<PAGE>1
Prospectus for the T. Rowe Price New Income Fund, Inc. dated July 1, 1993,
revised to February 1, 1994 should be inserted here.
<PAGE>2
PROSPECTUS
To Open an Account:
Investor Services T. Rowe Price
1-800-638-5660 New Income Fund
547-2308 in Baltimore
Yields & Prices: July 1, 1993
Tele*AccessR Revised to
24 hours, 7 days a week February 1, 1994
1-800-638-2587
625-7676 in Baltimore
Existing Account:
Shareholder Services
1-800-225-5132
625-6500 in Baltimore
Investor Centers:
101 East Lombard Street
First Floor
Baltimore, Maryland
Farragut Square
First Floor
900 17th Street, NW
Washington, D.C.
T. Rowe Price Financial Center
First Floor
10090 Red Run Boulevard
Owings Mills, Maryland
ARCO Tower
31st Floor
515 South Flower Street
Los Angeles, California
T. ROWE PRICE
Invest With ConfidenceR (registered trademark)
<PAGE>3
STATEMENT OF ADDITIONAL INFORMATION
T. Rowe Price New Income Fund, Inc.R (registered trademark)
(the "Fund")
This Statement of Additional Information is not a prospectus but
should be read in conjunction with the Fund's prospectus dated July 1, 1993,
revised to February 1, 1994, which may be obtained from T. Rowe Price
Investment Services, Inc., 100 East Pratt Street, Baltimore, Maryland 21202.
The date of this Statement of Additional Information is July 1,
1993, revised to February 1, 1994.
<PAGE>4
TABLE OF CONTENTS
Page Page
Capital Stock. . . . . . . . . . . 47 Investment Program. . . . . . . . 3
(page 8 in Prospectus) (page 2 in Prospectus)
Covered Call and Put Options . . . 19 Investment Restrictions . . . . . 26
Custodian. . . . . . . . . . . . . 34 Legal Counsel . . . . . . . . . . 48
Distributor for Fund . . . . . . . 34 Lending of Portfolio Securities . 18
Dealer Options . . . . . . . . . . 24 Net Asset Value Per Share . . . . 40
Dividends. . . . . . . . . . . . . 40 Management of Fund. . . . . . . . 29
Federal and State Registration Portfolio Transactions. . . . . . 35
of Shares. . . . . . . . . . . . . 48 Pricing of Securities . . . . . . 39
Foreign Securities . . . . . . . . 8 Principal Holders of
Foreign Currency Transactions. . . 9 Securities. . . . . . . . . . . 31
Futures Contracts. . . . . . . . . 13 Ratings of Corporate Debt
Illiquid Securities. . . . . . . . .8 Securities. . . . . . . . . . . 49
Independent Accountants. . . . . . 48 Repurchase Agreements . . . . . . .7
Industry Concentration . . . . . . 12 Risk Factors. . . . . . . . . . . 28
Investment Management Services . . 31 Tax Status. . . . . . . . . . . . 40
(page 12 in Prospectus) (page 11 in Prospectus)
Investment Objective . . . . . . . .2 Warrants. . . . . . . . . . . . . 12
(page 2 in Prospectus) When-Issued Securities. . . . . . 13
Investment Objective and Policies. .2 Yield Information . . . . . . . . 41
Investment Performance . . . . . . 41
INVESTMENT OBJECTIVE AND POLICIES
The following information supplements the discussion of the Fund's
investment objective and policies discussed on pages 2 and 4 through 7 of the
prospectus. The Fund will not make a material change in its investment
objective without obtaining shareholder approval. Unless otherwise specified,
the investment program and restrictions of the Fund are not fundamental
policies. The operating policies of the Fund are subject to change by its
Board of Directors without shareholder approval. However, shareholders will
be notified of a material change in an operating policy. The fundamental
policies of the Fund may not be changed without the approval of at least a
majority of the outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the holders of 50% or
more of the shares are represented.
INVESTMENT OBJECTIVE
The Fund's investment objective is to seek the highest level of
income over time consistent with preservation of capital. The Fund's share
price and yield will fluctuate with changing market conditions, and your
investment may be worth more or less when redeemed than when purchased. The
Fund should not be relied upon as a complete investment program, nor used to
play short-term swings in the bond market. The Fund cannot guarantee it will
achieve its investment objective.
INVESTMENT PROGRAM
The securities that the Fund may invest in include those described
below.
<PAGE>5
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.
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, and 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 will not invest in any security issued by a commercial
bank unless (i) the bank has total assets of at least $1 billion, or the
equivalent in other currencies, or, in the case of domestic banks which do not
have total assets of at least $1 billion, the aggregate investment made in any
one such bank is limited to $100,000 and the principal amount of such
investment is insured in full by the Federal Deposit Insurance Corporation,
(ii) in the case of U.S. banks, it is a member of the Federal Deposit
Insurance Corporation, and (iii) in the case of foreign banks, the security
is, in the opinion of the Fund's investment manager, T. Rowe Price Associates,
Inc. ("T. Rowe Price"), of an investment quality comparable with other debt
securities which may be purchased by the Fund. These limitations do not
prohibit investments in securities issued by foreign branches of U.S. banks,
provided such U.S. banks meet the foregoing requirements.
Savings and Loan Obligations. Negotiable certificates of deposit
and other short-term debt obligations of savings and loan associations. The
Fund will not invest in any security issued by a savings and loan association
unless: (i) the savings and loan association has total assets of at least $1
billion, or, in the case of savings and loan associations which do not have
total assets of at least $1 billion, the aggregate investment made in any one
savings and loan association is limited to $100,000 and the principal amount
of such investment is insured in full by the Federal Deposit Insurance
Corporation; and (ii) the savings and loan association issuing the security is
a member of the Federal Home Loan Bank System.
The Fund will not purchase any security of a small bank or savings
and loan association which is not readily marketable if, as a result, more
than 10% of the value of its net assets would be invested in such securities
or illiquid securities, including repurchase agreements maturing in more than
seven days. (See Investment Restriction (2) on page 24.)
Collateralized Mortgage Obligations (CMOs). CMOs are obligations
fully collateralized by a portfolio of mortgages or mortgage-related
securities. Payments of principal and interest on the mortgages are passed
through to the holders of the CMOs on the same schedule as they are received,
although certain classes of CMOs have priority over others with respect to the
<PAGE>6
receipt of prepayments on the mortgages. Therefore, depending on the type of
CMOs in which a Fund invests, the investment may be subject to a greater or
lesser risk of prepayment than other types of mortgage-related securities.
Mortgage-Backed Securities. Mortgage-backed securities are
securities representing interest in a pool of mortgages. Principal and
interest payments made on the mortgages in the underlying mortgage pool are
passed through to the Fund. Unscheduled prepayments of principal shorten the
securities' weighted average life and may lower their total return. (When a
mortgage in the underlying mortgage pool is prepaid, an unscheduled principal
prepayment is passed through to the Fund. This principal is returned to the
Fund at par. As a result, if a mortgage security were trading at a premium,
its total return would be lowered by prepayments, and if a mortgage security
were trading at a discount, its total return would be increased by
prepayments). The value of these securities also may change because of
changes in the market's perception of the creditworthiness of the federal
agency that issued them. In addition, the mortgage securities market in
general may be adversely affected by changes in governmental regulation or tax
policies.
The Fund may also invest in the securities of certain supranational
entities, such as the International Development Bank.
Asset-Backed Securities
The Fund may invest a portion of its assets in debt obligations
known as asset-backed securities. The credit quality of most asset-backed
securities depends primarily on the credit quality of the assets underlying
such securities, how well the entity issuing the security is insulated from
the credit risk of the originator or any other affiliated entities and the
amount and quality of any credit support provided to the securities. The rate
of principal payment on asset-backed securities generally depends on the rate
of principal payments received on the underlying assets which in turn may be
affected by a variety of economic and other factors. As a result, the yield
on any asset-backed security is difficult to predict with precision and actual
yield to maturity may be more or less than the anticipated yield to maturity.
Asset-backed securities may be classified either as pass-through certificates
or collateralized obligations.
Pass-through certificates are asset-backed securities which
represent an undivided fractional ownership interest in an underlying pool of
assets. Pass-through certificates usually provide for payments of principal
and interest received to be passed through to their holders, usually after
deduction for certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest in the
underlying assets, the holders thereof bear directly the risk of any defaults
by the obligors on the underlying assets not covered by any credit support.
See "Types of Credit Support".
<PAGE>7
Asset-backed securities issued in the form of debt instruments,
also known as collateralized obligations, are generally issued as the debt of
a special purpose entity organized solely for the purpose of owning such
assets and issuing such debt. Such assets are most often trade, credit card
or automobile receivables. The assets collateralizing such asset-backed
securities are pledged to a trustee or custodian for the benefit of the
holders thereof. Such issuers generally hold no assets other than those
underlying the asset-backed securities and any credit support provided. As a
result, although payments on such asset-backed securities are obligations of
the issuers, in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing entities are
unlikely to have sufficient assets to satisfy their obligations on the related
asset-backed securities.
Methods of Allocating Cash Flows. While many asset-backed
securities are issued with only one class of security, many asset-backed
securities are issued in more than one class, each with different payment
terms. Multiple class asset-backed securities are issued for two main
reasons. First, multiple classes may be used as a method of providing credit
support. This is accomplished typically through creation of one or more
classes whose right to payments on the asset-backed security is made
subordinate to the right to such payments of the remaining class or classes.
See "Types of Credit Support". Second, multiple classes may permit the
issuance of securities with payment terms, interest rates or other
characteristics differing both from those of each other and from those of the
underlying assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests with respect to
the allocation of interest and principal of the assets backing the security),
and securities with class or classes having characteristics which mimic the
characteristics of non-asset-backed securities, such as floating interest
rates (i.e., interest rates which adjust as a specified benchmark changes) or
scheduled amortization of principal.
Asset-backed securities in which the payment streams on the
underlying assets are allocated in a manner different than those described
above may be issued in the future. The Fund may invest in such asset-backed
securities if such investment is otherwise consistent with its investment
objective and policies and with the investment restrictions of the Fund.
