<PAGE>
PROSPECTUS DATED NOVEMBER 6, 1996
AS SUPPLEMENTED FEBRUARY 18, 1997
GOVERNMENT INCOME FUND
INTERMEDIATE BOND FUND
ADJUSTABLE RATE MORTGAGE SECURITIES FUND
PIPER JAFFRAY TOWER
222 SOUTH NINTH STREET, MINNEAPOLIS, MINNESOTA 55402-3804
(800) 866-7778 (TOLL FREE)
GOVERNMENT INCOME FUND has an investment objective of high current income to
the extent consistent with preservation of capital. The Fund will invest
primarily in securities which are issued or guaranteed as to payment of
principal and interest by the U.S. Government or its agencies or
instrumentalities. The Fund invests a significant portion of its assets in
mortgage-related U.S. Government securities, which may include derivative
mortgage securities.
INTERMEDIATE BOND FUND has an investment objective of a high level of
current income consistent with preservation of capital. The Fund seeks to
achieve its objective by investing primarily in a broad range of investment
quality debt securities.
ADJUSTABLE RATE MORTGAGE SECURITIES FUND has an investment objective of
providing the maximum current income that is consistent with low volatility of
principal. The Fund seeks to achieve its objective by investing primarily in
adjustable rate mortgage securities.
PLEASE REMEMBER, YOU COULD LOSE MONEY WITH THIS INVESTMENT. NEITHER SAFETY
OF PRINCIPAL NOR STABILITY OF INCOME IS GUARANTEED.
INVESTMENTS IN THE FUNDS MAY INVOLVE ADDITIONAL RISKS. EACH FUND MAY INVEST
A SIGNIFICANT PORTION OF ITS ASSETS IN MORTGAGE-RELATED SECURITIES, INCLUDING
DERIVATIVE MORTGAGE SECURITIES. SEE "CHARACTERISTICS AND RISKS OF SECURITIES AND
SPECIAL INVESTMENT METHODS." THE MARKET VALUES OF THE SECURITIES IN WHICH THE
FUNDS INVEST WILL FLUCTUATE WITH CHANGING INTEREST RATES, AS WILL EACH FUND'S
NET ASSET VALUE.
This Prospectus concisely describes the information about the Funds that you
ought to know before investing. Please read it carefully before investing and
retain it for future reference.
A Statement of Additional Information about the Funds dated February 18,
1997 is available free of charge. Write to the Funds at Piper Jaffray Tower, 222
South Ninth Street, Minneapolis, Minnesota 55402-3804 or telephone (800)
866-7778 (toll free). The Statement of Additional Information has been filed
with the Securities and Exchange Commission and is incorporated in its entirety
by reference in this Prospectus.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY
STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<PAGE>
INTRODUCTION
Government Income Fund ("Government Fund") and Intermediate Bond Fund ("Bond
Fund") (formerly Institutional Government Income Portfolio) are series of Piper
Funds Inc. ("Piper Funds"), an open-end management investment company the shares
of which are currently issued in twelve separate series. Adjustable Rate
Mortgage Securities Fund ("ARMS Fund") is the sole outstanding series of another
open-end management investment company, Piper Funds Inc.-II ("Piper Funds II").
Each of Government Fund, Bond Fund and ARMS Fund (sometimes referred to
individually as a "Fund" or collectively as the "Funds") has a different
investment objective, as described on the cover page of this Prospectus, and is
designed to meet different investment needs. The Funds are classified as
diversified mutual funds.
THE INVESTMENT ADVISER
The Funds are managed by Piper Capital Management Incorporated (the
"Adviser"), a wholly owned subsidiary of Piper Jaffray Companies Inc. Each Fund
pays the Adviser a fee for managing its investment portfolio. The fees for
Government Fund, Bond Fund and ARMS Fund are paid at annual rates of .50%, .30%
and .35%, respectively, of average daily net assets and are scaled downward as
assets increase in size above $250 million, $100 million and $500 million,
respectively. See "Management--Investment Adviser."
THE DISTRIBUTOR
Piper Jaffray Inc. ("Piper Jaffray"), a wholly owned subsidiary of Piper
Jaffray Companies Inc. and an affiliate of the Adviser, serves as Distributor of
the Funds' shares.
OFFERING PRICE
Shares of the Funds are offered to the public at the next determined net
asset value after receipt of an order by a shareholder's Piper Jaffray
Investment Executive or other broker-dealer, plus a maximum sales charge of 2%
of the offering price (2.04% of the net asset value) on purchases of less than
$100,000. The sales charge is reduced on a graduated scale on purchases of
$100,000 or more. In connection with purchases of $500,000 or more, there is no
initial sales charge; however, a contingent deferred sales charge of .50% for
Government Fund and .30% for Bond Fund and ARMS Fund will be imposed in the
event of a redemption transaction occurring within 12 months following such a
purchase. See "How to Purchase Shares--Purchase Price" and "How to Redeem
Shares--Contingent Deferred Sales Charge."
The shares of Bond Fund offered through this Prospectus are Class A shares.
All references to Bond Fund's shares, unless otherwise specified, are to shares
of such class. Bond Fund also offers Class Y shares, which have their own
expense structure (including elimination of all sales charges) and are available
only to investors making an initial investment of $1 million or more. To obtain
more information about the Class Y shares of Bond Fund, call the Fund at the
telephone number that appears on the cover of this Prospectus. Government Fund
and ARMS Fund each offer only one class of shares.
MINIMUM INITIAL AND SUBSEQUENT INVESTMENTS
The minimum initial investment for each Fund is $250. There is no minimum
for subsequent investments. The Distributor, in its discretion, may waive the
minimum. See "How to Purchase Shares--Minimum Investments."
EXCHANGES
You may exchange your shares for shares of any other mutual fund managed by
the Adviser which is eligible for sale in your state of residence, provided
that, if you hold your Fund shares through a broker-dealer other than the
Distributor, the exchange privilege may not be available. Exchanges will be
permitted only if there is a valid sales agreement between your broker-dealer
and the Distributor for the fund into which the exchange will be made. All
exchanges are subject to the minimum investment requirements and other
applicable terms set forth in the prospectus of the fund whose shares you
acquire. Exchanges are made
2
<PAGE>
on the basis of the net asset values of the funds involved, except that
investors exchanging into a fund which has a higher sales charge must pay the
difference. However, ARMS Fund shares which were received in the Merger may be
exchanged into shares of a fund with a higher sales charge without payment of an
additional sales charge. You may make four exchanges per year without payment of
a service charge. Thereafter, there is a $5 service charge for each exchange.
See "Shareholder Services--Exchange Privilege."
REDEMPTION PRICE
Shares of the Funds may be redeemed at any time at their net asset value
next determined after a redemption request is received by your Piper Jaffray
Investment Executive or other broker-dealer. A contingent deferred sales charge
will be imposed upon the redemption of certain shares initially purchased
without a sales charge. See "How to Redeem Shares--Contingent Deferred Sales
Charge." Each Fund reserves the right, upon 30 days' written notice, to redeem
an account if the net asset value of the shares falls below $200. See "How to
Redeem Shares--Involuntary Redemption."
CERTAIN RISK FACTORS TO CONSIDER
An investment in any of the Funds is subject to certain risks, as set forth
in detail under "Investment Objectives and Policies" and "Characteristics and
Risks of Securities and Special Investment Methods." As with other mutual funds,
there can be no assurance that any Fund will achieve its objective. Each of the
Funds is subject to interest-rate risk (the risk that rising interest rates will
make bonds issued at lower interest rates worth less). As a result, the value of
each Fund's shares will vary. Each Fund is also subject to credit risk (the risk
that a bond issuer will fail to make timely payments of interest or principal)
to the extent it invests in non-U.S. Government securities. Each of the Funds
may engage in the following investment practices: the use of repurchase
agreements, borrowing from banks and the purchase or sale of securities on a
"when-issued" or forward commitment basis, including the use of mortgage dollar
rolls by Government Fund and Bond Fund. In addition, Government Fund and ARMS
Fund may enter into reverse repurchase agreements, engage in options
transactions on the securities in which they may invest and enter into interest
rate futures contracts and options on futures contracts and ARMS Fund may enter
into interest rate transactions and invest in Eurodollar instruments. All of
these techniques may increase the volatility of a Fund's net asset value.
Government Fund may engage in over-the-counter ("OTC") options transactions. The
staff of the Securities and Exchange Commission has taken the position that
purchased OTC options and the assets used as "cover" for written OTC options are
illiquid securities (with an exception for a certain percentage of such options
in limited circumstances). See "Characteristics and Risks of Securities and
Special Investment Methods--Options Transactions." The Funds may engage in
short-term trading in attempting to achieve their investment objectives, which
will increase transaction costs. The Funds may purchase mortgage-related
securities which, in addition to interest rate risk, are subject to prepayment
risk. The Funds' investments in mortgage-related securities include derivative
mortgage securities. Recent market experience has shown that certain derivative
mortgage securities may be extremely sensitive to changes in interest rates and
in prepayment rates on the underlying mortgage assets and, as a result, the
prices of such securities may be highly volatile. All of these transactions
involve certain special risks, as set forth under "Investment Objectives and
Policies" and "Characteristics and Risks of Securities and Special Investment
Methods."
SHAREHOLDER INQUIRIES
Any questions or communications regarding a shareholder account should be
directed to your Piper Jaffray Investment Executive or, in the case of shares
held through another broker-dealer, to IFTC at (800) 874-6205. General inquiries
regarding the Funds should be directed to the Funds at the telephone number set
forth on the cover page of this Prospectus.
3
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
GOVERNMENT INTERMEDIATE ADJUSTABLE RATE
INCOME BOND MORTGAGE
FUND FUND SECURITIES FUND
---------- ------------------ ------------------
<S> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load Imposed on Purchases
(as a percentage of offering price)...... 2.00% 2.00% 2.00%
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management Fees............................ .50% .25% .35%
Rule 12b-1 Fees (after voluntary limitation
for Government Fund and Bond Fund)*...... .34% .22% .15%
Other Expenses............................. .27% .19% .26%
--- --- ---
Total Fund Operating Expenses (after
voluntary fee limitations for Government
Fund and Bond Fund)...................... 1.11% .66% .76%
</TABLE>
- ------------------------
* See the discussion below for an explanation of voluntary Rule 12b-1 fee
limitations and expense reimbursements.
EXAMPLE
You would pay the following expenses on a $1,000 investment, assuming (1) 5%
annual return and (2) redemption at the end of each time period:
<TABLE>
<CAPTION>
GOVERNMENT INTERMEDIATE ADJUSTABLE RATE
INCOME BOND MORTGAGE
FUND FUND SECURITIES FUND
---------- ------------------ ------------------
<S> <C> <C> <C>
1 Year...................................... $ 31 $ 27 $ 28
3 Years..................................... $ 55 $ 41 $ 44
5 Years..................................... $ 80 $ 56 $ 61
10 Years..................................... $152 $101 $112
</TABLE>
The purpose of the above Fund Expenses table is to assist you in
understanding the various costs and expenses that investors in the Funds will
bear directly or indirectly. THE EXAMPLE CONTAINED IN THE TABLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE
GREATER OR LESS THAN THOSE SHOWN.
The information in the table for Government Fund is based on actual expenses
incurred by the Fund during the fiscal year ended September 30, 1996, except
that Rule 12b-1 fees reflect a voluntary limitation by the Distributor of
amounts payable to it under the Fund's Rule 12b-1 Plan to .34% of average daily
net assets for the fiscal year ending September 30, 1997. Rule 12b-1 fees had
been limited to .32% of average daily net assets for the fiscal year ended
September 30, 1996 resulting in total fund operating expenses of 1.09% of
average daily net assets. Absent such limitation, total fund operating expenses
for Government Fund for the fiscal year ended September 30, 1996 would have been
1.28% of average daily net assets.
