<PAGE>
<PAGE>
PROSPECTUS
July 1, 1999
California Tax-Free Money Fund
California Tax-Free Bond Fund
A money market fund and a long-term bond fund seeking income that is exempt
from federal and California state income taxes.
The Securities and Exchange Commission has not approved or disapproved these
securities or passed upon the adequacy of this prospectus. Any representation
to the contrary is a criminal offense.
(T. ROWE PRICE RAM LOGO)
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T. Rowe Price California Tax-Free Income Trust California Tax-Free Money Fund
California Tax-Free Bond Fund
Prospectus
July 1, 1999
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1 ABOUT THE FUNDS
Objective, Strategy, Risks, and Expenses 1
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Other Information About the Funds 6
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Some Basics of Fixed Income Investing 10
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2 ABOUT YOUR ACCOUNT
Pricing Shares and Receiving 13
Sale Proceeds
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Distributions and Taxes 14
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Transaction Procedures and 17
Special Requirements
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3 MORE ABOUT THE FUNDS
Organization and Management 20
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Understanding Performance Information 22
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Investment Policies and Practices 23
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Financial Highlights 32
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4 INVESTING WITH T. ROWE PRICE
Account Requirements 34
and Transaction Information
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Opening a New Account 34
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Purchasing Additional Shares 35
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Exchanging and Redeeming 36
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Rights Reserved by the Funds 37
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Information About Your Services 38
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T. Rowe Price Brokerage 40
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Investment Information 41
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</TABLE>
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates,
Inc., and its affiliates managed $149.2 billion, including over $8 billion in
municipal bond assets, for more than seven million individual and institutional
investor accounts as of March 31, 1999.
Mutual fund shares are not deposits or obligations of, or guaranteed by, any
depository institution. Shares are not insured by the FDIC, Federal Reserve, or
any other government agency, and are subject to investment risks, including
possible loss of the principal amount invested.
<PAGE>
ABOUT THE FUNDS
1
OBJECTIVE, STRATEGY, RISKS, AND EXPENSES
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To help you decide whether these funds are appropriate for you, this section
reviews their major characteristics.
What is each fund's objective?
The California Tax-Free Money Fund seeks to provide preservation of capital,
liquidity and, consistent with these objectives, the highest level of income
exempt from federal and California state income taxes.
The California Tax-Free Bond Fund seeks to provide, 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.
What is each fund's principal investment strategy?
The California Tax-Free Money Fund will invest at least 65% of total assets
in California municipal securities. All securities held by the fund will
mature in 397 days or less and the fund's weighted average maturity will not
exceed 90 days. While the fund's yield will fluctuate with changes in
interest rates, its share price is managed to remain stable at $1.00. The
fund buys securities rated within the two highest money market rating
categories assigned by established rating agencies or, if unrated, by T. Rowe
Price. All securities purchased by the fund will present minimal credit risk
in the opinion of T. Rowe Price.
The California Tax-Free Bond Fund's weighted average maturity is expected to
exceed 15 years. The 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. The fund will
invest at least 65% of its total assets in California municipals.
In selecting securities for the money fund, fund managers may examine
relationships among yields on various types and maturities of money market
securities in the context of their outlook for interest rates. Similarly,
investment decisions for the bond fund reflect the managers' outlook for
interest rates and the economy as well as the prices and yields of various
securities. For example, if we expect rates to fall, we may buy longer-term
securities within each fund's maturity range to provide higher yield (and, in
the case of the bond fund, greater appreciation potential). Conversely,
shorter maturities may be favored if rates are expected to
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T. ROWE PRICE
rise. In addition, if our economic outlook is positive, we may take advantage
of the bond fund's "basket" for noninvestment-grade bonds. From time to time,
a fund may invest a significant portion of its assets in municipal bonds of
certain sectors with special risks such as hospital, electric utility, or
private activity bonds. The funds may sell holdings for a variety of reasons,
such as to adjust the portfolio's average maturity or quality or to shift
assets into higher-yielding securities.
Each fund sometimes invests in obligations of the Commonwealth of Puerto Rico
and its public corporations (as well as the U.S. territories of Guam and the
Virgin Islands) that are exempt from federal and California state income
taxes. The funds will generally purchase these securities when they offer a
comparably attractive combination of risk and return.
Due to seasonal variations or shortages in the supply of suitable California
securities, each fund may invest 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 the fund's
annual income.
While most assets will be invested in municipal securities, other securities
may also be purchased, including derivatives such as futures, in keeping with
fund objectives.
. Income from California municipal securities is exempt from federal and
California state income taxes.
What are the main risks of investing in the funds?
Any of the following could cause a decline in either fund's share price or
income.
. Interest rate risk This risk refers to the decline in bond prices that
accompanies a rise in the overall level of interest rates. (Bond prices and
interest rates move in opposite directions.) Generally, the longer the
maturity of a fund or security, the greater its interest rate risk. This risk
is minimal for the money fund.
While a rise in rates is the principal source of interest rate risk for bond
funds, falling rates bring the possibility that a bond may be "called," or
redeemed before maturity, and that the proceeds may be reinvested in
lower-yielding securities.
. Credit risk This is the chance that any of a fund's holdings will have its
credit rating downgraded or will default (fail to make scheduled interest or
principal payments), potentially reducing the fund's income level and share
price.
As of June 1, 1999, the state of California was rated Aa3 by Moody's, A+ by
Standard & Poor's, and AA- by Fitch.
<PAGE>
ABOUT THE FUNDS
Each fund may invest a significant portion of assets in securities that are
not general obligations of the state. These may be issued by local
governments or public authorities and are rated according to their particular
creditworthiness, which may vary significantly from the state's general
obligations. Due to a variety of factors, many local California municipals
have experienced downgrades during the 1990s. After filing for bankruptcy in
1994, Orange County defaulted on the payment of certain of its debt
obligations.
While generally considered to be of medium quality, securities in the BBB
category may be more susceptible to adverse economic or investing conditions,
and some BBB securities have speculative characteristics. Each fund may
retain a security whose credit quality is downgraded after purchase.
. Significant political and economic developments within a state may have
direct and indirect repercussions on virtually all municipal bonds issued in
the state.
. Geographical risk A fund investing within a single state is, by definition,
less diversified geographically than one investing across many states and
therefore has greater exposure to adverse economic and political changes
within that state.
. 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 securities is
strongly influenced by the value of tax-exempt income to investors. Broadly
lower income tax rates could reduce the advantage of owning municipals.
. Other risks Bonds of certain sectors have special risks. For example, the
health care industry can be affected by federal or state legislation,
electric utilities are subject to governmental regulation, and private
activity bonds are not government backed.
Each fund's investments in the Commonwealth of Puerto Rico and its public
corporations (as well as the U.S. territories of Guam and the Virgin Islands)
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.
. Derivatives risk (bond fund only) To the extent the fund uses these
instruments, it may be exposed to additional volatility and potential losses.
. Year 2000 risk Organizations, governmental entities, and markets in which
the funds invest will be affected by the Year 2000 problem. While at this
time the funds cannot predict the degree of impact, it is possible that fund
returns could be adversely affected as a result.
. Risks of the money fund An investment in the money market fund is not
insured or guaranteed by the FDIC or any other government agency. Although
the fund
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T. ROWE PRICE
seeks to preserve the value of your investment at $1.00 per share, it is
possible to lose money by investing in the fund. For example, a sharp and
unexpected rise in interest rates in an unusually short period of time or the
default of a portfolio security could cause the fund's NAV to fall below
$1.00. However, the fund has maintained a constant share price since its
inception, and fund managers will make every effort to continue to meet this
objective.
As with any mutual fund, there can be no guarantee the funds will achieve
their objectives.
. The income level of the funds will fluctuate with changing market conditions
and interest rate levels. The bond fund's share price will also fluctuate;
when you sell your shares, you may lose money.
How can I tell which fund is most appropriate for me?
Consider your investment goals, your time horizon for achieving them, and
your tolerance for risk. The funds can be used to generate income or to
diversify a stock portfolio. The higher your tax bracket, the more likely
tax-exempt securities are appropriate. If you are investing for higher
tax-free income and can accept the possibility of price decline in an effort
to achieve income exempt from federal and California state income taxes, the
bond fund could be an appropriate part of your overall investment strategy.
If you are investing for tax-free income with principal stability and
liquidity, you should consider the money market fund.
Both funds are inappropriate for tax-deferred accounts, such as IRAs.
. The fund or funds you select should not represent your complete investment
program or be used for short-term trading purposes.
How has each fund performed in the past?
The bar charts and the average annual total return table indicate risk by
illustrating how much returns can differ from one year to the next. Each
fund's past performance is no guarantee of its future returns.
The funds can also experience short-term performance swings, as shown by the
best and worst calendar quarter returns accompanying the following charts.
The returns are only for the years depicted in the charts.
<TABLE>
INPUT CALF BAR CHARTS HERE
<CAPTION>
Calendar Year Total Returns
Fund 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
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<S> <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <S>
Money 5.48% 4.87% 3.72% 2.46% 1.92% 2.35% 3.29% 2.85% 3.04% 2.77%
Bond 8.50 5.84 12.12 8.93 12.49 -5.72 17.36 4.51 9.08 6.41
--------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
ABOUT THE FUNDS
Money Fund Quarter ended Total return
Best quarter 6/30/1990 1.25%
Worst quarter 3/31/1993 0.43%
Bond Fund Quarter ended Total return
Best quarter 3/31/1995 6.74%
Worst quarter 3/31/1994 -5.80%
The Money Fund's return for the 3 months ended 3/31/99 was 0.51%.
The Bond Fund's return for the 3 months ended 3/31/99 was 0.59%.
<TABLE>
Table 1 Average Annual Total Returns
<CAPTION>
Periods ended December 31, 1998
1 year 5 years 10 years
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<S> <C> <C> <C> <S>
California Tax-Free Money Fund 2.77% 2.86% 3.27%
Lipper California Tax-Exempt Money
Market Funds Average 2.72 2.89 3.39
Lipper California Tax-Exempt Money 2.77 3.00 3.47
Market Funds Index
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California Tax-Free Bond Fund 6.41 6.06 7.79
Lehman Brothers Municipal Bond 6.48 6.22 8.22
Index
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Lipper California Municipal Debt
Funds Average 5.77 5.67 7.61
Lipper California Municipal Debt 6.15 5.81 7.74
Funds Index
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</TABLE>
These figures include changes in principal value, reinvested dividends, and
capital gain distributions, if any.
What fees or expenses will I pay?
The funds are 100% no load. There are no fees or charges to buy or sell fund
shares, reinvest dividends, or exchange into other T. Rowe Price funds. There
are no 12b-1 fees.
<TABLE>
Table 2 Fees and Expenses of the Funds
<CAPTION>
Annual fund operating expenses
(expenses that are deducted from fund assets)
Management Other Total annual fund Fee waiver/expense Net
Fund fee expenses operating expenses reimbursement expenses
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<S> <C> <C> <C> <C> <C> <S>
Money/a/ 0.42% 0.22% 0.64% 0.09% 0.55%
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Bond 0.42 0.16 0.58 -- --
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</TABLE>
/a/
To limit the fund's expenses, T. Rowe Price contractually obligated itself to
waive its fees and bear any expenses that would cause the fund's ratio of
expenses to average net assets to exceed 0.55%. The first agreement was from
March 1, 1997, to February 28, 1999; and the second agreement from March 1,
1999, to February 28, 2001. 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 0.55%;
however, no reimbursement will be made after February 28, 2001 (for the first
agreement), or February 28, 2003 (for the second
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T. ROWE PRICE
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.
Example. The following table gives you a rough idea of how expense ratios
may translate into dollars and helps you to compare the cost of investing in
these funds with that of other funds. Although your actual costs may be
higher or lower, the table shows how much you would pay if operating expenses
remain the same, the expense limitation currently in place is not renewed (if
applicable), you invest $10,000, you earn a 5% annual return, and you hold
the investment for the following periods:
<TABLE>
<CAPTION>
Fund 1 year 3 years 5 years 10 years
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<S> <C> <C> <C> <C> <S>
Money $56 $186 $338 $781
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Bond 59 186 324 726
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</TABLE>
OTHER INFORMATION ABOUT THE FUNDS
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What are the funds' potential rewards?
The regular income dividends you receive from the funds should be exempt from
federal income taxes and California state taxes for shareholders who live in
California.
. The California Tax-Free Money Fund is expected to provide a high level of
tax-free income consistent with price stability.
. The California Tax-Free Bond Fund is expected to provide higher income than
the California Tax-Free Money Fund but with share price volatility.
How does the portfolio manager try to reduce risk?
Consistent with each fund's objective, the portfolio manager uses various
tools to try to reduce risk and increase total return, including:
. Diversification of assets to reduce the impact of a single holding on a
fund's net asset value.
. Thorough credit research by our own analysts.
. Adjustment of fund duration-a concept related to maturity-to try to reduce
the drop in price when interest rates rise or to benefit from the rise in
price when rates fall. Duration, which indicates a fund's price sensitivity
to interest rate changes, is explained later on in this section.
<PAGE>
ABOUT THE FUNDS
What is the credit quality of California general obligations?
As of June 1, 1999, the state was rated Aa3 by Moody's, A+ by Standard &
Poor's, and AA- by Fitch. Both Moody's and Standard & Poor's carry a positive
outlook on the state. This upgrade and the positive outlook by the other
rating agencies reflect California's economic improvement and return to
financial stability following the recession of the early 1990s. Restrictions
on taxes and spending, such as Proposition 13 and Article XIIB of the
constitution, have resulted in a broad shift by 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.
. Credit ratings and the financial and economic conditions of the state and
local governments, public authorities, or others in which a fund 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
significant portion of assets in bonds 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. This was the
case in the early 1990s 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 through the middle part of the decade.
Certain fund holdings do 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.
As of June 1, 1999, Puerto Rico's general obligations were rated Baa1 by
Moody's and A by Standard & Poor's.
What are derivatives and can each fund 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
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T. ROWE PRICE
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 uses derivatives in situations
in which they may enable the fund to accomplish the following: increase
yield; 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 portfolio 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 (over 15 year maturity),
investment-grade bond.
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.
What is tax-free about municipal bonds and bond funds?
The regular income dividends you receive should be exempt from regular
federal income taxes. These dividends may also be exempt from your state's
income tax (if any). However, fund capital gain distributions are taxable to
you. (See Useful Information on Distributions and Taxes for details.)
. Municipal securities are also called "tax-exempts" because the interest
income they provide is usually exempt from federal income taxes.
<PAGE>
ABOUT THE FUNDS
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. These bonds carry higher yields than regular municipals.
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 fund will not purchase a security if,
as a result, more than 20% of the fund's income would be subject to the AMT.
The portion of income subject to the AMT will be reported annually to
shareholders. (Please see Distributions and Taxes - Taxes on Fund
Distributions.)
Additionally, under highly unusual circumstances, the IRS may determine that
a bond issued as tax-exempt should in fact be taxable. If a fund were to hold
such a bond, the fund may have to distribute taxable income or reclassify as
taxable income previously distributed as tax-free.
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.
How can I tell if a tax-free or taxable fund is suitable for me?
The primary factor is your expected federal income tax rate. The higher your
tax bracket, the more likely tax-exempts will be appropriate. If a municipal
fund's tax-exempt yield is higher than the after-tax yield on a taxable bond
or money fund, then your income will be higher in the municipal fund. To find
what a taxable fund would have to yield to equal the yield on a municipal
fund, divide the municipal fund's yield by one minus your tax rate. For quick
reference, the next table shows a range of taxable-equivalent yields.
<TABLE>
Table 3 Taxable-Equivalent Yields
<CAPTION>
If your A tax-free yield of
federal tax 2% 3% 4% 5% 6% 7%
rate is: Equals a taxable yield of:
<S> <C> <C> <C> <C> <C> <C> <S>
28% 2.8% 4.2% 5.6% 6.9% 8.3% 9.7%
------------------------------------------
31% 2.9 4.3 5.8 7.2 8.7 10.1
------------------------------------------
36% 3.1 4.7 6.2 7.8 9.4 10.9
------------------------------------------
39.6% 3.3 5.0 6.6 8.3 9.9 11.6
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</TABLE>
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T. ROWE PRICE
SOME BASICS OF FIXED INCOME INVESTING
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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 yield the same as 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 yield?
Credit quality refers to a bond issuer's expected ability to make all
required interest and principal payments on time. 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-quality securities.
What is meant by a bond fund's maturity?
Every bond has a stated maturity date when the issuer must repay the bond's
entire principal value to the investor. However, many bonds are "callable,"
meaning their principal can be repaid earlier, 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 that environment, a bond's "effective maturity" is
usually its nearest call date.
A bond mutual fund has no real maturity, but it does have a weighted 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. Some
funds target effective maturities rather than stated maturities when
computing the average. This 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.
<PAGE>
ABOUT THE FUNDS
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 is expressed in years,
like maturity, but it is a better indicator of price sensitivity 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 expressed in years - 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 share price by multiplying fund duration 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. (T. Rowe Price bond fund shareholder reports
show duration.)
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 rates, as shown in Table 4.
<TABLE>
Table 4 How Interest Rates May Affect Bond Prices
<CAPTION>
Price per $1,000 of a Municipal Bond if Interest Rates:
Rates Rates
Bond maturity Coupon Increase Decrease
1% 2% 1% 2%
<S> <S> <S> <C> <C> <C> <C> <S>
1 year 2000 3.15% $990 $981 $1,010 $1,020
------------------------------------------------------------
3 years 2002 3.78 972 946 1,029 1,058
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5 years 2004 4.00 956 915 1,046 1,095
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10 years 2009 4.48 924 854 1,084 1,176
-----------------------------------------------------------------
20 years 2019 5.09 885 788 1,136 1,297
------------------------------------------------------------
30 years 2029 5.16 864 755 1,170 1,386
-------------------------------------------------------------------------------------------------
</TABLE>
The table reflects yields on AAA-rated municipals as of May 31, 1999. This is
an illustration and does not represent expected yields or share price changes
of any T. Rowe Price fund.
What are the major differences between money market and bond funds?
. Price Bond funds have fluctuating share prices. Money market funds are
managed to maintain a stable share price.
. 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).
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T. ROWE PRICE
. Income Short- and intermediate-term bond funds typically offer more income
than money market funds and less income than longer-term bond funds.
Do money market securities react to changes in interest rates?
Yes. As interest rates change, the prices of 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 the fund maintain a $1.00 share price.
<PAGE>
ABOUT YOUR ACCOUNT
2
PRICING SHARES AND RECEIVING SALE PROCEEDS
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Here are some procedures you should know when investing in a T. Rowe Price
fund.
How and when shares are priced
The share price (also called "net asset value" or NAV per share) for the
funds is calculated at the close of the New York Stock Exchange, normally 4
p.m. ET, each day the New York Stock Exchange is open for business. To
calculate the NAV, the fund's assets are valued and totaled, liabilities are
subtracted, and the balance, called net assets, is divided by the number of
shares outstanding. Current market values are used to price bond fund shares.
Amortized cost is used to value money fund securities.
. 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.
Fund shares may be purchased through various third-party intermediaries
including banks, brokers, and investment advisers. Where authorized by a
fund, orders will be priced at the NAV next computed after receipt by the
intermediary. Consult your intermediary to determine when your orders will be
priced. The intermediary may charge a fee for its services.
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
. 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>
T. ROWE PRICE
financial institution account. The ACH system is supported by over 20,000
banks, savings banks, and credit unions. Proceeds sent by bank wire should be
credited to your account the next business day.
. Exception: Under certain circumstances and when deemed to be in each fund's
best interests, your proceeds may not be sent for up to seven calendar days
after we receive your redemption request.
. If for some reason we cannot accept your request to sell shares, we will
contact you.
USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES
----------------------------------------------------------
. 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 day of the
reinvestment and to reinvest all subsequent distributions in shares of the
fund. No interest will accrue on amounts represented by uncashed distribution
or redemption checks.
Income dividends
. Money funds declare income dividends daily to shareholders of record as of
12 noon ET on that day. Wire purchase orders received before 12 noon ET
receive the dividend for that day. Other purchase orders receive the dividend
on the next business day after payment has been received.
. 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.
. Dividends are ordinarily paid on the first business day of each month.
. 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
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ABOUT THE FUNDS
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
. Since money funds are managed to maintain a constant share price, they are
not expected to make capital gain distributions.
. A capital gain or loss is the difference between the purchase and sale price
of a security.
. 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.
Tax Information
. You will be sent timely information for your tax filing needs.
Although the regular monthly income dividends you receive from each fund are
expected to be exempt from federal and state and local (if any) income taxes,
you need to be aware of the possible tax consequences when:
. You sell fund shares, including an exchange from one fund to another.
. The fund makes a distribution to your account.
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. For shareholders who receive
Social Security benefits, the receipt of tax-exempt interest may increase the
portion of benefits that are subject to tax.
If a fund invests 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 that
should be included in your AMT calculation, if any, will be reported to you
in January.
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.
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 most new accounts or those opened by
exchange in 1984
<PAGE>
T. ROWE PRICE
or later, we will provide the gain or loss on the shares you sold during the
year, based on the "average cost," single category 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, you will be sent Form 1099-DIV indicating the tax status of any
capital gain distributions made to you. This information will also be
reported to the IRS. A fund's capital gain distributions are generally
taxable to you for the year in which they were paid. Dividends are expected
to be tax-exempt.
The tax treatment of a capital gain distribution is determined by how long
the fund held the portfolio securities, not how long you held shares in the
fund. Short-term (one year or less) capital gain distributions are taxable at
the same rate as ordinary income and long-term gains on securities held more
than 12 months are taxed at a maximum rate of 20%. If you realized a loss on
the sale or exchange of fund shares that you held six months or less, your
short-term loss will be reclassified to a long-term loss to the extent of any
long-term capital gain distribution received during the period you held the
shares.
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 each fund invests
in these securities, the likelihood of a taxable gain distribution will be
increased.
. 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 wish to find out a fund's record date before
investing. Of course, a fund's share price may, at any time, reflect
undistributed capital gains or income and unrealized appreciation, which may
result in future taxable distributions.
TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS
----------------------------------------------------------
. Following these procedures helps assure timely and accurate transactions.
<PAGE>
ABOUT THE FUNDS
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. Each 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. The fund does not accept purchases made by credit card check.
Sale (Redemption) Conditions
Holds on immediate redemptions: 10-day hold
If you sell shares that you just purchased and paid for by check or ACH
transfer, the funds 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 boxes that state you do not want these services. Personal computer
transactions must be authorized separately. T. Rowe Price funds and their
agents use reasonable procedures (including shareholder identity
verification) to confirm that instructions given by telephone or computer are
genuine; they are not liable for acting on these instructions. If these
procedures are not followed, it is the opinion of certain regulatory agencies
that the funds and their agents may be liable for any losses that may result
from acting on the instructions. A confirmation is sent promptly after a
transaction. All telephone 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
<PAGE>
T. ROWE PRICE
$250,000, or your sale amounts to more than 1% of fund net assets, the fund
has the right to pay the difference between the redemption amount and the
lesser of the two previously mentioned figures with securities from the fund.
Excessive Trading
. 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. To deter such activity, we have adopted
an excessive trading policy. If you violate our excessive trading policy, you
may be barred indefinitely and without further notice from further purchases
of T. Rowe Price funds.
. Trades placed directly with T. Rowe Price If you trade directly with T.
Rowe Price, you can make one purchase and sale involving the same fund within
any 120-day period. For example, if 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
this limit, you are in violation of our excessive trading policy.