Types of Credit Support. Asset-backed securities are often backed
by a pool of assets representing the obligations of a number of different
parties. To lessen the effect of failures by obligors on underlying assets to
make payments, such securities may contain elements of credit support. Such
credit support falls into two classes: liquidity protection and protection
against ultimate default by an obligor on the underlying assets. Liquidity
protection refers to the provision of advances, generally by the entity
administering the pool of assets, to ensure that scheduled payments on the
underlying pool are made in a timely fashion. Protection against ultimate
default ensures ultimate payment of the obligations on at least a portion of
the assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained from third parties, through
various means of structuring the transaction or through a combination of such
approaches. Examples of asset-backed securities with credit support arising
out of the structure of the transaction include "senior-subordinated
securities" (multiple class asset-backed securities with certain classes
subordinate to other classes as to the payment of principal thereon, with the
result that defaults on the underlying assets are borne first by the holders
of the subordinated class) and asset-backed securities that have "reserve
funds" (where cash or investments, sometimes funded from a portion of the
initial payments on the underlying assets, are held in reserve against future
<PAGE>8
losses) or that have been "overcollateralized" (where the scheduled payments
on, or the principal amount of, the underlying assets substantially exceeds
that required to make payment of the asset-backed securities and pay any
servicing or other fees). The degree of credit support provided on each issue
is based generally on historical information respecting the level of credit
risk associated with such payments. Delinquency or loss in excess of that
anticipated could adversely affect the return on an investment in an asset-
backed security.
Automobile Receivable Securities. The Fund may invest in Asset-
Backed Securities which are backed by receivables from motor vehicle
installment sales contracts or installment loans secured by motor vehicles
("Automobile Receivable Securities"). Since installment sales contracts for
motor vehicles or installment loans related thereto ("Automobile Contracts")
typically have shorter durations and lower incidences of prepayment,
Automobile Receivable Securities generally will exhibit a shorter average life
and are less susceptible to prepayment risk.
Most entities that issue Automobile Receivable Securities create an
enforceable interest in their respective Automobile Contracts only by filing a
financing statement and by having the servicer of the Automobile Contracts,
which is usually the originator of the Automobile Contracts, take custody
thereof. In such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in violation of
its obligation not to do so, there is a risk that such party could acquire an
interest in the Automobile Contracts superior to that of the holders of
Automobile Receivable Securities. Also although most Automobile Contracts
grant a security interest in the motor vehicle being financed, in most states
the security interest in a motor vehicle must be noted on the certificate of
title to create an enforceable security interest against competing claims of
other parties. Due to the large number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually is not
amended to reflect the assignment of the seller's security interest for the
benefit of the holders of the Automobile Receivable Securities. Therefore,
there is the possibility that recoveries on repossessed collateral may not, in
some cases, be available to support payments on the securities. In addition,
various state and federal securities laws give the motor vehicle owner the
right to assert against the holder of the owner's Automobile Contract certain
defenses such owner would have against the seller of the motor vehicle. The
assertion of such defenses could reduce payments on the Automobile Receivable
Securities.
Credit Card Receivable Securities. The Fund may invest in Asset-
Backed Securities backed by receivables from revolving credit card agreements
("Credit Card Receivable Securities"). Credit balances on revolving credit
card agreements ("Accounts") are generally paid down more rapidly than are
Automobile Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order to lengthen
the maturity of Credit Card Receivable Securities, most such securities
provide for a fixed period during which only interest payments on the
underlying Accounts are passed through to the security holder and principal
payments received on such Accounts are used to fund the transfer to the pool
of assets supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial fixed period
usually may be shortened upon the occurrence of specified events which signal
a potential deterioration in the quality of the assets backing the security,
such as the imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable Securities thus
depends upon the continued generation of additional principal amounts in the
<PAGE>9
underlying accounts during the initial period and the non-occurrence of
specified events. An acceleration in cardholders' payment rates or any other
event which shortens the period during which additional credit card charges on
an Account may be transferred to the pool of assets supporting the related
Credit Card Receivable Security could shorten the weighted average life and
yield of the Credit Card Receivable Security.
Credit cardholders are entitled to the protection of a number of
state and federal consumer credit laws, many of which give such holder the
right to set off certain amounts against balances owed on the credit card,
thereby reducing amounts paid on Accounts. In addition, unlike most other
Asset-Backed Securities, Accounts are unsecured obligations of the cardholder.
Other Assets. T. Rowe Price anticipates that Asset-Backed
Securities backed by assets other than those described above will be issued in
the future. The Fund may invest in such securities in the future if such
investment is otherwise consistent with its investment objective and policies.
After purchase by the Fund, a security may cease to be rated or its
rating may be reduced below the minimum required for purchase by the Fund.
Neither event will 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 or S&P 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.
There are, of course, other types of securities that are, or may
become, available, which are similar to the foregoing.
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 Standard & Poor's Corporation, P1 by Moody's
Investors Service, Inc. 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. The Fund
will not enter into a repurchase agreement which does not provide for payment
within seven days if, as a result, more than 10% of the value of its net
assets would then be invested in such repurchase agreements. The Fund will
only enter into repurchase agreements where (i) the underlying securities are
of the type (excluding maturity limitations) which the Fund's investment
guidelines would allow it to purchase directly, (ii) 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 (iii) 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.
<PAGE>10
Illiquid Securities
The Fund may invest in illiquid securities including repurchase
agreements which do not provide for payment within seven days, but will not
acquire such securities if, as a result, they would comprise more than 10% of
the value of the Fund's net assets.
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 Board of Directors. If through the appreciation of illiquid
securities or the depreciation of liquid securities, the Fund should be in a
position where more than 10% of the value of its net assets are 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, will consider whether securities
purchased under Rule 144A are illiquid and thus subject to the Fund's
restriction of investing no more than 10% of its 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 (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 10% of its 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.
Foreign Securities
Subject to the Fund's quality and maturity standards, the Fund may
invest without limitation in the securities (payable in U.S. dollars) of
foreign issuers in developed countries and in the securities of foreign
branches of U.S. banks such as negotiable certificates of deposit
(Eurodollars). The Fund may also invest up to 20% of its net assets in non-
U.S. dollar-denominated fixed income securities principally traded in
financial markets outside the United States. Because the Fund may invest in
foreign securities, investment in the Fund involves risks that are different
<PAGE>11
in some respects from an investment in a fund which invests only in debt
obligations of U.S. domestic issuers. Foreign investments may be affected
favorably or unfavorably by changes in currency rates and exchange control
regulations. There may be less publicly available information about a foreign
company than about a U.S. company, and foreign companies may not be subject to
accounting, auditing, and financial reporting standards and requirements
comparable to those applicable to U.S. companies. There may be less
governmental supervision of securities markets, brokers and issuers of
securities. Securities of some foreign companies are less liquid or more
volatile than securities of U.S. companies, and foreign brokerage commissions
and custodian fees are generally higher than in the United States. Settlement
practices may include delays and may differ from those customary in United
States markets. Investments in foreign securities may also be subject to
other risks different from those affecting U.S. investments, including local
political or economic developments, expropriation or nationalization of
assets, restrictions on foreign investment and repatriation of capital,
imposition of withholding taxes on dividend or interest payments, currency
blockage (which would prevent cash from being brought back to the United
States), and difficulty in enforcing legal rights outside the United States.
Foreign Currency Transactions
A forward foreign currency exchange contract involves an obligation
to purchase or sell a specific currency at a future date, which may be any
fixed number of days from the date of the contract agreed upon by the parties,
at a price set at the time of the contract. These contracts are principally
traded in the interbank market conducted directly between currency traders
(usually large, commercial banks) and their customers. A forward contract
generally has no deposit requirement, and no commissions are charged at any
stage for trades.
The Fund may enter into forward foreign currency exchange contracts
for a variety of purposes in connection with the management of the foreign
securities portion of its portfolio. The Fund's use of such contracts would
include, but not be limited to, the following:
First, when the Fund enters into a contract for the purchase or
sale of a security denominated in a foreign currency, it may desire to "lock
in" the U.S. dollar price of the security. By entering into a forward
contract for the purchase or sale, for a fixed amount of dollars, of the
amount of foreign currency involved in the underlying security transactions,
the Fund will be able to protect itself against a possible loss resulting from
an adverse change in the relationship between the U.S. dollar and the subject
foreign currency during the period between the date the security is purchased
or sold and the date on which payment is made or received.
Second, when T. Rowe Price believes that the currency of a
particular foreign country may suffer or enjoy a substantial movement against
another currency, including the U.S. dollar, it may enter into a forward
contract to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. Alternatively, where appropriate, the
Fund may hedge all or part of its foreign currency exposure through the use of
a basket of currencies or a proxy currency where such currency or currencies
act as an effective proxy for other currencies. In such a case, the Fund may
enter into a forward contract where the amount of the foreign currency to be
sold exceeds the value of the securities denominated in such currency. The
use of this basket hedging technique may be more efficient and economical than
<PAGE>12
entering into separate forward contracts for each currency held in the Fund.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible since the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward
contract is entered into and the date it matures. The projection of short-
term currency market movement is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain. T. Rowe Price
does not intend to enter into such forward contracts under this second
circumstance if, as a result, the Fund will have more than 20% of the value of
its net assets committed to the consummation of such contracts. Other than as
set forth above and immediately below, the Fund will also not enter into such
forward contracts or maintain a net exposure to such contracts where the
consummation of the contracts would obligate the Fund to deliver an amount of
foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency. The Fund, however, in order to
avoid excess transactions and transaction costs, may maintain a net exposure
to forward contracts in excess of the value of the Fund's portfolio securities
or other assets denominated in that currency provided the excess amount is
"covered" by liquid, high-grade debt securities, denominated in any currency,
at least equal at all times to the amount of such excess. Under normal
circumstances, consideration of the prospect for currency parities will be
incorporated into the longer term investment decisions made with regard to
overall diversification strategies. However, T. Rowe Price believes that it
is important to have the flexibility to enter into such forward contracts when
it determines that the best interests of the Fund will be served.
Third, the Fund may use forward contracts when the Fund wishes to
hedge out of the dollar into a foreign currency in order to create a synthetic
bond or money market instrument--the security would be issued by a U.S. issuer
but the dollar component would be transformed into a foreign currency through
a forward contract.
At the maturity of a forward contract, the Fund may either sell the
portfolio security and make delivery of the foreign currency, or it may retain
the security and terminate its contractual obligation to deliver the foreign
currency by purchasing an "offsetting" contract obligating it to purchase, on
the same maturity date, the same amount of the foreign currency.