The information set forth for Bond Fund is based on actual expenses incurred
by the Fund during the fiscal year ended September 30, 1996, except that Rule
12b-1 fees reflect a voluntary limitation by the Distributor of amounts payable
to it under the Fund's Rule 12b-1 plan to .22% of average daily net assets and
4
<PAGE>
other expenses have been adjusted to reflect the fact that the Fund will not
incur excise taxes in fiscal 1997. During the fiscal year ended September 30,
1996, the Fund paid federal excise taxes in an amount equal to 0.08% of average
daily net assets and the Distributor limited its Rule 12b-1 fees to .20% of the
Fund's average daily net assets, resulting in total fund operating expenses of
0.72% of average daily net assets. Absent the Distributor's limitation of its
Rule 12b-1-fees, Bond Fund's total fund operating expenses for the fiscal year
ended September 30, 1996 would have been 0.82% of average daily net assets.
The information set forth for ARMS Fund is based on total fund operating
expenses for the fiscal year ended August 31, 1996, absent any expense
limitations. The Adviser voluntarily limited total fund operating expenses
during such fiscal year to .60% of average daily net assets, but has
discontinued such limitation.
Voluntary Rule 12b-1 fee limitations for Government Fund and Bond Fund may
be revised or terminated at any time after September 30, 1997. The Adviser may
or may not assume additional expenses of the Funds from time to time, in its
discretion, while retaining the ability to be reimbursed by the Funds for
expenses assumed during a fiscal year prior to the end of such year. The
foregoing policy will have the effect of lowering a Fund's overall expense ratio
and increasing yield to investors when such amounts are assumed or the inverse
when such amounts are reimbursed.
As a result of Government Fund's annual payment of its Rule 12b-1 fee, a
portion of which is considered an asset-based sales charge, long-term
shareholders of Government Fund may pay more than the economic equivalent of the
maximum 6.25% front end sales charge permitted under the rules of the National
Association of Securities Dealers, Inc. For additional information, including a
more complete explanation of management and Rule 12b-1 fees, see
"Management--Investment Adviser" and "Distribution of Fund Shares."
5
<PAGE>
FINANCIAL HIGHLIGHTS
The following financial highlights show certain per share data and selected
information for a share of capital stock outstanding during the indicated
periods for each Fund. This information has been audited by KPMG Peat Marwick
LLP, independent auditors, and should be read in conjunction with the financial
statements of each Fund contained in its annual report. An annual report of each
Fund is available without charge by contacting the Funds at 800-866-7778 (toll
free). In addition to financial statements, such reports contain further
information about the performance of the Funds.
GOVERNMENT INCOME FUND
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30, PERIOD FROM YEAR PERIOD FROM
---------------------------------------------- 11/1/88 TO ENDED 3/16/87(A)
1996 1995 1994 1993 1992 1991 1990 9/30/89 10/31/88 TO 10/31/87
------- ----- ----- ----- ----- ----- ----- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of
period...................... $ 8.99 8.42 10.01 9.86 9.69 9.02 9.18 9.50 9.40 10.00
------- ----- ----- ----- ----- ----- ----- ----- -------- -----------
Operations:
Net investment income....... 0.60 0.60 0.69 0.80 0.90 0.84 0.81 0.76 0.82 0.45
Net realized and unrealized
gains (losses) on
investments............... (0.16) 0.60 (1.58) 0.15 0.17 0.67 (0.16) (0.32) 0.10 (0.60)
------- ----- ----- ----- ----- ----- ----- ----- -------- -----------
Total from operations... 0.44 1.20 (0.89) 0.95 1.07 1.51 0.65 0.44 0.92 (0.15)
------- ----- ----- ----- ----- ----- ----- ----- -------- -----------
Distributions from net
investment income........... (0.60) (0.63) (0.68) (0.80) (0.90) (0.84) (0.81) (0.76) (0.82) (0.45)
Distributions from net
realized
gains....................... -- -- (0.02) -- -- -- -- -- -- --
------- ----- ----- ----- ----- ----- ----- ----- -------- -----------
Total distributions..... (0.60) (0.63) (0.70) (0.80) (0.90) (0.84) (0.81) (0.76) (0.82) (0.45)
------- ----- ----- ----- ----- ----- ----- ----- -------- -----------
Net asset value, end of
period...................... $ 8.83 8.99 8.42 10.01 9.86 9.69 9.02 9.18 9.50 9.40
------- ----- ----- ----- ----- ----- ----- ----- -------- -----------
------- ----- ----- ----- ----- ----- ----- ----- -------- -----------
Total return (c).............. 4.99% 14.87% (9.26%) 10.06% 11.57% 17.51% 7.31% 4.78% 10.18% 1.41%
Net assets, end of period
(in millions)............... $ 84 106 126 160 124 76 73 85 62 75
Ratio of expenses to average
daily net assets (d)........ 1.09% 1.11% 1.05% 1.09% 1.11% 1.18% 1.08% 1.15%(b) 1.23% .70%(b)
Ratio of net investment income
to average daily net
assets (d).................. 6.66% 7.02% 7.43% 8.10% 9.15% 9.00% 8.87% 8.81%(b) 8.68% 8.07%(b)
Portfolio turnover rate
(excluding short-term
securities)................. 32% 87% 121% 191% 118% 110% 202% 149% 217% 281%
</TABLE>
- ------------------------------
(a) Commencement of operations.
(b) Adjusted to an annual basis.
(c) Total return is based on the change in net asset value during the period,
assumes reinvestment of all distributions and does not reflect a sales
charge.
(d) During the periods reflected above, the Distributor voluntarily waived fees.
Had the maximum Rule 12b-1 fee of .50% been in effect, the ratios of
expenses and net investment income to average daily net assets would have
been: 1.28%/6.47% in fiscal 1996, 1.29%/6.84% in fiscal 1995, 1.24%/7.24% in
fiscal 1994, 1.27%/7.92% in fiscal 1993, 1.29%/8.97% in fiscal 1992,
1.36%/8.82% in fiscal 1991, 1.27%/8.68% in fiscal 1990, 1.35%/8.61% in
fiscal 1989, 1.43%/8.48% in fiscal 1988 and 1.48%/7.29% in fiscal 1987.
Beginning in fiscal 1995, the expense ratios reflect the effect of gross
expenses paid indirectly by the Fund. Prior period expense ratios have not
been adjusted.
6
<PAGE>
INTERMEDIATE BOND FUND*
<TABLE>
<CAPTION>
PERIOD FROM
FISCAL YEAR ENDED SEPTEMBER 30, 11/1/88 PERIOD FROM
---------------------------------------------- TO 7/11/88(A)
1996 1995 1994 1993 1992 1991 1990 9/30/89 TO 10/31/88
------- ----- ----- ----- ----- ----- ----- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period.... $ 8.12 7.98 12.22 11.51 10.71 10.02 9.96 10.08 10.00
------- ----- ----- ----- ----- ----- ----- ----------- -----------
Operations:
Net investment income................. 0.53(b) 0.88 0.90 1.29 1.07 0.94 0.91 0.82 0.21
Net realized and unrealized gains
(losses) on investments............. (0.11) 0.31 (3.96) 0.56 0.73 0.67 0.08 (0.12) 0.08
------- ----- ----- ----- ----- ----- ----- ----------- -----------
Total from operations............. 0.42 1.19 (3.06) 1.85 1.80 1.61 0.99 0.70 0.29
------- ----- ----- ----- ----- ----- ----- ----------- -----------
Distributions:
From net investment income............ (1.04) (1.05) (0.95) (0.90) (0.91) (0.90) (0.90) (0.81) (0.21)
From net realized gains............... -- -- (0.23) (0.24) (0.09) (0.02) (0.03) (0.01) --
------- ----- ----- ----- ----- ----- ----- ----------- -----------
Total distributions............... (1.04) (1.05) (1.18) (1.14) (1.00) (0.92) (0.93) (0.82) (0.21)
------- ----- ----- ----- ----- ----- ----- ----------- -----------
Net asset value, end of period.......... $ 7.50 8.12 7.98 12.22 11.51 10.71 10.02 9.96 10.08
------- ----- ----- ----- ----- ----- ----- ----------- -----------
------- ----- ----- ----- ----- ----- ----- ----------- -----------
Total return (d)........................ 5.68% 16.15% (26.65%) 17.04% 17.70% 16.80% 10.30% 7.38% 3.09%
Net assets, end of period (in
millions)............................. $ 136 319 564 792 470 132 36 28 18
Ratio of expenses to average daily net
assets (e)(f)......................... 0.72% 0.97% 0.78% 0.70% 0.65% 0.75% 0.78% 0.85%(c) 0.75%(c)
Ratio of net investment income to
average daily net assets (e).......... 6.65% 8.02% 9.33% 12.51% 11.01% 9.29% 9.00% 9.03%(c) 7.91%(c)
Portfolio turnover rate (excluding
short-term securities)................ 89% 136% 169% 109% 64% 29% 76% 23% 14%
</TABLE>
- ------------------------------
*On September 12, 1996, shareholders of Intermediate Bond Fund approved the
discontinuance of a fundamental policy requiring the Fund to invest only in
securities issued or guaranteed as to payment of principal and interest by
the U.S. government or its agencies or instrumentalities and repurchase
agreements fully secured by such securities. In connection with the
discontinuance of this policy, the Fund's investment policies were revised to
permit investments in a broad range of investment quality debt securities and
the Fund's name was changed from Institutional Government Income Portfolio to
Intermediate Bond Fund.
(a) Commencement of operations.
(b) Based on average shares outstanding during the period.
(c) Adjusted to an annual basis.
(d) Total return is based on the change in net asset value during the period,
assumes reinvestment of all distributions and does not reflect a sales
charge.
(e) During the years reflected above, the Distributor voluntarily waived fees.
In addition, the Adviser waived various fees and expenses during fiscal
periods 1990, 1989 and 1988. Had the maximum Rule 12b-1 fee been in effect
and had the Fund paid all fees and expenses, the ratios of expenses and net
investment income to average daily net assets would have been: 0.82%/6.55%
in fiscal 1996, 1.07%/7.92% in fiscal 1995, 0.85%/9.26% in fiscal 1994,
0.77%/12.44% in fiscal 1993, 0.72%/10.94% in fiscal 1992 0.82%/9.22% in
fiscal 1991, 0.91%/8.87% in fiscal 1990, 1.40%/8.48% in fiscal 1989 and
1.53%/7.13% in fiscal 1988. Beginning in fiscal 1995, the expense ratios
reflect the effect of gross expenses paid indirectly by the Fund. Prior
period expense ratios have not been adjusted.
(f) Includes federal excise taxes of 0.08%, 0.37%, 0.23%, 0.09% and 0.02% for
the fiscal years ended 9/30/96, 9/30/95, 9/30/94, 9/30/93 and 9/30/92,
respectively.