Two types of transactions are exempt from this policy: 1) trades solely in
money market funds (exchanges between a money fund and a nonmoney fund are
not exempt); and 2) systematic purchases or redemptions (see Information
About Your Services).
. Trades placed through intermediaries If you purchase fund shares through an
intermediary including a broker, bank, investment adviser, or other third
party and hold them for less than 60 calendar days, you are in violation of
our excessive trading policy.
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 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
<PAGE>
ABOUT THE FUNDS
investor whose 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
. 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:
. Written requests 1) to redeem over $100,000, or 2) to wire redemption
proceeds.
. Remitting redemption proceeds to any person, address, or bank account not on
record.
. Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration (name or ownership) from yours.
. 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>
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.
. Shareholders benefit from T. Rowe Price's 62 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:
. Receive a proportional interest in a fund's income and capital gain
distributions.
. Cast one vote per share on certain fund matters, including the election of
fund trustees, 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, 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, must 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
instructions on voting by mail or telephone, or on the Internet.
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 are independent of T. Rowe Price.
<PAGE>
ABOUT THE FUNDS
. All decisions regarding the purchase and sale of fund investments are made
by T. Rowe Price - specifically by each fund's 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 each fund's investment program. The Investment
Advisory Committees comprise the following members:
Money Fund Patrice L. Berchtenbreiter Ely, Chairman, Jeremy N. Baker, Linda
A. Brisson, Joseph K. Lynagh, and Mary J. Miller. 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, Linda A. Brisson,
Patricia S. Deford, Patrice L. Berchtenbreiter Ely, Joseph K. Lynagh,
Konstantine B. Mallas, and Arthur S. Varnado. Ms. 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.
The Management Fee
This fee has two parts - an "individual fund fee," which reflects a fund's
particular characteristics, 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 the Spectrum Funds, and any
institutional, index, 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>
Group Fee Schedule
<CAPTION>
<S> <C> <C> <C>
0.3 First
34 $
% 50
/a/ billion
--------------------------------------
0.305% Next $30 billion
--------------------------------------
0.300% Next $40 billion
--------------------------------------
0.295% Thereafter
--------------------------------------------------------------------------------------------------------------
</TABLE>
/a/ Represents a blended group fee rate containing various break points.
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 T. Rowe Price funds' assets of over $87 billion
at February 28, 1999, the group fee was 0.32%. The individual fund fee is
0.10%.
<PAGE>
T. ROWE PRICE
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 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. Therefore, total return
numbers include the effect of compounding.
Advertisements for a fund may include cumulative or average annual total
return figures, which may be compared with various indices, other performance
measures, or other mutual funds.
Cumulative Total Return
This is the actual return of an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated during the period. For example, a fund could have a 10-year
positive cumulative return despite experiencing three negative years during
that time.
Average Annual Total Return
This is always hypothetical and should not be confused with actual
year-by-year results. It smooths out all the variations in annual performance
to tell you what constant year-by-year return would have produced the
investment's actual cumulative return. This gives you an idea of an
investment's annual contribution to your portfolio, provided you held it for
the entire period.
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 price at
the end of the given period. 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.
<PAGE>
ABOUT THE FUNDS
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.
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 in this prospectus. 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.
. Fund managers have considerable leeway in choosing investment strategies and
selecting securities they believe will help each fund achieve its objective.
Types of Portfolio Securities
In seeking to meet its investment objective, each fund 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
<PAGE>
T. ROWE PRICE
with its investment program. 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 if more than 10% of
the outstanding voting securities of the issuer would be held by each fund.
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) Except as permitted by Rule 2a-7 under
the Investment Company Act of 1940, with respect to 75% of the fund's total
assets, the money fund will not purchase a security if, as a result, more
than 5% of its total assets would be invested in securities of a single
issuer. Under Rule 2a-7, the 5% limit, among other things, 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.
. 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 and Taxable Securities
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, each fund will not
purchase any security if, as a result, less than 80% of the fund's income
would be exempt from federal and California state income taxes. Up to 20% of
fund income could be derived from securities subject to the alternative
minimum tax.
<PAGE>
ABOUT THE FUNDS
Operating policy During periods of abnormal market conditions, for temporary
defensive purposes, each fund may invest without limit in high-quality,
short-term securities whose income is subject to federal and California state
income taxes.
Operating policy Industrial development bonds are a special type of private
activity bond permitted under IRS guidelines and are typically backed by a
corporate obligor to finance projects benefiting the public. Each fund is
limited to 25% of total assets in industrial development bonds related to 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.
In addition to general obligation and revenue bonds, each fund's 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 may invest up to 2% of its total assets in
municipal warrants.
Securities With "Puts"
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 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 put feature
terminates prior to being exercised, the funds may be forced to hold the
longer-term security, which could experience substantially more volatility.
<PAGE>
T. ROWE PRICE
Securities With Credit Enhancements
. 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.
. 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
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 funds. The number of
municipal bond insurers is relatively small, and not all of them have the
highest rating.
. 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
Derivatives and synthetics in which the funds may invest include:
. 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. The fund 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.
Operating policy The bond fund may invest up to 10% of its total assets in
residual interest bonds.
<PAGE>
ABOUT THE FUNDS
. 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.
. 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 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 may invest up to 10% of its total assets in
embedded interest rate swaps and caps.
Private Placements
Each fund may seek to enhance its 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 invest up to 15% (10% for the money fund)
of its net assets in illiquid securities, including unmarketable private
placements.
Types of Investment Management Practices
Reserve 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 provides
flexibility in meeting redemptions, expenses, and the timing of new
investments; can help in structuring the fund's weighted average maturity;
and serves as a short-term defense during periods of unusual market
volatility. The fund's reserve position can consist of shares of one or more
T. Rowe Price internal money mar-
<PAGE>
T. ROWE PRICE
ket funds as well as 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.
For temporary, defensive purposes, the fund may invest without limitation in
money market reserves. The effect of taking such a position is that the fund
may not achieve its investment objective.
When-Issued Securities (all funds) 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 cash or high-grade marketable securities held by its
custodian equal in value to its commitment for these securities. Each fund
does 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 their exposure
to the municipal bond market; to protect portfolio value; in an effort to
enhance income; as a cash management tool; 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 exceed 5% of a bond fund's net asset
value.
Borrowing Money and Transferring Assets
Each fund can borrow money from banks and other Price funds 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.
<PAGE>
ABOUT THE FUNDS
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 the
fund's total assets. Each 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. The bond fund's portfolio turnover rates for the
fiscal years ending February 28, 1999, 1998, and 1997, were 27.2%, 35.0%, and
47.3%, 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
whose revenues are paid from similar types of projects, such as hospital
bonds.
Credit-Quality Considerations
The credit quality of most bond issues is evaluated by rating agencies such
as Moody's and Standard & Poor's on the basis of 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. Other things being equal,
lower-rated bonds have higher yields due to greater risk. High-yield bonds,
also called "junk" bonds, are those rated below BBB.
Table 5 shows the rating scale used by the major rating agencies, and Table 6
provides an explanation of quality ratings. T. Rowe Price considers publicly
available ratings but emphasizes its own credit analysis when selecting
investments.
<PAGE>
T. ROWE PRICE
<TABLE>
Table 5 Ratings of Municipal Debt Securities
<CAPTION>
<C> <S> <S> <S> <S> <S> <S> <S> <S> <S>
Moody's Standard &
Investors Poor's Fitch
Service, Inc. Corporation IBCA, 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 IBCA
Short Term MIG1/ VMIG1 Best quality SP1+ Very strong quality F-1+ Exceptionally strong
SP1 Strong grade quality
F-1 Very strong quality
----------------------------------------------------------------------------------------------
MIG2/ VMIG2 High quality SP2 Satisfactory grade F-2 Good credit quality
----------------------------------------------------------------------------------------------
Commercial P-1 Superior A-1+ Extremely strong F-1+ Exceptionally strong
Paper quality quality quality
A-1 Strong quality F-1 Very strong quality
----------------------------------------------------------------------------------------------
P-2 Strong quality A-2 Satisfactory quality F-2 Good credit quality
---------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
Table 6 Explanation of Quality Ratings
<CAPTION>
<C> <S> <S> <S>
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
Corporation capacity to 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
CCC, CC to the 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 IBCA, Inc. AAA Highest quality; obligor has
exceptionally 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>
ABOUT THE FUNDS
Year 2000 Processing Issue
Many computer programs use two digits rather than four to identify the year.
These programs, if not adapted, will not correctly handle the change from
"99" to "00" on January 1, 2000, and will not be able to perform necessary
functions. The Year 2000 issue affects virtually all companies and
organizations.
T. Rowe Price has implemented steps intended to assure that major computer
systems and processes are capable of Year 2000 processing. We are working
with third parties to assess the adequacy of their compliance efforts and are
developing contingency plans intended to assure that third-party
noncompliance will not materially affect T. Rowe Price's operations.
Companies, organizations, governmental entities, and markets in which the T.
Rowe Price funds invest will be affected by the Year 2000 issue, but at this
time the funds cannot predict the degree of impact. For funds that invest in
foreign markets, especially emerging markets, it is possible foreign
companies and
<PAGE>
T. ROWE PRICE
markets will not be as prepared for Year 2000 as domestic companies and
markets. To the extent the effect of Year 2000 is negative, a fund's returns
could be reduced.
FINANCIAL HIGHLIGHTS
----------------------------------------------------------
Table 7, 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 fund's financial statements, which are
included in its annual report and are incorporated by reference into the
Statement of Additional Information (available upon request). The total
returns in the table represent the rate that an investor would have earned or
lost on an investment in each fund (assuming reinvestment of all dividends
and distributions). The financial statements in the annual report were
audited by the funds' independent accountants, PricewaterhouseCoopers LLP.
<TABLE>
Table 7 Financial Highlights
<CAPTION>
Year ended February 28
Money Fund 1995 1996/a/ 1997 1998 1999
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
Income From Investment Operations
Net investment income 0.025/b/ 0.032/b/ 0.028/b/ 0.030/b/ 0.026/b/
----------------------------------------------------------------------------
Net gains or losses on
securities (both realized -- -- -- -- --
and unrealized)
----------------------------------------------------------------------------
Total from investment
operations 0.025 0.032 0.028 0.030 0.026
Less Distributions
Dividends (from net (0.025 ) (0.032 ) (0.028 ) (0.030 ) (0.026 )
investment income)
----------------------------------------------------------------------------
Distributions (from capital -- -- -- -- --
gains)
----------------------------------------------------------------------------
Total distributions (0.025 ) (0.032 ) (0.028 ) (0.030 ) (0.026 )
----------------------------------------------------------------------------
Net asset value, $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
end of period
----------------------------------------------------------------------------
Total return 2.55%/b/ 3.24%/b/ 2.87%/b/ 3.01%/b/ 2.65%/b/
Ratios/Supplemental Data
Net assets, end of period $76,289 $72,739 $82,210 $92,406 $102,346
(in thousands)
----------------------------------------------------------------------------
Ratio of expenses to average 0.55%/b/ 0.55%/b/ 0.55%/b/ 0.55%/b/ 0.55%/b/
net assets
----------------------------------------------------------------------------
Ratio of net income to 2.51%/b/ 3.20%/b/ 2.82%/b/ 2.98%/b/ 2.62%/b/
average net assets
----------------------------------------------------------------------------------------------------------------
</TABLE>
/a/ Fiscal year ended February 29.
/b/
Excludes expenses in excess of a 0.55% voluntary expense limitation in effect
November 7, 1990, through February 28, 1999.
<PAGE>
ABOUT THE FUNDS
<TABLE>
Table 7 Financial Highlights (continued)
<CAPTION>
Year ended February 28
Bond Fund 1995 1996/a/ 1997 1998 1999
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of period $ 10.43 $ 10.00 $ 10.45 $ 10.47 $ 10.88
Income From Investment Operations
Net investment income 0.55/b/ 0.55 0.55 0.54 0.52
--------------------------------------------------------
Net gains or losses
on securities (both
realized and (0.41) 0.45 0.02 0.41 0.11
unrealized)
--------------------------------------------------------
Total from investment
operations 0.14 1.00 0.57 0.95 0.63
Less Distributions
Dividends (from net (0.55) (0.55) (0.55) (0.54) (0.52)
investment income)
--------------------------------------------------------
Distributions (from (0.02) -- -- -- (0.03)
capital gains)
--------------------------------------------------------
Total distributions (0.57) (0.55) (0.55) (0.54) (0.55)
--------------------------------------------------------
Net asset value, $ 10.00 $ 10.45 $ 10.47 $ 10.88 $ 10.96
end of period
--------------------------------------------------------
Total return 1.60%/b/ 10.28% 5.64% 9.31% 5.95%
Ratios/Supplemental Data
Net assets, end of $131,953 $146,194 $160,813 $195,100 $226,001
period (in thousands)
--------------------------------------------------------
Ratio of expenses to 0.60%/b/ 0.63% 0.62% 0.58% 0.58%
average net assets
--------------------------------------------------------
Ratio of net income 5.60%/b/ 5.40% 5.29% 5.09% 4.80%
to average net assets
--------------------------------------------------------
Portfolio turnover 78.0% 61.9% 47.3% 35.0% 27.2%
rate
--------------------------------------------------------------------------------
</TABLE>
/a/ Fiscal year ended February 29.
/b/
Excludes expenses in excess of a 0.60% voluntary expense limitation in effect
November 7, 1990, through February 28, 1995.
<PAGE>
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 institutional account procedures, please call your designated
account manager or service representative.
OPENING A NEW ACCOUNT
----------------------------------------------------------
$2,500 minimum initial investment; $1,000 for retirement plans or 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
appropriate address in the next paragraph. We do not accept third-party checks
to open new accounts.
Mail via United States Postal Service
T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21297-1300
<PAGE>
ABOUT THE FUNDS
Mail via private carriers/overnight services
T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117-4842
By Wire
Call Investor Services for an account number and give the following wire
information to your bank:
Receiving Bank: PNC Bank, N.A. (Pittsburgh) Receiving Bank ABA#: 043000096
Beneficiary: T. Rowe Price [fund name] Beneficiary Account: 1004397951
Originator to Beneficiary Information (OBI): name of owner(s) and account
number
Complete a New Account Form and mail it to one of the appropriate addresses
listed below.
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 Information About Your 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 retirement plans, Automatic Asset
Builder, and gifts or transfers to minors (UGMA/UTMA) accounts.
By ACH Transfer
Use Tele*Access or your personal computer or call Investor Services if you have
established electronic transfers using the ACH network.
<PAGE>
T. ROWE PRICE
By Wire
Call Shareholder Services or use the wire address listed 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 following address 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.
Mail via United States Postal Service
T. Rowe Price Funds Account Services P.O. Box 17300 Baltimore, MD 21297-1300
/(For //mail via private carriers and overnight services//, 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
----------------------------------------------------------
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 fund is registered.)
Redemptions
Redemption proceeds can be mailed to your account address, sent by ACH transfer
to your bank, or wired to your bank (provided your bank information is already
on file). For charges, see Electronic Transfers - By Wire under Information
About Your Services.
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, one year, or two years, as specified in
the prospectus. The fee is paid to the fund.
<PAGE>
ABOUT THE FUNDS
By Phone
Call Shareholder Services
If you find our phones busy during unusually volatile markets, please consider
placing your order by your personal computer or Tele*Access (if you have
previously authorized these services), mailgram, or express mail. For exchange
policies, please see Transaction Procedures and Special Requirements - Excessive
Trading.
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. 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). Please use the appropriate address below:
Mail via United States Postal Service
T. Rowe Price Account Services P.O. Box 17302 Baltimore, MD 21297-1302
Mailgram, Express, Registered, or Certified Mail
T. Rowe Price Account Services 10090 Red Run Boulevard Owings Mills, MD 21117
RIGHTS RESERVED BY THE FUNDS
----------------------------------------------------------
Each fund and its agents reserve the following rights: (1) to waive or lower
investment minimums; (2) to accept initial purchases by telephone or mailgram;
(3) to refuse any purchase or exchange order; (4) to cancel or rescind any
purchase or exchange order (including, but not limited to, orders deemed to
result in excessive trading, market timing, fraud, or 5% ownership) 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; (5)
to freeze any account and suspend account services when notice has been received
of a dispute
<PAGE>
T. ROWE PRICE
between the registered or beneficial account owners or there is reason to
believe a fraudulent transaction may occur; (6) to otherwise modify the
conditions of purchase and any services at any time; or (7) to act on
instructions believed to be genuine. These actions will be taken when, in the
sole discretion of management, they are deemed to be in the best interest of the
fund.
In an effort to protect each fund from the possible adverse effects of a
substantial redemption in a large account, as a matter of general policy, no
shareholder or group of shareholders controlled by the same person or group of
persons will knowingly be permitted to purchase in excess of 5% of the
outstanding shares of the fund, except upon approval of the fund's management.
INFORMATION ABOUT YOUR SERVICES
----------------------------------------------------------
Shareholder Services 1-800-225-5132 Investor Services 1-800-638-5660
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically, and others you must authorize or request 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 discusses some of the services currently offered. Our
Services Guide, which we mail to all new shareholders, contains detailed
descriptions of these and other services.
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: Traditional IRAs, Roth 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.
<PAGE>
ABOUT THE FUNDS
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, duplicate
statements, and tax forms; and (3) initiate purchase, redemption, and exchange
transactions in your accounts (see Electronic Transfers in this section).
Web Address www.troweprice.com
After authorizing this service, account transactions may also be conducted
through our Web site on the Internet. If you subscribe to America Online/(R)/,
you can access our Web site via keyword "T. Rowe Price" and conduct transactions
in your account.
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 back 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.
<PAGE>
T. ROWE PRICE
Automatic Investing
($50 minimum) You can invest automatically in several different ways, including:
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.
T. ROWE PRICE BROKERAGE
----------------------------------------------------------
To Open an Account 1-800-638-5660 For Existing Brokerage Investors
1-800-225-7720
This service gives you the opportunity to consolidate all of your investments
with one company. Investments available through our brokerage service include
stocks, options, bonds, and others at commission savings over full-service
brokers. We also provide a wide range of services, including:
Automated Telephone and Computer Services
You can enter stock and option orders, access quotes, and review account
information around the clock by phone with Tele-Trader or via the Internet with
Internet-Trader. Any trades executed through Tele-Trader save you an additional
10% on commissions. You will save 20% on commissions for stock trades and 10% on
option trades when you use Internet-Trader. All trades are subject to a $35
minimum commission except stock trades placed through Internet-Trader, which are
subject to a $29.95 minimum commission.
Investor Information
A variety of informative reports, such as our Brokerage Insights series and S&P
Market Month newsletter, as well as access to on-line research tools can help
you better evaluate economic trends and investment opportunities.
<PAGE>
ABOUT THE FUNDS
Dividend Reinvestment Service
Virtually all stocks held in customer accounts are eligible for this free
service.
/T. Rowe Price// Brokerage is a division of //T. Rowe Price// Investment /
/Services, Inc., Member NASD/SIPC./
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. Most of this information is also
available on our Web site at www.troweprice.com.
Shareholder Reports
Fund managers' reviews of their strategies and performance. 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
A 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, Diversifying Overseas: A T. Rowe
Price Guide to International Investing, Managing Your Retirement Distribution,
Personal Strategy Planner, Retirees Financial Guide, Retirement Planning Kit,
and Tax Considerations for Investors.
<PAGE>
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
informative reports.
For Mutual Fund or T. Rowe Price Brokerage Information
Investor Services
1-800-638-5660
For Existing Accounts
Shareholder Services
1-800-225-5132
For Yields, Prices, Account Information, or to Conduct Transactions
Tele*Access/(R)/
24 hours, 7 days 1-800-638-2587
Internet Address
www.troweprice.com
Headquarters
100 East Pratt St. Baltimore, MD 21202
Walk-in
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
Warner Center, Plaza 5 21800 Oxnard Street Suite 270 Woodland Hills, CA 91367
4200 West Cypress St. 10th Floor Tampa, FL 33607
4410 Arrows West Drive Colorado Springs, CO 80907
A Statement of Additional Information about the fund has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. Further information about the fund's investments, including a review
of market conditions and the manager's recent strategies and their impact on
performance, is available in the annual and semiannual shareholder reports. To
obtain free copies of any of these documents, or for shareholder inquiries, call
1-800-638-5660.
Fund reports and Statements of Additional Information are also available from
the Securities and Exchange Commission by calling 1-800-SEC-0330 or by writing
the SEC's Public Reference Section, Washington, D.C. 20549-6009 (you will be
charged a duplicating fee); by visiting the SEC's public reference room; or by
consulting the SEC's Web site at www.sec.gov.
1940 Act File No. 811-4525
(LOGO)
C05-040 7/1/99
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
The date of this Statement of Additional Information is July 1, 1999.
T. ROWE PRICE CALIFORNIA TAX-FREE INCOME TRUST (the "Trust")
California Tax-Free Bond Fund
California Tax-Free Money Fund
and
T. ROWE PRICE STATE TAX-FREE INCOME TRUST (the "Trust")
Florida Intermediate Tax-Free Fund
Georgia Tax-Free Bond Fund
Maryland Short-Term Tax-Free Bond Fund
Maryland Tax-Free Bond Fund
New Jersey Tax-Free Bond Fund
New York Tax-Free Bond Fund
New York Tax-Free Money Fund
Virginia Short-Term Tax-Free Bond Fund
Virginia Tax-Free Bond Fund
and
T. ROWE PRICE TAX-EFFICIENT FUNDS, INC.
T. Rowe Price Tax-Efficient Balanced Fund
T. Rowe Price Tax-Efficient Growth Fund
T. ROWE PRICE TAX-EXEMPT MONEY FUND, INC.
T. Rowe Price Tax-Exempt Money Fund--PLUS Class
(A Separate Class of T. Rowe Price Tax-Exempt Money Fund,
Inc.)
T. ROWE PRICE TAX-FREE HIGH YIELD FUND, INC.
T. ROWE PRICE TAX-FREE INCOME FUND, INC.
T. ROWE PRICE TAX-FREE INTERMEDIATE BOND FUND, INC.
T. ROWE PRICE TAX-FREE SHORT-INTERMEDIATE FUND, INC.
______________________________________________________________________________
Mailing Address:
T. Rowe Price Investment Services, Inc.
100 East Pratt Street
Baltimore, Maryland 21202
1-800-638-5660
This Statement of Additional Information is not a prospectus but should be
read in conjunction with the appropriate fund prospectus dated July 1, 1999,
which may be obtained from T. Rowe Price Investment Services, Inc.
("Investment Services"). Shareholders of the T. Rowe Price Tax-Exempt Money
Fund--PLUS Class should refer to the Tax-Exempt Money Fund for information
relating to their investment.
Each fund's financial statements for the year ended February 28, 1999, and
the report of independent accountants are included in each fund's Annual
Report and incorporated by reference into this Statement of Additional
Information.
If you would like a prospectus or an annual or semiannual shareholder report
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.