As indicated above, it is impossible to forecast with absolute
precision the market value of portfolio securities at the expiration of the
forward contract. Accordingly, it may be necessary for the Fund to purchase
additional foreign currency on the spot market (and bear the expense of such
purchase) if the market value of the security is less than the amount of
foreign currency the Fund is obligated to deliver and if a decision is made to
sell the security and make delivery of the foreign currency. Conversely, it
may be necessary to sell on the spot market some of the foreign currency
received upon the sale of the portfolio security if its market value exceeds
the amount of foreign currency the Fund is obligated to deliver. However, as
noted, in order to avoid excessive transactions and transaction costs, the
Fund may use liquid, high-grade debt securities, denominated in any currency,
to cover the amount by which the value of a forward contract exceeds the value
of the securities to which it relates.
<PAGE>13
If the Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss (as described
below) to the extent that there has been movement in forward contract prices.
If the Fund engages in an offsetting transaction, it may subsequently enter
into a new forward contract to sell the foreign currency. Should forward
prices decline during the period between the Fund's entering into a forward
contract for the sale of a foreign currency and the date it enters into an
offsetting contract for the purchase of the foreign currency, the Fund will
realize a gain to the extent the price of the currency it has agreed to sell
exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, the Fund will suffer a loss to the extent the price of the
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell.
The Fund's dealing in forward foreign currency exchange contracts
will be limited to the transactions described above. However, the Fund
reserves the right to enter into forward foreign currency contracts for
different purposes and under different circumstances. Of course, the Fund is
not required to enter into forward contracts with regard to its foreign
currency-denominated securities and will not do so unless deemed appropriate
by T. Rowe Price. It also should be realized that this method of hedging
against a decline in the value of a currency does not eliminate fluctuations
in the underlying prices of the securities. It simply establishes a rate of
exchange at a future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the hedged
currency, at the same time, they tend to limit any potential gain which might
result from an increase in the value of that currency.
Although the Fund values its assets daily in terms of U.S. dollars,
it does not intend to convert its holdings of foreign currencies into U.S.
dollars on a daily basis. It will do so from time to time, and investors
should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference (the "spread") between the prices at which they are
buying and selling various currencies. Thus, a dealer may offer to sell a
foreign currency to the Fund at one rate, while offering a lesser rate of
exchange should the Fund desire to resell that currency to the dealer.
Hybrid Commodity and Security Instruments
Recently, instruments have been developed which combine the
elements of futures contracts or options with those of debt, preferred equity
or a depository instrument (hereinafter "Hybrid Instruments"). Often these
Hybrid Instruments are indexed to the price of a commodity, particular
currency or a domestic or foreign debt or equity securities index. 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 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.
<PAGE>14
The risks of investing in Hybrid Instruments reflect a combination
of the risks from investing in securities, options, futures and currencies,
including volatility and lack of liquidity. Reference is made to the
discussion of futures on page 13, forward contracts on page 9, and options on
page 19 for a discussion of these risks. Further, the prices of the Hybrid
Instrument and the related commodity or currency 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. In
addition, because the purchase and sale of Hybrid Instruments could take place
in an over-the-counter market or in a private transaction between the Fund and
the seller of the Hybrid Instrument, the creditworthiness of the contra party
to the transaction would be a risk factor which the Fund would have to
consider. Hybrid Instruments also may not be subject to regulation of the
Commodities Futures Trading Commission ("CFTC"), which generally regulates the
trading of commodity futures, the SEC, which regulates the offer and sale of
securities, or any other governmental regulatory authority.
Warrants
The Fund may invest in warrants; however, in order to comply with
the securities laws of a certain state, not more than 5% of its assets (at the
time of purchase) will be invested in warrants other than warrants acquired in
units or attached to other securities. Of such 5% not more than 2% of assets
at the time of purchase may be invested in warrants that are not listed on the
New York or American Stock Exchanges. Should the law of this state change or
should the Fund obtain a waiver of its application, the Fund may invest in
warrants to a greater extent than 5% of its assets. Warrants are pure
speculation in that they 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 equity 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. (See "Covered Call and Put Options," page 19.) The prices of
warrants do not necessarily move parallel to the prices of the underlying
securities.
Industry Concentration
When the market for corporate debt securities is dominated by
issues in the gas utility, gas transmission utility, electric utility,
telephone utility, or petroleum industry, the Fund will as a matter of
fundamental policy concentrate 25% or more, but not more than 50% of its
assets, in any one such industry, if the Fund has cash for such investment
(i.e., will not sell portfolio securities to raise cash) and, if in T. Rowe
Price's judgment, the return available and the marketability, quality, and
availability of the debt securities of such industry justifies such
concentration in light of the Fund's investment objective. Domination would
exist with respect to any one such industry, when, in the preceding 30-day
period, more than 25% of all new-issue corporate debt offerings (within the
four highest grades of Moody's or S&P and with maturities of 10 years or less)
of $25,000,000 or more consisted of issues in such industry. Although the
Fund will normally purchase corporate debt securities in the secondary market
as opposed to new offerings, T. Rowe Price believes that the new issue-based
dominance standard, as defined above, is appropriate because it is easily
determined and represents an accurate correlation to the secondary market.
<PAGE>15
Investors should understand that concentration in any industry may result in
increased risk. Investments in any of these industries may be affected by
environmental conditions, energy conservation programs, fuel shortages,
difficulty in obtaining adequate return on capital in financing operations and
large construction programs, and the ability of the capital markets to absorb
debt issues. In addition, it is possible that the public service commissions
which have jurisdiction over these industries may not grant future increases
in rates sufficient to offset increases in operating expenses. These
industries also face numerous legislative and regulatory uncertainties at both
federal and state government levels. Management believes that any risk to the
Fund which might result from concentration in any industry will be minimized
by the Fund's practice of diversifying its investments in other respects. The
Fund's policy with respect to industry concentration is a fundamental policy.
(For investment restriction on industry concentration, see Investment
Restriction (4) on page 24.)
When-Issued Securities
The Fund may from time to time purchase securities on a
"when-issued" basis. The price of such securities, which may be expressed in
yield terms, is fixed at the time the commitment to purchase is made, but
delivery and payment for the when-issued securities take place at a later
date. Normally, the settlement date occurs within 90 days of the purchase.
During the period between purchase and settlement, no payment is made by the
Fund to the issuer and no interest accrues to the Fund. Forward commitments
involve a risk of loss if the value of the security to be purchased declines
prior to the settlement date, which risk is in addition to the risk of decline
in value of the Fund's other assets. Such when-issued securities may be sold
prior to the settlement date. At the time the Fund makes the commitment to
purchase a security on a when-issued basis, it will record the transaction and
reflect the value of the security in determining its net asset value. The
Fund does not believe that its net asset value or income will be adversely
affected by its purchase of securities on a when-issued basis. The Fund will
maintain cash and marketable securities equal in value to commitments for
when-issued securities. Such segregated securities either will mature or, if
necessary, be sold on or before the settlement date.
Futures Contracts
Transactions in Futures
The Fund may enter into financial futures contracts, including
interest rate and currency futures ("futures or futures contracts").
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. Futures can also be used as an
efficient means of regulating the Fund's exposure to the market.
<PAGE>16
The Fund will enter into futures contracts which are traded on
national or foreign futures exchanges and are standardized as to maturity date
and underlying financial instrument. The principal financial futures
exchanges in the United States are the Board of Trade of the City of Chicago,
the Chicago Mercantile Exchange, the New York Futures Exchange and the Kansas
City Board of Trade. Futures exchanges and trading in the United States are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission (the "CFTC"). Futures are traded in London at the London
International Financial Futures Exchange, in Paris at the MATIF and in Tokyo
at the Tokyo Stock Exchange. Although techniques other than the sale and
purchase of futures contracts could be used for the above-referenced purposes,
futures contracts offer an effective and relatively low cost means of
implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in transactions in futures contracts and
options thereon only for bona fide hedging, yield enhancement and risk
management purposes, in each case in accordance with the rules and regulations
of the CFTC, and not for speculation.
The Fund may not enter into futures contracts or options thereon if
immediately thereafter the sum of the amounts of initial margin deposits on
the Fund's existing futures and premiums paid for options on futures would
exceed 5% of the market value of the Fund's total assets; 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.
In instances involving the purchase of futures contracts or call
options thereon or the writing of put options thereon by the Fund, an amount
of cash, U.S. government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts and options
thereon (less any related margin deposits), will be deposited in a segregated
account with the Fund's custodian to cover the position, or alternative cover
will be employed thereby insuring that the use of such futures contracts and
options is unleveraged.
In addition, CFTC regulations may impose limitations on the Fund's
ability to engage in certain yield enhancement and risk management strategies.
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
A futures contract provides for the future sale by one party and
purchase by another party of a specified amount of a specific financial
instrument (e.g., units of a debt security) for a specified price, date, time
and place designated at the time the contract is made. Brokerage fees are
incurred when a futures contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred to as buying
or purchasing a contract or holding a long position. Entering into a contract
to sell is commonly referred to as selling a contract or holding a short
position.
<PAGE>17
Unlike when the Fund purchases or sells a security, no price would
be paid or received by the Fund upon the purchase or sale of a futures
contract. Upon entering into a futures contract, and to maintain the Fund's
open positions in futures contracts, the Fund would be required to deposit
with its custodian in a segregated account in the name of the futures broker
an amount of cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as "initial margin."
The margin required for a particular futures contract is set by the exchange
on which the contract is traded, and may be significantly modified from time
to time by the exchange during the term of the contract. Futures contracts
are customarily purchased and sold on margins that may range upward from less
than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by increase in
the case of a sale or by decrease in the case of a purchase) so that the loss
on the futures contract reaches a point at which the margin on deposit does
not satisfy margin requirements, the broker will require an increase in the
margin. However, if the value of a position increases because of favorable
price changes in the futures contract so that the margin deposit exceeds the
required margin, the broker will pay the excess to the Fund.
These subsequent payments, called "variation margin," to and from
the futures broker, are made on a daily basis as the price of the underlying
assets fluctuate making the long and short positions in the futures contract
more or less valuable, a process known as "marking to the market." The Fund
expects to earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require actual
future delivery of and payment for the underlying instruments, in practice
most futures contracts are usually closed out before the delivery date.
Closing out an open futures contract sale or purchase is effected by entering
into an offsetting futures contract purchase or sale, 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.
