,449,502
Georgia Tax-Free Bond Fund (1,081,414) 1,575,022
Florida Insured Intermediate
Tax-Free Fund (433,854) 1,661,557
Virginia Short-Term Tax-Free
Bond Fund (17,585) 71,415
If, in any taxable year, a Fund should not qualify as a
regulated investment company under the Code: (i) the Fund would
be taxed at normal corporate rates on the entire amount of its
taxable income, if any, without deduction for dividends or other
distributions to shareholders and (ii) the Fund's distributions
PAGE 80
to the extent made out of the Fund's current or accumulated
earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been
considered capital gain dividends or tax-exempt dividends).
The Funds anticipate acquiring bonds after initial issuance
at a price less than the principal amount of such bonds ("market
discount bonds"). Gain on the disposition of such bonds is
treated as taxable ordinary income to the extent of accrued
market discount. Such gains cannot be offset by losses on the
sale of other securities but must be distributed to shareholders
annually and taxed as ordinary income.
Each year, the Funds will mail you information on the tax
status of dividends and distributions. The Funds anticipate that
substantially all of the dividends to be paid by each Fund will
be exempt from federal, state, and/or city or local income taxes,
as applicable. However, due to seasonal variations in the supply
of short-term investments, there may be periods when it would not
be unusual for a certain percentage of dividends of a Fund to be
derived from out of state securities. Any such dividends would
be subject to state and local income taxes (if any). If any
portion of a Fund's dividends is not exempt from federal income
taxes, you will receive a Form 1099 stating the taxable portion.
The Funds will also advise you of the percentage of your
dividends, if any, which should be included in the computation of
alternative minimum tax. Social security recipients who receive
interest from tax-exempt securities may have to pay taxes on a
portion of their social security benefits.
Because the interest on municipal securities is tax exempt,
any interest on money you borrow that is directly or
indirectly used to purchase shares of a Fund is not deductible.
(See Section 265(a)(2) of the Internal Revenue Code.) Further,
entities or persons who are "substantial users" (or persons
related to "substantial users") of facilities financed by
industrial development bonds should consult their tax advisers
before purchasing shares of a Fund. The income from such bonds
may not be tax exempt for such substantial users.
Florida Insured Intermediate Tax-Free Fund
Although Florida does not have a state income tax, it does
impose an intangible personal property tax (intangibles tax) on
assets, including shares of mutual funds. This tax is based on
the net asset value of shares owned on January 1.
Under Florida law, shares of the Fund will be exempt from
the intangibles tax to the extent that, on January 1, the Fund's
assets are solely invested in certain exempt Florida securities,
U.S. government securities, certain short-term cash investments,
or other exempt securities. If, on January 1, the Fund's assets
are invested in these tax-exempt securities and other non-tax-
PAGE 81
exempt securities, only that portion of a share's net asset value
represented by U.S. government securities will be exempt from the
intangibles tax. Because the Fund will make every effort to have
its portfolio invested exclusively in exempt Florida municipal
obligations (and other qualifying investments) on January 1,
shares of the Fund should be exempt from the intangibles tax.
However, under certain circumstances, the Fund may invest in
securities other than Florida municipal obligations and there can
be no guarantee that such non-exempt investments would not be in
the Fund's portfolio on January 1. In such cases, all or a
portion of the value of the Fund's shares may be subject to the
intangibles tax, and a portion of the Fund's income may be
subject to federal income taxes.
YIELD INFORMATION
Bond Funds
From time to time, the Funds may advertise a yield figure
calculated in the following manner:
An income factor is calculated for each security in the
portfolio based upon the security's market value at the beginning
of the period and yield as determined in conformity with
regulations of the Securities and Exchange Commission. The
income factors are then totalled for all securities in the
portfolio. Next, expenses of each Fund for the period net of
expected reimbursements are deducted from the income to arrive at
net income, which is then converted to a per-share amount by
dividing net income by the average number of shares outstanding
during the period. The net income per share is divided by the
net asset value on the last day of the period to produce a
monthly yield which is then annualized. A taxable equivalent
yield is calculated by dividing this yield by one minus the sum
of the effective federal, state, and/or city or local income tax
rates. Quoted yield factors are for comparison purposes only,
and are not intended to indicate future performance or forecast
the dividend per share of each Fund.