C03-043 7/1/99
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TABLE OF CONTENTS
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Page Page
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Capital Stock 69 Pricing of Securities 60
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Code of Ethics 54 Principal Holders of Securities 48
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Custodian 54 Ratings of Commercial Paper 75
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Distributor for the 53 Ratings of Municipal Debt Securities 73
Funds
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Dividends and 62 Ratings of Municipal Notes and 75
Distributions Variable Rate Securities
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Federal Registration 71 Risk Factors 3
of Shares
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Independent 71 Risk Factors Associated with a 5
Accountants California Portfolio
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Investment Management 48 Risk Factors Associated with a 8
Services Florida Portfolio
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Investment Objectives 2 Risk Factors Associated with a 10
and Policies Georgia Portfolio
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Investment Performance 67 Risk Factors Associated with a 11
Maryland Portfolio
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Investment Program 19 Risk Factors Associated with a New 12
Jersey Portfolio
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Investment 37 Risk Factors Associated with a New 14
Restrictions York Portfolio
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Legal Counsel 71 Risk Factors Associated with a 16
Virginia Portfolio
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Management of the Risk Factors Associated with
Funds Tax-Efficient Growth Fund and the
40 Equity Portion of Tax-Efficient 19
Balanced Fund
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Net Asset Value Per 62 Shareholder Services by Outside 54
Share Parties
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Organization of the 70 Tax Status 62
Funds
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Portfolio Management 26 Yield Information 64
Practices
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Portfolio Transactions 54
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INVESTMENT OBJECTIVES AND POLICIES
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The following information supplements the discussion of each fund's
investment objectives and policies discussed in each funds 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 Board
of Directors/Trustees without shareholder approval. However, shareholders
will be notified of a material change in an operating policy. Each fund's
fundamental policies 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 are represented. References to the following are as
indicated:
Investment Company Act of 1940 ("1940 Act")
Securities and Exchange Commission ("SEC")
T. Rowe Price Associates, Inc. ("T. Rowe Price")
Moody's Investors Service, Inc. ("Moody's")
Standard & Poor's Corporation ("S&P")
Internal Revenue Code of 1986 ("Code")
Rowe Price-Fleming International, Inc. ("Price-Fleming")
Throughout this Statement of Additional Information, "the fund" is intended
to refer to each fund listed on the cover page, unless otherwise indicated.
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RISK FACTORS
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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 as they apply to the fund.
All Funds (other than Tax-Efficient Growth Fund)
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.
All Funds
Because of their investment policies, the funds may or may not be suitable or
appropriate for all investors. The funds (except for the Money Funds) are not
an appropriate investment for those whose primary objective is principal
stability. The value of the portfolio securities of the fund will fluctuate
based upon market conditions. The Tax-Efficient Balanced Fund will normally
have 40-50% of its assets in equity securities. The Tax-Efficient Growth Fund
will normally invest substantially all of its assets in common stocks. Assets
of these funds invested in equity securities will be subject to all of the
risks of investing in the stock market. There can, of course, be no assurance
that the funds will achieve their investment objectives.
All Funds (other than Tax-Efficient Growth Fund)
Municipal Securities
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 obligations,
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 IBCA, Inc.
("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, offerings of 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 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.
<PAGE>
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 transactions.
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 1940 Act, 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
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, S&P, or 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
Directors/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. 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
insurance premium based on the bond's principal value, the issuer is able to
obtain a higher credit rating for the bond. Once purchased, municipal bond
insurance cannot be canceled, and the protection it affords continues as long
as the bonds are outstanding and the insurer remains solvent.
The funds may also purchase bonds that 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 risk that a
municipal bond insurance company may experience 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, 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
Directors/Trustees determines present minimal credit risk, and which are
Eligible Securities as defined in Rule 2a-7 under the 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 (which may include sub-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 Directors/Trustees. In addition, the
fund may treat variable and floating rate instruments with demand features as
short-term securities pursuant to Rule 2a-7 under the 1940 Act.
Bond and Balanced Funds
Because of their investment policies, the Bond and Balanced 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
<PAGE>
income taxes. The Bond and Balanced 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
yield from such securities normally exceeds 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
and Balanced 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. These funds are
also not intended to provide a vehicle for short-term trading purposes.
Special Risks of High-Yield Investing The fund may invest in low-quality
bonds commonly referred to as "junk bonds." 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 fund invests in such bonds, achievement of its investment objective will
be more dependent on T. Rowe Price's credit analysis than would be the case
if the fund 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 the advent of 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 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.
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 $34.3
billion in long-term debt in 1998. Approximately 26% was general obligation
debt, backed by the taxing power of the issuer, and 74% were revenue bonds
and lease backed obligations, issued for a wide variety of purposes,
including transportation, housing, education and health care.
As of February 1, 1999, the State of California had approximately $19.2
billion in outstanding general obligation bonds secured by the state's
revenue and taxing power. An additional $14.3 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 20% 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 1999, the state
issued $1.7 billion in short-term notes for this purpose. California also
operates a commercial paper program which it uses to finance construction
projects. $0.5 billion of commercial paper was outstanding as of February 1,
1999.
The state supports $6.7 billion in lease-purchase obligations attributable to
the State Public Works Board and other issuers. 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
<PAGE>
Agency, the Department of Water 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 1998 population of 33 million represents 12% of
the U.S. total. The state's per capita personal income in 1997 exceeded the
U.S. average by 4%. The Asian economic crisis, which began in 1997, has had
some dampening effect on the state's economy, particularly in high technology
manufacturing.
California's economy suffered through a severe recession during the early
1990s 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, exhibiting significant job growth and
gains in personal income. Growth is expected to moderate in 1999 and 2000.
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 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
<PAGE>
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 1990s 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 considerably. Fiscal 1998 closed with a reserve
balance of $2.8 billion. Much of this cushion is the result of explosive
growth in capital gains tax collections triggered by a federal tax rate cut.
The Governor has proposed a budget for fiscal 1999 which features continued
growth in capital gains tax collections, offset by a cut in the vehicle
license fee. The state's reserve is projected to be $1.1 billion at the end
of fiscal 1999 (1.9% of revenues.) This reserve will be dedicated to balance
the ongoing costs of reductions in the vehicle license fee. In October 1998,
Moody's upgraded the state's general obligation bonds to Aa3 from A1; the
state's general obligations are rated A+ by S&P, and AA- 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 realized significant cutbacks in funding
during the last recession. 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. The County's ratings were restored to investment grade in
1998.
Sectors Certain areas of potential investment concentration present unique
risks. In 1998, $3.5 billion of tax-exempt debt issued in California was for
public or nonprofit 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. All hospitals are dependent on third-party reimbursement sources
such as the federal Medicare and state MediCal programs or private insurers.
To the extent these third party payers 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 between 1998 and 2002. Municipal utilities, while not subject to
the legislation, are being faced with competitive market forces and must use
the transition period wisely to proactively prepare for deregulation. They
are under pressure to reduce rates and cut costs in order to maintain their
customer bases. 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
nonprofit 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.
<PAGE>
RISK FACTORS ASSOCIATED WITH A FLORIDA PORTFOLIO
The fund's program of investing primarily in AAA-rated Florida municipal
bonds should significantly lessen the credit risks which would be associated
with a portfolio of lower-quality Florida bonds. Nevertheless, 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 bonds
across many states and municipalities. The credit quality of the fund will
depend upon the continued financial strength of 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 1998, $15.2 billion in
state and local debt was issued in Florida, a 27% increase from the previous
year. Of this total debt amount, approximately 16% represented general
obligation debt and 84% represented revenue bonds and lease-backed
obligations. Debt issued in 1998 was for a wide variety of public purposes,
including transportation, housing, education, health care and utilities.
As of April 9, 1999, the State of Florida had $11.5 billion outstanding
general obligation bonds secured by the state's full faith and credit and
taxing power. General bonded debt service accounted for a modest 2.4% of all
governmental expenditures in fiscal year 1998. An additional $4 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 S&P, and AA by Fitch as of April 5, 1999. 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 14.7 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.
Visitor traffic grew by 10% in 1998 and reached an all-time high of 47.3
million visitors. This trend is expected to continue again in 1999.
During most of the 1980s, 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% nationally. Florida's rapid non-farm job growth since 1996
has reversed this trend and the state's February 1999 unemployment rate
stands at 4.4% versus the national average of 4.6%. State per capita income
is 98% 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
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
<PAGE>
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 midyear 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. Additionally, Florida recently settled a lawsuit
with the tobacco industry where the state sought to recover the costs
associated with tobacco usage by Floridians. This settlement resulted in a
$750 million payment to the state in 1997, a $220 million payment in 1998 and
future payments that rise to $440 million in 2003. At the end of 1998, the
state had reserves of $2.5 billion in the General Revenue Fund (15% 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 not 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 1997, $1.9 billion of tax-exempt debt issued in Florida was for
public or nonprofit 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. All hospitals are
dependent on third party reimbursement sources such as the federal Medicare
and state Medicaid programs or private insurers. 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 health care. 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
nonprofit 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.
<PAGE>
RISK FACTORS ASSOCIATED WITH A GEORGIA 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 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 $6 billion in
municipal bonds in 1998, a 34% increase from the previous year. Of this total
debt amount, approximately 30% was general obligation debt backed by the
unlimited taxing power of the issuer and 70% was revenue bond debt secured by
specific pledged fees or charges for an enterprise or project. As of June 1,
1999, the state was rated Aaa by Moody's and AAA by S&P and Fitch.
The State of Georgia currently has net direct obligations of approximately
$5.2 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 GO bonds.
Previously, capital requirements were funded through the issuance of bonds by
10 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 5.1%
of fiscal year 1998 treasury receipts.
In addition to the general obligation and lease-backed debt described above,
$318 million bonds have been issued and are outstanding 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 7.6 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.
The state's economy is well diversified. The current labor force of 4 million
is largely concentrated in service and wholesale/retail trade jobs, followed
by lesser amounts in manufacturing and government. Employment gains have
substantially exceeded the region and the U.S. since 1980. Georgia's one year
employment growth (February 1998 to February 1999) stood at 3.2% compared to
the national rate of 2.2%. The state's economy continues to outperform the
nation. 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
25th 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
1998 showed a continuation of this positive trend with a surplus of $685
million and an ending general fund balance of $1.2 billion, or 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
<PAGE>
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 1997, $676 million of tax-exempt debt issued in Georgia was for
public or nonprofit 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. All hospitals are dependent on third party reimbursement sources
such as the federal Medicare and state Medicaid programs or private insurers.
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.
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
nonprofit 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 MARYLAND PORTFOLIO
The fund's concentration in the debt obligations of one state carries a
higher risk than a portfolio that is more 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 two basic types of
debt, with varying degrees of credit risk: general obligation bonds backed by
the unlimited taxing power of the issuer and revenue bonds secured by
specific pledged fees or charges for a related project. In 1998, $3.8 billion
in state and local debt was issued in Maryland, a 33% increase from the
previous year. Of this total amount, approximately 45% represented general
obligation debt and 55% revenue bonds. 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 1998 was for a wide variety of public
purposes, including health care, housing, utilities, and education.
The State of Maryland had approximately $3.4 billion in general obligation
bonds outstanding as of December 31, 1998 along with an additional $1.1
billion in other tax-supported debt. General obligation debt of the State of
Maryland is rated Triple-A by Moody's, S&P, 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 of the state government are authorized to borrow money under
legislation which expressly provides that the loan obligations shall not be
deemed to constitute 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
<PAGE>
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.
Economy Maryland's economic growth has recovered from the effects of federal
downsizing in the early 1990s. Employment growth data suggest that the state
matched national growth rates of about 2% in 1998. The per capita income
level is another sign of strength in the economy. It continues to maintain a
high 112% of national per capita, as demonstrated by 1997 data. According to
the Maryland Board of Revenue Estimates, the national economy is expected to
slow in the later part of 1999 and the state's economy is expected to mirror
this trend. However, the state's economy is expected to be resilient because
of its overall diversification and particularly because of its low share of
manufacturing employment (7% of total employment compared to 16% nationally).
The manufacturing sector tends to be more vulnerable during economic
downturns.
Financial To a large degree, the risk of the portfolio is dependent upon the
financial strength of the State of Maryland and its localities. Financial
management continues to demonstrate a conservative approach to managing the
state's finances. Fiscal year 1998 concluded with a General Fund operating
surplus of $1.2 billion. The general fund balance rose to a healthy $1.6
billion or 14% of general revenues. For the current fiscal year, the state's
Board of Revenue Estimates reported in January 1999 that the revenue forecast
has been revised upward to $8.2 billion, an increase of $195 million. These
results are reassuring that the budget will remain balanced as the state
implements income tax reduction.
Sectors Certain areas of potential investment concentration present unique
risks. In 1998, $815.5 million or 22% of Maryland tax-exempt debt was issued
in the health care sector by public or nonprofit 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. All hospitals are dependent
on third party reimbursement mechanisms. At the present time, Maryland
hospitals operate under a system in which reimbursement is determined by a
state-administered set of rates and charges that applies to all payors. A
federal waiver allows this system to be applied to Medicare reimbursement as
well rather than the Federal Diagnosis-Related Group (DRG) system required
elsewhere. In order to maintain this Medicare waiver, the cumulative rate of
increase in Maryland hospital charges since the base year 1980 must remain
below that of U.S. hospitals overall. From 1983 through 1992, the rate of
increase for Maryland hospitals was below the national average; for the six
years from 1993 through 1998, Maryland hospital costs have grown faster than
the national rate, although the cumulative rate of increase since the base
year is still below the national average. Any loss of the Medicare waiver in
the future may have an adverse impact upon the credit quality of Maryland
hospitals.
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
issuer's 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
industry.
The fund may invest in private activity bond issues for corporate and
nonprofit 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 more geographically diversified. In
addition to State of New Jersey 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 New Jersey and its local governments issue two basic types
of debt, with varying degrees of credit risk: general obligation bonds backed
by the unlimited taxing power of the issuer and revenue bonds
<PAGE>
secured by specific pledged fees or charges for a related project. In 1998,
$8.7 billion in state and local debt was issued in New Jersey, a 4% decrease
from the previous year. Of this total amount, approximately 31% represented
general obligation debt and 69% revenue bonds. 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 1998 was for a wide variety of public
purposes, including health care, education, and transportation.
The State of New Jersey had approximately $3.6 billion in general obligation
bonds outstanding as of June 30, 1998. General obligation debt of the state
is rated Aa1 by Moody's and AA+ by S&P and Fitch.
Many agencies of the state government are authorized to borrow money under
legislation which expressly provides that the loan obligations shall not be
deemed to constitute debt or a pledge of the faith and credit of the state.
The New Jersey Economic Development Authority, New Jersey Building Authority,
New Jersey Educational Facilities Authority, New Jersey Sports and Exposition
Authority, and New Jersey Transportation Trust Fund Authority have
outstanding bonds of this type.
Economy The state has recovered from the recession of the early 1990s. New
Jersey's large and diverse economy had the best two-year period of economic
growth from 1997-1998 since 1987-1988. However, employment growth in
1997-1998 was slightly lower than national growth rates. New Jersey may
narrow the employment growth gap further, but is expected to remain below
national growth levels. New Jersey personal income growth was stronger than
the national average. Per capita income in 1997 was also very strong at
approximately 128% of the nation. Real Gross State Product increased about
3.5% in 1998, the highest growth in 10 years. For the duration of 1999, New
Jersey's economy is expected to track the national economy with a possible
slowdown by the middle to end of the year.
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. The State
of New Jersey had General Fund operating deficits in the 1996 and 1997 fiscal
years, but in fiscal year 1998 the state reported a $130 million surplus. The
surplus caused the general fund balance to increase to $1.8 billion and
unreserved funds to increase to $905 million (5% of general revenues). In
1998 and in the current 1999 fiscal year the state has benefited from
stronger than expected revenue growth. A recent initiative that may have an
affect on the state's financial condition is the Governor's proposed property
tax rebate program. The program is projected to cost $200 million per year
over five years for a total of $1 billion.
Sectors Certain areas of potential investment concentration present unique
risks. In 1998, 20% of New Jersey tax-exempt debt was issued in the health
care sector by public or nonprofit 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 or Medicaid programs and
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 have
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
issuer's 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, 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
nonprofit borrowers. These issues sold through government 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. 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
<PAGE>
have issued several billion dollars of bonds to fund incinerator projects and
solid waste projects. A federal decision striking down New Jersey's system of
solid waste flow control increases the potential risk of default absent a
legislative solution, or some form of subsidy by local or state governments.
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 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 persisted. 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 $36.5 billion in
long-term municipal bonds in 1998, a 32% increase from the previous year. As
of March 31, 1999, total state-related bonded debt was projected to be $34.7
billion, of which $4.7 billion was general obligation debt and $29.7 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, 1999, the state's general obligation bonds
were rated A2 by Moody's, A by S&P 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, 1997, there
were 17 authorities that had aggregate debt outstanding, including refunding
bonds, of $846.
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.
Subsequent to the fiscal crisis of the mid-70s, 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. Due to a strong wall street
performance and a booming
<PAGE>
economy, New York ended fiscal 1998 with an accumulated surplus of $567
million. 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 1998 ended
with an operating surplus of $1.8 billion, which will helped smooth budget
balancing efforts for fiscal year 1999. Fiscal year 1998 is estimated to have
ended with another large operating surplus.
New York State has a large, diversified economy which has witnessed a basic
shift away from manufacturing toward service sector employment. In 1997, per
capita income in New York State was $30,752, 20% 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 18,175,301 in 1998. 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 0.9% between 1994 and 1998, well below 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 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, 1998, had a total General
Fund balance of $378 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 May 1, 1999 the City's general obligation bonds are rated A3 by
Moody's, A- by S&P and A by Fitch. S&P has listed the City's rating on
positive credit watch.
While New York City sustained a decade long record of relative financial
stability, during the 1990s 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 1999 fiscal year with an operating surplus of $1.66 billion.
The City's finances have been bolstered by strong tax receipts growth, fueled
by strong financial markets over the last several years. Revenues and
expenditures for the 1999 fiscal year were balanced in accordance with GAAP
for the nineteenth consecutive year. New York City remains exposed to future
budget pressure should there be a sharp down turn in the financial services
sector, though it has established a budget stabilization account for
contingency.
Long Island and LILCO
The Long Island Lighting Company (LILCO) was the single largest property
taxpayer in both Nassau and Suffolk Counties. LILCO 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 1986, the State Legislature created the Long Island Power
Authority (LIPA) and ownership of the Shoreham Plant was subsequently
transferred to LIPA for one dollar in exchange for certain rate benefits to
LILCO.
As requested by the Governor, LIPA 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. With the issuance of $7 billion in debt, LIPA
will purchase LILCO common stock, acquire or redeem certain preferred stock
and outstanding debt, and fund the cost of
<PAGE>
certain rebates and credits to LIPA's customers. With these purchases, LIPA
would acquire LILCO's electric transmission and distribution system, its 18%
ownership interest in the Nine Mile Point 2 nuclear plant and the regulatory
asset of Shoreham. In May 1998, LIPA sold its first two series of bonds
amounting to $4.9 billion. This allowed for the acquisition of LILCO by LIPA
and a merger of the remaining portions of the former LILCO business with
Keyspan Energy to form Marketspan Corp. LIPA will now be the provider of
retail electric service throughout most of Long Island.
Sectors Certain areas of potential investment concentration present unique
risks. In 1998, $4.6 billion of tax-exempt debt issued in New York was for
public or nonprofit 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 state's support for
Medicaid and health services has slowed over the last several years. In 1997
health care reform was implemented. Under the new system, hospitals are
permitted to negotiate inpatient payment rates with private payors. In
addition, the federal balanced budget act of 1997 contains provisions to
reduce Medicare expenditures. 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
nonprofit 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
9.8% of the tax-exempt debt issued in New York during 1997.
RISK FACTORS ASSOCIATED WITH A VIRGINIA 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 Commonwealth of Virginia general obligations and 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 Commonwealth of Virginia and its local governments issued $5.8
billion of municipal bonds in 1998, including general obligation debt backed
by the unlimited taxing power of the issuer and 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 1998
was for a wide variety of public purposes, including transportation, housing,
education, health care, and industrial development.
As of June 30, 1998, the Commonwealth of Virginia had $1.1 billion
outstanding general obligation bonds secured by the Commonwealth'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
Commonwealth'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.
<PAGE>
The Commonwealth also supports $2.6 billion in debt issued by the Virginia
Public Building Authority, the Virginia College Building Authority, the
Virginia Biotechnology Research Park Authority, the Virginia Port Authority,
and the Innovative Technology Authority for transportation purposes. These
bonds are not backed by the full faith and credit of the Commonwealth but
instead, are subject to annual appropriations from the Commonwealth's General
Fund.
In addition to the Commonwealth and public authorities described above, an
additional $8.0 billion in bonds has been issued by special public
authorities in Virginia that are not obligations of the Commonwealth. 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 Commonwealth of Virginia has a population of approximately 6.8
million, making it the twelfth largest state. Since the 1930s the
Commonwealth'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 30% of
the Commonwealth's population is concentrated. The next largest metropolitan
area is the Norfolk-Virginia Beach-Newport News area, followed by the
Richmond-Petersburg area, including the Commonwealth's capital of Richmond.
The Commonwealth'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 Commonwealth of Virginia and its localities.
Virginia is rated Triple-A by Moody's, S&P and Fitch. The Commonwealth's
budget is prepared on a biennial basis. From 1970 through 1998 the General
Fund showed a positive balance for all of its two-year budgetary periods. The
national recession and its negative effects on Virginia's personal income tax
collections did, however, force the Commonwealth to draw down its General
Fund balances to a deficit position in 1992. Spending cuts and improved
economic conditions allowed for positive operations from 1993 on. The
Commonwealth posted a budgetary surplus for fiscal years 1995 to 1998 despite
federal retiree settlements and other transfers. On June 30, 1998, the
unreserved general fund balance, including a revenue stabilization account,
totaled $970 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. 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.
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
nonprofit 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.
<PAGE>
All Funds
Puerto Rico From time to time the funds invest in obligations of the
Commonwealth of the Puerto Rico and its public Corporations which are exempt
form general 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 island's public functions, such as water,
wastewater, highways, telecommunications, education and public construction.
As of January 31, 1999, public sector debt issued by the Commonwealth and its
public corporations totaled $21.3 billion.
Since the 1980's 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 year 1998 reached 1.1 million
people. The number of unemployed citizens, however, remains high at 13.7
percent.
Debt ratios for the Commonwealth remain high as it assumes much of the
responsibility for the local infrastructure. Sizable infrastructure programs
are ongoing to upgrade the island's water, sewer and road systems. The
Commonwealth's general obligations debt is secured by a first lien on
revenues. The Commonwealth has maintained a fiscal policy which seeks to
correlate the growth in spending with the growth of the economic base
available to service that debt. Between fiscal years 1994 and 1998, however
the debt increased 46% while gross product rose 36%. Short term debt remains
a modest 11.7% of total debt outstanding as of January 31, 1999. The maximum
annual debt service requirement on Commonwealth general obligation debt
totals 9.7% of governmental revenues for fiscal year 1998. This is well below
the 15% limit imposed by the Commonwealth of Puerto Rico.
The fiscal year 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 balance of $324
million was recorded for the end of fiscal year 1998.
The Commonwealth's economy remains vulnerable to changes in oil prices,
American trade, foreign policy, levels of foreign assistance, and natural
disasters. On September 21, 1998, Puerto Rico was directly hit by Hurricane
Georges, which caused extensive public and private damage. Despite the
overall destructiveness of the storm, the net impact may have been positive,
as aid from the Federal Emergency Management Agency and insurers is estimated
to exceed $3 billion.
Per capita income levels, while being the highest in the Caribbean, lag far
behind the United States. In 1997 legislation was introduced proposing a
mechanism to permanently settle the political relationship with the United
States. In March 1998, the U.S. House of Representatives voted in favor of a
political status act that includes a referendum and a 10-year transition
plan. A referendum held in December of 1998 resulted in an ambiguous outcome
to the status question. Of the voting options available, a majority of voters
opted for the choice labeled "None of the Above." While there are various
interpretations to this result, it remains clear that no definite resolution
to the status issue is anticipated in the near future.