<PAGE>18
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 policies and economic
events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single trading day.
The daily limit establishes the maximum amount that the price of a futures
contract may vary either up or down from the previous day's settlement price
at the end of a trading session. Once the daily limit has been reached in a
particular type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price movement during a
particular trading day and therefore does not limit potential losses, because
the limit may prevent the liquidation of unfavorable positions. Futures
contract prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of futures positions and subjecting some futures traders to
substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss, as well as gain, to the investor. For example, if at the
time of purchase, 10% of the value of the futures contract is deposited as
margin, a subsequent 10% decrease in the value of the futures contract would
result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit, if the contract
were closed out. Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract. However, the
Fund would presumably have sustained comparable losses if, instead of the
futures contract, it had invested in the underlying instrument and sold it
after the decline. Furthermore, in the case of a futures contract purchase,
in order to be certain that the Fund has sufficient assets to satisfy its
obligations under a futures contract, the Fund earmarks to the futures
contract money market instruments equal in value to the current value of the
underlying instrument less the margin deposit.
Liquidity. The Fund may elect to close some or all of its futures
positions at any time prior to their expiration. The Fund would do so to
reduce exposure represented by long futures positions or increase exposure
represented by 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.
<PAGE>19
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 the underlying
instruments, if any, might partially or completely offset losses on the
futures contract. However, as described below, there is no guarantee that the
price of the underlying instruments will, in fact, correlate with the price
movements in the futures contract and thus provide an offset to losses on a
futures contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may be
unsuccessful to some degree because of unexpected market behavior, market or
interest rate trends. There are several risks in connection with the use by
the Fund of futures contract 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 underlying instruments on which the futures are written
might advance and the value of the underlying instruments held in the Fund's
portfolio might decline. If this were to occur, the Fund would lose money on
the futures and also would experience a decline in value in its underlying
instruments. However, while this might occur to a certain degree, T. Rowe
Price believes that over time the value of the Fund's portfolio will tend to
move in the same direction as the market indices which are intended to
correlate to the price movements of the underlying instruments sought to be
hedged. 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>20
In addition to the possibility that there might be an imperfect
correlation, or no correlation at all, between price movements in the futures
contracts and the portion of the portfolio being hedged, the price movements
of futures contracts might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First, all
participants in the futures market are subject to margin deposit and
maintenance requirements. Rather than meeting additional margin deposit
requirements, investors might close futures contracts through offsetting
transactions which could distort the normal relationship between the
underlying instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements in the
securities markets, and as a result the futures market might attract more
speculators than the securities markets do. Increased participation by
speculators in the futures market might also cause temporary price
distortions. Due to the possibility of price distortion in the futures market
and also because of the imperfect correlation between price movements in the
underlying instruments and movements in the prices of futures contracts, even
a correct forecast of general market trends by T. Rowe Price might not result
in a successful hedging transaction over a very short time period.
Options on Futures Contracts
Options on futures are similar to options on underlying instruments
except that options on futures give the purchaser the right, in return for the
premium paid, to assume a position in a futures contract (a long position if
the option is a call and a short position if the option is a put), rather than
to purchase or sell the futures contract, at a specified exercise price at any
time during the period of the option. Upon exercise of the option, the
delivery of the futures position by the writer of the option to the holder of
the option will be accompanied by 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. Alternatively, settlement may be made totally in
cash. Purchasers of options who fail to exercise their options prior to the
exercise date suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put options on
interest rate futures, the Fund may write or purchase call and put options on
financial indices. Such options would be used in a manner similar to the use
of options on futures contracts. From time to time, a single order to
purchase or sell futures contracts (or options thereon) may be made on behalf
of the Fund and other T. Rowe Price Funds. Such aggregated orders would be
allocated among the Fund and the other T. Rowe Price Funds in a fair and non-
discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The Fund may seek to close out an option position by writing or
buying an offsetting option covering the same index, underlying instruments or
contract and having the same exercise price and expiration date. The ability
to establish and close out positions on such options will be subject to the
maintenance of a liquid secondary market. Reasons for the absence of a liquid
secondary market on an exchange include the following: (i) there may be
insufficient trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing transactions or
both; (iii) trading halts, suspensions or other restrictions may be imposed
with respect to particular classes or series of options, or underlying
instruments; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or a clearing
<PAGE>21
corporation may not at all times be adequate to handle current trading volume;
or (vi) one or more exchanges could, for economic or other reasons, decide or
be compelled at some future date to discontinue the trading of options (or a
particular class or series of options), in which event the secondary market on
that exchange (or in the class or series of options) would cease to exist,
although outstanding options on the exchange that had been issued by a
clearing corporation as a result of trades on that exchange would continue to
be exercisable in accordance with their terms. There is no assurance that
higher than anticipated trading activity or other unforeseen events might not,
at times, render certain of the facilities of any of the clearing corporations
inadequate, and thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of customers' orders.
Lending of Portfolio Securities
For the purpose of realizing additional income, the Fund may make
secured loans of portfolio securities amounting to not more than 30% of its
total assets. This policy is a fundamental policy. Securities loans are made
to broker-dealers, 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 on five business days' notice or, in connection
with securities trading on foreign markets, within such longer period of time
which coincides with the normal settlement period for purchases and sales of
such securities in such foreign markets. The Fund will not have the right to
vote 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.
InterFund Borrowing and Lending
Subject to approval by the Securities and Exchange Commission, the
Fund may make loans to, or borrow funds from, other mutual funds sponsored or
advised by T. Rowe Price or Rowe Price-Fleming International, Inc.
(collectively, "Price Funds"). The Fund has no current intention of engaging
in these practices at this time.
Foreign Futures and Options
Participation in foreign futures and foreign options transactions
involves the execution and clearing of trades on or subject to the rules of a
foreign board of trade. Neither the National Futures Association nor any
domestic exchange regulates activities of any foreign boards of trade,
including the execution, delivery and clearing of transactions, or has the
power to compel enforcement of the rules of a foreign board of trade or any
applicable foreign law. This is true even if the exchange is formally linked
to a domestic market so that a position taken on the market may be liquidated
by a transaction on another market. Moreover, such laws or regulations will
vary depending on the foreign country in which the foreign futures or foreign
<PAGE>22
options transaction occurs. For these reasons, customers who trade foreign
futures or foreign options contracts may not be afforded certain of the
protective measures provided by the Commodity Exchange Act, the CFTC's
regulations and the rules of the National Futures Association and any domestic
exchange, including the right to use reparations proceedings before the
Commission and arbitration proceedings provided by the National Futures
Association or any domestic futures exchange. In particular, funds received
from customers for foreign futures or foreign options transactions may not be
provided the same protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any foreign
futures or foreign options contract and, therefore, the potential profit and
loss thereon may be affected by any variance in the foreign exchange rate
between the time your order is placed and the time it is liquidated, offset or
exercised.
Writing Covered Call Options
The Fund may write (sell) "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 will write only covered call options. This means that
the Fund will 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, or will
establish and maintain with its custodian for the term of the option, an
account consisting of cash, U.S. government securities or other liquid high-
grade debt obligations having a value equal to the fluctuating market value of
the optioned securities or currencies. In order to comply with the
requirements of several states, the Fund will not write a covered call option
if, as a result, the aggregate market value of all portfolio securities or
currencies covering call or put options exceeds 25% of the market value of the
Fund's net assets. Should these state laws change or should the Fund obtain a
waiver of their application, the Fund reserves the right to increase this
percentage. 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.
<PAGE>23
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 will not do), but capable of enhancing the Fund's total return. When
writing a covered call option, the 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.
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 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 a favorable price. 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
<PAGE>24
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.
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 of 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 or other liquid high-grade debt obligations 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 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. In order to comply with the requirements
of several states, the Fund will not write a covered put option if, as a
<PAGE>25
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. Should these state laws change or should the Fund obtain a waiver of
their application, the Fund reserves the right to increase this percentage.
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 below.
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.
To the extent required by the laws of certain states, the Fund may
not be permitted to commit more than 5% of its assets to premiums when
purchasing put and call options. Should these state laws change or should the
Fund obtain a waiver of their application, the Fund may commit more than 5% of
its assets to premiums when purchasing call and put 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>26
Purchasing Call Options
The Fund may purchase American or European 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 below.
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.
To the extent required by the laws of certain states, the Fund may
not be permitted to commit more than 5% of its assets to premiums when
purchasing call and put options. Should these state laws change or should the
Fund obtain a waiver of their application, the Fund may 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 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
<PAGE>27
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) 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 the 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 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. Accordingly, the Fund will treat dealer options as subject to the
Fund's limitation on unmarketable securities. If the SEC changes its position
on the liquidity of dealer options, the Fund will change its treatment of such
instrument accordingly.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in financial
futures or options transactions other than those described above, it reserves
the right to do so. Such futures or 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
The Fund may enter into certain option, futures, and forward
foreign exchange contracts, including options and futures on currencies, which
will be treated as Section 1256 contracts or straddles.
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. Such gains
or losses 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 regardless of the holding period of the instrument. 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. For securities offsetting a purchased
put, this adjustment of the holding period may increase the gain from sales of
securities held less than three months. 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.
<PAGE>28
Losses on written covered calls and purchased puts on securities,
excluding certain "qualified covered call" options on equity securities, may
be long-term capital loss, if the security covering the option was held for
more than twelve 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. Pending tax regulations could limit 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. In
addition, gains realized on the sale or other disposition of securities,
including option, futures or foreign forward exchange contracts on securities
or securities indexes and, in some cases, currencies, held for less than three
months, must be limited to less than 30% of the Fund's annual gross income.
In order to avoid realizing excessive gains on securities or currencies held
less than three months, the Fund may be required to defer the closing out of
option, futures or foreign forward exchange contracts beyond the time when it
would otherwise be advantageous to do so. It is anticipated that unrealized
gains on Section 1256 option, futures and foreign forward exchange contracts,
which have been open for less than three months as of the end of the Fund's
fiscal year and which are recognized for tax purposes, will not be considered
gains on securities or currencies held less than three months for purposes of
the 30% test.