7
<PAGE>
ADJUSTABLE RATE MORTGAGE SECURITIES FUND
<TABLE>
<CAPTION>
MONTH YEAR YEAR YEAR YEAR PERIOD
ENDED ENDED ENDED ENDED ENDED ENDED
9/30/96 8/31/96 8/31/95 8/31/94 8/31/93 8/31/92(B)
------- ------- ------- ------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
PER-SHARE DATA (A)
Net asset value, beginning of period....... $ 8.03 $ 7.99 $ 8.10 $ 8.88 $ 8.95 $ 8.80
------- ------- ------- ------- ------- -----------
Operations:
Net investment income.................... 0.04 0.49 0.47 0.55 0.63 0.40
Net realized and unrealized gains
(losses) on investments................ 0.03 0.01 (0.05) (0.82) (0.09) 0.07
------- ------- ------- ------- ------- -----------
Total from operations.................. 0.07 0.50 0.42 (0.27) 0.54 0.47
------- ------- ------- ------- ------- -----------
Distributions to shareholders:
From net investment income............... (0.04) (0.46) (0.53) (0.51) (0.61) (0.32)
------- ------- ------- ------- ------- -----------
Net asset value, end of period........... $ 8.06 $ 8.03 $ 7.99 $ 8.10 $ 8.88 $ 8.95
------- ------- ------- ------- ------- -----------
------- ------- ------- ------- ------- -----------
SELECTED INFORMATION (A)
Total return (c)........................... 0.85% 6.40% 5.43% (3.18%) 6.24% 5.49%
Net assets at end of period (in
millions)................................ $ 263 $ 270 $ 409 $ 500 $ 551 $ 555
Ratio of expenses to average daily net
assets (d)............................... 0.82%(f) 0.60% 0.63% 0.60% 0.58% 0.58%(f)
Ratio of net investment income to average
daily net assets (d)..................... 5.82%(f) 5.74% 5.62% 6.39% 7.25% 7.70%(f)
Portfolio turnover rate (excluding
short-term securities)................... 2% 51% 36% 39% 39% 41%
Amount of borrowings outstanding at end of
period (in millions) (e)................. $ -- $ -- $ -- $ 145 $ 145 $ 145
Average amount of borrowings outstanding
during the period (in millions) (e)...... $ -- $ -- $ 57 $ 145 $ 149 $ 90
Average number of shares outstanding during
the period (in millions) (e)............. -- -- 53 62 62 52
Average per-share amount of borrowings
outstanding during the period (e)........ $ -- $ -- $ 1.09 $ 2.34 $ 2.41 $ 1.67
</TABLE>
- ------------------------------
(a) On September 1, 1995 four closed-end funds, American Adjustable Rate Term
Trust Inc.--1996, American Adjustable Rate Term Trust Inc.--1997, American
Adjustable Rate Term Trust Inc.--1998 ("DDJ") and American Adjustable Rate
Term Trust Inc.--1999 were combined to create the Fund. DDJ is considered
the surviving entity for financial reporting purposes. The financial
highlights presented for the periods prior to September 1, 1995 are those of
DDJ. The per-share historical information for such periods has been adjusted
to reflect the impact of additional shares created resulting from the
difference in the net asset value per share of DDJ at the time of the merger
($8.71) and the initial net asset value per share of the Fund ($8.00).
(b) Commencement of operations of DDJ was January 30, 1992.
(c) Total return is based on the change in net asset value, assumes reinvestment
of all distributions and does not reflect a sales charge.
(d) Various fees and expenses of the Fund were voluntarily waived or absorbed by
the Adviser during the year ending 8/31/96. Had the Fund paid all expenses,
the ratios of expenses and net investment income to average daily net assets
would have been 0.76%/5.58%, respectively. Beginning in the year ended
8/31/96, the expense ratios reflect the effect of gross expenses paid
indirectly by the Fund. Prior period expense ratios have not been adjusted.
(e) DDJ was a closed-end management investment company and was permitted to
enter into borrowings for other than temporary or emergency purposes. The
Fund may borrow only for temporary or emergency purposes.
(f) Adjusted to an annual basis.
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives listed below cannot be changed without shareholder
approval. The investment policies and techniques employed in pursuit of the
Funds' objectives may be changed without shareholder approval, unless otherwise
noted.
Because of the risks associated with bond investments, the Funds are
intended to be long-term investment vehicles and are not designed to provide
investors with a means of speculating on short-term market movements. Investors
should be willing to accept the risk of the potential for sudden, sometimes
substantial declines in market value. No assurance can be given that the Funds
will achieve their objectives or that shareholders will be protected from the
risk of loss that is inherent in bond market investing.
8
<PAGE>
GOVERNMENT INCOME FUND
INVESTMENT OBJECTIVE. Government Income Fund ("Government Fund") has an
investment objective of high current income to the extent consistent with
preservation of capital.
INVESTMENT POLICIES AND TECHNIQUES. Government Fund invests primarily in
securities which are issued or guaranteed as to payment of principal and
interest by the U.S. Government or its agencies or instrumentalities ("U.S.
Government Securities"). The Fund invests a significant portion of its assets in
mortgage-related U.S. Government Securities. The Fund may also invest up to 10%
of its total assets in mortgage-related securities issued by private entities.
The Fund's investments in mortgage-related securities may include derivative
mortgage securities; however, the Fund will limit its aggregate investments in
inverse floating, interest-only and principal-only derivative mortgage
securities (discussed below under "Characteristics and Risks of Securities and
Special Investment Methods") to 10% of net assets. Recent market experience has
shown that certain derivative mortgage securities may be extremely sensitive to
changes in interest rates and in prepayment rates on the underlying mortgage
assets and, as a result, the prices of such securities may be highly volatile.
In addition, the Fund may invest in repurchase agreements and enter into reverse
repurchase agreements with respect to U.S. Government Securities. See
"Characteristics and Risk of Securities and Special Investment
Methods--Repurchase Agreements" and "--Reverse Repurchase Agreements." Under
normal circumstances, the Fund will invest at least 65% of the value of its
total assets in U.S. Government Securities, which amount does not include
mortgage-related securities issued by private entities. The Fund may also invest
in cash and short-term money market securities and, for temporary defensive
purposes, may invest more than 35% of its total assets in such securities.
Investments in short-term money market securities may include U.S. Government
securities, time deposits, bank certificates of deposit, bankers' acceptances,
high-grade commercial paper and other money market instruments. See "Investment
Objectives, Policies and Restrictions--Short-Term Money Market Securities" in
the Statement of Additional Information.
Government Fund may engage in options and financial futures transactions
which relate to the securities in which it invests and may lend its portfolio
securities. See "Characteristics and Risks of Securities and Special Investment
Methods."
Government Fund may purchase or sell securities offered on a "when-issued"
or "forward commitment" basis and, in connection therewith, may enter into
mortgage "dollar rolls." The Fund may also enter into reverse repurchase
agreements. The use of these techniques could result in increased volatility of
the Fund's net asset value. See "Characteristics and Risks of Securities and
Special Investment Methods."
The Adviser will attempt to maintain an average effective duration of three
to eight years for Government Fund's portfolio. Effective duration estimates the
interest rate risk of a portfolio of securities. See "Characteristics and Risks
of Securities and Special Investment Methods--Effective Duration."
INVESTMENT RISKS. Government Fund is subject to interest rate risk, which
is the potential for a decline in bond prices due to rising interest rates. In
general, bond prices vary inversely with interest rates. When interest rates
rise, bond prices generally fall. Conversely, when interest rates fall, bond
prices generally rise. Interest rate risk applies to U.S. Government Securities
as well as other bonds. U.S. Government Securities are guaranteed only as to the
payment of interest and principal. The current market prices for such securities
are not guaranteed and will fluctuate. The Fund also is subject to a certain
amount of credit risk. Credit risk, also known as default risk, is the
possibility that a bond issuer will fail to make timely payments of interest or
principal. Up to 35% of the Fund's total assets may be invested in securities
which are not issued or guaranteed as to the payment of principal and interest
by the U.S. Government or its agencies or instrumentalities.
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Government Fund invests a significant portion of its assets in
mortgage-related securities. As a result, the Fund is subject to prepayment
risk. Prepayment risk results because, as interest rates fall, homeowners are
more likely to refinance their home mortgages. When home mortgages are
refinanced, the principal on mortgage-related securities held by the Fund is
"prepaid" earlier than expected. The Fund must then reinvest the unanticipated
principal payments at a time when interest rates on new mortgage investments are
falling. Prepayment risk has two important effects on the Fund:
- When interest rates fall and additional mortgage prepayments must be
reinvested at lower interest rates, the income of the Fund will be
reduced.
- When interest rates fall, prices on mortgage-backed securities may not
rise as much as comparable Treasury bonds because bond market investors
may anticipate an increase in mortgage prepayments and a likely decline in
income.
Government Fund's investments in mortgage-related securities also subject
the Fund to extension risk. Extension risk is the possibility that rising
interest rates may cause prepayments to occur at a slower than expected rate.
This particular risk may effectively change a security which was considered
short- or intermediate-duration at the time of purchase into a long-duration
security. Long-duration securities generally fluctuate more widely in response
to changes in interest rates than short- or intermediate-duration securities.
The Fund's investments in mortgage-related securities include derivative
mortgage securities such as collateralized mortgage obligations and stripped
mortgage-backed securities which may involve risks in addition to those found in
other mortgage-related securities. Recent market experience has shown that
certain derivative mortgage securities may be highly sensitive to changes in
interest and prepayment rates and, as a result, the prices of such securities
may be highly volatile. In addition, recent market experience has shown that
during periods of rising interest rates, the market for certain derivative
mortgage securities may become more unstable and such securities may become more
difficult to sell as market makers choose not to repurchase such securities or
offer prices, based on current market conditions, which are unacceptable to the
Fund. The investment techniques used by the Fund also pose certain risks. See
"Characteristics and Risks of Securities and Special Investment Methods."
INTERMEDIATE BOND FUND
On September 12, 1996, shareholders of Bond Fund approved the discontinuance
of a fundamental policy requiring the Fund to invest only in securities issued
or guaranteed as to payment of principal and interest by the U.S. government or
its agencies or instrumentalities and repurchase agreements fully secured by
such securities. In connection with the discontinuance of this policy, the
Fund's investment policies were revised to permit investments in a broad range
of investment quality debt securities and the Fund's name was changed from
Institutional Government Income Portfolio to Intermediate Bond Fund.
INVESTMENT OBJECTIVE. Intermediate Bond Fund ("Bond Fund") has an
investment objective of a high level of current income consistent with
preservation of capital.
INVESTMENT POLICIES AND TECHNIQUES. Bond Fund will seek to realize its
objective by investing in a diversified portfolio of debt securities. The Fund
will invest primarily (at least 65% of its total assets under normal
circumstances) in the following debt securities: U.S. Government Securities
(including mortgage-related securities), corporate fixed-income securities
(excluding, for purposes of the 65% requirement, preferred or preference stock)
and other fixed-income securities, including privately issued mortgage-related
securities, asset-backed securities and U.S. dollar-denominated Yankee bonds.
Bond Fund also may invest in cash and short-term money market securities and,
for temporary defensive purposes, may invest more than 35% of its total assets
in such securities. The Fund's investments in short-term money market securities
may
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include time deposits, bank certificates of deposit, bankers' acceptances,
high-grade commercial paper and other money market instruments. See "Investment
Objectives, Policies and Restrictions--Short-Term Money Market Securities" in
the Statement of Additional Information. In addition, Bond Fund may invest in
repurchase agreements with respect to U.S. Government Securities. See
"Characteristics and Risks of Securities and Special Investment
Methods--Repurchase Agreements."
The Fund's investments in mortgage-related securities may include certain
tranches of collateralized mortgage obligations. The Fund, however, will not
invest in any inverse floating, interest only, principal only or inverse
interest only tranches of collateralized mortgage obligations or in any stripped
mortgage-backed securities.
Bond Fund will invest only in securities rated investment grade (securities
rated Baa or better by Moody's Investors Service, Inc. ("Moody's") or BBB or
better by Standard & Poor's Corporation ("Standard & Poor's")) or, in the case
of unrated securities, judged to be of comparable quality by the Adviser. If a
credit rating agency lowers the rating of a portfolio security held by Bond Fund
to below investment grade, the Fund may retain the portfolio security if the
Adviser deems it in the best interest of the Fund's shareholders, provided that
in no event will more than 5% of the Fund's net assets be invested in fixed-
income securities rated lower than investment grade. Securities rated Baa are
considered by Moody's as medium-grade obligations which lack outstanding
investment characteristics and in fact have speculative characteristics as well,
while securities rated BBB are regarded by Standard & Poor's as having an
adequate capacity to pay principal and interest. Bond Fund may be more dependent
on the Adviser's investment analysis with respect to securities for which a
comparable quality determination is made than is the case with respect to rated
securities. See Appendix A to the Statement of Additional Information for a
description of Moody's and Standard & Poor's ratings applicable to fixed income
securities.