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 preciously 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 10-year period for existing claimants and to eliminate it
for corporations without established operations after
<PAGE>
October 1995. At present, it is difficult to forecast what the short- and
long-term effects of a phaseout of the Section 936 credit would have on the
Puerto Rican economy.
A final risk factor with Commonwealth is the large amount of unfunded pension
liabilities. The two main public pension systems are largely unfunded. The
employees retirement system has an unfunded liability of $6 billion and the
teachers retirement system has an unfunded liability of $1 billion. The
government is working to resolve the liability as evidenced by the use of a
portion of the proceeds of a sale of the Puerto Rican Telephone Company to
cover a portion of the fund's deficiency.
RISK FACTORS ASSOCIATED WITH TAX-EFFICIENT GROWTH FUND AND
THE EQUITY PORTION OF TAX-EFFICIENT BALANCED FUND
Foreign Securities
The funds may invest in foreign securities. These include
nondollar-denominated securities traded outside of the U.S. and
dollar-denominated securities of foreign issuers traded in the U.S. (such as
ADRs). Such investments increase a portfolio's diversification and may
enhance return, but they also involve some special risks, such as exposure to
potentially adverse local political and economic developments;
nationalization and exchange controls; potentially lower liquidity and higher
volatility; possible problems arising from accounting, disclosure,
settlement, and regulatory practices that differ from U.S. standards; and the
chance that fluctuations in foreign exchange rates will decrease the
investment's value (favorable changes can increase its value). These risks
are heightened for investments in developing countries, and there is no limit
on the amount of the funds' foreign investments that may be made in such
countries.
INVESTMENT PROGRAM
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Types of Securities
Set forth below is additional information about certain of the investments
described in each fund's prospectus.
Municipal Securities
Subject to the investment objectives and programs described in the prospectus
and the additional investment restrictions described in this Statement of
Additional Information, each fund's portfolio may consist of any combination
of the various types of municipal securities described below or other types
of municipal securities 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 fund relies 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 fund from such a security might not be
exempt from federal income tax.
Municipal securities are classified by maturity as notes, bonds, or
adjustable rate securities.
Municipal Notes
Municipal notes generally are used to provide 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.
<PAGE>
. 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
need 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 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 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 fund's Board determines such securities are illiquid,
they will be subject to the fund's limit on illiquid securities. 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
<PAGE>
the proceeds of the escrow account. To the extent permitted by the SEC 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.
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 order to minimize
movements in the principal value of the investment. 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 the following
forms:
Variable Rate Securities Variable rate instruments are those whose terms
provide for the adjustment of their interest rates on set dates and
which, upon such adjustment, can reasonably be expected to have a market
value that approximates its par value. Subject to the provisions of Rule
2a-7 under the 1940 Act, (1) a variable rate instrument, the principal
amount of which is scheduled to be paid in 397 days or less, is deemed to
have a maturity equal to the period remaining until the next readjustment
of the interest; (2) a variable rate instrument which is subject to a
demand feature which entitles the purchaser to receive the principal
amount of the underlying security or securities either (i) upon notice of
usually 30 days, or (ii) at specified intervals not exceeding 397 days
and upon no more than 30 days' notice 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) an instrument 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
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 funds will determine the maturity of these securities in
accordance with the amended provisions of such rule.
Floating Rate Securities Floating rate instruments are those whose terms
provide for the adjustment of their interest rates whenever a specified
interest rate changes and which, at any time, can reasonably be expected
to have a market value that approximates its par value. Subject to the
provisions of Rule 2a-7 under the 1940 Act, (1) the maturity of a
floating rate instrument is deemed to be the period remaining until the
date (noted on the face of the instrument) on which the principal amount
must be paid, or in the case of an instrument called for redemption, the
date on which the redemption payment must be made; and (2) floating rate
instruments with demand features are 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 funds will
determine the maturity of these securities in accordance with the amended
provisions or such rule.
<PAGE>
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.
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 hold participation interests is exempt from federal income tax
to the funds. However, there is no guarantee the IRS would treat such
interest income as tax-exempt.
Bond and Balanced Funds
. Residual Interest Bonds are a type of high-risk derivative. The funds may
purchase municipal bond issues that are structured as two-part, residual
interest bond and variable rate 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 index or auction process
held approximately every seven to 35 days while the bondholders 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, seven- to 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.
. Embedded Interest Rate Swaps and Caps 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 the fund's total return.
The funds may invest in other types of derivative instruments as they become
available.
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
<PAGE>
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.
There are, of course, other types of securities that are, or may become
available, which are similar to the foregoing and the funds may invest in
these securities.
All Funds
When-Issued Securities
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 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 maintain cash, high-grade marketable debt securities
or other suitable cover with its custodian bank equal in value to commitments
for when-issued securities. Such 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 fully invested
or almost 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 the 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 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.
All Funds (other than the Money Funds)
Forwards
The funds 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 to sell the escrow receipts during the
when-issued period.
All Funds
Investment in Taxable Money Market Securities
Although the funds (other than Tax-Efficient Balanced and Tax-Efficient
Growth Funds) expect to be solely invested in municipal securities, for
temporary defensive purposes they may elect to invest in the taxable money
market securities listed next (without limitation) when such action is deemed
to be in the best interests of shareholders. The interest earned on these
money market securities is not exempt from federal income tax and may be
taxable to shareholders as ordinary income.
. U.S. Government Obligations Bills, notes, bonds, and other debt securities
issued by the U.S. Treasury. These are direct obligations of the U.S.
government and differ mainly in the length of their maturities.
<PAGE>
. U.S. Government Agency Securities Issued or guaranteed by U.S.
government-sponsored enterprises and federal agencies. These include
securities issued by the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Bank, Federal Land Banks,
Farmers Home Administration, Banks for Cooperatives, Federal Intermediate
Credit Banks, Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these securities are
supported by the full faith and credit of the U.S. Treasury; the remainder
are supported only by the credit of the instrumentality, which may or may not
include the right of the issuer to borrow from the Treasury.
. Bank Obligations Certificates of deposit, bankers' acceptances, and other
short-term debt obligations. Certificates of deposit are short-term
obligations of commercial banks. A bankers' acceptance is a time draft drawn
on a commercial bank by a borrower, usually in connection with international
commercial transactions. Certificates of deposit may have fixed or variable
rates. The fund may invest in U.S. banks, foreign branches of U.S. banks,
U.S. branches of foreign banks, and foreign branches of foreign banks.
. Short-Term Corporate Debt Securities Short-term corporate debt securities
rated at least AA by S&P, Moody's or Fitch.
. 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 Directors/Trustees.
. 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 other funds may also purchase
money market securities. In determining the maturity of money market
securities, funds will follow the provisions of Rule 2a-7 under the 1940 Act.
Tax-Efficient Balanced and Tax-Efficient Growth Funds
Hybrid Instruments
Hybrid Instruments (a type of potentially high-risk derivative) have been
developed and combine the elements of futures contracts or options with those
of debt, preferred equity, or a depository instrument (hereinafter "Hybrid
Instruments"). Generally, a Hybrid Instrument will be a debt security,
preferred stock, depository share, trust certificate, certificate of deposit,
or other evidence of indebtedness on which a portion of or all interest
payments, and/or the principal or stated amount payable at maturity,
redemption, or retirement, is determined by reference to prices, changes in
prices, or differences between prices, of securities, currencies,
intangibles, goods, articles, or commodities (collectively "Underlying
Assets") or by another objective index, economic factor, or other measure,
such as interest rates, currency exchange rates, commodity indices, and
securities indices (collectively "Benchmarks"). Thus, Hybrid Instruments may
take a variety of forms, including, but not limited to, debt instruments with
interest or principal payments or redemption terms determined by reference to
the value of a currency or commodity or securities index at a future point in
time, preferred stock with dividend rates determined by reference to the
value of a currency, or convertible securities with the conversion terms
related to a particular commodity.
Hybrid Instruments can be an efficient means of creating exposure to a
particular market, or segment of a market, with the objective of enhancing
total return. For example, a fund may wish to take advantage of expected
declines in interest rates in several European countries, but avoid the
transaction costs associated with buying and currency-hedging the foreign
bond positions. One solution would be to purchase a U.S. dollar-denominated
Hybrid Instrument whose redemption price is linked to the average three-year
interest rate in a designated group of countries. The redemption price
formula would provide for payoffs of greater than par if the average interest
rate was lower than a specified level, and payoffs of less than par if rates
were above the specified level. Furthermore, the fund could limit the
downside risk of the security by establishing a minimum redemption price so
that the principal paid at maturity could not be below a predetermined
minimum level if interest rates were to rise significantly. The purpose of
this arrangement, known as a structured security with an embedded put option,
would be to give the fund the desired European bond exposure while avoiding
currency risk, limiting downside market risk, and lowering transactions
costs. Of
<PAGE>
course, there is no guarantee that the strategy will be successful, and the
fund could lose money if, for example, interest rates do not move as
anticipated or credit problems develop with the issuer of the Hybrid.
The risks of investing in Hybrid Instruments reflect a combination of the
risks of investing in securities, options, futures and currencies. Thus, an
investment in a Hybrid Instrument may entail significant risks that are not
associated with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars, or bears
interest either at a fixed rate or a floating rate determined by reference to
a common, nationally published benchmark. The risks of a particular Hybrid
Instrument will, of course, depend upon the terms of the instrument, but may
include, without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the instrument is
linked. Such risks generally depend upon factors which are unrelated to the
operations or credit quality of the issuer of the Hybrid Instrument and which
may not be readily foreseen by the purchaser, such as economic and political
events, the supply and demand for the Underlying Assets, and interest rate
movements. In recent years, various Benchmarks and prices for Underlying
Assets have been highly volatile, and such volatility may be expected in the
future. Reference is also made to the discussion of futures, options, and
forward contracts herein for a discussion of the risks associated with such
investments.
Hybrid Instruments are potentially more volatile and carry greater market
risks than traditional debt instruments. Depending on the structure of the
particular Hybrid Instrument, changes in a Benchmark may be magnified by the
terms of the Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices of the
Hybrid Instrument and the Benchmark or Underlying Asset may not move in the
same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred dividends at below
market (or even relatively nominal) rates. Alternatively, Hybrid Instruments
may bear interest at above market rates but bear an increased risk of
principal loss (or gain). The latter scenario may result if "leverage" is
used to structure the Hybrid Instrument. Leverage risk occurs when the Hybrid
Instrument is structured so that a given change in a Benchmark or Underlying
Asset is multiplied to produce a greater value change in the Hybrid
Instrument, thereby magnifying the risk of loss as well as the potential for
gain.
Hybrid Instruments may also carry liquidity risk since the instruments are
often "customized" to meet the portfolio needs of a particular investor, and
therefore, the number of investors that are willing and able to buy such
instruments in the secondary market may be smaller than that for more
traditional debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market without the
guarantee of a central clearing organization or in a transaction between the
fund and the issuer of the Hybrid Instrument, the creditworthiness of the
counter party of issuer of the Hybrid Instrument would be an additional risk
factor which the fund would have to consider and monitor. Hybrid Instruments
also may not be subject to regulation of the Commodities Futures Trading
Commission ("CFTC"), which generally regulates the trading of commodity
futures by U.S. persons, the SEC, which regulates the offer and sale of
securities by and to U.S. persons, or any other governmental regulatory
authority.
The various risks discussed above, particularly the market risk of such
instruments, may in turn cause significant fluctuations in the net asset
value of the fund. Accordingly, the fund will limit its investments in Hybrid
Instruments to 10% of total assets. However, because of their volatility, it
is possible that the fund's investment in Hybrid Instruments will account for
more than 10% of the fund's return (positive or negative).
Illiquid or Restricted Securities
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act of 1933 (the "1933 Act"). Where registration
is required, the fund may be obligated to pay all or part of the registration
expenses, and a considerable period may elapse between the time of the
decision to sell and the time the fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the fund might obtain a less favorable
price than prevailed when it decided to sell. Restricted securities will be
priced at fair value as determined in accordance with procedures prescribed
by the fund's Board of Directors/Trustees. If, through the appreciation of
illiquid securities or the depreciation of
<PAGE>
liquid securities, the fund should be in a position where more than 15% of
the value of its net assets is invested in illiquid assets, including
restricted securities, the fund will take appropriate steps to protect
liquidity.
Notwithstanding the above, the fund may purchase securities which, while
privately placed, are eligible for purchase and sale under Rule 144A under
the 1933 Act. This rule permits certain qualified institutional buyers, such
as the fund, to trade in privately placed securities even though such
securities are not registered under the 1933 Act. T. Rowe Price, under the
supervision of the fund's Board of Directors/Trustees, will consider whether
securities purchased under Rule 144A are illiquid and thus subject to the
fund's restriction of investing no more than 15% of its net assets in
illiquid securities. A determination of whether a Rule 144A security is
liquid or not is a question of fact. In making this determination, T. Rowe
Price will consider the trading markets for the specific security taking into
account the unregistered nature of a Rule 144A security. In addition, T. Rowe
Price could consider the following: (1) frequency of trades and quotes; (2)
number of dealers and potential purchases; (3) dealer undertakings to make a
market; and (4) the nature of the security and of marketplace trades (e.g.,
the time needed to dispose of the security, the method of soliciting offers,
and the mechanics of transfer). The liquidity of Rule 144A securities would
be monitored and, if as a result of changed conditions it is determined that
a Rule 144A security is no longer liquid, the fund's holdings of illiquid
securities would be reviewed to determine what, if any, steps are required to
assure that the fund does not invest more than 15% of its net assets in
illiquid securities. Investing in Rule 144A securities could have the effect
of increasing the amount of the fund's assets invested in illiquid securities
if qualified institutional buyers are unwilling to purchase such securities.
Warrants
The fund may acquire warrants. Warrants can be highly volatile and have no
voting rights, pay no dividends, and have no rights with respect to the
assets of the corporation issuing them. Warrants basically are options to
purchase securities at a specific price valid for a specific period of time.
They do not represent ownership of the securities, but only the right to buy
them. Warrants differ from call options in that warrants are issued by the
issuer of the security which may be purchased on their exercise, whereas call
options may be written or issued by anyone. The prices of warrants do not
necessarily move parallel to the prices of the underlying securities.
PORTFOLIO MANAGEMENT PRACTICES
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All Funds (other than the Money Funds)
Futures Contracts
Futures contracts are a type of potentially high-risk derivative.
Transactions in Futures
The Bond Funds may enter into futures contracts including stock index,
interest rate, and currency futures ("futures" or "futures contracts").
The Tax-Efficient Balanced and Tax-Efficient Growth Funds may enter into
futures contracts including stock index, interest rate, and currency futures
("futures or futures contracts").
All Funds (other than the Money Funds)
The nature of such futures and the regulatory limitations and risks are the
same as those described below.
Stock index futures contracts may be used to provide a hedge for a portion of
the fund's portfolio, as a cash management tool, or as an efficient way for
T. Rowe Price to implement either an increase or decrease in portfolio market
exposure in response to changing market conditions. The fund may purchase or
sell futures contracts with respect to any stock index. Nevertheless, to
hedge the fund's portfolio successfully, the fund
<PAGE>
must sell futures contacts with respect to indices or subindices whose
movements will have a significant correlation with movements in the prices of
the fund's portfolio securities.
Interest rate or currency futures contracts may be used as a hedge against
changes in prevailing levels of interest rates or currency exchange rates in
order to establish more definitely the effective return on securities or
currencies held or intended to be acquired by the fund. In this regard, the
fund could sell interest rate or currency futures as an offset against the
effect of expected increases in interest rates or currency exchange rates and
purchase such futures as an offset against the effect of expected declines in
interest rates or currency exchange rates.
The fund will enter into futures contracts which are traded on national (and
for the Tax-Efficient Balanced and Tax-Efficient Growth Funds, foreign)
futures exchanges, and are standardized as to maturity date and underlying
financial instrument. Futures exchanges and trading in the United States are
regulated under the Commodity Exchange Act by the 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
If the fund purchases or sells futures contracts or related options which do
not qualify as bona fide hedging under applicable CFTC rules, the aggregate
initial margin deposits and premium required to establish those positions
cannot exceed 5% of the liquidation 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 foreign currency options traded on a commodities
exchange will be considered "related options." This policy may be modified by
the Board of Directors/Trustees without a shareholder vote and does not limit
the percentage of the fund's assets at risk to 5%.
In instances involving the purchase of futures contracts or the writing of
call or put options thereon by the fund, an amount of cash, liquid assets, or
other suitable cover as permitted by the SEC, equal to the market value of
the futures contracts and options thereon (less any related margin deposits),
will be identified by the fund 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 stock index) 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.
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, or liquid assets 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.
<PAGE>
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 market."
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.
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 Treasury bills on an exchange may be fulfilled at any
time before delivery of the contract is required (i.e., on a specified date
in September, the "delivery month") by the purchase of one contract of
September Treasury bills on the same exchange. In such instance, the
difference between the price at which the futures contract was sold and the
price paid for the offsetting purchase, after allowance for transaction
costs, represents the profit or loss to the fund.
Tax-Efficient Balanced and Tax-Efficient Growth Funds
For example, the S&P's 500 Stock Index is made up of 500 selected common
stocks, most of which are listed on the New York Stock Exchange. The S&P 500
Index assigns relative weightings to the common stocks included in the Index,
and the Index fluctuates with changes in the market values of those common
stocks. In the case of futures contracts on the S&P 500 Index, the contracts
are to buy or sell 250 units. Thus, if the value of the S&P 500 Index were
$150, one contract would be worth $37,500 (250 units x $150). The stock index
futures contract specifies that no delivery of the actual stocks making up
the index will take place. Instead, settlement in cash occurs. Over the life
of the contract, the gain or loss realized by the fund will equal the
difference between the purchase (or sale) price of the contract and the price
at which the contract is terminated. For example, if the fund enters into a
futures contract to buy 250 units of the S&P 500 Index at a specified future
date at a contract price of $150 and the S&P 500 Index is at $154 on that
future date, the fund will gain $1,000 (250 units x gain of $4). If the fund
enters into a futures contract to sell 250 units of the stock index at a
specified future date at a contract price of $150 and the S&P 500 Index is at
$152 on that future date, the fund will lose $500 (250 units x loss of $2).
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
<PAGE>
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.
Margin deposits required on futures trading are low. 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.
. 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 next, 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 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 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.
<PAGE>
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 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.
All Funds (other than the Money Funds)
The fund may purchase and sell options on the same types of futures in which
it may invest.
Bond and Balanced Funds
Options on Futures Contracts
The fund might trade in municipal bond index option futures or similar
options on futures developed in the future. In 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 may 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 (another type of potentially high-risk derivative) 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 the 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>
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.
Tax-Efficient Balanced and Tax-Efficient Growth Funds
As an alternative to writing or purchasing call and put options on stock
index futures, the fund may write or purchase call and put options on stock
indices. Such options would be used in a manner similar to the use of options
on futures contracts.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks in Transactions on Futures
Contracts" are substantially the same as the risks of using options on
futures. If the fund were to write an option on a futures contract, it would
be required to deposit and maintain initial and variation margin in the same
manner as a regular futures contract. 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: (1) there may be insufficient trading
interest in certain options; (2) restrictions may be imposed by an exchange
on opening transactions or closing transactions or both; (3) trading halts,
suspensions or other restrictions may be imposed with respect to particular
classes or series of options, or underlying instruments; (4) unusual or
unforeseen circumstances may interrupt normal operations on an exchange; (5)
the facilities of an exchange or a clearing corporation may not at all times
be adequate to handle current trading volume; or (6) 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 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 significantly increased when an option on a
U.S. government securities future or an option on some type of index future
is used as a proxy for hedging a portfolio consisting of other types of
securities. Another risk is that the movements in the price of options on
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
<PAGE>
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 fund has no current intention of engaging in futures or options
transactions other than those described above, it reserves 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 Options, Futures Contracts, and Forward Foreign
Exchange Contracts
Although the fund invests almost exclusively in securities that generate
income that is exempt from federal income taxes, the fund may enter into
certain option, futures, and foreign exchange contracts, including options
and futures on currencies, which will be treated as Section 1256 contracts or
straddles that are not exempt from such taxes. Therefore, use of the
investment techniques described above could result in taxable income to
shareholders of the fund.
Transactions which are considered Section 1256 contracts will be considered
to have been closed at the end of the fund's fiscal year and any gains or
losses will be recognized for tax purposes at that time. Gains or losses
recognized from the normal closing or settlement of such transactions will be
characterized as 60% long-term capital gain or loss and 40% short-term
capital gain or loss, without regard to the holding period of the contract.
The fund will be required to distribute net gains on such transactions to
shareholders even though it may not have closed the transaction and received
cash to pay such distributions.
Options, futures and forward foreign exchange contracts, including options
and futures on currencies, which offset a foreign dollar denominated bond or
currency position may be considered straddles for tax purposes, in which case
a loss on any position in a straddle will be subject to deferral to the
extent of unrealized gain in an offsetting position. The holding period of
the securities or currencies comprising the straddle will be deemed not to
begin until the straddle is terminated. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an equity
security will not include the period of time the option is outstanding.
Losses on written covered calls and purchased puts on securities, excluding
certain "qualified covered call" options on equity securities, may be
long-term capital losses, if the security covering the option was held for
more than 12 months prior to the writing of the option.
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 or currencies. Tax regulations could be issued limiting the extent
that net gain realized from option, futures or foreign forward exchange
contracts on currencies is qualifying income for purposes of the 90%
requirement.
As a result of the "Taxpayer Relief Act of 1997," entering into certain
options, futures contracts, or forward contracts may result in the
"constructive sale" of offsetting stocks or debt securities of the fund.
Options on Securities
Options are another type of potentially high-risk derivative.
Bond and Money 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.
<PAGE>
Tax-Efficient Balanced and Tax-Efficient Growth Funds
Writing Covered Call Options
The fund may write (sell) American or European style "covered" call options
and purchase options to close out options previously written by the fund. In
writing covered call options, the fund expects to generate additional premium
income which should serve to enhance the fund's total return and reduce the
effect of any price decline of the security or currency involved in the
option. Covered call options will generally be written on securities or
currencies which, in T. Rowe Price's opinion, are not expected to have any
major price increases or moves in the near future but which, over the long
term, are deemed to be attractive investments for the fund.
A call option gives the holder (buyer) the "right to purchase" a security or
currency at a specified price (the exercise price) at expiration of the
option (European style) or at any time until a certain date (the expiration
date) (American style). So long as the obligation of the writer of a call
option continues, he may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring him to deliver the underlying
security or currency against payment of the exercise price. This obligation
terminates upon the expiration of the call option, or such earlier time at
which the writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his obligation to deliver
the underlying security or currency in the case of a call option, a writer is
required to deposit in escrow the underlying security or currency or other
assets in accordance with the rules of a clearing corporation.
The fund generally will write only covered call options. This means that the
fund will either own the security or currency subject to the option or an
option to purchase the same underlying security or currency, having an
exercise price equal to or less than the exercise price of the "covered"
option. From time to time, the fund will write a call option that is not
covered as indicated above but where the fund will establish and maintain
with its custodian for the term of the option, an account consisting of cash,
U.S. government securities, other liquid high-grade debt obligations, or
other suitable cover as permitted by the SEC having a value equal to the
fluctuating market value of the optioned securities or currencies. While such
an option would be "covered" with sufficient collateral to satisfy SEC
prohibitions on issuing senior securities, this type of strategy would expose
the fund to the risks of writing uncovered options.