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 the Fund's outstanding shares. Other
restrictions in the form of operating policies, are subject to change by the
Fund's Board of Directors without shareholder approval. Any investment
restriction which involves a maximum percentage of securities or assets shall
not be considered to be violated unless an excess over the percentage occurs
immediately after, and is caused by, an acquisition of securities or assets
of, or borrowings by, the Fund.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money, except the Fund may borrow from banks
or other Price Funds, as a temporary measure for extraordinary or
emergency purposes, and then only in amounts not exceeding 30% of
its total assets valued at market. The Fund will not borrow in
order to increase income (leveraging), but only to facilitate
redemption requests which might otherwise require untimely
disposition of portfolio securities. Interest paid on any such
borrowings will reduce net investment income. The Fund may enter
into interest rate futures contracts as set forth in (3) below;
(2) Commodities. Purchase or sell commodities or commodity
contracts; except that it may (i) enter into financial futures
contracts and options on financial futures contracts; (ii) invest
in or commit its assets to forward foreign currency exchange
<PAGE>29
contracts (although the Fund does not consider such contracts to
be commodities); and (iii) purchase or sell financial instruments
which have the characteristics of both futures contracts and
securities;
(3) Futures Contracts. Enter into a futures contract or options
thereon, although the Fund may enter into financial and currency
futures contracts or options on financial and currency futures
contracts;
(4) Industry Concentration. Purchase a security if, as a result, 25%
or more of the value of the Fund's total assets would be invested
in the securities of issuers having their principal activities in
the same industry; provided, however, that the Fund will invest
25% or more of its assets, but not more than 50%, in any one of
the gas utility, gas transmission utility, electric utility,
telephone utility, and petroleum industries under certain
circumstances (see page 16), but this limitation does not apply
to bank certificates of deposit;
(5) Loans. Make loans, although the Fund may (i) purchase money
market securities and enter into repurchase agreements; (ii)
acquire publicly-distributed bonds, debentures, notes and other
debt securities and purchase debt securities at private
placement; (iii) lend portfolio securities; and (iv) 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 30% of the value of the Fund's total
assets;
(6) 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 and then such mortgaging, pledging or
hypothecating may not exceed 30% of the Fund's total assets
valued at market at the time of the borrowing;
(7) Percent Limit on Assets Invested in Any One Issuer. Purchase a
security if, as a result, with respect to 75% of the value of the
Fund's total assets, more than 5% of the value of the Fund's
total assets would be invested in the securities of a single
issuer other than obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities;
(8) Percent Limit on Share Ownership of Any One Issuer. 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;
(9) Real Estate. Purchase or sell real estate or real estate limited
partnerships (although it may purchase money market securities
secured by real estate or interests therein, or issued by
companies which invest in real estate or interests therein);
(10) Senior Securities. Issue any class of securities senior to any
other class of securities;
<PAGE>30
(11) Short Sales and Purchases on Margin. Purchase securities on
margin or effect short sales of securities, but the Fund may make
margin deposits in connection with interest rate futures
transactions subject to (3) above; and
(12) Underwriting. Act as an underwriter of securities, except insofar
as it might be deemed to be such for purposes of the Securities
Act of 1933 upon the disposition of certain portfolio securities
acquired within the limitations of restriction (2) below.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Control of Portfolio Companies. Invest in companies for the
purpose of exercising management or control;
(2) Illiquid Securities. Purchase a security if, as a result, more
than 10% of its net assets would be invested in illiquid
securities, including repurchase agreements which do not provide
for payment within seven days.
(3) Investment Companies. Purchase securities of open-end or closed-
end investment companies except in compliance with the Investment
Company Act of 1940 and any applicable state law. Duplicate fees
may result from such purchases;
(4) Oil and Gas Programs. Purchase participations or other direct
interests or enter into leases with respect to, oil, gas, other
mineral exploration, or development programs;
(5) Options, Etc. Purchase and sell call and put options except as
set forth in its prospectus and Statement of Additional
Information;
(6) Ownership of Portfolio Securities by Officers and Directors.
Purchase or retain the securities of any issuer if, to the
knowledge of the Fund's management, those officers and directors
of the Fund, and of its investment manager, who each owns
beneficially more than .5% of the outstanding securities of such
issuer, together own beneficially more than 5% of such
securities; and
(7) Unseasoned Issuers. Purchase a security other than obligations
issued or guaranteed by the U.S. government, its agencies or
instrumentalities if, as a result, more than 5% of the value of
the Fund's total assets would be invested in the securities of
issuers which at the time of purchase had been in operation for
less than three (3) years (for this purpose, the period of
operation of any issuer shall include the period of operation of
any predecessor or unconditional guarantor of such issuer).
Under the 1940 Act, the Fund may not invest in any securities of any
issuer which, in its most recent fiscal year, derived more than 15% of its
gross revenues from "securities related activities," as defined by rules of
the 1940 Act, unless certain conditions are met. As a result of these
restrictions, the Fund may not invest in the securities of certain banks,
broker-dealers and other companies in foreign countries. If the Fund finds
that this restriction prevents it from pursuing its investment objective, it
may apply to the Securities and Exchange Commission for an order which would
<PAGE>31
permit it to acquire such securities, but no assurance can be given that any
such order will be granted. It is also possible the law in this area will
change, in which case the Fund could have greater flexibility in the purchase
of the securities of foreign banks, broker-dealers, and other companies.
RISK FACTORS
Because of its investment policy, the Fund may or may not be suitable or
appropriate for all investors. The Fund is not a money market fund and is not
an appropriate investment for those whose primary objective is principal
stability. There is risk in all investment. The Fund is designed for the
investor who seeks the highest level of income over the long-term consistent
with preservation of principal by investing primarily in marketable debt
securities. The value of the portfolio securities of the Fund will fluctuate
based upon market conditions. Although the Fund seeks to reduce risk by
investing in a diversified portfolio, such diversification does not eliminate
all risk. There can, of course, be no assurance that the Fund will achieve
these results. Reference is also made to the sections entitled "Repurchase
Agreements," "Foreign Securities," "Foreign Currency Transactions," "Illiquid
Securities," "Warrants," "Industry Concentration," "When-Issued Securities,"
"Futures Contracts," "Covered Call and Put Options," and "Lending of
Portfolio Securities," for discussions of the risks associated with these
investments or investment practices.
Yields on short, intermediate and long-term securities are dependent on
a variety of factors, including the general conditions of the money and bond
markets, the size of a particular offering, the maturity of the obligation,
and the rating of the issue. Debt 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 debt 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 the
Fund to achieve its investment objective is also dependent on the continuing
ability of the issuers of the debt securities in which the Fund invests to
meet their obligations for the payment of interest and principal when due.
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.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for securities or assets
other than cash will be limited to (1) bona fide reorganizations; (2)
statutory mergers; or (3) other acquisitions of portfolio securities that: (a)
meet the investment objective and policies of the Funds; (b) are acquired for
investment and not for resale except in accordance with applicable law; (c)
have a value that is readily ascertainable via listing on or trading in a
recognized United States or international exchange or market; and (d) are not
illiquid.
<PAGE>32
MANAGEMENT OF FUND
The officers and directors 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 who
are considered "interested persons" of T. Rowe Price or the Fund as defined
under Section 2(a)(19) of the Investment Company Act of 1940 are noted with an
asterisk (*). These directors are referred to as inside directors by virtue
of their officership, directorship and/or employment with T. Rowe Price.
ROBERT P. BLACK, Director--Retired; formerly President, Federal Reserve Bank
of Richmond; Address: 10 Dahlgren Road, Richmond, Virginia 23233
CALVIN W. BURNETT, PH.D., Director--President, Coppin State College; Director,
Maryland Chamber of Commerce and Provident Bank of Maryland; President,
Baltimore Area Council Boy Scouts of America; Vice President, Board of
Directors, The Walters Art Gallery; Address: 2000 North Warwick Avenue,
Baltimore, Maryland 21216
*GEORGE J. COLLINS, Chairman of the Board--President, Managing Director, and
Chief Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
ANTHONY W. DEERING, Director--Director, Executive Vice President and Chief
Financial 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
*CARTER O. HOFFMAN, Vice President and Director--Managing Director, T. Rowe
Price; Chartered Investment Counselor
F. PIERCE LINAWEAVER, Director--President, F. Pierce Linaweaver & Associates,
Inc.; formerly (1987-1991) Executive Vice President, EA Engineering,
Science, and Technology, Inc., and (1987-1990) President, EA
Engineering, Inc., Baltimore, Maryland; Address: The Legg Mason Tower,
111 South Calvert Street, Suite 2700, Baltimore, Maryland 21202
*JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe
Price; Chairman of the Board, T. Rowe Price Services, Inc., T. Rowe
Price Retirement Plan Services, Inc., and T. Rowe Price Trust Company;
President and Director, T. Rowe Price Investment Services, Inc;
Director, Rhone-Poulenc Rorer, Inc.
JOHN SAGAN, Director--President, John Sagan Associates; Director, Discount
Corporation of New York (D.C.N.Y.), New York, New York, Chartwell
Reinsurance Co., Stamford, Connecticut, and Teledent, Inc., Minneapolis,
Minnesota, LEMNA Corp., St. Paul, Minnesota; Address: 22149 Long
Boulevard, Dearborn, Michigan 48124
JOHN G. SCHREIBER, Director--President, Schreiber Investments, a real estate
investment company; Director and formerly (1/80-12/90) Executive Vice
President, JMB Realty Corporation, a national real estate investment
manager and developer; Address: 1115 East Illinois Road, Lake Forest,
Illinois 60045
*CHARLES P. SMITH, President and Director--Managing Director, T. Rowe Price;
Vice President, Rowe Price-Fleming International, Inc.
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price and Rowe
Price Fleming International, Inc.; formerly (4/80-5/90) Vice President
and Director, Private Finance, New York Life Insurance Company, New
York, New York
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe Price; Vice
President and Director, T. Rowe Price Investment Services, Inc., T. Rowe
Price Services, Inc., and T. Rowe Price Trust Company; Vice President,
Rowe Price-Fleming International, Inc. and T. Rowe Price Retirement Plan
Services, Inc.
<PAGE>33
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price and T. Rowe
Price Trust Company; formerly (1972-1989) charter member of the U.S.
Senior Executive Service and Director, Analysis and Evaluation Division
in the Office of Water Regulations and Standards of the U.S.