Bond Fund may purchase or sell securities offered on a "when-issued" or
"forward commitment" basis in an amount up to 25% of the value of its total
assets. In connection therewith, Bond Fund may enter into mortgage "dollar
rolls." See "Characteristics and Risks of Securities and Special Investment
Methods-- When-Issued Securities" and "--Mortgage Dollar Rolls." Bond Fund will
not lend its portfolio securities, purchase or sell options on securities or
enter into futures contracts or options thereon.
Under normal circumstances, Bond Fund will attempt to maintain for its
portfolio a dollar-weighted average maturity of three to ten years. In
calculating maturity, the Fund will consider various factors, including
anticipated payments of principal. Bond Fund will also attempt to maintain under
normal circumstances an average effective portfolio duration of two to six
years. Effective duration estimates the interest rate risk of a portfolio of
securities. See "Characteristics and Risks of Securities and Special Investment
Methods--Effective Duration."
INVESTMENT RISKS. Bond Fund is subject to interest rate risk, which is the
potential for a decline in bond prices due to rising interest rates. In general,
bond prices vary inversely with interest rates. When interest rates rise, bond
prices generally fall. Conversely, when interest rates fall, bond prices
generally rise. Interest rate risk applies to U.S. Government Securities as well
as other bonds. U.S. Government Securities are guaranteed only as to the payment
of interest and principal. The current market prices for such securities are not
guaranteed and will fluctuate. Bond Fund is subject to prepayment risk and
extension risk to the extent it invests in mortgage-related securities. See
"Government Income Fund--Investment Risks" above.
Bond Fund also is subject to credit risk. Credit risk, also known as default
risk, is the possibility that a bond issuer will fail to make timely payments of
interest or principal. The investment techniques used by Bond Fund also pose
certain risks. See "Characteristics and Risks of Securities and Special
Investment Methods."
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ADJUSTABLE RATE MORTGAGE SECURITIES FUND
INVESTMENT OBJECTIVE. Adjustable Rate Mortgage Securities Fund ("ARMS
Fund") has an investment objective of providing the maximum current income that
is consistent with low volatility of principal.
INVESTMENT POLICIES AND TECHNIQUES. ARMS Fund invests primarily (at least
65% of total assets under normal market conditions) in a portfolio of
mortgage-related securities having adjustable interest rates which reset at
periodic intervals ("adjustable rate mortgage securities" or "ARMS"). ARMS
include both pass-through securities representing interests in adjustable rate
mortgage loans and floating rate collateralized mortgage obligations. The
balance of ARMS Fund's assets (up to 35% of total assets) may be invested in (a)
mortgage-related securities other than ARMS, (b) U.S. Government Securities
(including, with respect to 10% of the Fund's net assets. U.S. Government
zero-coupon securities); (c) asset-backed securities; and (d) corporate
fixed-income securities. At least 85% of ARMS Fund's total assets must be either
U.S. Government Securities or securities rated, as of the date of purchase, AA
or better by Standard & Poor's, Aa or better by Moody's, comparably rated by any
other nationally recognized statistical rating organization ("NRSRO") or, if
unrated, of a comparable quality as determined by the Adviser. Up to 15% of ARMS
Fund's total assets may be invested in securities rated, as of the date of
purchase, A by Standard & Poor's or Moody's, comparably rated by any other NRSRO
or, if unrated, of comparable quality as determined by the Adviser. The Fund may
not invest in any security rated, as of the date of purchase, lower than A by
Standard & Poor's or Moody's (or below a comparable rating by any other NRSRO)
or, if unrated, of a quality lower than A as determined by the Adviser. In the
event that a security is downgraded to a rating below A or, if unrated, is no
longer of a quality comparable to a security rated A, as determined by the
Adviser, the Fund will sell such a security as promptly as possible. For a
discussion of Standard & Poor's and Moody's ratings, see Appendix A to the
Statement of Additional Information.
ARMS Fund may engage in options and financial futures transactions which
relate to the securities in which it invests, may purchase and sell interest
rate caps and floors, may make investments in Eurodollar instruments for hedging
purposes, may purchase or sell securities on a when-issued or forward commitment
basis and may lend its portfolio securities. See "Characteristics and Risks of
Securities and Special Investment Methods."
For temporary defensive purposes ARMS Fund may invest without limitation in
cash and short-term money market securities. Investments in short-term money
market securities may include U.S. Government Securities, time deposits, bank
certificates of deposit, bankers' acceptances, high-grade commercial paper and
other money market instruments. See "Investment Objectives, Policies and
Restrictions--Short-Term Money Market Securities" in the Statement of Additional
Information.
The Adviser will attempt to maintain an average effective duration of one to
four years for ARMS Fund's portfolio. Effective duration estimates the interest
rate risk of a portfolio of securities. See "Characteristics and Risks of
Securities and Special Investment Methods--Effective Duration."
INVESTMENT RISKS. ARMS Fund is subject to interest rate risk, which is the
potential for a decline in bond prices due to rising interest rates. In general,
bond prices vary inversely with interest rates. When interest rates rise, bond
prices generally fall. Conversely, when interest rates fall, bond prices
generally rise. Although the values of ARMS, like other debt securities,
generally vary inversely with changes in market interest rates, the values of
ARMS should generally be more resistant to price swings than other debt
securities because the interest rates of ARMS move with market interest rates.
The adjustable rate feature of ARMS will not, however, eliminate fluctuations in
the prices of ARMS, particularly during periods of extreme fluctuations in
interest rates. Also, since many adjustable rate mortgages only reset on an
annual basis, it can be expected that the prices of ARMS will fluctuate to the
extent changes in prevailing interest
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rates are not immediately reflected in the interest rates payable on the
underlying adjustable rate mortgages. The Fund's investments in ARMS and other
mortgage-related securities are also subject to prepayment risk and extension
risk. See "Government Income Fund--Investment Risks" above. In addition, the
Fund is subject to credit risk to the extent it invests in non-U.S. Government
securities. Credit risk, also known as default risk, is the possibility that a
bond issuer will fail to make timely payments of interest or principal. The
investment techniques used by ARMS Fund also pose certain risks. See
"Characteristics and Risks of Securities and Special Investment Methods."
CHARACTERISTICS AND RISKS OF SECURITIES
AND SPECIAL INVESTMENT METHODS
The following describes in greater detail the different types of securities
and investment techniques used by one or more of the Funds. Additional
information about the Funds' investments and investment practices may be found
in the Statement of Additional Information.
GENERAL
The different types of securities in which the Funds invest all have
attendant risks of varying degrees. Because each Fund seeks a different
investment objective and has different investment policies, each is subject to
varying degrees of financial, market and credit risks. Therefore, investors
should carefully consider the investment objective, investment policies and
potential risks of each Fund before investing. Certain securities in which the
Funds invest and certain investment techniques used by the Funds could be
considered "derivative instruments." The term "derivatives" has been used to
identify a variety of financial instruments; there is no discrete class of
instruments that is covered by the term. A "derivative" is commonly defined as a
financial instrument whose value is based upon, or derived from, an underlying
index, reference rate (e.g., interest rates or currency exchange rates),
security, commodity, or other asset. Securities in which one or more of the
Funds invest that could be considered derivatives include mortgage-related
securities and asset-backed securities, which derive their value from underlying
pools of mortgages and assets, respectively. In addition, interest rate caps and
floors, options on securities, futures contracts, options on futures contracts
and when-issued securities transactions are derivative contracts. Derivative
securities and contracts and other types of investments and investment
techniques that may be used by one or more of the Funds are described in greater
detail, including the risks of each, in this section.
U.S. GOVERNMENT SECURITIES
Each Fund may invest in U.S. Government Securities. Such securities are
issued or guaranteed as to payment of principal and interest by the U.S.
Government or its agencies or instrumentalities. THE CURRENT MARKET PRICES FOR
SUCH SECURITIES ARE NOT GUARANTEED AND WILL FLUCTUATE. The Funds may invest in
direct obligations of the U.S. Treasury, such as U.S. Treasury bills, notes and
bonds, and in obligations of U.S. Government agencies or instrumentalities,
including, but not limited to, Federal Home Loan Banks, the Farmers Home
Administration, Federal Farm Credit Banks, the Federal National Mortgage
Association, the Government National Mortgage Association, the Federal Home Loan
Mortgage Corporation, the Financing Corporation and the Student Loan Marketing
Association.
Obligations of U.S. Government agencies or instrumentalities are backed in a
variety of ways by the U.S. Government or its agencies or instrumentalities.
Some of these obligations, such as Government National Mortgage Association
mortgage-backed securities, are backed by the full faith and credit of the U.S.
Treasury. Others, such as obligations of the Federal Home Loan Banks, are backed
by the right of the issuer to borrow from the Treasury. Still others, such as
those issued by the Federal National Mortgage Association, are backed by the
discretionary authority of the U.S. Government to purchase certain obligations
of the agency or
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instrumentality. Finally, obligations of other agencies or instrumentalities are
backed only by the credit of the agency or instrumentality issuing the
obligations.
U.S. Government Securities include securities that have no coupons, or have
been stripped of their unmatured interest coupons, individual interest coupons
from such securities that trade separately, and evidences of receipt of such
securities. Such securities may pay no cash income, and are purchased at a deep
discount from their value at maturity. Because interest on zero-coupon
securities is not distributed on a current basis but is, in effect, compounded,
the market prices of zero-coupon securities are more volatile than the market
prices of securities of comparable quality and similar maturity that pay
interest periodically and may respond to a greater degree to fluctuations in
interest rates than do such non-zero-coupon securities. Although holders of
zero-coupon securities do not receive periodic payments of interest, income
accretes on such securities and is subject to the distribution requirements of
the Internal Revenue Code of 1986, as amended. Because such income may not be
matched by a corresponding cash distribution to a Fund, a Fund may be required
to borrow money or dispose of other securities to be able to make distributions
to shareholders. ARMS Fund will limit its investments in zero coupon securities
to those issued by the U.S. Treasury through its STRIPS program, which
securities constitute direct obligations of the U.S. Government, and will invest
no more than 10% of its net assets in such securities. Government Fund and Bond
Fund may also invest in custodial receipts issued in connection with so called
trademark zero coupon securities, such as CATs and TIGRs. Since such securities
are not issued by the U.S. Treasury, however, they are not considered U.S.
Government Securities for purposes of the Funds' investment policies, although
the underlying bond represented by such receipt is a debt obligation of the U.S.
Treasury.
MORTGAGE-RELATED SECURITIES
Each Fund may invest in U.S. Government mortgage-related securities and in
mortgage-related securities issued by private entities. Mortgage-related
securities are securities that, directly or indirectly, represent participations
in, or are secured by and payable from, loans secured by real property.
Mortgage-related securities, as the term is used in this Prospectus, include
guaranteed mortgage pass-through securities, private mortgage pass-through
securities, adjustable rate mortgage securities and derivative mortgage
securities such as collateralized mortgage obligations and stripped
mortgage-backed securities. Mortgage-related securities fall into three
categories: (a) those issued or guaranteed by the United States Government or
one of its agencies or instrumentalities, such as Government National Mortgage
Association ("GNMA"), Federal National Mortgage Association ("FNMA") and Federal
Home Loan Mortgage Corporation ("FHLMC"); (b) those issued by non-governmental
issuers that represent interests in, or are collateralized by, mortgage-related
securities issued or guaranteed by the United States Government or one of its
agencies or instrumentalities; and (c) those issued by non-governmental issuers
that represent an interest in, or are collateralized by, whole mortgage loans or
mortgage-related securities without a government guarantee but usually with
over-collateralization or some other form of private credit enhancement.
Non-governmental issuers referred to in (b) and (c) above include originators of
and investors in mortgage loans, including savings and loan associations,
mortgage bankers, commercial banks, investment banks and special purpose
subsidiaries of the foregoing. Securities in categories (b) and (c) are not
considered U.S. Government Securities for purposes of this Prospectus.