The yield of each Fund calculated under the above-described
method for the month ended February 28, 1997, was as follows:
New York Tax-Free Bond Fund 4.67%
California Tax-Free Bond Fund 4.63%
Maryland Tax-Free Bond Fund 4.69%
Maryland Short-Term Tax-Free Bond Fund 3.39%
Virginia Tax-Free Bond Fund 4.79%
Virginia Short-Term Tax-Free Bond Fund(d) 3.33%
New Jersey Tax-Free Bond Fund 4.74%
Georgia Tax-Free Bond Fund 4.67%
Florida Insured Intermediate
Tax-Free Fund 4.08%
PAGE 82
The tax equivalent yields (assuming a federal tax bracket of
31.0%) for each Fund for the same period were as follows:
New York Tax-Free Bond Fund(a) 7.54%
California Tax-Free Bond Fund(b) 7.40%
Maryland Tax-Free Bond Fund(c) 7.39%
Maryland Short-Term Tax-Free
Bond Fund(c) 5.34%
Virginia Tax-Free Bond Fund(d) 7.37%
Virginia Short-Term Tax-Free Bond Fund(d) 5.12%
New Jersey Tax-Free Bond Fund(e) 7.34%
Georgia Tax-Free Bond Fund(f) 7.20%
Florida Insured Intermediate
Tax-Free Fund(g) 6.11%
(a) Assumes a state tax bracket of 6.85% and a local tax bracket
of 3.4%
(b) Assumes a state tax bracket of 9.3%.
(c) Assumes a state tax bracket of 5.0% and a local tax bracket
of 3.0%.
(d) Assumes a state tax bracket of 5.75%.
(e) Assumes a state tax bracket of 6.37%.
(f) Assumes a state tax bracket of 6.0%.
(g) Assumes an intangible tax rate of 0.2%.
The tax equivalent yields (assuming a federal tax bracket of
28.0%) for each Fund for the same period were as follows:
New York Tax-Free Bond Fund(a) 7.23%
California Tax-Free Bond Fund(b) 7.09%
Maryland Tax-Free Bond Fund(c) 7.08%
Maryland Short-Term Tax-Free Bond Fund(c) 5.12%
Virginia Tax-Free Bond Fund(d) 7.05%
Virginia Short-Term Tax-Free Bond Fund(d) 4.90%
New Jersey Tax-Free Bond Fund(e) 6.97%
Georgia Tax-Free Bond Fund(f) 6.90%
Florida Insured Intermediate 6.00%
Tax-Free Fund(g) 5.87%
(a) Assumes a state tax bracket of 6.85% and a local tax bracket
of 3.4%.
(b) Assumes a state tax bracket of 9.3%.
(c) Assumes a state tax bracket of 5.0% and a local tax bracket
of 3.0%.
(d) Assumes a state tax bracket of 5.75%.
(e) Assumes a state tax bracket of 5.525%.
(f) Assumes a state tax bracket of 6.0%.
(g) Assumes an intangible tax rate of 0.2%.
New York Money and California Money Funds
Each Fund's current and historical yield for a period is
calculated by dividing the net change in value of an account
PAGE 83
(including all dividends accrued and dividends reinvested in
additional shares) by the account value at the beginning of the
period to obtain the base period return. This base period return
is divided by the number of days in the period then multiplied by
365 to arrive at the annualized yield for that period. Each
Fund's annualized compound yield for such period is compounded by
dividing the base period return by the number of days in the
period, and compounding that figure over 365 days.