Portfolio securities or currencies on which call options may be written will
be purchased solely on the basis of investment considerations consistent with
the fund's investment objective. The writing of covered call options is a
conservative investment technique believed to involve relatively little risk
(in contrast to the writing of naked or uncovered options, which the fund
generally will not do), but capable of enhancing the fund's total return.
When writing a covered call option, a fund, in return for the premium, gives
up the opportunity for profit from a price increase in the underlying
security or currency above the exercise price, but conversely retains the
risk of loss should the price of the security or currency decline. Unlike one
who owns securities or currencies not subject to an option, the fund has no
control over when it may be required to sell the underlying securities or
currencies, since it may be assigned an exercise notice at any time prior to
the expiration of its obligation as a writer. If a call option which the fund
has written expires, the fund will realize a gain in the amount of the
premium; however, such gain may be offset by a decline in the market value of
the underlying security or currency during the option period. If the call
option is exercised, the fund will realize a gain or loss from the sale of
the underlying security or currency. The fund does not consider a security or
currency covered by a call to be "pledged" as that term is used in the fund's
policy which limits the pledging or mortgaging of its assets. If the fund
writes an uncovered option as described above, it will bear the risk of
having to purchase the security subject to the option at a price higher than
the exercise price of the option. As the price of a security could appreciate
substantially, the fund's loss could be significant.
The premium received is the market value of an option. The premium the fund
will receive from writing a call option will reflect, among other things, the
current market price of the underlying security or currency, the relationship
of the exercise price to such market price, the historical price volatility
of the underlying security or currency, and the length of the option period.
Once the decision to write a call option has been made, T. Rowe Price, in
determining whether a particular call option should be written on a
particular security or currency, will consider the reasonableness of the
anticipated premium and the likelihood that a liquid
<PAGE>
secondary market will exist for those options. The premium received by the
fund for writing covered call options will be recorded as a liability of the
fund. This liability will be adjusted daily to the option's current market
value, which will be the latest sale price at the time at which the net asset
value per share of the fund is computed (close of the New York Stock
Exchange), or, in the absence of such sale, the latest asked price. The
option will be terminated upon expiration of the option, the purchase of an
identical option in a closing transaction, or delivery of the underlying
security or currency upon the exercise of the option.
Closing transactions will be effected in order to realize a profit on an
outstanding call option, to prevent an underlying security or currency from
being called, or, to permit the sale of the underlying security or currency.
Furthermore, effecting a closing transaction will permit the fund to write
another call option on the underlying security or currency with either a
different exercise price or expiration date or both. If the fund desires to
sell a particular security or currency from its portfolio on which it has
written a call option, or purchased a put option, it will seek to effect a
closing transaction prior to, or concurrently with, the sale of the security
or currency. There is, of course, no assurance that the fund will be able to
effect such closing transactions at favorable prices. If the fund cannot
enter into such a transaction, it may be required to hold a security or
currency that it might otherwise have sold. When the fund writes a covered
call option, it runs the risk of not being able to participate in the
appreciation of the underlying securities or currencies above the exercise
price, as well as the risk of being required to hold on to securities or
currencies that are depreciating in value. This could result in higher
transaction costs. The fund will pay transaction costs in connection with the
writing of options to close out previously written options. Such transaction
costs are normally higher than those applicable to purchases and sales of
portfolio securities.
Call options written by the fund will normally have expiration dates of less
than nine months from the date written. The exercise price of the options may
be below, equal to, or above the current market values of the underlying
securities or currencies at the time the options are written. From time to
time, the fund may purchase an underlying security or currency for delivery
in accordance with an exercise notice of a call option assigned to it, rather
than delivering such security or currency from its portfolio. In such cases,
additional costs may be incurred.
The fund will realize a profit or loss from a closing purchase transaction if
the cost of the transaction is less or more than the premium received from
the writing of the option. Because increases in the market price of a call
option will generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a call option
is likely to be offset in whole or in part by appreciation of the underlying
security or currency owned by the fund.
The fund will not write a covered call option if, as a result, the aggregate
market value of all portfolio securities or currencies covering written call
or put options exceeds 25% of the market value of the fund's net assets. In
calculating the 25% limit, the fund will offset, against the value of assets
covering written calls and puts, the value of purchased calls and puts on
identical securities or currencies with identical maturity dates.
Writing Covered Put Options
The fund may write American or European style covered put options and
purchase options to close out options previously written by the fund. A put
option gives the purchaser of the option the right to sell, and the writer
(seller) has the obligation to buy, the underlying security or currency at
the exercise price during the option period (American style) or at the
expiration of the option (European style). So long as the obligation of the
writer continues, he may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring him to make payment to the
exercise price against delivery of the underlying security or currency. The
operation of put options in other respects, including their related risks and
rewards, is substantially identical to that of call options.
The fund would write put options only on a covered basis, which means that
the fund would maintain in a segregated account cash, U.S. government
securities, other liquid high-grade debt obligations, or other suitable cover
as determined by the SEC, in an amount not less than the exercise price or
the fund will own an option to sell the underlying security or currency
subject to the option having an exercise price equal to or greater than the
exercise price of the "covered" option at all times while the put option is
outstanding. (The
<PAGE>
rules of a clearing corporation currently require that such assets be
deposited in escrow to secure payment of the exercise price.)
The fund would generally write covered put options in circumstances where T.
Rowe Price wishes to purchase the underlying security or currency for the
fund's portfolio at a price lower than the current market price of the
security or currency. In such event the fund would write a put option at an
exercise price which, reduced by the premium received on the option, reflects
the lower price it is willing to pay. Since the fund would also receive
interest on debt securities or currencies maintained to cover the exercise
price of the option, this technique could be used to enhance current return
during periods of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency would decline
below the exercise price less the premiums received. Such a decline could be
substantial and result in a significant loss to the fund. In addition, the
fund, because it does not own the specific securities or currencies which it
may be required to purchase in exercise of the put, cannot benefit from
appreciation, if any, with respect to such specific securities or currencies.
The fund will not write a covered put option if, as a result, the aggregate
market value of all portfolio securities or currencies covering put or call
options exceeds 25% of the market value of the fund's net assets. In
calculating the 25% limit, the fund will offset, against the value of assets
covering written puts and calls, the value of purchased puts and calls on
identical securities or currencies with identical maturity dates.
Purchasing Put Options
The fund may purchase American or European style put options. As the holder
of a put option, the fund has the right to sell the underlying security or
currency at the exercise price at any time during the option period (American
style) or at the expiration of the option (European style). The fund may
enter into closing sale transactions with respect to such options, exercise
them or permit them to expire. The fund may purchase put options for
defensive purposes in order to protect against an anticipated decline in the
value of its securities or currencies. An example of such use of put options
is provided next.
The fund may purchase a put option on an underlying security or currency (a
"protective put") owned by the fund as a defensive technique in order to
protect against an anticipated decline in the value of the security or
currency. Such hedge protection is provided only during the life of the put
option when the fund, as the holder of the put option, is able to sell the
underlying security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's exchange
value. For example, a put option may be purchased in order to protect
unrealized appreciation of a security or currency where T. Rowe Price deems
it desirable to continue to hold the security or currency because of tax
considerations. The premium paid for the put option and any transaction costs
would reduce any capital gain otherwise available for distribution when the
security or currency is eventually sold.
The fund may also purchase put options at a time when the fund does not own
the underlying security or currency. By purchasing put options on a security
or currency it does not own, the fund seeks to benefit from a decline in the
market price of the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the underlying
security or currency remains equal to or greater than the exercise price
during the life of the put option, the fund will lose its entire investment
in the put option. In order for the purchase of a put option to be
profitable, the market price of the underlying security or currency must
decline sufficiently below the exercise price to cover the premium and
transaction costs, unless the put option is sold in a closing sale
transaction.
The fund will not commit more than 5% of its assets to premiums when
purchasing put and call options. The premium paid by the fund when purchasing
a put option will be recorded as an asset of the fund. This asset will be
adjusted daily to the option's current market value, which will be the latest
sale price at the time at which the net asset value per share of the fund is
computed (close of New York Stock Exchange), or, in the absence of such sale,
the latest bid price. This asset will be terminated upon expiration of the
option, the selling (writing) of an identical option in a closing
transaction, or the delivery of the underlying security or currency upon the
exercise of the option.
<PAGE>
Purchasing Call Options
The fund may purchase American or European style call options. As the holder
of a call option, the fund has the right to purchase the underlying security
or currency at the exercise price at any time during the option period
(American style) or at the expiration of the option (European style). The
fund may enter into closing sale transactions with respect to such options,
exercise them or permit them to expire. The fund may purchase call options
for the purpose of increasing its current return or avoiding tax consequences
which could reduce its current return. The fund may also purchase call
options in order to acquire the underlying securities or currencies. Examples
of such uses of call options are provided next.
Call options may be purchased by the fund for the purpose of acquiring the
underlying securities or currencies for its portfolio. Utilized in this
fashion, the purchase of call options enables the fund to acquire the
securities or currencies at the exercise price of the call option plus the
premium paid. At times the net cost of acquiring securities or currencies in
this manner may be less than the cost of acquiring the securities or
currencies directly. This technique may also be useful to the fund in
purchasing a large block of securities or currencies that would be more
difficult to acquire by direct market purchases. So long as it holds such a
call option rather than the underlying security or currency itself, the fund
is partially protected from any unexpected decline in the market price of the
underlying security or currency and in such event could allow the call option
to expire, incurring a loss only to the extent of the premium paid for the
option.
The fund will not commit more than 5% of its assets to premiums when
purchasing call and put options. The fund may also purchase call options on
underlying securities or currencies it owns in order to protect unrealized
gains on call options previously written by it. A call option would be
purchased for this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call options may
also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The fund may engage in transactions involving dealer options. Certain risks
are specific to dealer options. While the fund would look to a clearing
corporation to exercise exchange-traded options, if the fund were to purchase
a dealer option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the dealer to do
so would result in the loss of the premium paid by the fund as well as loss
of the expected benefit of the transaction.
Exchange-traded options generally have a continuous liquid market while
dealer options have none. Consequently, the fund will generally be able to
realize the value of a dealer option it has purchased only by exercising it
or reselling it to the dealer who issued it. Similarly, when the fund writes
a dealer option, it generally will be able to close out the option prior to
its expiration only by entering into a closing purchase transaction with the
dealer to which the fund originally wrote the option. While the fund will
seek to enter into dealer options only with dealers who will agree to and
which are expected to be capable of entering into closing transactions with
the fund, there can be no assurance that the fund will be able to liquidate a
dealer option at a favorable price at any time prior to expiration. Until the
fund, as a covered dealer call option writer, is able to effect a closing
purchase transaction, it will not be able to liquidate securities (or other
assets) or currencies used as cover until the option expires or is exercised.
In the event of insolvency of the contra party, the fund may be unable to
liquidate a dealer option. With respect to options written by the fund, the
inability to enter into a closing transaction may result in material losses
to the fund. For example, since the fund must maintain a secured position
with respect to any call option on a security it writes, the fund may not
sell the assets which it has segregated to secure the position while it is
obligated under the option. This requirement may impair a fund's ability to
sell portfolio securities or currencies at a time when such sale might be
advantageous.
The Staff of the SEC has taken the position that purchased dealer options and
the assets used to secure the written dealer options are illiquid securities.
The fund may treat the cover used for written Over-the-Counter ("OTC")
options as liquid if the dealer agrees that the fund may repurchase the OTC
option it has written for a maximum price to be calculated by a predetermined
formula. In such cases, the OTC option would be considered illiquid only to
the extent the maximum repurchase price under the formula exceeds the
intrinsic value of the option.
<PAGE>
Lending of Portfolio Securities
Securities loans are made to broker-dealers or institutional investors or
other persons, pursuant to agreements requiring that the loans be
continuously secured by collateral at least equal at all times to the value
of the securities lent, marked to market on a daily basis. The collateral
received will consist of cash, U.S. government securities, letters of credit
or such other collateral as may be permitted under its investment program.
While the securities are being lent, the fund will continue to receive the
equivalent of the interest or dividends paid by the issuer on the securities,
as well as interest on the investment of the collateral or a fee from the
borrower. The fund has a right to call each loan and obtain the securities,
within such period of time which coincides with the normal settlement period
for purchases and sales of such securities in the respective markets. The
fund will not have the right to vote on securities while they are being lent,
but it will call a loan in anticipation of any important vote. The risks in
lending portfolio securities, as with other extensions of secured credit,
consist of possible delay in receiving additional collateral or in the
recovery of the securities or possible loss of rights in the collateral
should the borrower fail financially. Loans will only be made to firms deemed
by T. Rowe Price to be of good standing and will not be made unless, in the
judgment of T. Rowe Price, the consideration to be earned from such loans
would justify the risk.
Repurchase Agreements
The fund may enter into a repurchase agreement through which an investor
(such as the fund) purchases a security (known as the "underlying security")
from a well-established securities dealer or a bank that is a member of the
Federal Reserve System. Any such dealer or bank will be on T. Rowe Price's
approved list and have a credit rating with respect to its short-term debt of
at least A1 by S&P, P1 by Moody's, or the equivalent rating by T. Rowe Price.
At that time, the bank or securities dealer agrees to repurchase the
underlying security at the same price, plus specified interest. Repurchase
agreements are generally for a short period of time, often less than a week.
Repurchase agreements which do not provide for payment within seven days will
be treated as illiquid securities. The fund will only enter into repurchase
agreements where (1) the underlying securities are of the type (excluding
maturity limitations) which the fund's investment guidelines would allow it
to purchase directly, (2) the market value of the underlying security,
including interest accrued, will be at all times equal to or exceed the value
of the repurchase agreement, and (3) payment for the underlying security is
made only upon physical delivery or evidence of book-entry transfer to the
account of the custodian or a bank acting as agent. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the fund
could experience both delays in liquidating the underlying security and
losses, including: (a) possible decline in the value of the underlying
security during the period while the fund seeks to enforce its rights
thereto; (b) possible subnormal levels of income and lack of access to income
during this period; and (c) expenses of enforcing its rights.
Reverse Repurchase Agreements
Although the fund has no current intention of engaging in reverse repurchase
agreements, the fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a fund is the seller
of, rather than the investor in, securities, and agrees to repurchase them at
an agreed upon time and price. Use of a reverse repurchase agreement may be
preferable to a regular sale and later repurchase of the securities because
it avoids certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the fund, subject to
Investment Restriction (1). (See "Investment Restrictions.")
All Funds
INVESTMENT RESTRICTIONS
-------------------------------------------------------------------------------
Fundamental policies may not be changed without the approval of the lesser of
(1) 67% of the 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
fund's Board of Directors/Trustees without shareholder approval. Any
investment restriction which involves a maximum percentage of securities or
assets shall not be
<PAGE>
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, the fund. Calculation of the fund's total assets for
compliance with any of the following fundamental or operating policies or any
other investment restrictions set forth in the fund's prospectus or Statement
of Additional Information will not include cash collateral held in connection
with securities lending activities.
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;
(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 (National Tax-Free,
California, Tax-Efficient Balanced, and Tax-Efficient Growth 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 (National Tax-Free,
California, Tax-Efficient Balanced, and Tax-Efficient Growth 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
1940 Act;
(9) Taxable Securities (All Funds, except Tax-Efficient Balanced and
Tax-Efficient Growth Funds) 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, any state, city, or
local income tax. Normally, the fund will not purchase a security if, as
a result, more than 20% of the fund's income would be subject to the AMT;
or
<PAGE>
(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 1933 Act in connection with the purchase and sale of its
portfolio securities in the ordinary course of pursuing its investment
program.
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 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
currency contracts or hybrid investments 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. Industries are determined by reference to the
classifications of industries set forth in the fund's semiannual and
annual reports. It is the position of the Staff of the SEC that foreign
governments are industries for purposes of this restriction.
For purposes of investment restriction (4), the fund will consider the
acquisition of a debt security to include the execution of a note or
other evidence of an extension of credit with a term of more than nine
months.
Operating Policies
As a matter of operating policy, the fund may not:
(1) Borrowing 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 (All Funds except Tax-Efficient Balanced and
Tax-Efficient Growth Funds) 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 each Money Fund may invest up to 10% of its 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
such options 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 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 (i) in compliance with the Investment Company
Act of 1940; (ii) in the case of the Tax-Free Funds, only securities of
other tax-free money market funds; or (iii) in the case of Tax-Efficient
Balanced and Tax-Efficient Growth Funds, securities of the Reserve
Investment or Government Reserve Investment Funds;
(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;
<PAGE>
(9) Oil and Gas Programs Purchase participations or other direct interests
in, or enter into leases with respect to oil, gas, or other mineral
exploration or development programs if, as a result thereof, 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; or
(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.
NOTES
With respect to investment restriction (6), the funds have no current
intention of purchasing the securities of other investment companies.
Duplicate fees could result from any such purchases.
MANAGEMENT OF THE FUNDS
-------------------------------------------------------------------------------
The officers and directors/trustees of the fund 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 fund's
directors/trustees who are considered "interested persons" of T. Rowe Price
as defined under Section 2(a)(19) of the 1940 Act are noted with an asterisk
(*). These directors/trustees are referred to as inside directors by virtue
of their officership, directorship, and/or employment with T. Rowe Price.
Independent Directors/Trustees/(a)/
All Funds except Tax-Efficient Funds
CALVIN W. BURNETT, PH.D., 3/16/32, President, Coppin State College; Director,
Maryland Chamber of Commerce and Provident Bank of Maryland; Former
President, Baltimore Area Council Boy Scouts of America; Vice President,
Board of Directors, The Walters Art Gallery; Address: 2500 West North Avenue,
Baltimore, Maryland 21216
ANTHONY W. DEERING, 1/28/45, Director, Chairman of the Board, President and
Chief Operating 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, 8/22/34, President, F. Pierce Linaweaver & Associates,
Inc.; Consulting Environmental & Civil Engineer(s); formerly (1987-1991)
Executive Vice President, EA Engineering, Science, and Technology, Inc., and
President, EA Engineering, Inc., Baltimore, Maryland; Address: Green Spring
Station, 2360 West Joppa Road, Suite 224, Lutherville, Maryland 21093
JOHN G. SCHREIBER, 10/21/46, Owner/President, Schreiber Investments, Inc., a
real estate investment company; Director, AMLI Residential Properties Trust
and Urban Shopping Centers, Inc.; Partner, Blackstone Real Estate Partners,
L.P.; Director and formerly Executive Vice President, JMB Realty Corporation,
a national real estate investment manager and developer; Address: 1115 East
Illinois Road, Lake Forest, Illinois 60045
Tax-Efficient Funds
DONALD W. DICK, JR., 1/27/43, Principal, EuroCapital Advisors, LLC, an
acquisition and management advisory firm; formerly (5/89-6/95) Principal,
Overseas Partners, Inc., a financial investment firm; formerly (6/65-3/89)
Director and Vice President; Consumer Products Division, McCormick & Company,
Inc., international food processors; Director, Waverly, Inc., Baltimore,
Maryland; Address: 925 Cleveland Street, #177, Greenville, South Carolina
29601
<PAGE>
DAVID K. FAGIN, 4/9/38, Chairman and Chief Executive Officer, Western
Exploration and Development, Ltd.; Director Golden Star Resources Ltd. and
Miranda Mining Development Corporation; formerly (7/91- 9/97) Chairman,
Chief Executive Officer, Golden Star Resources Ltd.; (1986-7/91) President,
Chief Operating Officer and Director, Homestake Mining Company; Address: 1700
Lincoln Street, Suite 4710, Denver, Colorado 80203
HANNE M. MERRIMAN, 11/16/41, Retail business consultant; formerly President
and Chief Operating Officer (1991-92), Nan Duskin, Inc., a women's specialty
store, Director (1984-90) and Chairman (1989-90) Federal Reserve Bank of
Richmond, and President and Chief Executive Officer (1988-89), Honeybee,
Inc., a division of Spiegel, Inc.; Director, Central Illinois Public Service
Company, CIPSCO Incorporated, Finlay Enterprises, Inc., The Rouse Company,
State Farm Mutual Automobile Insurance Company and USAir Group, Inc.;
Address: 3201 New Mexico Avenue, N.W., Suite 350, Washington, D.C. 20016
HUBERT D. VOS, 8/2/33, Owner/President, Stonington Capital Corporation, a
private investment company; Address: 1114 State Street, Suite 247, P.O. Box
90409, Santa Barbara, California 93190-0409
PAUL M. WYTHES, 6/23/33, Founding General Partner, Sutter Hill Ventures, a
venture capital limited partnership, providing equity capital to young high
technology companies throughout the United States; Director, Teltone
Corporation, Interventional Technologies Inc. and Stuart Medical, Inc.;
Address: 755 Page Mill Road, Suite A200, Palo Alto, California 94304-1005
(a) Unless otherwise indicated, the Independent Directors/Trustees have been
at their respective companies for at least five years.
Officers
HENRY H. HOPKINS, 12/23/42, Vice President-Vice President, Price-Fleming and
T. Rowe Price Retirement Plan Services, Inc.; Director and Managing Director,
T. Rowe Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc. and T. Rowe Price Trust Company
PATRICIA S. LIPPERT, 1/12/53, Secretary-Assistant Vice President, T. Rowe
Price and T. Rowe Price Investment Services, Inc.
CARMEN F. DEYESU, 8/1/41, Treasurer-Vice President, T. Rowe Price, T. Rowe
Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, 1/18/56, Controller-Vice President, T. Rowe Price and T.
Rowe Price Trust Company
INGRID I. VORDEMBERGE, 9/27/35, Assistant Vice President-Employee, T. Rowe
Price
California and State Tax-Free Trusts
* WILLIAM T. REYNOLDS, 5/26/48, Chairman of the Board -Director and Managing
Director, T. Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Trustee and Vice President -Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board,
T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., and T.
Rowe Price Retirement Plan Services, Inc.; Chairman of the Board, President,
and Trust Officer, T. Rowe Price Trust Company; Director, Price-Fleming and
General Re Corporation
* M. DAVID TESTA, 4/22/44, Trustee -Chairman of the Board and Director,
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
MARY J. MILLER, 7/19/55, President -Managing Director, T. Rowe Price
JANET G. ALBRIGHT, 3/31/57, Vice President -Vice President, T. Rowe Price
JEREMY N. BAKER, 2/27/68, Vice President -Employee, T. Rowe Price
PATRICE BERCHTENBREITER ELY, 1/13/53, Vice President -Vice President, T. Rowe
Price
<PAGE>
PATRICIA S. DEFORD, 9/29/57, Vice President -Vice President, T. Rowe Price
CHARLES B. HILL, 9/22/61, Vice President -Vice President, T. Rowe Price
JOSEPH K. LYNAGH, 6/9/58, Vice President -Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, 5/26/63, Vice President -Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, 9/19/59, Vice President -Vice President, T. Rowe Price
WILLIAM F. SNIDER, 9/16/69, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, 4/5/59, Vice President -Vice President, T. Rowe Price
State Tax-Free Trust Only
ROBERT A. DONAHUE, 11/8/64, Vice President -Assistant Vice President and
Municipal Credit Analyst, T. Rowe Price; (1998) formerly Director of Policy
Evaluation, District of Columbia Public Schools
MARCY M. LASH, 1/30/63, Vice President -Assistant Vice President and
Municipal Credit Analyst, T. Rowe Price; (1998) formerly Assistant Vice
President, underwriting, at Connie Lee Insurance Company
HUGH D. MCGUIRK, 7/6/60, Vice President -Vice President, T. Rowe Price
JULIE A. SALSBERY, 4/29/70, Vice President -Assistant Vice President and
Fixed Income Trader, T. Rowe Price; (1997) formerly assistant portfolio
manager/trader at Wainwright Asset Management
Tax-Efficient Funds
* JAMES A.C. KENNEDY, 8/17/53, Director-Director and Managing Director, T.
Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director and President -Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board,
T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., and T.
Rowe Price Retirement Plan Services, Inc.; Chairman of the Board, President,
and Trust Officer, T. Rowe Price Trust Company; Director, Price-Fleming and
General Re Corporation
* M. DAVID TESTA, 4/22/44, Director -Chairman of the Board and Director,
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
MARY J. MILLER, 7/19/55, Executive Vice President -Managing Director, T. Rowe
Price
DONALD J. PETERS, 7/3/59, Executive Vice President -Vice President, T. Rowe
Price; formerly portfolio manager, Geewax Terker and Company
STEPHEN W. BOESEL, 12/28/44, Vice President -Managing Director, T. Rowe
Price; Vice President, T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc.
JILL L. HAUSER, 6/23/58, Vice President -Vice President, T. Rowe Price
THOMAS J. HUBER, 9/23/66, Vice President -Vice President, T. Rowe Price;
formerly a Corporate Banking Officer with NationsBank; Chartered Financial
Analyst
HUGH D. MCGUIRK, 7/6/60, Vice President -Vice President, T. Rowe Price
LARRY J. PUGLIA, 8/25/60, Vice President -Managing Director, T. Rowe Price;
Chartered Financial Analyst
WILLIAM T. REYNOLDS, 5/26/48, Vice President -Director and Managing Director,
T. Rowe Price; Chartered Financial Analyst
ROBERT W. SHARPS, 6/10/71, Vice President -Assistant Vice President, T. Rowe
Price; formerly Senior Consultant, KPMG Peat Marwick; Chartered Financial
Analyst
WILLIAM F. SNIDER, 9/16/69, Vice President -Vice President, T. Rowe Price
<PAGE>
WILLIAM J. STROMBERG, 3/10/60, Vice President -Managing Director, T. Rowe
Price; Chartered Financial Analyst
ARTHUR S. VARNADO, 6/1/60, Vice President -Vice President, T. Rowe Price
MARK R. WEIGMAN, 7/30/62, Vice President-Vice President, T. Rowe Price; Vice
President, T. Rowe Price Trust Company; Chartered Financial Analyst
J. JEFFREY LANG, 1/10/62, Assistant Vice President-Assistant Vice President,
T. Rowe Price; Vice President, T. Rowe Price Trust Company
Tax-Exempt Money Fund
* WILLIAM T. REYNOLDS, 5/26/48, Chairman of the Board -Director and Managing
Director, T. Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director and Vice President -Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board,
T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., and T.
Rowe Price Retirement Plan Services, Inc.; Chairman of the Board, President,
and Trust Officer, T. Rowe Price Trust Company; Director, Price-Fleming and
General Re Corporation
* M. DAVID TESTA, 4/22/44, Director -Chairman of the Board and Director,
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
PATRICE BERCHTENBREITER ELY, 1/13/53, President -Vice President, T. Rowe
Price
JANET G. ALBRIGHT, 3/31/57, Vice President -Vice President, T. Rowe Price
JEREMY N. BAKER, 2/27/68, Vice President -Employee, T. Rowe Price
PATRICIA S. DEFORD, 9/29/57, Vice President -Vice President, T. Rowe Price
JOSEPH K. LYNAGH, 6/9/58, Vice President -Vice President, T. Rowe Price
MARY J. MILLER, 7/19/55, Vice President -Managing Director, T. Rowe Price
EDWARD T. SCHNEIDER, 9/19/59, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, 4/5/59, Vice President -Vice President, T. Rowe Price
Tax-Free High Yield Fund
* WILLIAM T. REYNOLDS, 5/26/48, Chairman of the Board -Director and Managing
Director, T. Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director and Vice President -Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board,
T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., and T.
Rowe Price Retirement Plan Services, Inc.; Chairman of the Board, President,
and Trust Officer, T. Rowe Price Trust Company; Director, Price-Fleming and
General Re Corporation
* M. DAVID TESTA, 4/22/44, Director -Chairman of the Board and Director,
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
WILLIAM F. SNIDER, 9/16/69, President -Vice President, T. Rowe Price
PATRICIA S. DEFORD, 9/29/57, Executive Vice President -Vice President, T.
Rowe Price
JANET G. ALBRIGHT, 3/31/57, Vice President -Vice President, T. Rowe Price
CHARLES B. HILL, 9/22/61, Vice President -Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, 5/26/63, Vice President -Vice President, T. Rowe Price
HUGH D. MCGUIRK, 7/6/60, Vice President -Vice President, T. Rowe Price
<PAGE>
MARY J. MILLER, 7/19/55, Vice President -Managing Director, T. Rowe Price
EDWARD T. SCHNEIDER, 9/19/59, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, 4/5/59, Vice President -Vice President, T. Rowe Price
Tax-Free Income Fund
* WILLIAM T. REYNOLDS, 5/26/48, Chairman of the Board -Director and Managing
Director, T. Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director and Vice President -Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board,
T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., and T.
Rowe Price Retirement Plan Services, Inc.; Chairman of the Board, President,
and Trust Officer, T. Rowe Price Trust Company; Director, Price-Fleming and
General Re Corporation
* M. DAVID TESTA, 4/22/44, Director -Chairman of the Board and Director,
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
MARY J. MILLER, 7/19/55, President -Managing Director, T. Rowe Price
JANET G. ALBRIGHT, 3/31/57, Vice President -Vice President, T. Rowe Price
PATRICE BERCHTENBREITER ELY, 1/13/53, Vice President -Vice President, T. Rowe
Price
PATRICIA S. DEFORD, 9/29/57, Vice President -Vice President, T. Rowe Price
CHARLES B. HILL, 9/22/61, Vice President -Vice President, T. Rowe Price
MARCY M. LASH, 1/30/63, Vice President -Assistant Vice President and
Municipal Credit Analyst, T. Rowe Price; (1998) formerly Assistant Vice
President, underwriting, at Connie Lee Insurance Company
KONSTANTINE B. MALLAS, 5/26/63, Vice President -Vice President, T. Rowe Price
HUGH D. MCGUIRK, 7/6/60, Vice President -Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, 9/19/59, Vice President -Vice President, T. Rowe Price
WILLIAM F. SNIDER, 9/16/69, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, 4/5/59, Vice President -Vice President, T. Rowe Price
Tax-Free Intermediate Bond Fund
* WILLIAM T. REYNOLDS, 5/26/48, Director -Director and Managing Director, T.
Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director -Vice Chairman of the Board, Managing
Director, and Director, T. Rowe Price; Chairman of the Board, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Retirement Plan Services, Inc.; Chairman of the Board, President, and Trust
Officer, T. Rowe Price Trust Company; Director, Price-Fleming and General Re
Corporation
* M. DAVID TESTA, 4/22/44, Director -Chairman of the Board and Director,
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
CHARLES B. HILL, 9/22/61, President -Vice President, T. Rowe Price
MARY J. MILLER, 7/19/55, Executive Vice President -Managing Director, T. Rowe
Price
JANET G. ALBRIGHT, 3/31/57, Vice President -Vice President, T. Rowe Price
PATRICIA S. DEFORD, 9/29/57, Vice President -Vice President, T. Rowe Price
ROBERT A. DONAHUE, 11/8/64, Vice President -Assistant Vice President and
Municipal Credit Analyst, T. Rowe Price; (1998) formerly Director of Policy
Evaluation, District of Columbia Public Schools
<PAGE>
KONSTANTINE B. MALLAS, 5/26/63, Vice President -Vice President, T. Rowe Price
HUGH D. MCGUIRK, 7/6/60, Vice President -Vice President, T. Rowe Price
JULIE A. SALSBERY, 4/29/70, Vice President -Assistant Vice President and
Fixed Income Trader, T. Rowe Price; (1997) formerly assistant portfolio
manager/trader at Wainwright Asset Management
EDWARD T. SCHNEIDER, 9/19/59, Vice President -Vice President, T. Rowe Price
WILLIAM F. SNIDER, 9/16/69, Vice President -Vice President, T. Rowe Price
Tax-Free Short-Intermediate Fund
* WILLIAM T. REYNOLDS, 5/26/48, Chairman of the Board -Director and Managing
Director, T. Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, 6/25/43, Director and Vice President -Vice Chairman of the
Board, Managing Director, and Director, T. Rowe Price; Chairman of the Board,
T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., and T.
Rowe Price Retirement Plan Services, Inc.; Chairman of the Board, President,
and Trust Officer, T. Rowe Price Trust Company; Director, Price-Fleming and
General Re Corporation
* M. DAVID TESTA, 4/22/44, Director -Chairman of the Board and Director,
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
MARY J. MILLER, 7/19/55, President -Managing Director, T. Rowe Price
CHARLES B. HILL, 9/22/61, Executive Vice President -Vice President, T. Rowe
Price
JANET G. ALBRIGHT, 3/31/57, Vice President -Vice President, T. Rowe Price
PATRICE BERCHTENBREITER ELY, 1/13/53, Vice President -Vice President, T. Rowe
Price
PATRICIA S. DEFORD, 9/29/57, Vice President -Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, 5/26/63, Vice President -Vice President, T. Rowe Price
HUGH D. MCGUIRK, 7/6/60, Vice President -Vice President, T. Rowe Price
JULIE A. SALSBERY, 4/29/70, Vice President -Assistant Vice President and
Fixed Income Trader, T. Rowe Price; (1997) formerly assistant portfolio
manager/trader at Wainwright Asset Management
EDWARD T. SCHNEIDER, 9/19/59, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, 4/5/59, Vice President -Vice President, T. Rowe Price
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 or Price-Fleming does not receive any remuneration
from the fund.
<TABLE>
<CAPTION>
Name of Person, Aggregate Compensation from Total Compensation from Fund and
Position Fund(a) Fund Complex Paid to Directors/
- --------------------------- ---------------------------------------- Trustees(b)
- ------------------------------------------------------------------------------------------------------------------------
----------------------------------------------
<S> <C> <S>
California Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 218 $37,917
Calvin W. Burnett, Trustee 1,471 65,000
Anthony W. Deering, Trustee 1,319 80,000
F. Pierce Linaweaver, Trustee 1,471 67,000
John G. Schriber, Trustee 1,471 67,000
- --------------------------------------------------------------------------------------------------------------------------
California Tax-Free Money Fund
Robert P. Black, Trustee(c) $ 190 $37,917
Calvin W. Burnett, Trustee 1,344 65,000
Anthony W. Deering, Trustee 1,275 80,000
F. Pierce Linaweaver, Trustee 1,344 67,000
John G. Schriber, Trustee 1,344 67,000
- --------------------------------------------------------------------------------------------------------------------------
Florida Intermediate Tax-Free Fund
Robert P. Black, Trustee(c) $ 190 $37,917
Calvin W. Burnett, Trustee 1,337 65,000
Anthony W. Deering, Trustee 1,268 80,000
F. Pierce Linaweaver, Trustee 1,338 67,000
John G. Schriber, Trustee 1,338 67,000
- --------------------------------------------------------------------------------------------------------------------------
Georgia Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 270 $37,917
Calvin W. Burnett, Trustee 1,274 65,000
Anthony W. Deering, Trustee 1,221 80,000
F. Pierce Linaweaver, Trustee 1,274 67,000
John G. Schriber, Trustee 1,274 67,000
- --------------------------------------------------------------------------------------------------------------------------
Maryland Short-Term Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 195 $37,917
Calvin W. Burnett, Trustee 1,371 65,000
Anthony W. Deering, Trustee 1,252 80,000
F. Pierce Linaweaver, Trustee 1,371 67,000
John G. Schriber, Trustee 1,371 67,000
- --------------------------------------------------------------------------------------------------------------------------
Maryland Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 411 $37,917
Calvin W. Burnett, Trustee 2,365 65,000
Anthony W. Deering, Trustee 1,670 80,000
F. Pierce Linaweaver, Trustee 2,365 67,000
John G. Schriber, Trustee 2,365 67,000
- --------------------------------------------------------------------------------------------------------------------------
New Jersey Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 192 $37,917
Calvin W. Burnett, Trustee 1,356 65,000
Anthony W. Deering, Trustee 1,283 80,000
F. Pierce Linaweaver, Trustee 1,356 67,000
John G. Schriber, Trustee 1,356 67,000
- --------------------------------------------------------------------------------------------------------------------------
New York Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 419 $37,917
Calvin W. Burnett, Trustee 1,403 65,000
Anthony W. Deering, Trustee 1,276 80,000
F. Pierce Linaweaver, Trustee 1,403 67,000
John G. Schriber, Trustee 1,383 67,000
- --------------------------------------------------------------------------------------------------------------------------
New York Tax-Free Money Fund
Robert P. Black, Trustee(c) $ 192 $37,917
Calvin W. Burnett, Trustee 1,347 65,000
Anthony W. Deering, Trustee 1,275 80,000
F. Pierce Linaweaver, Trustee 1,347 67,000
John G. Schriber, Trustee 1,347 67,000
- --------------------------------------------------------------------------------------------------------------------------
Virginia Short-Term Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 423 $37,917
Calvin W. Burnett, Trustee 1,683 65,000
Anthony W. Deering, Trustee 1,396 80,000
F. Pierce Linaweaver, Trustee 1,683 67,000
John G. Schriber, Trustee 1,683 67,000
- --------------------------------------------------------------------------------------------------------------------------
Virginia Tax-Free Bond Fund
Robert P. Black, Trustee(c) $ 365 $37,917
Calvin W. Burnett, Trustee 2,092 65,000
Anthony W. Deering, Trustee 1,554 80,000
F. Pierce Linaweaver, Trustee 2,092 67,000
John G. Schriber, Trustee 2,092 67,000
- --------------------------------------------------------------------------------------------------------------------------
Tax-Efficient Balanced Fund(d)
Donald W. Dick, Jr., Director(c) $1,008 $82,000
David K. Fagin, Director 1,034 65,000
Hanne M. Merriman, Director 1,032 65,000
Hubert D. Vos, Director 1,032 66,000
Paul M. Wythes, Director 1,032 80,000
- --------------------------------------------------------------------------------------------------------------------------
Tax-Exempt Money Fund
Robert P. Black, Director(c) $ 742 $37,917
Calvin W. Burnett, Director 2,633 65,000
Anthony W. Deering, Director 1,708 80,000
F. Pierce Linaweaver, Director 2,633 67,000
John G. Schriber, Director 2,634 67,000
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free High Yield Fund
Robert P. Black, Director(c) $ 799 $37,917
Calvin W. Burnett, Director 2,820 65,000
Anthony W. Deering, Director 1,806 80,000
F. Pierce Linaweaver, Director 2,820 67,000
John G. Schriber, Director 2,820 67,000
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free Income Fund
Robert P. Black, Director(c) $ 411 $37,917
Calvin W. Burnett, Director 1,804 65,000
Anthony W. Deering, Director 1,447 80,000
F. Pierce Linaweaver, Director 1,804 67,000
John G. Schriber, Director 1,805 67,000
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free Intermediate Bond Fund
Robert P. Black, Director(c) $ 407 $37,917
Calvin W. Burnett, Director 1,360 65,000
Anthony W. Deering, Director 1,142 80,000
F. Pierce Linaweaver, Director 1,322 67,000
John G. Schriber, Director 1,348 67,000
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free Short-Intermediate Fund
Robert P. Black, Director(c) $ 291 $37,917
Calvin W. Burnett, Director 1,373 65,000
Anthony W. Deering, Director 1,250 80,000
F. Pierce Linaweaver, Director 1,373 67,000
John G. Schriber, Director 1,373 67,000
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<PAGE>
<PAGE>
(a) Amounts in this column are based on accrued compensation from March 1,
1998 to February 28, 1999.
(b) Amounts in this column are based on compensation received from January
1, 1998, to December 31, 1998. The T. Rowe Price complex included 87 funds
as of December 31, 1998.
(c) Mr. Black retired from his position with the funds in April 1998.
(d) Expenses accrued from June 30, 1998 to February 28, 1999.
All Funds
The fund's Executive Committee, consisting of the fund's interested
directors/trustees, has been authorized by its respective Board of
Directors/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.
PRINCIPAL HOLDERS OF SECURITIES
-------------------------------------------------------------------------------
As of the date of the prospectus, the officers and directors/trustees of the
fund, as a group, owned less than 1% of the outstanding shares of the fund.
As of May 28, 1999, the following shareholders beneficially owned more than
5% of the outstanding shares of the fund:
New York Tax-Free Money Fund: Coleman M. Brandt and Grace L. Brandt JT TEN,
330 West 72nd Street, Apt. 10A, New York, New York 10023-2649.
Tax-Exempt Money Fund-PLUS Class: Larry J. Neiterman and Elin W. Neiterman JT
TEN, 8 Red Oak Drive, Sudbury, Massachusetts 01776-2826; George W. Mead, 700
Belle Isle, Wisconsin Rapids, Wisconsin 54494-4174.
INVESTMENT MANAGEMENT SERVICES
-------------------------------------------------------------------------------
Services
Under the Management Agreement, T. Rowe Price provides the fund with
discretionary investment services. Specifically, T. Rowe Price is responsible
for supervising and directing the investments of the fund in accordance with
the fund's investment objectives, program, and restrictions as provided in
its prospectus and
<PAGE>
this Statement of Additional Information. T. Rowe Price is also responsible
for effecting all security transactions on behalf of the fund, including the
negotiation of commissions and the allocation of principal business and
portfolio brokerage. In addition to these services, T. Rowe Price provides
the fund with certain corporate administrative services, including:
maintaining the fund's corporate existence and corporate records; registering
and qualifying fund shares under federal laws; monitoring the financial,
accounting, and administrative functions of the fund; maintaining liaison
with the agents employed by the fund such as the fund's custodian and
transfer agent; assisting the fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as officers,
directors/trustees, and committee members of the fund without cost to the
fund.
The Management Agreement also provides that T. Rowe Price, its
directors/trustees, officers, employees, and certain other persons performing
specific functions for the fund will only be liable to the fund for losses
resulting from willful misfeasance, bad faith, gross negligence, or reckless
disregard of duty.
Management Fee
The 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 next.
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 determined below ("Daily Price Funds' Group Fee
Accrual") by the ratio of the Price 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:
<TABLE>
Price Funds' Annual Group Base Fee Rate for Each Level of
Assets
<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% Next $40
billion
---------------------------------------------------------------------------
0.390% Next $1 billion 0.330% Next $10 billion 0.295% Thereafter
---------------------------------------------------------------------------
0.370% Next $1 billion 0.320% Next $10 billion
</TABLE>
For the purpose of calculating the Group Fee, the Price Funds include all the
mutual funds distributed by Investment Services, (excluding the T. Rowe Price
Spectrum Funds, and any institutional, index, 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 the funds' 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 and multiplying this product by the net assets of the fund for that day,
as determined in accordance with the fund's prospectus as of the close of
business on the previous business day on which the fund was open for
business. The individual fund fees are listed in the following chart:
<TABLE>
<CAPTION>
<S> <C>
California Tax-Free Bond Fund 0.10 %
California Tax-Free Money Fund 0.10
Florida Intermediate Tax-Free Fund 0.05
Georgia Tax-Free Bond Fund 0.10
Maryland Tax-Free Bond Fund 0.10
Maryland Short-Term Tax-Free Bond Fund 0.10
New Jersey Tax-Free Bond Fund 0.10%
New York Tax-Free Bond Fund 0.10
New York Tax-Free Money Fund 0.10
Virginia Tax-Free Bond Fund 0.10
Virginia Short-Term Tax-Free Bond Fund 0.10
Tax-Efficient Balanced Fund 0.20
Tax-Efficient Growth Fund 0.30
Tax-Exempt Money Fund 0.10
Tax-Free High Yield Fund 0.30
Tax-Free Income Fund 0.15
Tax-Free Intermediate Bond Fund 0.05
Tax-Free Short-Intermediate Fund 0.10
</TABLE>
<PAGE>
The following chart sets forth the total management fees, if any, paid to T.
Rowe Price by each fund, during the last three years:
<TABLE>
<CAPTION>
Fund 1999 1998 1997
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 878,000 $ 744,000 $ 644,000
California Tax-Free Money 333,000 263,000 195,000
Florida Intermediate Tax-Free 343,000 302,000 211,000
Georgia Tax-Free Bond 157,000 108,000 41,000
Maryland Tax-Free Bond 4,157,000 3,659,000 3,398,000
Maryland Short-Term Tax-Free Bond 468,000 488,000 378,000
New Jersey Tax-Free Bond 462,000 352,000 244,000
New York Tax-Free Bond 818,000 670,000 582,000
New York Tax-Free Money 348,000 281,000 205,000
Virginia Tax-Free Bond 1,081,000 895,000 829,000
Virginia Short-Term Tax-Free Bond 5,000 0 (a) 0 (a)
Tax-Efficient Balanced 14,000 0 (b) --
Tax-Efficient Growth 0 (b) 0 (b) 0 (b)
Tax-Exempt Money 3,176,000 2,989,000 2,880,000
Tax-Exempt Money Fund-PLUS Class 2,000 0 (b) 0 (b)
Tax-Free High Yield 8,119,000 7,051,000 6,309,000
Tax-Free Income 6,800,000 6,428,000 6,426,000
Tax-Free Intermediate Bond 438,000 391,000 315,000
Tax-Free Short-Intermediate 1,895,000 1,856,000 1,884,000
- --------------------------------------------------------------------------------------------
</TABLE>
(a) Due to effect of expense limitations discussed below, the fund did
not pay T. Rowe Price an investment management fee.
(b) Prior to commencement of operations.
Limitation on Fund Expenses
The Management Agreement between the fund and T. Rowe Price provides that the
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 a fund are calculated on a monthly basis. If a fund is
entitled to reimbursement, that month's advisory fee will be reduced or
postponed, with any adjustment made after the end of the year.
The following chart sets forth expense ratio limitations and the periods for
which they are effective. For each, T. Rowe Price has agreed to bear any fund
expenses which would cause the fund's ratio of expenses to average
<PAGE>
net assets to exceed the indicated percentage limitations. The expenses borne
by T. Rowe Price are subject to reimbursement by the fund through the
indicated reimbursement date, provided no reimbursement will be made if it
would result in the fund's expense ratio exceeding its applicable limitation.
No reimbursements may be made for the California and New York Funds unless
approved by shareholders.
California Tax-Free Money Fund, Georgia Tax-Free Bond Fund, Maryland Tax-Free
Bond Fund, New York Tax-Free Money Fund, Tax-Efficient Balanced Fund,
Tax-Efficient Growth Fund, Tax-Exempt Money Fund-PLUS Class, and Virginia
Short-Term Tax-Free Bond Fund
<TABLE>
<CAPTION>
Expense Reimbursement
Fund Limitation Period ------- -------------
---- ----------------- Ratio Date
----- ----
Limitation
----------
<S> <S> <C> <S>
0
.
March 1, 1999 - 55
California Tax-Free Money(a) February 28, 2001 % February 28, 2003
0.
March 1, 1999 - 65
Georgia Tax-Free Bond(b) February 28, 2001 % February 28, 2003
0
.
March 1, 1999 - 60
Maryland Tax-Free Bond(c) February 28, 2001 % February 28, 2003
0
.
March 1, 1999 - 5
New York Tax-Free Money(d) February 28, 2001 5% February 28, 2003
1
.
March 1, 1999 - 00
Tax-Efficient Balanced(e) February 28, 2001 % February 28, 2003
1.