(a) GUARANTEED MORTGAGE PASS-THROUGH SECURITIES. The government guaranteed
mortgage pass-through securities in which each Fund may invest include
certificates issued or guaranteed by GNMA, FNMA and FHLMC, which represent
interests in underlying residential mortgage loans. These mortgage pass-through
securities provide for the pass-through to investors of their pro-rata share of
monthly payments (including any prepayments) made by the individual borrowers on
the pooled mortgage loans, net of any fees paid to the guarantor of such
securities and the servicer of the underlying mortgage loans. Each of GNMA,
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FNMA and FHLMC guarantee timely distributions of interest to certificate
holders. GNMA and FNMA guarantee timely distributions of scheduled principal.
FHLMC generally guarantees only ultimate collection of principal of the
underlying mortgage loans. For a further description of these securities, see
"Investment Objectives, Policies and Restrictions--Mortgage-Related Securities"
in the Statement of Additional Information.
(b) PRIVATE MORTGAGE PASS-THROUGH SECURITIES. Private mortgage
pass-through securities ("Private Pass-Throughs") are structured similarly to
GNMA, FNMA and FHLMC mortgage pass-through securities and are issued by
originators of and investors in mortgage loans, including savings and loan
associations, mortgage bankers, commercial banks, investment banks and special
purpose subsidiaries of the foregoing. These securities usually are backed by a
pool of conventional fixed rate or adjustable loans. Since Private Pass-Throughs
typically are not guaranteed by an entity having the credit status of GNMA, FNMA
or FHLMC, such securities generally are structured with one or more types of
credit enhancement. See "Investment Objectives, Policies and
Restrictions--Mortgage-Related Securities" in the Statement of Additional
Information.
(c) ADJUSTABLE RATE MORTGAGE SECURITIES. Each Fund may also invest in
adjustable rate mortgage securities ("ARMS") and ARMS Fund must invest at least
65% of its total assets in such securities under normal market conditions. (For
purposes of ARMS Fund's 65% requirement, adjustable rate tranches of CMOs,
discussed below, are also considered ARMS). ARMS are pass-through mortgage
securities collateralized by mortgages with interest rates that are adjusted
from time to time. The adjustments usually are determined in accordance with a
predetermined interest rate index and may be subject to certain limits. While
the values of ARMS, like other debt securities, generally vary inversely with
changes in market interest rates (increasing in value during periods of
declining interest rates and decreasing in value during periods of increasing
interest rates), the values of ARMS should generally be more resistant to price
swings than other debt securities because the interest rates of ARMS move with
market interest rates. The adjustable rate feature of ARMS will not, however,
eliminate fluctuations in the prices of ARMS, particularly during periods of
extreme fluctuations in interest rates. ARMS typically have caps which limit the
maximum amount by which the interest rate may be increased or decreased at
periodic intervals or over the life of the loan. To the extent that interest
rates increase in excess of the caps, ARMS can be expected to behave more like
traditional debt securities and to decline in value to a greater extent than
would be the case in the absence of such caps. Also, since many adjustable rate
mortgages only reset on an annual basis, it can be expected that the prices of
ARMS will fluctuate to the extent that changes in prevailing interest rates are
not immediately reflected in the interest rates payable on the underlying
adjustable rate mortgages. The extent to which the prices of ARMS fluctuate with
changes in interest rates will also be affected by the indices underlying the
ARMS. Some indices, such as the one-year constant maturity Treasury note rate,
closely mirror changes in market interest rate levels. Others, such as the 11th
District Federal Reserve Cost of Funds Index (often related to ARMS issued by
FNMA), tend to lag changes in market levels and tend to be somewhat less
volatile.
(d) COLLATERALIZED MORTGAGE OBLIGATIONS. Each Fund may invest, within the
limits discussed below, in CMOs (collateralized mortgage obligations and
multiclass pass-through securities unless the context otherwise indicates),
which are derivative mortgage securities. Collateralized mortgage obligations
are debt instruments issued by special purpose entities which are secured by
pools of mortgage loans or other mortgage-related securities. Multi-class
pass-through securities are equity interests in a trust composed of mortgage
loans or other mortgage-related securities. Payments of principal and interest
on underlying collateral provide the funds to pay debt service on the
collateralized mortgage obligation or make scheduled
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distributions on the multi-class pass-through security. CMOs may be issued by
agencies or instrumentalities of the U.S. Government or by private
organizations.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, often referred to as a "tranche," is issued at a specific
coupon rate and has a stated maturity or final distribution date. Principal
prepayments on collateral underlying a CMO may cause it to be retired
substantially earlier than the stated maturities or final distribution dates.
The principal and interest on the underlying mortgages may be allocated
among the several tranches of a CMO in many ways. For example, certain tranches
may have variable or floating interest rates and others may be stripped
securities which provide only the principal or interest feature of the
underlying security. See "Stripped Mortgage-Backed Securities," below. Tranches
with variable or floating interest rates are considered ARMS for purposes of the
requirement that ARMS Fund invest at least 65% of its total assets in ARMS under
normal market conditions. Floating rate CMOs are generally backed by fixed rate
mortgages and generally have lifetime caps on the coupon rate thereon. These
caps, similar to the caps on adjustable rate mortgages, represent a ceiling
beyond which the coupon rate on a floating rate CMO may not be increased
regardless of increases in the interest rate index to which the floating rate
CMO is geared, which may cause the security to be valued at a greater discount
than if the security was not subject to a ceiling.
Generally, the purpose of the allocation of the cash flow of a CMO to the
various tranches is to obtain a more predictable cash flow to certain of the
individual tranches than exists with the underlying collateral of the CMO. As a
general rule, the more predictable the cash flow is on a CMO tranche, the lower
the anticipated yield will be on that tranche at the time of issuance relative
to prevailing market yields on mortgage-related securities. As part of the
process of creating more predictable cash flows on most of the tranches of a
CMO, one or more tranches generally must be created that absorb most of the
volatility in the cash flows on the underlying mortgage loans. The yields on
these tranches, which may include inverse floaters, interest only and principal
only tranches and Z tranches, discussed below, are generally higher than
prevailing market yields on mortgage-related securities with similar maturities.
As a result of the uncertainty of the cash flows of these tranches, the market
prices of and yield on these tranches generally may be more volatile.
An inverse floater is a CMO tranche with a coupon rate that moves inversely
to a designated index, such as LIBOR (London Inter-Bank Offered Rate) or COFI
(Cost of Funds Index). Like most other fixed-income securities, the value of
inverse floaters will decrease as interest rates increase. Inverse floaters,
however, may exhibit greater price volatility than the majority of mortgage
pass-through securities or CMOs. Coupon rates on inverse floaters typically
change at a multiple of the changes in the relevant index rate. Thus, any rise
in the index rate (as a consequence of an increase in interest rates) causes a
correspondingly greater drop in the coupon rate of an inverse floater while any
drop in the index rate causes a correspondingly greater increase in the coupon
of an inverse floater. Some inverse floaters also exhibit extreme sensitivity to
changes in prepayments.
Z tranches of CMOs defer interest and principal payments until one or more
other classes of the CMO have been paid in full. Interest accrues on the Z
tranche, being added to principal, and is compounded through the accretion
period. After the other classes have been paid in full, interest payments begin
and continue through maturity. Z tranches have characteristics similar to
zero-coupon bonds. Like a zero-coupon bond, during its accretion period a Z
tranche has the advantage of eliminating the risk of reinvesting interest
payments at lower rates during a period of declining market interest rates. At
the same time, however, and also like a zero-coupon bond, the market value of a
Z tranche can be expected to fluctuate more widely with changes in market
interest rates than would the market value of a tranche which pays interest
currently. In
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addition, changes in prepayment rates on the underlying mortgage loans will
affect the accretion period of a Z tranche, and therefore also are likely to
influence its market value.
Neither Bond Fund nor ARMS Fund will invest in inverse floating,
interest-only, principal-only or inverse interest-only tranches of CMOs. In
addition, ARMS Fund will not invest in Z tranches or residual interests of CMOS.
Government Fund may invest in any CMO tranche, but will limit its aggregate
investments in inverse floaters and interest-only and principal-only tranches of
CMOs (or classes of SMBS, as described in more detail below) to 10% of the
Fund's net assets.
(e) STRIPPED MORTGAGE-BACKED SECURITIES. Government Fund may invest in
stripped mortgage-backed securities ("SMBS"), which are derivative multi-class
mortgage securities. Neither Bond Fund nor ARMS Fund may invest in SMBS. SMBS
may be issued by agencies or instrumentalities of the United States Government
or by private originators of, or investors in, mortgage loans, including savings
and loan associations, mortgage bankers, commercial banks, investment banks and
special purpose subsidiaries of the foregoing.
There are generally two classes of SMBS, one of which (the interest-only or
"IO" class) entitles the holders thereof to receive distributions consisting
solely or primarily of all or a portion of the interest on the underlying pool
of mortgage loans or mortgage-related securities ("Mortgage Assets") and the
other of which (the principal-only or "PO" class) entitles the holders thereof
to receive distributions consisting solely or primarily of all or a portion of
the principal of the underlying pool of Mortgage Assets. The cash flows and
yields on IO and PO classes are extremely sensitive to the rate of principal
payments (including prepayments) on the related underlying Mortgage Assets. For
example, a rapid or slow rate of principal payments may have a material adverse
effect on the yield to maturity of IOs or POs, respectively. If the underlying
Mortgage Assets experience greater than anticipated prepayments of principal, an
IO investor may incur substantial losses. Conversely, if the underlying Mortgage
Assets experience slower than anticipated prepayments of principal, the yield on
a PO class will be affected more severely than would be the case with a
traditional mortgage-related security. Government Fund will limit its aggregate
investments in IO and PO classes and inverse floaters to 10% of the Fund's net
assets.
CORPORATE FIXED-INCOME SECURITIES
Bond Fund and ARMS Fund may invest in corporate fixed-income securities,
which include corporate bonds, debentures, notes and other similar corporate
debt instruments. Fixed-income securities may be acquired with warrants
attached. Corporate income-producing securities may also include forms of
preferred or preference stock, although such securities are not considered debt
securities for purposes of the requirement that Bond Fund invest at least 65% of
its total assets in debt securities. The values of corporate fixed-income
securities typically will fluctuate in response to general economic conditions,
to changes in interest rates and, to a greater extent than the values of
mortgage-related securities, to business conditions affecting the specific
industries in which the issuers are engaged. Corporate fixed-income securities
will typically decrease in value as a result of increases in interest rates. The
Funds may invest in certain types of corporate fixed-income securities that have
been issued with original issue discount or market discount. An investment in
such securities poses certain economic risks and may have certain adverse cash
flow consequences to the investor.
Bond Fund's investments in corporate fixed-income securities may also
include zero-coupon, pay-in-kind and delayed interest securities. Zero-coupon
securities pay no cash income to their holders until they mature and are issued
at substantial discounts from their value at maturity. When held to maturity,
their entire return comes from the difference between their purchase price and
their maturity value. Pay-in-kind securities pay interest through the issuance
to the holders of additional securities. Delayed interest securities
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are securities that remain zero-coupon securities until a predetermined date at
which time the stated coupon rate becomes effective and interest becomes payable
at regular intervals. Because interest on zero-coupon, pay-in-kind and delayed
interest securities is not paid on a current basis, the values of securities of
this type are subject to greater fluctuations than are the value of securities
that distribute income regularly and may be more speculative than such
securities. Accordingly, the values of these securities may be highly volatile
as interest rates rise or fall. In addition, Bond Fund's investments in
zero-coupon, pay-in-kind and delayed interest securities will result in special
tax consequences. Although zero-coupon securities do not make interest payments,
for tax purposes a portion of the difference between a zero-coupon security's
maturity value and its purchase price is taxable income of the Fund each year.