The Money Funds' current yield and compound yield for the
seven days ended February 28, 1997 were:
Current Compound
Yield Yield
_______ ________
New York Tax-Free Money Fund 2.91% 2.95%
California Tax-Free Money Fund 2.81% 2.85%
From time to time, a Fund may also illustrate the effect of
tax equivalent yields using information such as that set forth
below:
TAX-EXEMPT VS. TAXABLE YIELDS
New York Funds
_________________________________________________________________
Your Taxable Income (1997)(a) Marginal Tax Rates
Joint Return Single Return Federal(d)State Local(b) Comb-
ined
Margin-
al(c)
_________________________________________________________________
$ 26,000- $ 40,000 $ 13,000-$ 20,000 15.0 5.90 3.30 22.8
40,001- 41,200 20,001- 24,650 15.0 6.85 3.30 23.6
41,201- 45,000 24,651- 25,000 28.0 6.85 3.30 35.3
45,001- 90,000 25,001- 50,000 28.0 6.85 3.35 35.3
90,001- 99,600 50,001- 59,750 28.0 6.85 3.40 35.4
99,601- 151,750 59,751- 124,650 31.0 6.85 3.40 38.1
151,751- 271,050 124,651- 271,050 36 6.85 3.40 42.6
271,051 and above 271,051 and above 39.6 6.85 3.40 45.8
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
3.89 5.18 6.48 7.77 9.07 10.36 11.66 12.95
3.93 5.24 6.54 7.85 9.16 10.47 11.78 13.09
4.64 6.18 7.73 9.27 10.82 12.36 13.91 15.46
4.64 6.18 7.73 9.27 10.82 12.36 13.91 15.46
PAGE 84
4.64 6.19 7.74 9.29 10.84 12.38 13.93 15.48
4.85 6.46 8.08 9.69 11.31 12.92 14.54 16.16
5.23 6.97 8.71 10.45 12.20 13.94 15.68 17.42
5.54 7.38 9.23 11.07 12.92 14.76 16.61 18.45
_________________________________________________________________
(a) Net amount subject to federal income tax after deductions
and exemptions.
(b) Tax rates are for New York City Residents.
(c) Combined marginal rate assumes the deduction of state and
local income taxes on the federal return.
(d) Marginal rates may vary depending on family size and nature
and amount of itemized deductions.
California Funds
_________________________________________________________________
Your Taxable Income (1997)(a) Marginal Tax Rates
Joint Return Single Return Federal(c) State Comb-
ined
Margin-
al(b)
_________________________________________________________________
$ 36,714- $ 41,200 $ 18,357- $ 24,650 15.0 6.0 20.1
41,201- 50,968 24,651- 25,484 28.0 6.0 32.3
50,969- 64,414 25,485- 32,207 28.0 8.0 33.8
64,414- 99,600 32,208- 59,750 28.0 9.3 34.7
99,601- 151,750 59,751- 124,650 31.0 9.3 37.4
151,751- 271,050 124,651- 271,050 36.0 9.3 42.0
271,051 and above 271,051 and above 39.6 9.3 45.2
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
3.75 5.01 6.26 7.51 8.76 10.01 11.26 12.52
4.43 5.91 7.39 8.86 10.34 11.82 13.29 14.77
4.53 6.04 7.55 9.06 10.57 12.08 13.60 15.11
4.59 6.13 7.66 9.19 10.72 12.25 13.78 15.31
4.79 6.39 7.99 9.58 11.18 12.78 14.38 15.97
5.17 6.90 8.62 10.34 12.07 13.79 15.52 17.24
5.47 7.30 9.12 10.95 12.77 14.60 16.42 18.25
_________________________________________________________________
(a) Net amount subject to federal income tax after deductions
and exemptions.
(b) Combined marginal rate assumes the deduction of state income
taxes on the federal return.
(c) Marginal rates may vary depending on family size and nature
and amount of itemized deductions.
Maryland Funds
_________________________________________________________________
Your Taxable Income (1997)(a) Marginal Tax Rates
PAGE 85
Joint Return Single Return Federal(d)State Local(b)Comb-
ined
Margin-
al(c)
_________________________________________________________________
$ 41,201-$ 99,600$ 24,651- $ 59,750 28.0 5.0 3.0 33.8
99,601- 151,750 59,751- 124,650 31.0 5.0 3.0 36.5
151,751- 271,050 124,651- 271,050 36.0 5.0 3.0 41.1
271,051 and above 271,051 and above 39.6 5.0 3.0 44.4
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
4.53 6.04 7.55 9.06 10.57 12.08 13.60 15.11
4.72 6.30 7.87 9.45 11.02 12.60 14.17 15.75
5.09 6.79 8.49 10.19 11.88 13.58 15.28 16.98
5.40 7.19 8.99 10.79 12.59 14.39 16.19 17.99
_________________________________________________________________
(a) Net amount subject to federal income tax after deductions
and exemptions.
(b) Assumes a local tax rate equal to 60% of the state rate for
residents in the 5% state bracket.
(c) Combined marginal rate assumes the deduction of state and
local income taxes on the federal return.