Environmental Protection Agency
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
CHARLES H. SALISBURY, JR., Vice President--Managing Director, T. Rowe Price;
Vice President and Director, Rowe Price-Fleming International, Inc.;
President, Trust Officer and Director, T. Rowe Price Trust Company;
Director, T. Rowe Price Retirement Plan Services, Inc.; Chartered
Investment Counselor
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price; Vice
President, Rowe Price-Fleming International, Inc. and T. Rowe Price
Trust Company
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T. Rowe Price
Services, Inc. and T. Rowe Price Trust Company
ROGER L. FIERY, Assistant Vice President--Vice President, Rowe Price-Fleming
International, Inc.
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President, T. Rowe Price
Services, Inc.
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T. Rowe Price
The Fund's Executive Committee, comprised of Messrs. Collins, Hoffman,
Riepe, and Smith, has been authorized by its Board of Directors to exercise
all powers of the Board to manage the Fund 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 of the
Fund, as a group, owned less than 1% of the outstanding shares of the Fund.
As of March 31, 1993, the following shareholders beneficially owned
more than 5% of the outstanding shares of the Fund: Yachtcrew & Co., Attn.:
Mark White, Spectrum Income Account, State Street Bank and Trust Co., 1776
Heritage Drive - 4W, North Quincy, Massachusetts 02171-2101.
<PAGE>34
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 objective, program, and restrictions as provided in its
prospectus and this Statement of Additional Information. T. Rowe Price is
also responsible for effecting all security transactions on behalf of the
Fund, including the allocation of principal business and portfolio brokerage
and the negotiation of commissions. In addition to these services, T. Rowe
Price provides the Fund with certain corporate administrative services,
including: maintaining the Fund's corporate existence, corporate records, and
registering and qualifying Fund shares under federal and state 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, and committee members of the Fund without cost to the
Fund.
The Management Agreement also provides that T. Rowe Price, its
directors, 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
below.
The monthly Group Fee ("Monthly Group Fee") is the sum of the daily
Group Fee accruals ("Daily Group Fee Accruals") for each month. The Daily
Group Fee Accrual for any particular day is computed by multiplying the Price
Funds' group fee accrual as determined below ("Daily Price Funds' Group Fee
Accrual") by the ratio of the 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:
<PAGE>35
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
_____________________________
0.480% First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Thereafter
For the purpose of calculating the Group Fee, the Price Funds include
all the mutual funds distributed by T. Rowe Price Investment Services, Inc.
(excluding T. Rowe Price Spectrum Fund, Inc. and any institutional or private
label mutual funds). For the purpose of calculating the Daily Price Funds'
Group Fee Accrual for any particular day, the net assets of each Price Fund
are determined in accordance with the Fund's prospectus as of the close of
business on the previous business day on which the Fund was open for business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the daily Fund
Fee accruals ("Daily Fund Fee Accruals") for each month. The Daily Fund Fee
Accrual for any particular day is computed by multiplying the fraction of one
(1) over the number of calendar days in the year by the individual Fund Fee
Rate of .15% 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 management fees paid by the Fund for the fiscal years ended February
28, 1993, February 29, 1992, and February 28, 1991, were $7,113,069,
$6,348,233, and $5,282,864, respectively.
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. However, in compliance with certain state
regulations, T. Rowe Price will reimburse the Fund for any expenses (excluding
interest, taxes, brokerage, other expenditures which are capitalized in
accordance with generally accepted accounting principles, and extraordinary
expenses) which in any year exceed the limits prescribed by any state in which
the Fund's shares are qualified for sale. Presently, the most restrictive
expense ratio limitation imposed by any state is 2.5% of the first $30 million
of the Fund's average daily net assets, 2% of the next $70 million of such
assets, and 1.5% of net assets in excess of $100 million. For the purpose of
determining whether the Fund is entitled to reimbursement, the expenses of the
Fund are calculated on a monthly basis. If the Fund is entitled to
reimbursement, that month's management fee will be reduced or postponed, with
any adjustment made after the end of the year.
<PAGE>36
T. Rowe Price Spectrum Fund, Inc.
The Fund is a party to a Special Servicing Agreement ("Agreement")
between and among T. Rowe Price Spectrum Fund, Inc. ("Spectrum Fund"), T. Rowe
Price, T. Rowe Price Services, Inc. and various other T. Rowe Price funds
which, along with the Fund, are funds in which Spectrum Fund invests
(collectively all such funds "Underlying Price Funds").
The Agreement provides that, if the Board of Directors/Trustees of any
Underlying Price Fund determines that such Underlying Fund's share of the
aggregate expenses of Spectrum Fund is less than the estimated savings to the
Underlying Price Fund from the operation of Spectrum Fund, the Underlying
Price Fund will bear those expenses in proportion to the average daily value
of its shares owned by Spectrum Fund, provided further that no Underlying
Price Fund will bear such expenses in excess of the estimated savings to it.
Such savings are expected to result primarily from the elimination of numerous
separate shareholder accounts which are or would have been invested directly
in the Underlying Price Funds and the resulting reduction in shareholder
servicing costs. Although such cost savings are not certain, the estimated
savings to the Underlying Price Funds generated by the operation of Spectrum
Fund are expected to be sufficient to offset most, if not all, of the expenses
incurred by Spectrum Fund.
DISTRIBUTOR FOR FUND
T. Rowe Price Investment Services, Inc. ("Investment Services"), a
Maryland corporation formed in 1980 as a wholly-owned subsidiary of T. Rowe
Price, serves as the 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: registering and
qualifying its shares under the various state "blue sky" laws; preparing,
setting in type, printing, and mailing its prospectuses and reports to
shareholders; and issuing its shares, including expenses of confirming
purchase orders.
The Underwriting Agreement provides that Investment Services will pay
all fees and expenses in connection with: printing and distributing
prospectuses and reports for use in offering and selling Fund shares;
preparing, setting in type, printing, and mailing all sales literature and
advertising; Investment Services' federal and state registrations as a
broker-dealer; and offering and selling Fund shares, except for those fees and
expenses specifically assumed by the 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 its shares in all states in which the shares are qualified and 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>37
CUSTODIAN
State Street Bank and Trust Company (the "Bank") is the custodian for
the Fund'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 Bank Entry System, for the security depository system of the
Depository Trust Corporation. The Bank and Fund have entered into a Sub-
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 and affiliates of The
Chase Manhattan Bank and such other custodians including foreign banks and
foreign securities depositories, in accordance with regulations under the
Investment Company Act of 1940. The Bank's main office is at 225 Franklin
Street, Boston, Massachusetts 02110. the address for The Chase Manhattan
Bank, N.A., London is Woolgate House, Coleman Street, London, EC2P 2HD,
England.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T. Rowe Price is
also responsible for implementing these decisions, including the negotiation
of commissions and the allocation of portfolio brokerage and principal
business. The Fund's purchases and sales of portfolio securities are normally
done on a principal basis and do not involve the payment of a commission
although they may involve the disignation of selling concessions. That part
of the discussion below relating solely to brokerage commissions would not
normally apply to the Fund. However, it is included because T. Rowe Price
does manage a significant number of common stock protfolios which do engage in
agency transactions and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the Fund.
How Brokers and Dealers are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the issuer or a
primary market-maker acting as principal for the securities on a net basis,
with no brokerage commission being paid by the client, although the price
usually includes an undisclosed compensation. Transactions placed through
dealers serving as primary market-makers reflect the spread between the bid
and asked prices. Securities may also be purchased from underwriters at
prices which include underwriting fees.
T. Rowe Price may effect principal transactions on behalf of the Fund
with a broker or dealer who furnishes brokerage and/or research services,
designate any such broker or dealer to receive selling concessions, discounts
or other allowances, or otherwise deal with any such broker or dealer in
connection with the acquisition of securities in underwritings. The Fund may
receive brokerage and research services in connection with such designations
in fixed priced underwritings.
<PAGE>38
In purchasing and selling the Fund's portfolio 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 (in which the Fund does not generally engage), at competitive
commission rates. However, under certain conditions, the Fund may pay higher
brokerage commissions in return for brokerage and research services. 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, 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.
How Evaluations are Made of the Overall Reasonableness of Brokerage
Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what levels of
commission rates are reasonable in the marketplace for transactions executed
on behalf of the Fund. In evaluating the reasonableness of commission rates,
T. Rowe Price considers: (a) historical commission rates, both before and
since rates have been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c) rates quoted
by brokers and dealers; (d) the size of a particular transaction, in terms of
the number of shares, dollar amount, and number of clients involved; (e) the
complexity of a particular transaction in terms of both execution and
settlement; (f) the level and type of business done with a particular firm
over a period of time; and (g) the extent to which the broker or dealer has
capital at risk in the transaction.
Description of Research Services Received from Brokers and Dealers
T. Rowe Price receives a wide range of research services from brokers
and dealers. These services include information on the economy, industries,
groups of securities, individual companies, statistical information,
accounting and tax law interpretations, political developments, legal
developments affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement analysis,
performance analysis and analysis of corporate responsibility issues. These
services provide both domestic and international perspective. Research
services are received primarily in the form of written reports, computer
generated services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form of meetings
arranged with corporate and industry spokespersons, economists, academicians
and government representatives. In some cases, research services are
generated by third parties but are provided to T. Rowe Price by or through
broker-dealers.
Research services received from brokers and dealers are supplemental to
T. Rowe Price's own research effort and, when utilized, are subject to
internal analysis before being incorporated by T. Rowe Price into its
investment process. As a practical matter, it would not be possible for T.
Rowe Price to generate all of the information presently provided by brokers
and dealers. T. Rowe Price pays cash for certain research services received
from external sources. T. Rowe Price also allocates brokerage for research
services which are available for cash. While receipt of research services
<PAGE>39
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
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
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.
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 or selling concessions 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 and dealers, and attempts to allocate a
portion of its brokerage and selling concession 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 and dealers and make judgments as to the
level of business which would recognize such services. In addition, brokers
and dealers sometimes suggest a level of business they would like to receive
in return for the various brokerage and research services they provide.
Actual business 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.
<PAGE>40
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
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 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 T. Rowe Price Investment
Services, Inc., the Fund's distributor. At the present time, T. Rowe Price
does not recapture commissions or underwriting discounts or selling group
concessions in connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate elimination of
all or a portion of the selling-group concession or underwriting discount when
purchasing tax-exempt municipal securities on behalf of its clients in
underwritten offerings.