July 1, 1999 - 1
Tax-Efficient Growth February 28, 2001 5% February 28, 2003
Tax-Exempt Money Fund-PLUS May 1, 1999 - April
Class(f) 30, 2000 1.00% April 30, 2002
0
Virginia Short-Term Tax-Free July 1, 1998 - .
Bond(g) February 29, 2000 6 February 28, 2002
0%
- ----------------------------------------------------------------------------------------
</TABLE>
(a) The California Tax-Free Money Fund previously operated under a 0.55%
limitation that expired February 28, 1999. The reimbursement period for this
limitation extends through February 28, 2001.
(b) The Georgia Tax-Free Bond Fund previously operated under a 0.65%
limitation that expired February 28, 1999. The reimbursement period for this
limitation extends through February 28, 2001.
(c) The Maryland Tax-Free Bond Fund previously operated under a 0.65%
limitation that expired June 30, 1998. Effective July 1, 1998, T. Rowe Price
agreed to lower the expense limitation to 0.60% through February 28, 1999.
The reimbursement period for the first agreement extends through February 29,
2000 and the reimbursement period for the second agreement extends through
February 28, 2001.
(d) The New York Tax-Free Money Fund previously operated under a 0.55%
limitation that expired February 28, 1999. The reimbursement period for this
limitation extends through February 28, 2001.
(e) The Tax-Efficient Balanced Fund previously operated under a 1.00%
limitation that expired February 28, 1999. The reimbursement period for this
limitation extends through February 28, 2001.
(f) The Tax-Exempt Money Fund-PLUS Class previously operated under a 1.00%
limitation that expired April 30, 1999. The reimbursement period for this
limitation extends through April 30, 2000.
(g) The Virginia Short-Term Tax-Free Bond Fund previously operated under a
0.65% limitation that expired June 30, 1998. The reimbursement period for
this limitation extends through June 30, 2000.
Florida Intermediate Tax-Free, New Jersey Tax-Free Bond, and Tax-Free
Intermediate Bond Funds
The Florida Intermediate Tax-Free Fund previously operated under a 0.60%
limitation that expired February 28, 1999. The reimbursement period for this
limitation extends through February 28, 2001.
The New Jersey Tax-Free Bond Fund previously operated under a 0.65%
limitation that expired February 28, 1999. The reimbursement period for this
limitation extends through February 28, 2001.
The Tax-Free Intermediate Bond Fund previously operated under a 0.65%
limitation that expired February 28, 1998. The reimbursement period for this
limitation extends through February 29, 2000.
California Tax-Free Money and New York Tax-Free Money Funds
Pursuant to the California Money Fund's present expense limitation, $89,000,
of management fees were not accrued for the year ended February 28, 1999.
Additionally, $99,000 of unaccrued management fees related to a previous
expense limitation were not accrued. Pursuant to the New York Money Fund's
present expense limitations, $83,000 of management fees were not accrued for
the year ended February 28, 1999 and $94,000
<PAGE>
and remain unaccrued from prior periods. Subject to shareholder approval, the
expenses of both funds 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.
Florida Intermediate Tax-Free Fund
Pursuant to the present expense limitation, $1,000 of management fees for the
fund were not accrued for the year ended February 28, 1999, and $5,000
remains unaccrued from the prior period.
Georgia Tax-Free Bond Fund
Pursuant to the present expense limitation, $74,000 of management fees were
not accrued by the fund for the year ended February 28, 1999, and $78,000
remains unaccrued from the prior period.
Maryland Short-Term Tax-Free Bond Fund
Pursuant to a previous expense limitation, $7,000 of management fees remain
unaccrued by the fund for the year ended February 28, 1999.
New Jersey Tax-Free Bond Fund
Pursuant to the present expense limitation, $4,000 of management fees were
not accrued by the fund for the year ended February 28, 1999, and $20,000
remains unaccrued from the prior period.
Virginia Short-Term Tax-Free Bond Fund
Pursuant to the present expense limitation, $97,000 of management fees for
the fund were not accrued for the year ended February 28, 1999, and $104,000
of other expenses were borne by T. Rowe Price and are subject to future
reimbursement. Additionally, $184,000 of unaccrued fees and expenses remain
unaccrued from the prior period and are subject to future reimbursement.
Tax-Efficient Balanced Fund
Pursuant to the present expense limitation, $119,000 of management fees were
not accrued by the fund for the year ended February 28, 1999. Additionally,
$81,000 of other expenses were borne by the manager.
Tax-Free Intermediate Bond Fund
Pursuant to the present expense limitation, $13,000 of management fees were
not accrued by the fund for the year ended February 28, 1999. Additionally,
$23,000 of unaccrued fees and expenses from the prior period are subject to
reimbursement.
Management Related Services
As noted above, the Management Agreement spells out the expenses to be paid
by the fund. In addition to the Management Fee, the 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.
T. Rowe Price Services, Inc., a wholly owned subsidiary of T. Rowe Price,
acts as the fund's transfer and dividend disbursing agent and provides
shareholder and administrative services. Services for certain types of
retirement plans are provided by T. Rowe Price Retirement Plan Services,
Inc., also a wholly owned subsidiary. The address for each is 100 East Pratt
St., Baltimore, MD 21202. Additionally, T. Rowe Price, under a separate
agreement with the funds, provides accounting services to the funds.
<PAGE>
The funds paid the expenses shown in the following table for the fiscal year
ended February 28, 1999, to T. Rowe Price and its affiliates.
<TABLE>
<CAPTION>
Fund Transfer Agent and Accounting
---- Shareholder Services Services
-------------------- --------
<S> <C> <C>
California Tax-Free Bond $116,000 $ 94,000
California Tax-Free Money 72,000 68,000
Florida Intermediate Tax-Free 54,000 67,000
Georgia Tax-Free Bond 52,000 67,000
Maryland Short-Term Tax-Free Bond 71,000 67,000
Maryland Tax-Free Bond 456,000 84,000
New Jersey Tax-Free Bond 84,000 67,000
New York Tax-Free Bond 121,000 75,000
New York Tax-Free Money 65,000 68,000
Virginia Short-Term Tax-Free Bond 25,000 63,000
Virginia Tax-Free Bond 158,000 67,000
Tax-Efficient Balanced 36,000 62,000
Tax-Efficient Growth 0 (a) 0 (a)
Tax-Exempt Money 331,000 97,000
Tax-Exempt Money Fund--PLUS Class 0 (a) 0 (a)
Tax-Free High Yield 618,000 113,000
Tax-Free Income 574,000 112,000
Tax-Free Intermediate Bond 99,000 67,000
Tax-Free Short-Intermediate 208,000 93,000
- --------------------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to commencement of operations.
DISTRIBUTOR FOR THE FUNDS
-------------------------------------------------------------------------------
Investment Services, a Maryland corporation formed in 1980 as a wholly owned
subsidiary of T. Rowe Price, serves as fund's distributor. 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 the fund's shares is continuous.
Investment Services is located at the same address as the fund and T. Rowe
Price-100 East Pratt Street, Baltimore, Maryland 21202.
Investment Services serves as distributor to the fund pursuant to an
Underwriting Agreement ("Underwriting Agreement"), which provides that the
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 shares, except for those fees and expenses specifically
assumed by the fund. Investment Services' expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the fund in connection with the sale
of 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 fund.
<PAGE>
CUSTODIAN
-------------------------------------------------------------------------------
State Street Bank and Trust Company is the custodian for the fund's U.S.
securities and cash, but it does not participate in the fund's investment
decisions. Portfolio securities purchased in the U.S. are maintained in the
custody of the Bank and may be entered into the Federal Reserve Book Entry
System, or the security depository system of the Depository Trust
Corporation. State Street Bank's main office is at 225 Franklin Street,
Boston, Massachusetts 02110.
Tax-Efficient Balanced and Tax-Efficient Growth Funds
The fund has entered into a Custodian Agreement with The Chase Manhattan
Bank, N.A., London, pursuant to which portfolio securities which are
purchased outside the United States are maintained in the custody of various
foreign branches of The Chase Manhattan Bank and such other custodians,
including foreign banks and foreign securities depositories as are approved
in accordance with regulations under the 1940 Act. The address for The Chase
Manhattan Bank, N.A., London is Woolgate House, Coleman Street, London, EC2P
2HD, England.
All Funds
SHAREHOLDER SERVICES BY OUTSIDE PARTIES
-------------------------------------------------------------------------------
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. In addition, all employees must report
their personal securities transactions within 10 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; 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 fixed income 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 fund (other than Tax-Efficient Balanced and
Tax-Efficient Growth Funds to the extent they purchase equity securities).
However, it is included because T. Rowe Price does manage a significant
number of common stock portfolios (including the equity portion of the
Tax-Efficient Balanced and Tax-Efficient Growth Funds) which do engage in
agency
<PAGE>
transactions and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the fund.
How Brokers and Dealers Are Selected
Equity Securities
In purchasing and selling equity securities, it is T. Rowe Price's policy to
obtain quality execution at the most favorable prices through responsible
brokers and dealers and, in the case of agency transactions, at competitive
commission rates. However, under certain conditions, the fund may pay higher
brokerage commissions in return for brokerage and research services. As a
general practice, over-the-counter orders are executed with market-makers. In
selecting among market-makers, T. Rowe Price generally seeks to select those
it believes to be actively and effectively trading the security being
purchased or sold. In selecting broker-dealers to execute the fund's
portfolio transactions, consideration is given to such factors as the price
of the security, the rate of the commission, the size and difficulty of the
order, the reliability, integrity, financial condition, general execution and
operational capabilities of competing brokers and dealers, their expertise in
particular markets and brokerage and research services provided by them. It
is not the policy of T. Rowe Price to seek the lowest available commission
rate where it is believed that a broker or dealer charging a higher
commission rate would offer greater reliability or provide better price or
execution services.
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.
With respect to equity and fixed income securities, 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
research services in connection with brokerage transactions, including
designations in fixed price offerings.
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; (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.
Descriptions 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 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
<PAGE>
investment process. As a practical matter, it would not be possible for T.
Rowe Price's Equity Research Division 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 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
<PAGE>
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.
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 Investment Services, 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.
Trade Allocation Policies
T. Rowe Price has developed written trade allocation guidelines for its
Equity, Municipal, and Taxable Fixed Income Trading Desks. Generally, when
the amount of securities available in a public offering or the secondary
market is insufficient to satisfy the volume or price requirements for the
participating client portfolios, the guidelines require a pro-rata allocation
based upon the amounts initially requested by each portfolio manager. In
allocating trades made on combined basis, the Trading Desks seek to achieve
the same net unit price of the securities for each participating client.
Because a pro-rata allocation may not always adequately accommodate all facts
and circumstances, the guidelines provide for exceptions to allocate trades
on an adjusted, pro-rata basis. Examples of where adjustments may be made
include: (i) reallocations to recognize the efforts of a portfolio manager in
negotiating a transaction or a private placement; (ii) reallocations to
eliminate deminimis positions; (iii) priority for accounts with specialized
investment policies and objectives; and (iv) reallocations in light of a
participating portfolio's characteristics (e.g., industry or issuer
concentration, duration, and credit exposure).
Transactions With Related Brokers and Dealers
As provided in the Investment Management Agreement between the fund and T.
Rowe Price, T. Rowe Price is responsible not only for making decisions with
respect to the purchase and sale of the fund's portfolio securities, but also
for implementing these decisions, including the negotiation of commissions
and the allocation of portfolio brokerage and principal business. It is
expected that, from time to time, T. Rowe Price may place orders for the
fund's portfolio transactions with broker-dealer affiliates of Robert Fleming
Holdings Limited ("Robert Fleming" or "Flemings"), an affiliate of
Price-Fleming. Robert Fleming, through Copthall Overseas Limited, a wholly
owned subsidiary, owns 25% of the common stock of Price-Fleming. Fifty
percent of the common stock of Price-Fleming is owned by TRP Finance, Inc., a
wholly owned subsidiary of T. Rowe Price, and the remaining 25% is owned by
Jardine Fleming Holdings Limited, a subsidiary of Jardine Fleming Group
Limited ("JFG"). JFG is owned by Robert Fleming.
<PAGE>
The Board of Directors/Trustees of the fund has authorized T. Rowe Price to
utilize certain affiliates of Robert Fleming and JFG in the capacity of
broker in connection with the execution of the fund's portfolio transactions.
Other affiliates of Robert Fleming Holding and JFG also may be used. Although
it does not believe that the fund's use of these brokers would be subject to
Section 17(e) of the 1940 Act, the Board of Directors/Trustees of the fund
has agreed that the procedures set forth in Rule 17e-1 under that Act will be
followed when using such brokers.
Other
The funds engaged in portfolio transactions involving broker-dealers in the
following amounts for the fiscal years ended February 28, 1999, 1998, and
1997:
<TABLE>
<CAPTION>
Fund 1999 1998 1997
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 302,67,000 $ 289,794,000 $ 286,416,000
California Tax-Free Money 515,251,000 506,606,000 474,186,000
Florida Intermediate Tax-Free 141,767,000 142,932,000 244,915,000
Georgia Tax-Free Bond 73,638,000 97,029,000 104,491,000
Maryland Tax-Free Bond 837,338,000 918,045,000 775,356,000
Maryland Short-Term Tax-Free Bond 191,989,000 221,540,000 112,384,000
New Jersey Tax-Free Bond 158,774,000 161,209,000 238,572,000
New York Tax-Free Bond 445,461,000 354,373,000 432,992,000
New York Tax-Free Money 553,482,000 444,785,000 451,170,000
Virginia Tax-Free Bond 40,289,000 563,466,000 508,640,000
Virginia Short-Term Tax-Free Bond 492,844,000 56,461,000 35,817,000
Tax-Efficient Balanced 51,569,000 39,110,000 0(a)
Tax-Exempt Money 3,124,018,000 3,600,294,000 3,675,043,000
Tax-Free High Yield 2,000,100,000 1,755,491,000 1,801,447,000
Tax-Free Income 1,941,518,000 2,257,818,000 2,284,715,000
Tax-Free Intermediate Bond 153,826,000 272,682,000 320,231,000
Tax-Free Short-Intermediate 642,536,000 1,149,079,000 1,478,084,000
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to commencement of operations.
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, 1999, 1998, and 1997:
<TABLE>
<CAPTION>
Fund 1999 1998 1997
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 251,425,000 $ 253,929,000 $ 260,704,000
California Tax-Free Money 510,210,000 503,591,000 472,277,000
Florida Intermediate Tax-Free 129,590,000 128,653,000 229,787,000
Georgia Tax-Free Bond 60,945,000 85,009,000 98,598,000
Maryland Tax-Free Bond 708,876,000 793,036,000 680,479,000
Maryland Short-Term Tax-Free Bond 188,399,000 193,471,000 108,581,000
New Jersey Tax-Free Bond 140,671,000 136,223,000 225,435,000
New York Tax-Free Bond 383,633,000 299,419,000 394,711,000
New York Tax-Free Money 542,945,000 441,384,000 451,170,000
Virginia Tax-Free Bond 419,010,000 518,159,000 483,074,000
Virginia Short-Term Tax-Free Bond 35,660,000 55,291,000 34,013,000
Tax-Efficient Balanced 37,355,000 27,555,000 0(a)
Tax-Exempt Money 3,089,301,000 3,586,230,000 3,662,460,000
Tax-Free High Yield 1,644,317,000 1,527,098,000 1,621,470,000
Tax-Free Income 1,651,454,000 1,959,351,000 2,034,461,000
Tax-Free Intermediate Bond 143,749,000 249,144,000 302,633,000
Tax-Free Short-Intermediate 603,036,000 1,083,550,000 1,384,758,000
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
(a) Prior to commencement of operations.
The following amounts involved trades with brokers acting as agents or
underwriters for the fiscal years ended February 28, 1999, 1998, and 1997:
<TABLE>
<CAPTION>
Fund 1999 1998 1997
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 51,252,000 $ 35,865,000 $ 25,712,000
California Tax-Free Money 5,041,000 3,016,000 1,909,000
Florida Intermediate Tax-Free 12,177,000 14,279,000 15,128,000
Georgia Tax-Free Bond 12,693,000 12,020,000 5,893,000
Maryland Tax-Free Bond 128,462,000 125,009,000 94,877,000
Maryland Short-Term Tax-Free Bond 3,590,000 28,069,000 3,803,000
New Jersey Tax-Free Bond 18,103,000 24,987,000 13,137,000
New York Tax-Free Bond 61,828,000 54,954,000 38,281,000
New York Tax-Free Money 10,537,000 3,401,000 0
Virginia Tax-Free Bond 73,834,000 45,307,000 25,566,000
Virginia Short-Term Tax-Free Bond 4,629,000 1,170,000 1,804,000
Tax-Efficient Balanced 14,214,000 11,555,000 0(a)
Tax-Exempt Money 34,717,000 14,064,000 12,583,000
Tax-Free High Yield 355,783,000 228,393,000 179,977,000
Tax-Free Income 290,064,000 298,468,000 250,254,000
Tax-Free Intermediate Bond 10,077,000 23,538,000 17,598,000
Tax-Free Short-Intermediate 39,500,000 65,529,000 93,326,000
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to commencement of operations.
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, 1999, 1998, and 1997:
<TABLE>
<CAPTION>
Fund 1999 1998 1997
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 273,000 $ 206,000 $ 111,000
California Tax-Free Money 10,000 2,000 1,000
Florida Intermediate Tax-Free 48,000 59,000 85,000
Georgia Tax-Free Bond 51,000 74,000 30,000
Maryland Tax-Free Bond 545,000 680,000 371,000
Maryland Short-Term Tax-Free Bond 16,000 106,000 12,000
New Jersey Tax-Free Bond 88,000 176,000 75,000
New York Tax-Free Bond 353,000 362,000 251,000
New York Tax-Free Money 1,000 24,000 0
Virginia Tax-Free Bond 346,000 271,000 121,000
Virginia Short-Term Tax-Free Bond 17,000 6,000 4,000
Tax-Efficient Balanced 47,000 33,000 0(a)
Tax-Exempt Money 131,000 32,000 13,000
Tax-Free High Yield 2,152,000 1,655,000 1,139,000
Tax-Free Income 1,488,000 1,747,000 1,493,000
Tax-Free Intermediate Bond 49,000 112,000 108,000
Tax-Free Short-Intermediate 147,000 289,000 370,000
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
(a) Prior to commencement of operations.
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 rate for each fund for the fiscal years ended February
28, 1999, 1998, and 1997, was as follows:
<TABLE>
<CAPTION>
Fund 1999 1998 1997
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond 27.2% 35.0% 47.3%
California Tax-Free Money N/A N/A N/A
Florida Intermediate Tax-Free 26.9 25.0 75.8
Georgia Tax-Free Bond 19.9 49.0 71.1
Maryland Tax-Free Bond 15.4 19.2 26.2
Maryland Short-Term Tax-Free Bond 46.4 60.4 21.4
New Jersey Tax-Free Bond 25.5 34.3 78.9
New York Tax-Free Bond 55.4 55.0 96.9
New York Tax-Free Money N/A N/A N/A
Virginia Tax-Free Bond 47.3 64.3 66.2
Virginia Short-Term Tax-Free Bond 22.5 75.0 32.5
Tax-Efficient Balanced 19.8 12.5 (a)
Tax-Exempt Money N/A N/A N/A
Tax-Free High Yield 38.9 24.4 37.0
Tax-Free Income 34.1 36.3 40.7
Tax-Free Intermediate Bond 24.3 56.1 76.8
Tax-Free Short-Intermediate 39.9 76.8 84.3
- ----------------------------------------------------------------------------------
</TABLE>
PRICING OF SECURITIES
-------------------------------------------------------------------------------
Fixed income securities are generally traded in the over-the-counter market.
With the exception of the Money 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 Funds are valued at amortized cost.
<PAGE>
There are a number of pricing services available, and the Board of
Directors/Trustees, on the basis of an ongoing evaluation of these services,
may use or may discontinue the use of any pricing service in whole or part.
Securities or other assets for which the above valuation procedures 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/Trustees.
Tax-Efficient Balanced and Tax-Efficient Growth Funds
Equity securities listed or regularly traded on a securities exchange are
valued at the last quoted sales price at the time the valuations are made. A
security that is listed or traded on more than one exchange is valued at the
quotation on the exchange determined to be the primary market for such
security. Listed securities not traded on a particular day and securities
regularly traded in the over-the-counter market are valued at the mean of the
latest bid and asked prices. Other equity securities are valued at a price
within the limits of the latest bid and asked prices deemed by the Board of
Directors/Trustees, or by persons delegated by the Board, best to reflect
fair value.
Investments in mutual funds are valued at the closing net asset value per
share of the mutual fund on the day of valuation. In the absence of a last
sale price, purchased and written options are valued at the mean of the
latest bid and asked prices, respectively.
For the purposes of determining the fund's net asset value per share, the
U.S. dollar value of all assets and liabilities initially expressed in
foreign currencies is determined by using the mean of the bid and offer
prices of such currencies against U.S. dollars quoted by a major bank.
Assets and liabilities for which the above valuation procedures are
inappropriate or are deemed not to reflect fair value, are stated at fair
value as determined in good faith by or under the supervision of the officers
of the fund, as authorized by the Board of Directors/Trustees.
Maintenance of Money Fund's Net Asset Value Per Share at $1.00
It is the policy of the fund 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 1940 Act. 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 Directors/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) The 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) The fund must limit its purchase of portfolio instruments, including
repurchase agreements, to those U.S. dollar-denominated instruments which
the fund's Board of Directors/Trustees determines present minimal credit
risks, and which are eligible securities as defined by Rule 2a-7; and
(d) The Board of Directors/Trustees must determine that (i) it is in the best
interest of the fund and its shareholders to maintain a stable net asset
value per share under the amortized cost method; and (ii) the fund will
continue to use the amortized cost method only so long as the Board of
Directors/Trustees believes that it fairly reflects the market based net
asset value per share.
Although the fund believes 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 the 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 Directors/Trustees of the
fund might temporarily reduce or suspend dividend payments in an
<PAGE>
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 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 the 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 Directors/Trustees of the 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 the fund's shares is equal to the fund's
net asset value per share or share price. The 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 the 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 the fund is normally
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, Dr. Martin Luther King, Jr. Holiday, Presidents' Day,
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 the 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 the fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable for the fund
fairly to determine the value of its net assets, or (d) during which a
governmental body having jurisdiction over the fund may by order permit such
a suspension for the protection of the fund's shareholders; provided that
applicable rules and regulations of the SEC (or any succeeding governmental
authority) shall govern as to whether the conditions prescribed in (b), (c),
or (d) exist.
DIVIDENDS AND DISTRIBUTIONS
-------------------------------------------------------------------------------
Unless you elect otherwise, the fund's annual capital gain distribution and,
for the Tax-Efficient Balanced and Tax-Efficient Growth Funds, the annual
dividend, if any, will be reinvested on the reinvestment date using the NAV
per share of that date. The reinvestment date may precede the payment date by
as much as one day although the exact timing is subject to change and can be
as great as 10 days.
TAX STATUS
-------------------------------------------------------------------------------
The fund intends to qualify as a "regulated investment company" under
Subchapter M of the Code.
Generally, dividends paid by the funds are not eligible for the
dividends-received deduction applicable to 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 year-end) to permit pass-through of tax-exempt income to
shareholders. Each fund must also 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 taxable income, if any, and capital gains
(as of its tax year-end) to avoid federal income tax.
At the time of your purchase, the fund's net asset value may reflect
undistributed capital gains or net unrealized appreciation of securities held
by the fund. 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
<PAGE>
income tax purposes, the fund is 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.
If, in any taxable year, the 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 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).
The funds (other than Tax-Efficient Growth Fund) may acquire 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.