(d) Marginal rates may vary depending on family size and nature
and amount of itemized deductions.
New Jersey Fund
_________________________________________________________________
Your Taxable Income (1997)(a) Marginal Tax Rates
Joint Return Single Return Federal(c)State Comb-
ined
Margin-
al(b)
_________________________________________________________________
$ 0- $ 20,000 $ 0- $ 20,000 15.0 1.400 16.2
20,001- 41,200 20,001- 24,650 15.0 1.750 16.5
41,201- 50,000 24,651- 35,000 28.0 1.750 29.3
50,001- 70,000 28.0 2.450 29.8
70,001- 80,000 35,001- 40,000 28.0 3.500 30.5
80,001- 99,600 40,001- 59,750 28.0 5.525 32.0
99,601- 150,000 59,751- 75,000 31.0 5.525 34.8
150,001-151,750 75,001- 124,650 31.0 6.370 35.4
151,751- 271,050 124,651- 271,050 36.0 6.370 40.1
271,051 and above 271,051 and above 39.6 6.370 43.4
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
PAGE 86
_________________________________________________________________
3.58 4.77 5.97 7.16 8.35 9.55 10.74 11.93
3.59 4.79 5.99 7.19 8.38 9.58 10.78 11.98
4.24 5.66 7.07 8.49 9.90 11.32 12.73 14.14
4.27 5.70 7.12 8.55 9.97 11.40 12.82 14.25
4.32 5.76 7.19 8.63 10.07 11.51 12.95 14.39
4.41 5.88 7.35 8.82 10.29 11.76 13.24 14.71
4.60 6.13 7.67 9.20 10.74 12.27 13.80 15.34
4.64 6.19 7.74 9.29 10.84 12.38 13.93 15.48
5.01 6.68 8.35 10.02 11.69 13.36 15.03 16.69
5.30 7.07 8.83 10.60 12.37 14.13 15.90 17.67
_________________________________________________________________
(a) Net amount subject to federal income tax after deductions
and exemptions.
(b) Combined marginal rate assumes the deduction of state income
taxes on the federal return.
(c) Marginal rates may vary depending on family size and nature
and amount of itemized deductions.
Virginia Funds
_________________________________________________________________
Your Taxable Income (1997)(a) Marginal Tax Rates
Joint Return Single Return Federal(c) State Comb-
ined
Margin-
al(b)
_________________________________________________________________
$ 41,201- $ 99,600 $ 24,651- $ 59,750 28.0 5.75 32.1
99,601- 151,750 59,751- 124,650 31.0 5.75 35.0
151,751- 271,050 124,651- 271,050 36.0 5.75 39.7
271,051 and above 271,051 and above 39.6 5.75 43.1
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
4.42 5.89 7.36 8.84 10.31 11.78 13.25 14.73
4.62 6.15 7.69 9.23 10.77 12.31 13.85 15.38
4.98 6.63 8.29 9.95 11.61 13.27 14.93 16.58
5.27 7.03 8.79 10.54 12.30 14.06 15.82 17.57
_________________________________________________________________
(a) Net amount subject to federal income tax after deductions
and exemptions.
(b) Combined marginal rate assumes the deduction of state income
taxes on the federal return.
(c) Marginal rates may vary depending on family size and nature
and amount of itemized deductions.
Georgia Tax-Free Bond Fund
_________________________________________________________________
Your Taxable Income (1997)(a) Marginal Tax Rates
PAGE 87
Joint Return Single Return Federal(c) State Comb-
ined
Margin-
al(b)
_________________________________________________________________
$ 41,201- $ 99,600 $ 24,650-$ 59,750 28.0 6.00 32.3
99,601- 151,750 59,751- 124,650 31.0 6.00 35.1
151,751- 271,050 124,651- 271,050 36.0 6.00 39.8
271,051 and above 271,051 and above 39.6 6.00 43.2
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
4.43 5.91 7.39 8.86 10.34 11.82 13.29 14.77
4.62 6.16 7.70 9.24 10.79 12.33 13.87 15.41
4.98 6.64 8.31 9.97 11.63 13.29 14.95 16.61
5.28 7.04 8.80 10.56 12.32 14.08 15.85 17.61
_________________________________________________________________
(a) Net amount subject to federal income tax after deductions
and exemptions.