<PAGE>41
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 T. Rowe Price may place orders for the Fund's portfolio transactions with
broker-dealers through the same trading desk T. Rowe Price uses for portfolio
transactions in domestic securities. The trading desk accesses brokers and
dealers in various markets in which the Fund's foreign securities are located.
These brokers and dealers may include of certain affiliates of Robert Fleming
Holdings Limited ("Robert Fleming Holdings") and Jardine Fleming Group Limited
("JFG"), persons indirectly related to T. Rowe Price. Robert Fleming
Holdings, through Copthall Overseas Limited, a wholly-owned subsidiary, owns
25% of the common stock of Rowe Price-Fleming International, Inc. ("RPFI"), an
investment adviser registered under the Investment Advisers Act of 1940.
Fifty percent of the common stock of RPFI is owned by TRP Finance, Inc., a
wholly-owned subsidiary of T. Rowe Price, and the remaining 25% is owned by
Jardine Fleming International Holdings Limited, a subsidiary of JFG. JFG is
50% owned by Robert Fleming Holdings and 50% owned by Jardine Matheson
Holdings Limited. Orders for the Fund's portfolio transactions placed with
affiliates of Robert Fleming Holdings and JFG will result in commissions being
received by such affiliates.
The Board of Directors 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. These
affiliates include, but are not limited to, Jardine Fleming (Securities)
Limited ("JFS"), a wholly-owned subsidiary of JFG, Robert Fleming & Co.
Limited ("RF&Co."), Jardine Fleming Australia Securities Limited, and Robert
Fleming, Inc. (a New York brokerage firm). Other affiliates of Robert Fleming
Holdings 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
Investment Company Act of 1940, the Board of Directors of the Fund has agreed
that the procedures set forth in Rule 17(e)(1) under that Act will be followed
when using such brokers.
Other
For the fiscal years ended February 28, 1993, February 29, 1992, and
February 28, 1991, the Fund engaged in portfolio transactions involving
broker-dealers totaling $15,193,998,688, $6,648,064,026, and $5,750,325,831,
respectively. For the fiscal years ended February 28, 1993, February 29,
1992, and February 28, 1991, $15,189,018,688, $6,518,595,405, and
$5,704,403,396, respectively, consisted of principal transactions as to which
the Fund has no knowledge of the profits or losses realized by the respective
broker-dealers; and $4,980,000, $129,468,621 and $45,922,435, respectively,
involved trades with brokers acting as agents or underwriters, in which such
brokers received total commissions, including discounts received in connection
with underwritings, of $20,000, $401,635, and $197,480, respectively. Of all
such portfolio transactions, approximately 61%, 87%, and 39%, respectively,
were placed with firms which provided research, statistical, or other services
to T. Rowe Price in connection with the management of the Fund.
The portfolio turnover rate of the Fund for the fiscal years ended
February 28, 1993, February 29, 1992, and February 28, 1991, was 85.8%, 49.7%,
and 20.7%, respectively.
<PAGE>42
PRICING OF SECURITIES
Fixed income securities are generally traded in the over-the-counter
market. Investments in domestic securities with remaining maturities of one
year or more and foreign 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. Domestic securities with
remaining maturities less than one year are stated at fair value which is
determined by using a matrix system that establishes a value for each security
based on money market yields.
There are a number of pricing services available, and the Board of
Directors, on the basis of ongoing evaluation of these services, may use or
may discontinue the use of any pricing service in whole or in part.
For the purposes of determining the Fund's net asset value per share,
all assets and liabilities initially expressed in foreign currencies are
converted into U.S. dollars at the mean of the bid and offer prices of such
currencies against U.S. dollars quoted by any 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 officers of
the Fund, as authorized by the Board of Directors.
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 calculated as of
the close of trading on the New York Stock Exchange ("NYSE") every day the
NYSE is open for trading. The NYSE is closed on the following days: New
Year's Day, Washington's Birthday, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering, sale, redemption and
repurchase of shares) for 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 Securities and Exchange Commission (or
any succeeding governmental authority) shall given as to whether the
conditions prescribed in (b), (c), or (d) exist.
<PAGE>43
DIVIDENDS
Unless you elect otherwise, the Fund's annual capital gain
distributions, if any, will be reinvested on the reinvestment date using the
NAV per share of that date. The reinvestment date normally precedes the
payment date by about 10 days although the exact timing is subject to
change.
TAX STATUS
The Fund intends to qualify as a "regulated investment company" under
Subchapter M of the Internal Revenue Code of 1986, as amended ("Code").
Dividends and distributions paid by the Fund are not eligible for the
dividends-received deduction for corporate shareholders. For tax purposes,
it does not make any difference whether dividends and capital gain
distributions are paid in cash or in additional shares. The Fund must declare
dividends 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 100% of ordinary income 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 either dividends
or capital gain distributions. For federal 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. On May 31, 1993,
the books of the Fund indicated that the Fund's aggregate net assets included
realized capital losses of $207,461 and unrealized appreciation of
$71,315,746.
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 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).
To the extent the Fund invests in foreign securities, the following
would apply:
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 dividend paid by the Fund will be increased; if
the result is a loss, the income dividend paid by the Fund will be decreased.
Adjustments to reflect these gains and losses will be made at the end of the
Fund's taxable year.
<PAGE>44
YIELD INFORMATION
From time to time, the Fund may advertise a yield figure calculated in
the following manner:
An income factor is calculated for each security in the portfolio based
upon the security's market value at the beginning of the period and yield as
determined in conformity with regulations of the Securities and Exchange
Commission. The income factors are then totalled for all securities in the
portfolio. Next, expenses of 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. 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 the Fund calculated under the above-described method for
the month ended May 31, 1993 was 4.96%.
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 gains 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.
Cumulative Performance Percentage Change
Since
1 Year 5 Years 10 Years Inception
Ended Ended Ended 8/31/73 -
2/28/93+ 2/28/93 2/28/93 2/28/93++
________ _______ ________ __________
New Income Fund 10.12% 58.81% 168.20% 483.30%
Salomon Bros. Broad Investment
Grade Index 12.35 66.50 205.73 N/A
Salomon Bros. High Grade
Corporate Bond Index 15.91 77.65 254.17 560.67
Lehman Bros. Govt./Corp.
Bond Index 13.29 65.74 200.45 537.70
<PAGE>45
Average Annual Compound Rates of Return
Since
1 Year 5 Years 10 Years Inception
Ended Ended Ended 8/31/73 -
2/28/93+ 2/28/93 2/28/93 2/28/93++
________ _______ ________ __________
New Income Fund 10.12% 9.69% 10.37% 9.46%
Salomon Bros. Broad
Investment Grade Index 12.35 10.73 11.82 N/A
Salomon Bros. High Grade
Corporate Bond Index 15.91 12.18 13.48 10.16
Lehman Bros. Govt./Corp.
Bond Index 13.29 10.63 11.63 9.96
+If you invested $1,000 on 2/29/92, the total return on 2/28/93 would be
$101.20 ($1,000 X .1012).
++Assumes purchase of one share of the New Income Fund at the inception price
of $10.00 on 8/31/73.
From time to time, in reports and promotional literature, one or more of
the T. Rowe Price funds, including this Fund, may compare its performance to
Overnight Government Repurchase Agreements, Treasury bills, notes, and bonds,
certificates of deposit, and six-month money market certificates. Performance
may also be compared to (1) indices of broad groups of managed and unmanaged
securities considered to be representative of or similar to Fund portfolio
holdings, (2) other mutual funds, or (3) other measures of performance set
forth in publications such as:
Advertising News Service, Inc., "Bank Rate Monitor+ - The Weekly
Financial Rate Reporter" is a weekly publication which lists the yields
on various money market instruments offered to the public by 100 leading
banks and thrift institutions in the U.S., including loan rates offered
by these banks. Bank certificates of deposit differ from mutual funds
in several ways: the interest rate established by the sponsoring bank is
fixed for the term of a CD; there are penalties for early withdrawal
from CDs; and the principal on a CD is insured.
Donoghue Organization, Inc., "Donoghue's Money Fund Report" is a weekly
publication which tracks net assets, yield, maturity and portfolio
holdings on approximately 380 money market mutual funds offered in the
U.S. These funds are broken down into various categories such as U.S.
Treasury, Domestic Prime and Euros, Domestic Prime and Euros and
Yankees, and Aggressive.
First Boston High Yield Index shows statistics on the Composite Index
and analytical data on new issues in the marketplace and low-grade
issuers.
Lipper Analytical Services, Inc., "Lipper-Fixed Income Fund Performance
Analysis" is a monthly publication which tracks net assets, total
return, principal return and yield on approximately 950 fixed income
mutual funds offered in the United States.
Merrill Lynch, Pierce, Fenner & Smith, Inc., "Taxable Bond Indices" is a
monthly publication which lists principal, coupon and total return on
over 100 different taxable bond indices tracked by Merrill Lynch,
together with the par weighted characteristics of each Index. The index
<PAGE>46
used as a benchmark for the High Yield Fund is the High Yield Index.
The two indices used as benchmarks for the Short-Term Bond Fund are the
91-Day Treasury Bill Index and the 1-2.99 Year Treasury Note Index.
Morningstar, Inc. is a widely used independent research firm which rates
mutual funds by overall performance, investment objectives, and assets.
Salomon Brothers Inc. "Analytical Record of Yields and Yield Spreads" is
a publication which tracks historical yields and yield spreads on short-
term market rates, public obligations of the U.S. Treasury and agencies
of the U.S. government, public corporate debt obligations, municipal
debt obligations, and preferred stocks.
Salomon Brothers Inc. "Bond Market Round-up" is a weekly publication
which tracks the yields and yield spreads on a large, but select, group
of money market instruments, public corporate debt obligations, and
public obligations of the U.S. Treasury and agencies of the U.S.
Government.
Salomon Brothers Inc. "Market Performance" - is a monthly publication
which tracks principal return, total return and yield on the Salomon
Brothers Broad investment - Grade Bond Index and the components of the
Index.
Shearson Lehman Brothers, Inc. "The Bond Market Report" is a monthly
publication which tracks principal, coupon and total return on the
Shearson Lehman Govt./Corp. Index and Shearson Lehman Aggregate Bond
Index, as well as all the components of these Indices.
Telerate Systems, Inc. is a market data distribution network which
tracks a broad range of financial markets including, the daily rates on
money market instruments, public corporate debt obligations and public
obligations of the U.S. Treasury and agencies of the U.S. Government.