All Funds (other than Tax-Efficient Balanced and Tax-Efficient Growth Funds)
The funds anticipate that substantially all of the dividends to be paid by
each fund will be exempt from federal income taxes. If any portion of a
fund's dividends is not exempt from federal income taxes, you will receive a
Form 1099-DIV 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 benefit.
Because the interest on municipal securities is tax exempt, any interest on
money you borrow that is directly or indirectly used to purchase fund shares
is not deductible. (See Section 265(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.
Tax-Efficient Growth Fund
A portion of the dividends paid by the fund may be 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. The fund must declare dividends by
December 31 of each year equal to at least 98% of ordinary income (as of
December 31) and capital gains (as of October 31) in order to avoid a federal
excise tax and distribute within 12 months 100% of ordinary income and
capital gains as of December 31 to avoid a federal income tax.
Florida 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-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
<PAGE>
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.
Tax-Efficient Balanced and Tax-Efficient Growth Funds
Taxation of Foreign Shareholders
The Code provides that dividends from net income will be subject to U.S. tax.
For shareholders who are not engaged in a business in the U.S., this tax
would be imposed at the rate of 30% upon the gross amount of the dividends in
the absence of a Tax Treaty providing for a reduced rate or exemption from
U.S. taxation. Distributions of net long-term capital gains realized by the
fund are not subject to tax unless the foreign shareholder is a nonresident
alien individual who was physically present in the U.S. during the tax year
for more than 182 days.
Passive Foreign Investment Companies
The fund may purchase the securities of certain foreign investment funds or
trusts called passive foreign investment companies. Such trusts have been the
only or primary way to invest in certain countries. In addition to bearing
their proportionate share of the trust's expenses (management fees and
operating expenses), shareholders will also indirectly bear similar expenses
of such trusts. Capital gains on the sale of such holdings are considered
ordinary income regardless of how long the fund held its investment. In
addition, the fund may be subject to corporate income tax and an interest
charge on certain dividends and capital gains earned from these investments,
regardless of whether such income and gains are distributed to shareholders.
To avoid such tax and interest, the fund intends to treat these securities as
sold on the last day of its fiscal year and recognize any gains for tax
purposes at that time; deductions for losses are allowable only to the extent
of any gains resulting from these deemed sales for prior taxable years. Such
gains and losses will be treated as ordinary income. The fund will be
required to distribute any resulting income even though it has not sold the
security and received cash to pay such distributions.
Foreign Currency Gains and Losses
Foreign currency gains and losses, including the portion of gain or loss on
the sale of debt securities attributable to foreign exchange rate
fluctuations, are taxable as ordinary income. If the net effect of these
transactions is a gain, the ordinary income dividend paid by the fund will be
increased. If the result is a loss, the income dividend paid by the fund will
be decreased, or to the extent such dividend has already been paid, it may be
classified as a return of capital. Adjustments to reflect these gains and
losses will be made at the end of the fund's taxable year.
YIELD INFORMATION
-------------------------------------------------------------------------------
Money Funds
The fund's current and historical yield for a period is calculated by
dividing the net change in value of an account (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. The 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.
<PAGE>
The Money Funds' current and compound yields for the seven days ended
February 28, 1999, were:
<TABLE>
<CAPTION>
Fund Current Yield Compound Yield
---- ------------- --------------
<S> <C> <C>
2.15
California Tax-Free Money % 2.17%
New York Tax-Free Money 2.35 2.37
Tax-Exempt Money 2.51 2.54
</TABLE>
Bond Funds
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 SEC. The income factors are
then totaled for all securities in the portfolio. Next, expenses of the 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.
If applicable, a taxable-equivalent yield is calculated by dividing this
yield by one minus 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
the fund.
The yield of each fund calculated under the above-described method for the
month ended February 28, 1999, was:
<TABLE>
<CAPTION>
<S> <C>
3.97
California Tax-Free Bond Fund %
Florida Intermediate Tax-Free Fund 3.42
Georgia Tax-Free Bond Fund 3.95
Maryland Tax-Free Bond Fund 4.03
Maryland Short-Term Tax-Free Bond Fund 2.93
New Jersey Tax-Free Bond Fund 4.00
New York Tax-Free Bond Fund 4.15
Virginia Tax-Free Bond Fund 4.09
Virginia Short-Term Tax-Free Bond Fund 2.88
Tax-Efficient Balanced Fund --
Tax-Free High Yield Fund 4.46
Tax-Free Income Fund 4.11
Tax-Free Intermediate Bond Fund 3.36
Tax-Free Short-Intermediate Fund 3.16
</TABLE>
<PAGE>
The tax-equivalent yields (assuming a federal tax bracket of 31.0%) for each
fund for the same period were as follows:
<TABLE>
<CAPTION>
<S> <C>
6.34
California Tax-Free Bond Fund(a) %
Florida Intermediate Tax-Free Fund(b) 5.16
Georgia Tax-Free Bond Fund(c) 6.09
Maryland Tax-Free Bond Fund(d) 6.32
Maryland Short-Term Tax-Free Bond Fund(d) 4.59
New Jersey Tax-Free Bond Fund(e) 6.19
New York Tax-Free Bond Fund(f) 6.78
Virginia Tax-Free Bond Fund(g) 6.29
Virginia Short-Term Tax-Free Bond Fund(g) 4.43
Tax-Efficient Balanced Fund --
Tax-Free High Yield Fund 6.46
Tax-Free Income Fund 5.96
4.
Tax-Free Intermediate Bond Fund 87
Tax-Free Short-Intermediate Fund 4.58
- ------------------------------------------------------------------
</TABLE>
(a) Assumes a state tax bracket of 9.3%.
(b) Assumes an intangibles tax rate of 0.2%.
(c) Assumes a state tax bracket of 6.0%.
(d) Assumes a state tax bracket of 4.85% and a local tax bracket
of 2.67%.
(e) Assumes a state tax bracket of 6.37%.
(f) Assumes a state tax bracket of 6.85% and a local tax bracket
of 4.46%.
(g) Assumes a state tax bracket of 5.75%.
The tax-equivalent yields (assuming a federal tax bracket of 28.0%) for each
fund for the same period were as follows:
<TABLE>
<CAPTION>
<S> <C>
6.08
California Tax-Free Bond Fund(a) %
Florida Intermediate Tax-Free Fund(b) 4.95
Georgia Tax-Free Bond Fund(c) 5.83
Maryland Tax-Free Bond Fund(d) 6.05
Maryland Short-Term Tax-Free Bond Fund(d) 4.40
New Jersey Tax-Free Bond Fund(e) 5.88
New York Tax-Free Bond Fund(f) 6.49
Virginia Tax-Free Bond Fund(g) 6.02
Virginia Short-Term Tax-Free Bond Fund(g) 4.24
Tax-Efficient Balanced Fund --
Tax-Free High Yield Fund 6.19
Tax-Free Income Fund 5.71
Tax-Free Intermediate Bond Fund 4.67
Tax-Free Short-Intermediate Fund 4.39
- ------------------------------------------------------------------
</TABLE>
(a) Assumes a state tax bracket of 9.3%.
(b) Assumes an intangibles tax rate of 0.2%.
(c) Assumes a state tax bracket of 6.0%.
(d) Assumes a state tax bracket of 4.85% and a local tax bracket
of 2.67%.
(e) Assumes a state tax bracket of 5.525%.
(f) Assumes a state tax bracket of 6.85% and a local tax bracket
of 4.46%.
(g) Assumes a state tax bracket of 5.75%.
<PAGE>
INVESTMENT PERFORMANCE
-------------------------------------------------------------------------------
Total Return Performance
The 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 the
fund. Total return is calculated as the percentage change between the
beginning value of a static account in the fund and the ending value of that
account measured by the then current net asset value, including all shares
acquired through reinvestment of income and capital gain dividends. The
results shown are historical and should not be considered indicative of the
future performance of the fund. Each average annual compound rate of return
is derived from the cumulative performance of the fund over the time period
specified. The annual compound rate of return for the fund over any other
period of time will vary from the average.
<TABLE>
<CAPTION>
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. % Since Inception
Fund ----- ------ ------- ------- ---------
---- Ended Ended Ended Inception Date
----- ----- ----- --------- ----
2/28/99 2/28/99 2/28/99 2/28/99
------- ------- ------- -------
<S> <C> <C> <C> <C> <S>
California Tax-Free Bond 5.95% 37.08% 110.53% 128.18% 09/15/86
Florida Intermediate
Tax-Free 5.37 31.55 -- 40.54 03/31/93
Georgia Tax-Free Bond 5.73 36.81 -- 48.38 03/31/93
Maryland Short-Term Tax-Free
Bond 4.46 23.27 -- 29.70 01/29/93
Maryland Tax-Free Bond 5.80 34.87 108.59 118.19 03/31/87
New Jersey Tax-Free Bond 5.81 34.26 -- 79.00 04/30/91
New York Tax-Free Bond 6.08 36.04 113.69 140.75 08/28/86
Virginia Short-Term Tax-Free
Bond 4.51 -- -- 22.82 11/30/94
Virginia Tax-Free Bond 6.02 36.37 -- 78.33 04/30/91
Tax-Efficient Balanced 14.45 -- -- 31.57 06/30/97
Tax-Free High Yield 4.80 37.70 120.46 244.00 03/01/85
Tax-Free Income 5.48 35.91 112.75 375.44 10/26/76
Tax-Free Intermediate Bond 5.37 32.50 -- 49.29 11/30/92
Tax-Free Short-Intermediate 4.90 26.34 72.77 136.10 12/23/83
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. % Since Inception
Fund ----- ------ ------- ------- ---------
---- Ended Ended Ended Inception Date
----- ----- ----- --------- ----
2/28/99 2/28/99 2/28/99 2/28/99
------- ------- ------- -------
<S> <C> <C> <C> <C> <S>
California Tax-Free Bond 5.95% 6.51% 7.73% 6.85% 09/15/86
Florida Intermediate
Tax-Free 5.37 5.64 -- 5.92 03/31/93
Georgia Tax-Free Bond 5.73 6.47 -- 6.90 03/31/93
Maryland Short-Term Tax-Free
Bond 4.46 4.27 -- 4.37 01/29/93
Maryland Tax-Free Bond 5.80 6.17 7.63 6.77 03/31/87
New Jersey Tax-Free Bond 5.81 6.07 -- 7.72 04/30/91
New York Tax-Free Bond 6.08 6.35 7.89 7.28 08/28/86
Virginia Short-Term Tax-Free
Bond 4.51 -- -- 4.96 11/30/94
Virginia Tax-Free Bond 6.02 6.40 -- 7.66 04/30/91
Tax-Efficient Balanced 14.45 -- -- 17.90 06/30/97
Tax-Free High Yield 4.80 6.61 8.23 9.23 03/01/85
Tax-Free Income 5.48 6.33 7.84 7.23 10/26/76
Tax-Free Intermediate Bond 5.37 5.79 -- 6.63 11/30/92
Tax-Free Short-Intermediate 4.90 4.79 5.62 5.82 12/23/83
- -------------------------------------------------------------------------------
</TABLE>
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: (a) a
broad-based index; (b) other groups of mutual funds, including T. Rowe Price
Funds, tracked by independent research firms ranking entities, or financial
publications; (c) indices of securities 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 nonqualified 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
From time to time, in newsletters and other publications issued by Investment
Services, 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 and/or Investment Services may be made available.
<PAGE>
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 fund is a no-load fund which imposes 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 fund, brokerage fees could be incurred by the
shareholder in a subsequent sale of such securities.
CAPITAL STOCK
-------------------------------------------------------------------------------
Tax-Efficient Balanced, Tax-Efficient Growth, Tax-Exempt Money, Tax-Free High
Yield, Income, Intermediate Bond, and Short-Intermediate Funds
Currently, the T. Rowe Price Tax-Efficient Funds, Inc., which consists of two
series, Tax-Efficient Balanced Fund and Tax-Efficient Growth Fund, the T.
Rowe Price Tax-Exempt Money Fund, Inc., T. Rowe Price Tax-Free High Yield
Fund, Inc., T. Rowe Price Tax-Free Income Fund, Inc., T. Rowe Price Tax-Free
Intermediate Bond Fund, Inc., and the T. Rowe Price Tax-Free
Short-Intermediate Fund, Inc. are all organized as Maryland corporations.
The fund's Charter authorizes the Board of Directors/Trustees to classify and
reclassify any and all shares which are then unissued, including unissued
shares of capital stock into any number of classes or series, each class or
series consisting of such number of shares and having such designations, such
powers, preferences, rights, qualifications, limitations, and restrictions,
as shall be determined by the Board subject to the Investment Company Act and
other applicable law. The shares of any such additional classes or series
might therefore differ from the shares of the present class and series of
capital stock and from each other as to preferences, conversions or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to applicable
law, and might thus be superior or inferior to the capital stock or to other
classes or series in various characteristics. The Board of Directors/Trustees
may increase or decrease the aggregate number of shares of stock or the
number of shares of stock of any class or series that the fund has authorized
to issue without shareholder approval.
Except to the extent that the Fund's Board of Directors/Trustees might
provide by resolution that holders of shares of a particular class are
entitled to vote as a class on specified matters presented for a vote of the
holders of all shares entitled to vote on such matters, there would be no
right of class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no provision
entitling the holders of the present class of capital stock to a vote as a
class on any matter. Accordingly, the preferences, rights, and other
characteristics attaching to any class of shares, including the present class
of capital stock, might be altered or eliminated, or the class might be
combined with another class or classes, by action approved by the vote of the
holders of a majority of all the shares of all classes entitled to be voted
on the proposal, without any additional right to vote as a class by the
holders of the capital stock or of another affected class or classes.
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of directors/trustees (to the extent hereinafter provided) and on
<PAGE>
other matters submitted to the vote of shareholders. There will normally be
no meetings of shareholders for the purpose of electing directors/trustees
unless and until such time as less than a majority of the directors/trustees
holding office have been elected by shareholders, at which time the
directors/trustees then in office will call a shareholders' meeting for the
election of directors/trustees. Except as set forth above, the
directors/trustees shall continue to hold office and may appoint successor
directors/trustees. Voting rights are not cumulative, so that the holders of
more than 50% of the shares voting in the election of directors/trustees can,
if they choose to do so, elect all the directors/trustees of the fund, in
which event the holders of the remaining shares will be unable to elect any
person as a director/trustee. As set forth in the By-Laws of the Fund, a
special meeting of shareholders of the Fund shall be called by the Secretary
of the Fund on the written request of shareholders entitled to cast at least
10% of all the votes of the Fund entitled to be cast at such meeting.
Shareholders requesting such a meeting must pay to the Fund the reasonably
estimated costs of preparing and mailing the notice of the meeting. The Fund,
however, will otherwise assist the shareholders seeking to hold the special
meeting in communicating to the other shareholders of the Fund to the extent
required by Section 16(c) of the 1940 Act.
ORGANIZATION OF THE FUNDS
-------------------------------------------------------------------------------
California and State Tax-Free Trusts
Currently, the T. Rowe Price California Tax-Free Income Trust consists of two
series, California Tax-Free Bond Fund and California Tax-Free Money Fund, and
the T. Rowe Price State Tax-Free Income Trust consists of nine series,
Florida Intermediate Tax-Free Fund, Georgia Tax-Free Bond Fund, Maryland
Short-Term Tax-Free Bond Fund, Maryland Tax-Free Bond Fund, New Jersey
Tax-Free Bond Fund, New York Tax-Free Bond Fund, New York Tax-Free Money
Fund, Virginia Short-Term Tax-Free Bond Fund, and Virginia Tax-Free Bond Fund
each of which represents a separate class of each Trust's shares and has
different objectives and investment policies.
For tax and business reasons, the Funds were organized as Massachusetts
Business Trusts, and are registered with the SEC under the 1940 Act as
diversified, open-end investment companies, commonly known as "mutual fund."
The Declaration of Trust permits the Board of Trustees to issue an unlimited
number of full and fractional shares of a single class. The Declaration of
Trust also provides that the Board of Trustees may issue additional series or
classes of shares. Each share represents an equal proportionate beneficial
interest in the fund. In the event of the liquidation of the fund, each share
is entitled to a pro-rata share of the net assets of the fund.
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of trustees (to the extent hereinafter provided) and on other
matters submitted to the vote of shareholders. There will normally be no
meetings of shareholders for the purpose of electing trustees unless and
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 1940 Act, holders of record of not less than two-thirds
of the outstanding shares of the fund 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 the Trust, in which event the holders of the
remaining shares will be unable to elect any person as a trustee. No
amendments may be made to the Declaration of Trust without the affirmative
vote of a majority of the outstanding shares of the Trust.
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 Trust 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 the Trust, or (ii)
<PAGE>
upon liquidation and distribution of the assets of the Trust, if approved by
the vote of the holders of a majority of the outstanding shares of the Trust.
If not so terminated, the Trust will continue indefinitely.
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of the fund. However, the
Declaration of Trust disclaims shareholder liability for acts or obligations
of the fund and requires that notice of such disclaimer be given in each
agreement, obligation or instrument entered into or executed by the fund or a
Trustee. The Declaration of Trust provides for indemnification from fund
property for all losses and expenses of any shareholder held personally
liable for the obligations of the fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the fund itself would be unable to meet its
obligations, a possibility which T. Rowe Price believes is remote. Upon
payment of any liability incurred by the 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 the fund
is 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
-------------------------------------------------------------------------------
The fund's shares are registered for sale under the 1933 Act. Registration of
the fund's shares is not required under any state law, but the fund is
required to make certain filings with and pay fees to the states in order to
sell its shares in the states.
LEGAL COUNSEL
-------------------------------------------------------------------------------
Swidler Berlin Shereff Friedman, LLP, whose address is 919 Third Avenue, New
York, New York 10022-9998, is legal counsel to the fund.
INDEPENDENT ACCOUNTANTS
-------------------------------------------------------------------------------
PricewaterhouseCoopers LLP, 250 West Pratt Street, 21st Floor, Baltimore,
Maryland 21201, are the independent accountants to the funds.
The financial statements of the funds for the year ended February 28, 1999,
and the report of independent accountants are included in each fund's Annual
Report for the year ended February 28, 1999. A copy of each 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 year ended February 28, 1999, are incorporated into this
Statement of Additional Information by reference:
<PAGE>
<TABLE>
<CAPTION>
ANNUAL REPORT REFERENCES:
CALIFORNIA TAX- CALIFORNIA TAX- GEORGIA
FREE MONEY FUND FREE BOND FUND TAX-FREE
--------------- -------------- BOND FUND
---------
<S> <C> <C> <C>
Report of Independent
Accountants 28 28 19
Statement of Net Assets,
February 28, 1999 12-15 16-22 9-13
Statement of Operations, year
ended
February 28, 1999 23 23 14
Statement of Changes in Net
Assets, years ended
February 28, 1999 and February
28, 1998 24 24 15
Notes to Financial Statements,
February 28, 1999 25-27 25-27 16-18
Financial Highlights 10 11 8
</TABLE>
<TABLE>
<CAPTION>
NEW JERSEY FLORIDA NEW YORK TAX-
TAX-FREE INTERMEDIATE FREE MONEY FUND
BOND FUND TAX-FREE FUND ---------------
--------- -------------
<S> <C> <C> <C>
Report of Independent Accountants 20 19 26
Statement of Net Assets, February
28, 1999 9-14 10-13 11-14
Statement of Operations, year
ended
February 28, 1999 15 14 21
Statement of Changes in Net
Assets, years ended
February 28, 1999 and February
28, 1998 16 15 22
Notes to Financial Statements,
February 28, 1999 17-19 16-18 23-25
Financial Highlights 8 9 9
</TABLE>
<TABLE>
<CAPTION>
VIRGINIA VIRGINIA
NEW YORK TAX- SHORT-TERM TAX-FREE
FREE BOND FUND TAX-FREE BOND FUND
-------------- BOND FUND ---------
---------
<S> <C> <C> <C>
Report of Independent Accountants 26 27 27
Statement of Net Assets, February 28,
1999 15-20 12-14 15-21
Statement of Operations, year ended
February 28, 1999 21 22 22
Statement of Changes in Net Assets,
years ended
February 28, 1999 and February 28,
1998 22 23 23
Notes to Financial Statements,
February 28, 1999 23-25 24-26 24-26
Financial Highlights 10 10 11
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
TAX-EXEMPT TAX-FREE HIGH TAX-FREE
MONEY FUND YIELD FUND INCOME FUND
---------- ---------- -----------
<S> <C> <C> <C>
Report of Independent Accountants 21 31 26
Statement of Net Assets, February 28,
1999 3-15 3-25 3-21
Statement of Operations, year ended
February 28, 1999 16 26 22
Statement of Changes in Net Assets,
years ended
February 28, 1999 and February 28,
1998 17 27 23
Notes to Financial Statements,
February 28, 1999 18-20 28-30 24-25
Financial Highlights 2 2 2
</TABLE>
<TABLE>
<CAPTION>
TAX-FREE INTERMEDIATE TAX-FREE SHORT-
BOND FUND INTERMEDIATE FUND
--------- -----------------
<S> <C> <C>
Report of Independent Accountants 14 17
Statement of Net Assets, February
28, 1999 3-8 3-11
Statement of Operations, year
ended
February 28, 1999 9 12
Statement of Changes in Net
Assets, years ended
February 28, 1999 and February 28,
1998 10 13
Notes to Financial Statements,
February 28, 1999 11-13 14-16
Financial Highlights 2 2
</TABLE>
<TABLE>
<CAPTION>
TAX-EFFICIENT
BALANCED FUND
-------------
<S> <C>
Report of Independent Accountants 29
Portfolio of Investments, February 28, 1999 11-21
Statement of Assets and Liabilities, February 28, 1999 22
Statement of Operations, February 28, 1999 23
Statement of Changes in Net Assets, year ended
February 28, 1999, period from June 30, 1997
(commencement of operations) to February 28, 1998 24
Notes to Financial Statements, February 28, 1999 25-28
Financial Highlights 10
</TABLE>
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 know as high-grade bonds.
A-Bonds rated A possess many favorable investment attributes and are to be
considered as upper medium-grade obligations.
<PAGE>
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-Bonds rated C represent the lowest-rated, and have extremely poor prospects
of attaining investment standing.
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, B, CCC, CC, C-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 IBCA, Inc.
AAA-High grade, broadly marketable, suitable for investment by trustees and
fiduciary institutions, and liable to but slight market fluctuation other
than through changes in the money rate. The prime feature of a "AAA" bond is
the showing of earnings several times or many times interest requirements for
such stability of applicable interest that safety is beyond reasonable
question whenever changes occur in conditions. Other features may enter, such
as wide margin of protection through collateral, security or direct lien on
specific property. Sinking funds or voluntary reduction of debt by call or
purchase or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA-Of safety virtually beyond question and readily salable. Their merits are
not greatly unlike those of "AAA" class but a bond so rated may be junior
though of strong lien, or the margin of safety is less strikingly broad.
<PAGE>
The issue may be the obligation of a small company, strongly secured, but
influenced as to rating by the lesser financial power of the enterprise and
more local type of market.
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 interest and repay principal is
considered to be adequate. Adverse changes in economic conditions ad
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 RATE SECURITIES
-------------------------------------------------------------------------------
Moody's Investors Service, Inc. VMIG1/MIG-1 the best quality. VMIG2/MIG-2
high quality, with margins of protection ample though not so large as in the
preceding group. VMIG3/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. VMIG4/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 interest and principal. SP-3 speculative
capacity to pay principal and interest.
Fitch IBCA, 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.
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 IBCA, 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.