(b) Combined marginal rate assumes the deduction of state income
taxes on the federal return.
(c) Marginal rates may vary depending on family size and nature
and amount of itemized deductions.
Florida Fund
EFFECTIVE YIELD FACTORING IN INTANGIBLES TAX
_________________________________________________________________
Your Taxable Income (1997)(a)
Joint Return Single Return Federal Intangible
Tax Rate(c) Tax Rate
_________________________________________________________________
$ 41,200- $ 99,600 $ 24,650- $ 59,750
And Your Intangible Assets on 1/1/96 Total:
____________________________________________
40,000 or less 20,000 or less 28 N/A
40,001- 200,000 20,001- 100,000 28 0.1
200,001 and above 100,001 and above 28 0.2
_________________________________________________________________
$ 99,601- $151,750 $ 59,751- $124,650
And Your Intangible Assets on 1/1/96 Total:
____________________________________________
40,000 or less 20,000 or less 31 N/A
40,001- 200,000 20,001- 100,000 31 0.1
200,001 and above 100,001 and above 31 0.2
_________________________________________________________________
$151,751- $271,050 $124,651- $271,050
PAGE 88
And Your Intangible Assets on 1/1/96 Total:
____________________________________________
40,000 or less 20,000 or less 36 N/A
40,001- 200,000 20,001- 100,000 36 0.1
200,001 and above 100,001 and above 36 0.2
_________________________________________________________________
$271,051 and above+ $271,051 and above+
And Your Intangible Assets on 1/1/96 Total:
____________________________________________
40,000 or less 20,000 or less 39.6 N/A
40,001- 200,000 20,001- 100,000 39.6 0.1
200,001 and above 100,001 and above 39.6 0.2
_________________________________________________________________
A Tax-Exempt Yield Of (b):
3% 4% 5% 6% 7% 8% 9% 10% 11%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
4.17 5.56 6.94 8.33 9.72 11.11 12.50 13.89 15.28
4.27 5.66 7.04 8.43 9.82 11.21 12.60 13.99 15.38
4.37 5.76 7.14 8.53 9.92 11.31 12.70 14.09 15.48
_________________________________________________________________
4.35 5.80 7.25 8.70 10.14 11.59 13.04 14.49 15.94
4.45 5.90 7.35 8.80 10.24 11.69 13.14 14.59 16.04
4.55 6.00 7.45 8.90 10.34 11.79 13.24 14.69 16.14
_________________________________________________________________
4.69 6.25 7.81 9.38 10.94 12.50 14.06 15.63 17.19
4.79 6.35 7.91 9.48 11.04 12.60 14.16 15.73 17.29
4.89 6.45 8.01 9.58 11.14 12.70 14.26 15.83 17.39
________________________________________________________________
4.97 6.62 8.28 9.93 11.59 13.25 14.90 16.56 18.21
5.07 6.72 8.38 10.03 11.69 13.35 15.00 16.66 18.31
5.17 6.82 8.48 10.13 11.79 13.45 15.10 16.76 18.41
_________________________________________________________________
(a) Net amount subject to federal income tax after deductions
and exemptions.
(b) Assumes 100% exemption from federal income and Florida
intangible property taxes.
(c) Federal rates may vary depending on family size and nature
and amount of itemized deductions.
INVESTMENT PERFORMANCE
Total Return Performance
Each Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in each Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in each Fund and the ending value of that
PAGE 89
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of each Fund.
Each average annual compound rate of return is derived from the
cumulative performance of each Fund over the time period
specified. The annual compound rate of return for each Fund over
any other period of time will vary from the average.