Wall Street Journal is a national daily financial news publication which
lists the yields and current market values on money market instruments,
public corporate debt obligations, public obligations of the U.S.
Treasury and agencies of the U.S. Government as well as common stocks,
preferred stocks, convertible preferred stocks, options and commodities;
in addition to indices prepared by the research departments of such
financial organizations as Shearson Lehman/American Express Inc. and
Merrill Lynch, Pierce, Fenner and Smith, Inc., including information
provided by the Federal Reserve Board.
Performance rankings and ratings reported periodically in national financial
publications such as MONEY, FORBES, BUSINESS WEEK, BARRON'S, etc. will also be
used.
Benefits of Investing in High-Quality Bond Funds
o Higher Income
Bonds have generally provided a higher income than money market securities
because yield usually increased with longer maturities. For instance, the
yield on the 30-year Treasury bond usually exceeds the yield on the 1-year
Treasury bill or 5-year Treasury note. However, securities with longer
maturities fluctuate more in price than those with shorter maturities.
Therefore, the investor must weigh the advantages of higher yields against the
possibility of greater fluctuation in the principal value of your investment.
<PAGE>47
o Income Compounding
Investing in bond mutual funds allows investors to benefit from easy and
convenient compounding, because you can automatically reinvest monthly
dividends in additional fund shares. Each month investors earn interest on a
larger number of shares. Also, reinvesting dividends removes the temptation
to spend the income.
o Broad Diversification
Each share of a mutual fund represents an interest in a large pool of
securities, so even a small investment is broadly diversified by maturity.
Since most bonds trade efficiently only in very large blocks,mutual funds
provide a degree of diversification that may be difficult for individual
investors to achieve on their own.
o Lower Portfolio Volatility
Investing a portion of one's assets in longer term, high-quality bonds can
help smooth out the fluctuations in your overall investment results, because
bond prices do not necessarily move with stock prices. Also, bonds usually
have higher income yields than stocks, thus increasing the total income
component of your portfolio. This strategy should also add stability to
overall results, as income is always a positive component of total return.
o Liquidity
A bond fund can supplement a money market fund or bank account as a source of
capital for unexpected contingencies. T. Rowe Price fixed-income funds offer
you easy access to money through free checkwriting and convenient redemption
or exchange features. Of course, the value of a bond fund's shares redeemed
through checkwriting may be worth more or less than their value at the time of
their original purchase.
o Suitability
High-quality bond funds are most suitable for the following objectives:
obtaining a higher current income with minimal credit risk; compounding of
income over time; or diversifying overall investments to reduce volatility.
IRAs
An IRA is a long-term investment whose objective is to accumulate personal
savings for retirement. Due to the long-term nature of the investment, even
slight differences in performance will result in significantly different
assets at retirement. Mutual funds, with the diversity of choice, can be used
for IRA investments. Generally, individuals may need to adjust their
underlying IRA investments as their time to retirement and tolerance for risk
changes.
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, such as 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 T. Rowe Price
Investment Services, Inc. may be made available. These currently include:
the Asset Mix Worksheet which is designed to show shareholders how to reduce
<PAGE>48
their investment risk by developing a diversified investment plan; the College
Planning Guide which discusses various aspects of financial planning to meet
college expenses and assists parents in projecting the costs of a college
education for their children; and the Retirees Financial Guide which includes
a detailed workbook to determine how much money you can afford to spend and
still preserve your purchasing power and suggests how you might invest to
reach your goal. The Retirement Planning Kit (also available in a PC version)
which includes a detailed workbook to determine how much money you may need
for retirement and suggests how you might invest to reach your goal and the
Retirees Financial Guide which includes a detailed workbook to determine how
much money you can afford to spend and still preserve your purchasing power
and suggests how you might invest to reach your goal. From time to time,
other worksheets and guides may be made available as well. Of course, an
investment in the Fund cannot guarantee that such goals will be met.
To assist investors in understanding the different returns and risk
characteristics of various investments, the aforementioned guides will include
presentation of historical returns of various investments using published
indices. An example of this is shown below.
Historical Returns for Different Investments
______________________________________________
Annualized returns for periods ended 12/31/92
50 years 25 years 10 years 5 years
Small-Company Stocks 16.3% 12.4% 11.6% 13.6%
Large-Company Stocks 12.6 10.6 16.2 15.9
Foreign Stocks N/A N/A 17.1 1.6
Long-Term Corporate Bonds 5.4 8.8 13.1 12.5
Intermediate-Term U.S. Gov't Bonds 5.6 9.0 11.0 10.3
Treasury Bills 4.6 7.2 6.9 6.3
U.S. Inflation 4.3 5.9 3.8 4.2
Sources: Ibbotson Associates. Foreign stocks reflect performance of The
Morgan Stanley Capital International EAFE Index, which includes some 1,000
companies representing the stock markets of Europe, Australia, New Zealand,
and the Far East. This chart is for illustrative purposes only and should not
be considered as performance for any T. Rowe Price Fund. Past performance
does not guarantee future results.
Also included will be various portfolios demonstrating how these historical
indices would have performed in various combinations over a specified time
period in terms of return. An example of this is shown below.
<PAGE>49
Performance Characteristics of Retirement Portfolios*
Asset Mix Annualized Returns Number
20 Years Ending 12/31/92 of Value of
Years $10,000
with Investment
Negative After
Returns Period
_____________________ _______________________ ______ ________
Best Worst
Portfolio Growth Income Safety Average Year Year
_________ ________ ______ ______ _______ _____ _____
I. Low
Risk 15% 35% 50% 9.0% 19.8% -0.2% 1 $ 56,451
II. Moderate
Risk 55% 30% 15% 10.4% 25.7% -7.5% 2 $ 72,918
III. High
Risk 85% 15% 0% 11.2% 34.5% -16.2% 5 $83,382
Source: T. Rowe Price Associates, Inc.; data supplied by Ibbotson Associates.
* Based on actual performance of stocks (Wilshire 5000), Lehman Brothers
Government/Corporate Bond Index, and Treasury bills from January 1973
through December 1992. Past performance does not guarantee future
results. Figures include changes in principal value and reinvested
dividends. This Exhibit is for illustrative purposes only and is not
representative of the performance of any T. Rowe Price Fund.
From time to time, Insights, a T. Rowe Price publication of reports on
specific investment topics and strategies, may be included in the Fund's
fulfillment kit. Such reports may include information concerning:
calculating taxable gains and losses on mutual fund transactions, coping with
stock market volatility, benefiting from dollar cost averaging, understanding
international markets, investing in high-yield "junk" bonds, growth stock
investing, conservative stock investing, value investing, investing in small
companies, tax-free investing, fixed income investing, investing in
mortgage-backed securities, as well as other topics and strategies.
CAPITAL STOCK
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 (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 directors unless and
until such time as less than a majority of the directors holding office have
been elected by shareholders, at which time the directors then in office will
call a shareholders' meeting for the election of directors. Except as set
forth above, the directors shall continue to hold office and may appoint
successor directors. Voting rights are not cumulative, so that the holders of
more than 50% of the shares voting in the election of directors can, if they
choose to do so, elect all the directors of the Fund, in which event the
holders of the remaining shares will be unable to elect any person as a
director. The Fund's Board of Directors may increase or decrease the
aggregate number of shares of stock or the number of shares of stock of any
class or series authorized to be issued without shareholder approval.
<PAGE>50
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
Investment Company Act of 1940.
FEDERAL AND STATE REGISTRATION OF SHARES
The Fund's shares are registered for sale under the Securities Act of
1933, and the Fund or its shares are registered under the laws of all states
which require registration, as well as the District of Columbia and Puerto
Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman & Goodman, whose address is 919 Third
Avenue, New York, New York 10022, is legal counsel to the Fund.
INDEPENDENT ACCOUNTANTS
Price Waterhouse, 7 St. Paul Street, Suite 1700, Baltimore, Maryland
21202, are independent accountants to the Fund. The financial statements of
the Fund for the fiscal year ended February 28, 1993 and the report of
independent accountants are included in the Fund's Annual Report for the
fiscal year ended February 28, 1993 on pages 5 through 15. A copy of the
Annual Report accompanies this Statement of Additional Information. The
following financial statements and the report of independent accountants
appearing in the Annual Report for the fiscal year ended February 28, 1993 are
incorporated into this Statement of Additional Information by reference:
Annual Report
Page
_____________
Report of Independent Accountants 15
Statement of Net Assets, February 28, 1993 5-10
Statement of Operations, year ended
February 28, 1993 11
Statement of Changes in Net Assets, years
ended February 28, 1993 and February 29, 1992 12
Notes to Financial Statements
February 28, 1993 12-14
Per Share and Other Information 14
<PAGE>51
RATINGS OF CORPORATE DEBT SECURITIES
Moody's Investors Service, Inc. Aaa - Best quality. These bonds carry the
smallest degree of investment risk. Interest payments are protected by a
large, or exceptionally stable margin and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of
such issues. Aa - High quality by all standards. Together with the Aaa
group, they comprise what are generally known as high-grade bonds. They are
rated lower than the best quality bonds because margins of protection may not
be as large, fluctuations of protective elements may be of greater amplitude,
or there may be other elements present which make the long-term risks appear
somewhat greater than in Aaa securities. A - Upper-medium-grade obligations.
Factors giving security to principal and interest are considered adequate but
elements may be present which suggest a susceptibility to impairment sometime
in the future. Baa - Medium-grade obligations. 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.
Standard & Poor's Corporation. AAA - Highest grade obligations. They possess
the ultimate degree of protection as to principal and interest. Marketwise,
they move with interest rates, and hence provide the maximum safety on all
counts. AA - High-grade obligations. In the majority of instances, they
differ from AAA issues only in a small degree. Here too prices move with the
long-term money market. A - Upper-medium grade. They have considerable
investment strength, but are not entirely free from adverse effects of changes
in economic and trade conditions. Interest and principal are regarded as
safe. They predominantly reflect money rates in their market behavior but, to
some extent, also economic conditions. BBB - Medium-grade. Borderline
between definitely sound obligations and those where the speculative element
begins to predominate. These bonds have adequate asset coverage and normally
are protected by satisfactory earnings. Their susceptibility to changing
conditions, particularly to depression, necessitates constant watching.
Marketwise, the bonds are more responsive to business and trade conditions
than to interest rates. This group is the lowest which qualifies for
commercial bank investment.