ASSET-BACKED SECURITIES
Bond Fund and ARMS Fund may invest in asset-backed securities. Such
securities represent the application of the securitization techniques used to
develop mortgage-related securities to a broad range of other assets. Through
the use of trusts and special purpose corporations, various types of assets,
primarily automobile and credit card receivables and home equity loans, are
being securitized in pass-through structures similar to the mortgage
pass-through structures described above or in a pay-through structure similar to
the CMO structure.
In general, the collateral supporting asset-backed securities is of shorter
maturity than mortgage loans and is less likely to experience substantial
prepayments. As with mortgage-related securities, asset-backed securities are
often backed by a pool of assets representing obligations of a number of
different parties and use various credit enhancement techniques.
Generally, asset-backed securities involve many of the risks associated with
mortgage-related securities; however due to the difference in the underlying
collateral, asset-backed securities involve certain risks that are not posed by
mortgage-related securities. For example, asset-backed securities are typically
collateralized with assets such as credit card receivables, automobile loans, or
lease contracts which have historically had higher loss experience than that of
mortgage-related securities. Although the credit enhancements for these
securities generally contemplate this higher loss experience, the difference in
lien status and underlying collateral quality could create a situation where the
proceeds from repossessed collateral may not be sufficient to maintain credit
quality or support payments on these securities.
YANKEE BONDS
Bond Fund may invest in Yankee bonds, which are dollar denominated
fixed-income securities of foreign-domiciled issuers that are publicly traded in
the United States. The prominant issuers of Yankee bonds are supranational
agencies and Canadian provinces (including provincial utilities). Supranational
organizations are entities designated or supported by a government or government
entity to promote economic development, and include, among others, the Asian
Development Bank, the European Coal and Steel Community, the European Economic
Community and the World Bank. These organizations do not have taxing authority
and are dependent upon their members for payments of interest and principal.
Each supranational entity's lending activities are limited to a percentage of
its total capital (including "callable capital" contributed by members at the
entity's call), reserves and net income. Foreign corporations may also issue
Yankee bonds. Investments in Yankee bonds may involve risks not typically
associated with investments in domestic issuers. With respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
the Fund's investments in those countries. Moreover, individual foreign
economies may differ favorably or unfavorably from the United States economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payment position.
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EFFECTIVE DURATION
Effective duration estimates the interest rate risk (price volatility) of a
security, I.E., how much the value of the security is expected to change with a
given change in interest rates. The longer a security's effective duration, the
more sensitive its price is to changes in interest rates. For example, if
interest rates were to increase by 1%, the market value of a bond with an
effective duration of five years would decrease by about 5%, with all other
factors being constant.
It is important to understand that, while a valuable measure, effective
duration is based on certain assumptions and has several limitations. It is most
useful as a measure of interest rate risk when interest rate changes are small,
rapid and occur equally across all the different points of the yield curve. In
addition, effective duration is difficult to calculate precisely for bonds with
prepayment options, such as mortgage-backed securities, because the calculation
requires assumptions about prepayment rates. For example, when interest rates go
down, homeowners may prepay their mortgages at a higher rate than assumed in the
initial effective duration calculation, thereby shortening the effective
duration of the Fund's mortgage-related securities. Conversely, if rates
increase, prepayments may decrease to a greater extent than assumed, extending
the effective duration of such securities. For these reasons, the effective
durations of funds which invest a significant portion of their assets in
mortgage-related securities can be greatly affected by changes in interest
rates.
REPURCHASE AGREEMENTS
Each Fund may enter into repurchase agreements with respect to U.S.
Government Securities. A repurchase agreement involves the purchase by a Fund of
securities with the condition that after a stated period of time the original
seller (a member bank of the Federal Reserve System or a recognized securities
dealer) will buy back the same securities ("collateral") at a predetermined
price or yield. Repurchase agreements involve certain risks not associated with
direct investments in securities. In the event the original seller defaults on
its obligation to repurchase, as a result of its bankruptcy or otherwise, the
Fund will seek to sell the collateral, which action could involve costs or
delays. In such case, the Fund's ability to dispose of the collateral to recover
such investment may be restricted or delayed. While collateral will at all times
be maintained in an amount equal to the repurchase price under the agreement
(including accrued interest due thereunder), to the extent proceeds from the
sale of collateral were less than the repurchase price, a Fund would suffer a
loss. Repurchase agreements maturing in more than seven days are considered
illiquid and subject to each Fund's restriction on investing in illiquid
securities.
REVERSE REPURCHASE AGREEMENTS
Government Fund and ARMS Fund may engage in reverse repurchase agreements
with banks and securities dealers. Bond Fund may not enter into such agreements.
Reverse repurchase agreements are ordinary repurchase agreements in which the
Fund is the seller of, rather than the investor in, securities and agrees to
repurchase them at an agreed upon time and price. Use of a reverse repurchase
agreement may be preferable to a regular sale and later repurchase of the
securities because it avoids certain market risks and transaction costs. Because
certain of the incidents of ownership of the security are retained by the Fund,
reverse repurchase agreements are considered a form of borrowing by the Fund
from the buyer, collateralized by the security. At the time the Fund enters into
a reverse repurchase agreement, cash or liquid securities having a value
sufficient to make payments for the securities to be repurchased will be
segregated, and will be maintained throughout the period of the obligation. No
more than 25% of the total assets of Government Fund will be subject to reverse
repurchase agreements. In the case of ARMS Fund, reverse repurchase agreements
are subject to the Fund's limitations on borrowing, set forth below, and may be
entered into only for temporary or emergency purposes. In the case of Government
Fund reverse repurchase agreements may be used as a means of borrowing for
investment purposes. This speculative technique is referred to as
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leveraging. Leveraging may exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio. Money borrowed
for leveraging will be subject to interest costs which may or may not be
recovered by income from or appreciation of the securities purchased.
To attempt to minimize the risk to principal associated with leverage,
Government Fund will enter into reverse repurchase agreements only if such
agreements have terms of one year or less, and only if the Fund is able to
invest the proceeds in securities which the Adviser believes have limited
volatility and a higher interest rate than that payable on the reverse
repurchase agreements. The Adviser believes that such limited use of leverage
will facilitate Government Fund's ability to provide high current income without
adversely affecting the Fund's ability to preserve capital.
BORROWING
Government Fund, Bond Fund and ARMS Fund may borrow money from banks for
temporary or emergency purposes in amounts up to 10% (not including reverse
repurchase agreements), 5% and 10%, respectively, of the value of the Fund's
total assets. Interest paid by a Fund on borrowed funds would decrease the net
earnings of that Fund. Government Fund and ARMS Fund will not purchase portfolio
securities while outstanding borrowings (other than reverse repurchase
agreements in the case of Government Fund) exceed 5% of the value of the
respective Fund's total assets. Each Fund may mortgage, pledge or hypothecate
its assets (in an amount not exceeding 10% of the value of its total assets with
respect to Government Fund and Bond Fund) to secure temporary or emergency
borrowing. The policies set forth in this paragraph are fundamental and may not
be changed without the approval of a majority of a Fund's shares.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. Each of Government Fund and ARMS Fund may write
(i.e., sell) covered put and call options with respect to the securities in
which it may invest. By writing a call option, a Fund becomes obligated during
the term of the option to deliver the securities underlying the option upon
payment of the exercise price if the option is exercised. By writing a put
option, a Fund becomes obligated during the term of the option to purchase the
securities underlying the option at the exercise price if the option is
exercised. With respect to put options written by a Fund, there will have been a
predetermination that acquisition of the underlying security is in accordance
with the investment objective of such Fund.
The principal reason for writing call or put options is to obtain, through
the receipt of premiums, a greater current return than would be realized on the
underlying securities alone. Each Fund receives premiums from writing call or
put options, which they retain whether or not the options are exercised. By
writing a call option, a Fund might lose the potential for gain on the
underlying security while the option is open, and by writing a put option a Fund
might become obligated to purchase the underlying security for more than its
current market price upon exercise.
PURCHASING OPTIONS. Government Fund and ARMS Fund may purchase put options,
solely for hedging purposes, in order to protect portfolio holdings in an
underlying security against a substantial decline in the market value of such
holdings ("protective puts"). Such protection is provided during the life of the
put because a Fund may sell the underlying security at the put exercise price,
regardless of a decline in the underlying security's market price. Any loss to a
Fund is limited to the premium paid for, and transaction costs paid in
connection with, the put plus the initial excess, if any, of the market price of
the underlying security over the exercise price. However, if the market price of
such security increases, the profit a Fund realizes on the sale of the security
will be reduced by the premium paid for the put option less any amount for which
the put is sold.
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Government Fund and ARMS Fund also may purchase call options solely for the
purpose of hedging against an increase in prices of securities that the
respective Fund ultimately wants to buy. Such protection is provided during the
life of the call option because a Fund may buy the underlying security at the
call exercise price regardless of any increase in the underlying security's
market price. In order for a call option to be profitable, the market price of
the underlying security must rise sufficiently above the exercise price to cover
the premium and transaction costs. By using call options in this manner, a Fund
will reduce any profit it might have realized had it bought the underlying
security at the time it purchased the call option by the premium paid for the
call option and by transaction costs.
In addition to exchange-traded put and call options, Government Fund may
also purchase and write over-the-counter ("OTC") put and call options in
negotiated transactions with the writers of the options since options on many of
the portfolio securities held by the Fund are not traded on an exchange.
Government Fund will purchase OTC options only from investment dealers and other
financial institutions (such as commercial banks or savings and loan
associations) deemed creditworthy by the Adviser. ARMS Fund will purchase and
write only exchange-traded put and call options.
OTC options are two-party contracts with price and terms negotiated between
buyer and seller. In contrast, exchange-traded options are third-party contracts
with standardized strike prices and expiration dates, and are purchased from a
clearing corporation. Exchange-traded options have a continuous liquid market
while OTC options may not. The staff of the Securities and Exchange Commission
(the "SEC") has taken the position that purchased OTC options and the assets
used to "cover" written OTC options are illiquid securities; however, the entire
amount of assets used to cover OTC options written by the Fund will not be
treated as illiquid in certain circumstances, as set forth in the Statement of
Additional Information. Government Fund will treat OTC options, to the extent
set forth in the Statement of Additional Information, as subject to the Fund's
limitation on illiquid securities.
For further information concerning the characteristics and risks of options
transactions, see "Investment Objectives, Policies and Restrictions--Options" in
the Statement of Additional Information.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
Government Fund and ARMS Fund may enter into contracts for the purchase or
sale for future delivery of fixed-income securities or contracts based on
financial indices including any index of securities in which the respective Fund
may invest ("futures contracts"). A "sale" of a futures contract means the
acquisition of a contractual obligation to deliver the securities called for by
the contract at a specified price on a specified date. The purchaser of a
futures contract on an index agrees to take or make delivery of an amount of
cash equal to the difference between a specified dollar multiple of the value of
the index on the expiration date of the contract ("current contract value") and
the price at which the contract was originally struck. Generally, no physical
delivery of the fixed-income securities underlying the index is made. The
futures contracts which the Funds may enter into have been developed by and are
traded on national commodity exchanges.
The purpose of the acquisition or sale of a futures contract by a Fund is to
hedge against fluctuations in the value of its portfolio without actually buying
or selling securities. For example, if a Fund owns long-term U.S. Government
Securities and interest rates are expected to increase, the Fund might sell
futures contracts. If interest rates did increase, the value of the U.S.