Cumulative Performance Percentage Change
Since
Inception
1 Yr. 5 Yrs. 10 Yrs. Date
Inception Ended Ended Ended through
Date 2/28/97 2/28/97 2/28/97 2/28/97
________ ________ ________ ________ _______
New York Tax-
Free Bond Fund 8/28/86 5.02% 43.84% 93.66% 106.79%
California
Tax-Free Bond
Fund 9/15/86 5.64% 42.69% 82.79% 97.02%
Maryland
Tax-Free Bond
Fund 3/31/87 5.12% 41.33% N/A 89.76%
Maryland
Short-Term Tax-
Free Bond Fund 1/29/93 3.26% N/A N/A 18.75%
Virginia Tax-
Free Bond Fund 4/30/91 5.00% 42.68% N/A 54.27%
Virginia Short-
Term Tax-Free
Bond Fund 11/30/94 3.33% N/A N/A 12.48%
New Jersey
Tax-Free Bond
Fund 4/30/91 4.57% 42.66% N/A 54.86%
Florida Insured
Intermediate
Bond Fund 3/31/93 3.81% N/A N/A 25.00%
Georgia Tax-Free
Bond Fund 3/31/93 5.15% N/A N/A 27.93%
Average Annual Compound Rates of Return
Since
Inception
1 Yr. 5 Yrs. 10 Yrs. Date
Inception Ended Ended Ended through
Date 2/28/97 2/28/97 2/28/97 2/28/97
________ ________ ________ ________ _______
PAGE 90
New York Tax-
Free Bond Fund 8/28/86 5.02% 7.54% 6.83% 7.16%
California
Tax-Free Bond
Fund 9/15/86 5.64% 7.37% 6.22% 6.70%
Maryland
Tax-Free Bond
Fund 3/31/87 5.12% 7.16% N/A 6.67%
Maryland
Short-Term Tax-
Free Bond Fund 1/29/93 3.26% N/A N/A 4.30%
Virginia Tax-
Free Bond Fund 4/30/91 5.00% 7.37% N/A 7.71%
Virginia Short-
Term Tax-Free
Bond Fund 11/30/94 3.33% N/A N/A 5.38%
New Jersey
Tax-Free Bond
Fund 4/30/91 4.57% 7.36% N/A 7.79%
Florida Insured
Intermediate
Bond Fund 3/31/93 3.81% N/A N/A 5.87%
Georgia Tax-Free
Bond Fund 3/31/93 5.15% N/A N/A 6.49%
Outside Sources of Information
From time to time, in reports and promotional literature:
(1) the Fund's total return performance, ranking, or any other
measure of the Fund's performance may be compared to any one or
combination of the following: (i) a broad based index; (ii)
other groups of mutual funds, including T. Rowe Price Funds,
tracked by independent research firms ranking entities, or
financial publications; (iii) indices of stocks comparable to
those in which the Fund invests; (2) the Consumer Price Index (or
any other measure for inflation, government statistics, such as
GNP may be used to illustrate investment attributes of the Fund
or the general economic, business, investment, or financial
environment in which the Fund operates; (3) various financial,
economic and market statistics developed by brokers, dealers and
other persons may be used to illustrate aspects of the Fund's
performance; (4) the effect of tax-deferred compounding on the
Fund's investment returns, or on returns in general in both
qualified and non-qualified retirement plans or any other tax
advantage product, may be illustrated by graphs, charts, etc.;
and (5) the sectors or industries in which the Fund invests may
be compared to relevant indices or surveys in order to evaluate
the Fund's historical performance or current or potential value
with respect to the particular industry or sector.
Other Publications
PAGE 91
From time to time, in newsletters and other publications
issued by T. Rowe Price Investment Services, Inc., T. Rowe Price
mutual fund portfolio managers may discuss economic, financial
and political developments in the U.S. and abroad and how these
conditions have affected or may affect securities prices or the
Fund; individual securities within the Fund's portfolio; and
their philosophy regarding the selection of individual stocks,
including why specific stocks have been added, removed or
excluded from the Fund's portfolio.
Other Features and Benefits
The Fund is a member of the T. Rowe Price Family of Funds
and may help investors achieve various long-term investment
goals, which include, but are not limited to, investing money for
retirement, saving for a down payment on a home, or paying
college costs. To explain how the Fund could be used to assist
investors in planning for these goals and to illustrate basic
principles of investing, various worksheets and guides prepared
by T. Rowe Price Associates, Inc. and/or T. Rowe Price Investment
Services, Inc. may be made available.
No-Load Versus Load and 12b-1 Funds
Unlike the T. Rowe Price funds, many mutual funds charge
sales fees to investors or use fund assets to finance
distribution activities. These fees are in addition to the
normal advisory fees and expenses charged by all mutual funds.
There are several types of fees charged which vary in magnitude
and which may often be used in combination. A sales charge (or
"load") can be charged at the time the fund is purchased
(front-end load) or at the time of redemption (back-end load).
Front-end loads are charged on the total amount invested.
Back-end loads or "redemption fees" are charged either on the
amount originally invested or on the amount redeemed. 12b-1
plans allow for the payment of marketing and sales expenses from
fund assets. These expenses are usually computed daily as a
fixed percentage of assets.
The Funds are no-load funds which impose no sales charges or
12b-1 fees. No-load funds are generally sold directly to the
public without the use of commissioned sales representatives.
This means that 100% of your purchase is invested for you.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in
kind redemption of portfolio securities of the Funds, brokerage
fees could be incurred by the shareholder in a subsequent sale of
such securities.
Issuance of Fund Shares for Securities
PAGE 92
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objective and policies of a Fund; (b) are acquired for
investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
ORGANIZATION OF THE TRUSTS
For tax and business reasons, the Trusts were organized in
1986 as Massachusetts Business Trusts. The State Tax-Free Income
Trust and California Tax-Free Income Trust are registered with
the Securities and Exchange Commission under the Investment
Company Act of 1940 as, respectively, a non-diversified and
diversified, open-end investment company, commonly known as a
"mutual fund."
The Declaration of Trust permits the Board of Trustees to
issue an unlimited number of full and fractional shares of
beneficial interest of a single class without par value.
Currently, the State Tax-Free Income Trust consists of nine
series (i.e., the New York Tax-Free Bond Fund, the New York
Tax-Free Money Fund, the Maryland Tax-Free Bond Fund, the
Maryland Short-Term Tax-Free Bond Fund, the Virginia Tax-Free
Bond Fund, Virginia Short-Term Tax-Free Bond Fund the New Jersey
Tax-Free Bond Fund, the Georgia Tax-Free Bond Fund, and the
Florida Insured Intermediate Tax-Free Fund), and the California
Tax-Free Income Trust consists of two series (i.e., the Bond Fund
and the Money Fund) each of which represents a separate class of
each Trust's shares and has different objectives and investment
policies. The Declaration of Trust also provides that the Board
of Trustees may issue additional series of shares. Each share of
each Fund represents an equal proportionate beneficial interest
in that Fund, with each other share, and is entitled to such
dividends and distributions of income belonging to that fund as
are declared by the Trustees. In the event of the liquidation of
a Fund, each share is entitled to a pro rata share of the net
assets of that Fund.
Shareholders of each Fund are entitled to one vote for each
full share held (and fractional votes for fractional shares held)
irrespective of the relative net asset values of the Funds' share
and will vote in the election of or removal of trustees (to the
extent hereinafter provided); however, on matters affecting an
individual Fund, a separate vote of that Fund is required.
Shareholders of a Fund are not entitled to vote on any matter
which does not affect that Fund and which requires a separate
vote of the other Funds. There will normally be no meetings of
shareholders for the purpose of electing trustees unless and
PAGE 93
until such time as less than a majority of the trustees holding
office have been elected by shareholders, at which time the
trustees then in office will call a shareholders' meeting for the
election of trustees. Pursuant to Section 16(c) of the
Investment Company Act of 1940, holders of record of not less
than two-thirds of the outstanding shares may remove a trustee by
a vote cast in person or by proxy at a meeting called for that
purpose. Except as set forth above, the trustees shall continue
to hold office and may appoint successor trustees. Voting rights
are not cumulative, so that the holders of more than 50% of the
shares voting in the election of trustees can, if they choose to
do so, elect all the trustees of each Trust, in which event the
holders of the remaining shares will be unable to elect any
person as a trustee.
Shares have no preemptive or conversion rights; the right of
redemption and the privilege of exchange are described in the
prospectus. Shares are fully paid and nonassessable, except as
set forth below. The Trusts may be terminated (i) upon the sale
of its assets to another diversified, open-end management
investment company, if approved by the vote of the holders of
two-thirds of the outstanding shares of each Trust, or (ii) upon
liquidation and distribution of the assets of each Trust, if
approved by the vote of the holders of a majority of the
outstanding shares of each Trust. If not so terminated, each
Trust will continue indefinitely. Under Massachusetts law,
shareholders could, under certain circumstances, be held
personally liable for the obligations of each Trust. However,
the Declarations of Trust disclaims shareholder liability for
acts or obligations of the Trusts and requires that notice of
such disclaimer be given in each agreement, obligation or
instrument entered into or executed by the Trusts or a Trustee.