Government Securities in the Fund's portfolio would decline, but the value of
the Fund's futures contracts would increase at approximately the same rate,
thereby keeping the net asset value of the Fund from declining as much as it
otherwise would have. If, on the other hand, a Fund held cash reserves and
short-term investments pending anticipated investment in long-term obligations
and interest rates were expected to decline, the Fund might purchase futures
contracts for U.S. Government Securities. Since the behavior of such contracts
would generally be similar to that of long-term
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securities, the Fund could take advantage of the anticipated rise in the value
of long-term securities without actually buying them until the market had
stabilized. At that time, the Fund could accept delivery under the futures
contracts or the futures contracts could be liquidated and the Fund's reserves
could then be used to buy long-term securities in the cash market. Government
Fund and ARMS Fund will engage in such transactions only for hedging purposes,
on either an asset-based or a liability-based basis, in each case in accordance
with the rules and regulations of the Commodity Futures Trading Commission. See
Appendix B to the Statement of Additional Information.
Government Fund and ARMS Fund may purchase and sell put and call options on
futures contracts and enter into closing transactions with respect to such
options to terminate existing positions. The Funds may use such options on
futures contracts in connection with its hedging strategies in lieu of
purchasing and writing options directly on the underlying securities or
purchasing and selling the underlying futures contracts.
There are risks in using futures contracts and options on futures contracts
as hedging devices. The primary risks associated with the use of futures
contracts and options thereon are (a) the prices of futures contracts and
options may not correlate perfectly with the market value of the securities
subject to the hedge and (b) the possible lack of a liquid secondary market for
a futures contract and the resulting inability to close a futures position prior
to its maturity date. The risk that a Fund will be unable to close out a futures
position will be minimized by entering into such transactions on a national
exchange with an active and liquid secondary market.
Additional information with respect to interest rate futures contracts,
together with information regarding options on such contracts, is set forth in
Appendix B to the Statement of Additional Information.
EURODOLLAR INSTRUMENTS
ARMS Fund may make investments in Eurodollar instruments for hedging
purposes only. Eurodollar instruments are essentially U.S. dollar denominated
futures contracts or options thereon that are linked to LIBOR. Eurodollar
futures contracts enable purchasers to obtain a fixed rate for the lending of
funds and sellers to obtain a fixed rate for borrowings. ARMS Fund uses
Eurodollar futures contracts and options thereon to hedge against changes in
LIBOR, to which many short-term borrowings and floating rate securities are
linked. Eurodollar instruments are subject to the same limitations and risks as
other futures contracts and options thereon.
INTEREST RATE TRANSACTIONS
ARMS Fund may purchase or sell interest rate caps and floors to preserve a
return or spread on a particular investment or portion of its portfolio or for
other non-speculative purposes. The aggregate purchase price of caps and floors
held by ARMS Fund may not exceed 5% of the Fund's total assets. ARMS Fund may
sell, I.E., write, caps and floors without limitation, subject to the segregated
account requirement described below. The Fund does not intend to use these
transactions for speculative purposes. The purchase of an interest rate cap
entitles the purchaser, to the extent a specified index exceeds a predetermined
interest rate, to receive payments of interest on a contractually-based
principal amount from the party selling such interest rate cap. The purchase of
an interest rate floor entitles the purchaser, to the extent a specified index
falls below a predetermined interest rate, to receive payments of interest on a
contractually-based principal amount from the party selling such interest rate
floor.
ARMS Fund may enter into interest rate caps and floors on either an
asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities. To the extent the Fund sells, I.E., writes, caps
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and floors, it will maintain in a segregated account cash or high quality liquid
debt securities having an aggregate net asset value at least equal to the full
amount, accrued on a daily basis, of the Fund's obligations with respect to any
caps or floors. ARMS Fund will not enter into any interest rate cap or floor
transaction unless the unsecured senior debt or the claims-paying ability of the
other party thereto is rated at least A by Standard & Poor's or Moody's or is
comparably rated by any other NRSRO. The Adviser will monitor the
creditworthiness of contra-parties on an ongoing basis. If there is a default by
the other party to such a transaction, the Fund will have contractual remedies
pursuant to the agreements related to the transaction. Interest rate caps and
floors are somewhat recent innovations for which standardized documentation has
not yet been developed and, accordingly, they are less liquid than many other
investments.
WHEN-ISSUED SECURITIES
Each Fund may purchase securities on a "when-issued" basis and may purchase
or sell securities on a "forward commitment" basis. When such transactions are
negotiated, the price is fixed at the time the commitment is made, but delivery
and payment for the securities take place at a later date. The Funds will not
accrue income with respect to when-issued or forward commitment securities prior
to their stated delivery date. Pending delivery of the securities, each Fund
maintains in a segregated account cash or liquid securities in an amount
sufficient to meet its purchase commitments.
The purchase of securities on a when-issued or forward commitment basis
exposes the Funds to risk because the securities may decrease in value prior to
their delivery. Purchasing securities on a when-issued or forward commitment
basis involves the additional risk that the return available in the market when
the delivery takes place will be higher than that obtained in the transaction
itself. A Fund's purchase of securities on a when-issued or forward commitment
basis while remaining substantially fully invested increases the amount of the
Fund's assets that are subject to market risk to an amount that is greater than
the Fund's net asset value, which could result in increased volatility of the
price of the Fund's shares. For additional information concerning when-issued
and forward commitment transactions, see "Investment Objectives, Policies and
Restrictions" in the Statement of Additional Information.
MORTGAGE DOLLAR ROLLS
In connection with their ability to purchase securities on a when-issued or
forward commitment basis, Government Fund and Bond Fund may enter into mortgage
"dollar rolls" in which a Fund sells securities for delivery in the current
month and simultaneously contracts with the same counterparty to repurchase
similar (same type, coupon and maturity) but not identical securities on a
specified future date. ARMS Fund may not enter into such transactions. In a
mortgage dollar roll, the Fund gives up the right to receive principal and
interest paid on the securities sold. However, the Fund would benefit to the
extent of any difference between the price received for the securities sold and
the lower forward price for the future purchase plus any fee income received.
Unless such benefits exceed the income, capital appreciation and gain or loss
due to mortgage prepayments that would have been realized on the securities sold
as part of the mortgage dollar roll, the use of this technique will diminish the
investment performance of the Fund compared with what such performance would
have been without the use of mortgage dollar rolls. Each Fund will hold and
maintain in a segregated account until the settlement date cash or liquid
securities in an amount equal to the forward purchase price. The benefits
derived from the use of mortgage dollar rolls may depend upon the Adviser's
ability to predict correctly mortgage prepayments and interest rates. There is
no assurance that mortgage dollar rolls can be successfully employed. In
addition, the use of mortgage dollar rolls by a Fund while remaining
substantially fully invested increases the amount of the Fund's assets that are
subject to market risk to an amount that is greater than the Fund's net asset
value, which could result in increased volatility of the price of the Fund's
shares.
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No more than one-third of Government Fund's and 25% of Bond Fund's total
assets may be committed to the purchase of securities on a when-issued or
forward commitment basis, including mortgage dollar roll purchases.
ILLIQUID SECURITIES
As nonfundamental investment restrictions that may be changed at any time
without shareholder approval, neither Government Fund nor ARMS Fund will invest
more than 15% of its net assets in illiquid securities and Bond Fund will not
invest in such securities. A security is considered illiquid if it cannot be
sold in the ordinary course of business within seven days at approximately the
price at which it is valued. Illiquid securities may offer a higher yield than
securities which are more readily marketable, but they may not always be
marketable on advantageous terms.
The sale of illiquid securities often requires more time and results in
higher brokerage charges or dealer discounts and other selling expenses than
does the sale of securities eligible for trading on national securities
exchanges or in the over-the-counter markets. A Fund may be restricted in its
ability to sell such securities at a time when the Adviser deems it advisable to
do so. In addition, in order to meet redemption requests, a Fund may have to
sell other assets, rather than such illiquid securities, at a time which is not
advantageous.
"Restricted securities" are securities which were originally sold in private
placements and which have not been registered under the Securities Act of 1933
(the "1933 Act"). Such securities generally have been considered illiquid, since
they may be resold only subject to statutory restrictions and delays or if
registered under the 1933 Act. In 1990, however, the Securities and Exchange
Commission adopted Rule 144A under the 1933 Act, which provides a safe harbor
exemption from the registration requirements of the 1933 Act for resales of
restricted securities to "qualified institutional buyers," as defined in the
rule. The result of this rule has been the development of a more liquid and
efficient institutional resale market for restricted securities. Thus,
restricted securities are no longer necessarily illiquid. The Funds may
therefore invest in Rule 144A securities and treat them as liquid when they have
been determined to be liquid by the Board of Directors of the Company or by the
Adviser subject to the oversight of and pursuant to procedures adopted by the
Board of Directors. See "Investment Objectives, Policies and
Restrictions--Illiquid Securities" in the Statement of Additional Information.
Similar determinations may be made with respect to commercial paper issued in
reliance on the so-called "private placement" exemption from registration under
Section 4(2) of the 1933 Act and with respect to interest-only, principal-only
and inverse floating classes of mortgage-related securities issued by the U.S.
Government or its agencies and instrumentalities.
PORTFOLIO TURNOVER
The Funds may engage in short-term trading in attempting to achieve their
investment objectives and will actively use trading to benefit from yield
disparities among different issues of securities or otherwise to achieve their
investment objectives and policies. Since the Funds engage in short-term
trading, they pay greater brokerage commission costs or other transaction costs.
High portfolio turnover also may increase short-term capital gains, which are
taxable as ordinary income when distributed to shareholders.
The method of calculating portfolio turnover rate is set forth in the
Statement of Additional Information under "Investment Objectives, Policies and
Restrictions--Portfolio Turnover." The portfolio turnover rate for each Fund is
set forth in "Financial Highlights."
INVESTMENT RESTRICTIONS
Each Fund has adopted certain fundamental and nonfundamental investment
restrictions in addition to those set forth above. As a fundamental investment
restriction which may not be changed without shareholder approval, no Fund will
invest 25% or more of its total assets in any one industry, except that, under
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normal market conditions, ARMS Fund will invest 25% or more of the value of its
total assets in ARMS issued or guaranteed by the U.S. Government or its agencies
or instrumentalities or by private organizations. (Except for the requirement
that ARMS Fund invest 25% or more of its total assets in ARMS, this restriction
does not apply to securities of the U.S. Government or its agencies and
instrumentalities and repurchase agreements relating thereto. As to utility
companies, gas, electric, telephone, telegraph, satellite and microwave
communications companies are considered as separate industries. ARMS Fund will
determine the industry classification of asset-backed securities in its
portfolio based on the type of collateral underlying the securities and will
consider ARMS issued by the U.S. Government or its agencies or instrumentalities
and ARMS issued by private organizations to be securities of issuers in the same
industry.) In addition, as nonfundamental investment restrictions which may be
changed at any time without shareholder approval, Government Fund will not
invest more than 5% of its net assets in foreign securities and Bond Fund and
ARMS Fund will not invest in foreign securities, provided that Bond Fund may
invest in U.S. dollar-denominated Yankee bonds. Each Fund operates as a
diversified Fund, which means that, with respect to 75% of its total assets, the
Fund will not invest more than 5% of the value of its total assets (taken at
market value at the time of purchase) in the outstanding securities of any one
issuer, or own more than 10% of the outstanding voting securities of any one
issuer, in each case other than securities issued or guaranteed by the U.S.
Government or any agency or instrumentality thereof. A list of each Fund's
fundamental and nonfundamental investment restrictions is set forth in the
Statement of Additional Information.
Except for each Fund's policy regarding borrowing, if a percentage
restriction set forth under "Investment Objectives and Policies" or under
"Special Investment Methods" is adhered to at the time of an investment, a later
increase or decrease in percentage resulting from changes in values or assets
will not constitute a violation of such restriction.
MANAGEMENT
BOARD OF DIRECTORS
The Board of Directors of Piper Funds and Piper Funds II has the primary
responsibility for overseeing the overall management of each such company and
electing its officers.
INVESTMENT ADVISER
Piper Capital Management Incorporated (the "Adviser") has been retained
under Investment Advisory and Management Agreements with Piper Funds and Piper
Funds II to act as the Funds' investment adviser subject to the authority of the
Board of Directors.