The Declarations of Trust provides for indemnification from Trust
property for all losses and expenses of any shareholder held
personally liable for the obligations of the Trusts. Thus, the
risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which each
Trust itself would be unable to meet its obligations, a
possibility which Price Associates believes is remote. Upon
payment of any liability incurred by a Fund, the shareholders of
the Fund paying such liability will be entitled to reimbursement
from the general assets of the Fund. The Trustees intend to
conduct the operations of each Fund in such a way so as to avoid,
as far as possible, ultimate liability of the shareholders for
liabilities of such Fund.
FEDERAL REGISTRATION OF SHARES
Each Fund's shares are registered for sale under the
Securities Act of 1933. Registration of each Fund's shares is not
required under any state law, but the Fund's are required to make
certain filings with and pay fees to the states in order to sell
PAGE 94
its shares in the states.
LEGAL COUNSEL
Shereff, Friedman, Hoffman & Goodman, LLP whose address is
919 Third Avenue, New York, New York 10022, is legal counsel to
the Funds.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 217 East Redwood Street,
Baltimore, Maryland 21202, are independent accountants to the
Trusts. The financial statements of the New York, California,
Maryland, Virginia, New Jersey, Florida, and Georgia Funds for
the fiscal year ended February 28, 1997 and the report of
independent accountants, are included in each Fund's Annual
Report for the fiscal year ended February 28, 1997 on pages 9-27,
9-27, 9-33, 9-26, 8-20, 8-18, and 8-18, respectively. A copy of
the Annual Report accompanies this Statement of Additional
Information. The following financial statements and the report
of independent accountants appearing in each Annual Report for
the fiscal year ended February 28, 1997 are incorporated into
this Statement of Additional Information by reference:
NEW YORK
FUNDS' ANNUAL
REPORT PAGE
____________
Report of Independent Accountants 27
Statement of Net Assets, February 28, 1997 11-20
Statement of Operations, year ended
February 28, 1997 21
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 22
Notes to Financial Statements,
February 28, 1997 23-26
Financial Highlights 9-10
CALIFORNIA
FUNDS' ANNUAL
REPORT PAGE
_____________
Report of Independent Accountants 27
Statement of Net Assets, February 28, 1997 11-20
Statement of Operations, year ended
February 28, 1997 21
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 22
Notes to Financial Statements,
PAGE 95
February 28, 1997 23-26
Financial Highlights 9-10
MARYLAND
FUNDS' ANNUAL
REPORT PAGE
______________
Report of Independent Accountants 33
Statement of Net Assets, February 28, 1997 11-26
Statement of Operations, year ended
February 28, 1997 27
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 28
Notes to Financial Statements,
February 28, 1997 29-32
Financial Highlights 9-10
VIRGINIA
FUNDS' ANNUAL
REPORT PAGE
_____________
Report of Independent Accountants 26
Statement of Net Assets, February 28, 1997 11-20
Statement of Operations, year ended
February 28, 1997 21
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 22
Notes to Financial Statements,
February 28, 1997 23-25
Financial Highlights 9-10
NEW JERSEY
TAX-FREE BOND
FUND ANNUAL
REPORT PAGE
___________
Report of Independent Accountants 20
Statement of Net Assets, February 28, 1997 9-13
Statement of Operations, year ended
February 28, 1997 14
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 15
Notes to Financial Statements,
February 28, 1997 16-19
Financial Highlights 8
FLORIDA INSURED
INTERMEDIATE TAX-FREE
FUND ANNUAL
REPORT PAGE
PAGE 96
_____________
Report of Independent Accountants 18
Portfolio of Investments, February 28, 1997 9-11
Statement of Assets and Liabilities, year
ended February 28, 1997 12
Statement of Operations, February 28, 1997 13
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 14
Notes to Financial Statements,
February 28, 1997 15-17
Financial Highlights 8
GEORGIA
TAX-FREE BOND
FUND ANNUAL
REPORT PAGE
___________
Report of Independent Accountants 18
Statement of Net Assets, February 28, 1997 9-12
Statement of Operations, year ended
February 28, 1997 13
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 14
Notes to Financial Statements,
February 28, 1997 15-17
Financial Highlights 8
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