In addition to acting as the investment adviser for the other series of
Piper Funds, the Adviser also serves as investment adviser to a number of other
open-end and closed-end investment companies and to various other concerns,
including pension and profit sharing funds, corporate funds and individuals. As
of January 31, 1997, the Adviser rendered investment advice regarding
approximately $9 billion of assets. The Adviser is a wholly owned subsidiary of
Piper Jaffray Companies Inc., a publicly held corporation which is engaged
through its subsidiaries in various aspects of the financial services industry.
The address of the Adviser is Piper Jaffray Tower, 222 South Ninth Street,
Minneapolis, Minnesota 55402-3804.
The Adviser furnishes each Fund with investment advice and supervises the
management and investment programs of the Funds. The Adviser furnishes at its
own expense all necessary administrative services, office space, equipment and
clerical personnel for servicing the investments of the Funds. The Adviser also
provides investment advisory facilities and executive and supervisory personnel
for managing the investments and effecting the portfolio transactions of the
Funds. In addition, the Adviser pays the salaries and fees of all officers and
directors of Piper Funds and Piper Funds II who are affiliated with the Adviser.
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Under the Investment Advisory and Management Agreement, the Funds pay the
Adviser monthly fees. The fee for Government Fund is paid at an annual rate of
.50% on average daily net assets up to $250 million, .45% on net assets of over
$250 million and up to $500 million, and .40% on net assets of over $500
million. The fee for Bond Fund is paid at an annual rate of .30% on average
daily net assets up to $100 million, .25% on average daily net assets of over
$100 and up to $250 million and .20% on average daily net assets in excess of
$250 million. The fee for ARMS Fund is paid at an annual rate of .35% on average
daily net assets up to $500 million and .30% on average daily net assets in
excess of $500 million.
PORTFOLIO MANAGEMENT
Bruce D. Salvog and David M. Steele have been primarily responsible for the
day-to-day management of Government Fund's portfolio since March 1995. Mr.
Salvog, Mr. Steele and Worth Bruntjen share primary responsibility for the
day-to-day management of Bond Fund's portfolio. Mr. Bruntjen has been primarily
responsible for Bond Fund's management since the Fund's inception in 1988, and
was joined by Mr. Salvog and Mr. Steele in September 1996. Mr. Salvog has been a
Senior Vice President of the Adviser since 1992 and was a Portfolio Manager at
Kennedy Associates, Inc. in Seattle from 1984 to 1992. He has an AB from Harvard
University and 25 years of financial experience. Mr. Steele has been a Senior
Vice President of the Adviser since 1992 and was a portfolio manager at Kennedy
Associates, Inc. in Seattle from 1987 to 1992. He has an MBA from the University
of Southern California and 16 years of financial experience. Mr. Bruntjen is a
Senior Vice President of the Adviser and a fixed income manager for a variety of
client portfolios including foundations, pensions and profit-sharing plans. Mr.
Bruntjen has a BSBA from the University of Minnesota and 28 years of financial
experience.
Thomas S. McGlinch and Wan-Chong Kung are primarily responsible for the
day-to-day management of ARMS Fund's portfolio. Mr. McGlinch has managed the
portfolio since inception and Ms. Kung has been a co-manager since December
1995. Mr. McGlinch is a Senior Vice President and fixed income portfolio manager
for the Adviser. Prior to joining the Adviser in 1992, Mr. McGlinch was an
institutional mortgage-backed securities trader for the Distributor during 1992.
From 1988 to January 1992, Mr. McGlinch was a speciality products trader at FBS
Investment Services, Inc. He is a Chartered Financial Analyst with an MBA from
the University of St. Thomas. Ms. Kung is a Vice President and portfolio manager
for the Adviser. Prior to joining the Adviser in 1993, she was a Senior
Consultant at Cytrol Inc. in Edina, Minnesota from 1989 to December 1992. Ms.
Kung received a BS from the University of the Philippines in Manila and an MBA
from the University of Minnesota.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND CUSTODIAN
Investors Fiduciary Trust Company ("IFTC"), 127 West Tenth Street, Kansas
City, Missouri 64105, (800) 874-6205, serves as Custodian for the Funds'
portfolio securities and cash and as Transfer Agent and Dividend Disbursing
Agent for the Funds.
Piper Funds and Piper Funds II have entered into Shareholder Account
Servicing Agreements with the Distributor and Piper Trust Company, an affiliate
of the Distributor and the Adviser. Under these agreements the Distributor and
Piper Trust Company provide transfer agent and dividend disbursing agent
services for certain shareholder accounts. For more information, see "Investment
Advisory and Other Services--Transfer Agent and Dividend Disbursing Agent" in
the Statement of Additional Information.
PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSIONS
The Adviser selects brokers and futures commission merchants to use for the
Funds' portfolio transactions. In making its selection, the Adviser may consider
a number of factors, which are more fully discussed in the Statement of
Additional Information, including, but not limited to, research services, the
reasonableness of commissions and quality of services and execution. A broker's
sales of shares of any series of the
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Company may also be considered a factor if the Adviser is satisfied that a Fund
would receive from that broker the most favorable price and execution then
available for a transaction. Portfolio transactions for the Funds may be
effected through the Distributor on a securities exchange in compliance with
Section 17(e) of the Investment Company Act of 1940, as amended (the "1940
Act"). For more information, see "Portfolio Transactions and Allocation of
Brokerage" in the Statement of Additional Information.
DISTRIBUTION OF FUND SHARES
Piper Jaffray acts as the principal distributor of the Funds' shares. Piper
Funds and Piper Funds II have each adopted Distribution Plans (the "Plans") as
required by Rule 12b-1 under the 1940 Act. Under the Plans, the Distributor is
paid a total fee in connection with the servicing of each Fund's shareholder
accounts and/or in connection with distribution related services provided with
respect to each Fund. This fee is calculated daily and paid quarterly at an
annual rate equal to .50% of the average daily net assets of Government Fund,
.30% of the average daily net assets of Bond Fund and .15% of the average daily
net assets of ARMS Fund.
With respect to Government Fund and Bond Fund, a portion of each Fund's
total fee equal to .25% of Government Fund's and .05% of Bond Fund's average
daily net assets is categorized as a distribution fee intended to compensate the
Distributor for its expenses incurred in connection with the sale of Fund
shares. The remaining portion of the fee, equal to .25% of each Fund's average
daily net assets, is categorized as a servicing fee intended to compensate the
Distributor for ongoing servicing and/or maintenance of shareholder accounts.
All of the Rule 12b-1 fee paid by ARMS Fund is categorized as a servicing fee.
The Distributor has voluntarily agreed to limit the total fees payable by
Government Fund and Bond Fund under the Plan to .34% and .22%, respectively, of
such Fund's average daily net assets. This limitation may be revised or
terminated at any time after fiscal 1997 year end. Payments made under the Plans
are not tied exclusively to expenses actually incurred by the Distributor and
may exceed such expenses. The Adviser and the Distributor, out of their own
assets, may pay for certain expenses incurred in connection with the
distribution of shares of the Funds. In particular, the Adviser may make
payments out of its own assets to Piper Jaffray Investment Executives and other
broker-dealers in connection with their sales of shares of the Funds. See "How
to Purchase Shares--Purchase Price." Further information regarding the Plans is
contained in the Statement of Additional Information.
The Distributor uses all or a portion of its Rule 12b-1 fee to make payments
to Investment Executives of the Distributor and broker-dealers which have
entered into sales agreements with the Distributor. If shares of a Fund are sold
by a representative of a broker-dealer other than the Distributor, the
broker-dealer is paid .30% of the average daily net assets of Government Fund,
.20% of the average daily net assets of Bond Fund or .15% of the average daily
net assets of ARMS Fund attributable to shares sold by the broker-dealer's
representative. If shares of a Fund are sold by an Investment Executive of the
Distributor, compensation is paid to the Investment Executive in the manner set
forth in a written agreement, in an amount not to exceed .30% of the average
daily net assets of Government Fund, .20% of the average daily net assets of
Bond Fund or .15% of the average daily net assets of ARMS Fund attributable to
shares sold by the Investment Executive.
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SHAREHOLDER GUIDE TO INVESTING
HOW TO PURCHASE SHARES
GENERAL
The Funds' shares may be purchased at the public offering price from the
Distributor and from other broker-dealers who have sales agreements with the
Distributor. The address of the Distributor is that of the Funds. The
Distributor reserves the right to reject any purchase order. You should be aware
that, because the Funds do not issue stock certificates, Fund shares must be
kept in an account with the Distributor or with IFTC. All investments must be
arranged through your Piper Jaffray Investment Executive or other broker-dealer.
PURCHASE PRICE
You may purchase shares of the Funds at the net asset value per share next
calculated after receipt of your order by your Piper Jaffray Investment
Executive or other broker-dealer, plus a front-end sales charge as follows:
<TABLE>
<CAPTION>
SALES CHARGE
SALES CHARGE AS A PERCENTAGE
AS A PERCENTAGE OF NET
AMOUNT OF TRANSACTION AT OFFERING PRICE OF OFFERING PRICE ASSET VALUE
- -------------------------------------------------------------- ----------------- -----------------
<S> <C> <C>
Less than $100,000............................................ 2.00% 2.04%
$100,000 but less than $250,000............................... 1.25% 1.27%
$250,000 but less than $500,000............................... 0.50% 0.50%
$500,000 and over............................................. 0.00% 0.00%
</TABLE>
The Distributor and other broker-dealers who sell Fund shares receive
compensation from different sources. A portion of this compensation is typically
passed along to your Piper Jaffray Investment Executive or other sales
representative.
The Distributor receives the sales charge (as set forth in the table above)
that you pay upon purchasing shares of the Funds and reallows a portion of this
to other broker-dealers who sell Fund shares. If the Fund share purchase is not
subject to an initial sales charge, the Distributor may receive a fee (equal to
a percentage of the purchase price) from the Adviser in connection with the
purchase. The Distributor also receives any contingent deferred sales charges
that may be imposed on redemptions of certain Fund shares that were not subject
to an initial sales charge.
The Distributor also receives the Rule 12b-1 fees that are paid out of each
Fund's assets and pays a portion of these fees to broker-dealers who sell Fund
shares. See "Distribution of Fund Shares" above. In addition, the Distributor or
the Adviser, at their own expense, provide promotional incentives to Investment
Executives of the Distributor and to broker-dealers who have sales agreements
with the Distributor in connection with sales of shares of the Funds, other
series of the Company and other mutual funds for which the Adviser acts as
investment adviser. In some instances, these incentives may be made available
only to certain Investment Executives or broker-dealers who have sold or may
sell significant amounts of such shares. The incentives may include payment for
travel expenses, including lodging at luxury resorts, incurred in connection
with sales seminars.
PURCHASES OF $500,000 OR MORE
If you make a purchase of $500,000 or more (including purchases made under a
Letter of Intent), a contingent deferred sales charge will be assessed in the
event you redeem shares within 12 months following
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SHAREHOLDER GUIDE TO INVESTING
the purchase. For more information, please refer to the Contingent Deferred
Sales Charge section of "How To Redeem Shares."
MINIMUM INVESTMENTS
A minimum initial investment of $250 is required. There is no minimum for
subsequent investments. The Distributor, in its discretion, may waive the
minimum.
REDUCING YOUR SALES CHARGE
You may qualify for a reduced sales charge through one or more of several
plans. You must notify your Piper Jaffray Investment Executive or broker-dealer
at the time of purchase to take advantage of these plans.
AGGREGATION
Front-end or initial sales charges may be reduced or eliminated by
aggregating your purchase with purchases of certain related personal accounts.
In addition, purchases made by members of certain organized groups will be
aggregated for purposes of determining sales charges. Sales charges are
calculated by adding the dollar amount of your current purchase to the higher of
the cost or current value of shares of any Piper fund sold with a sales charge
that are currently held by you and your related accounts or by other members of
your group.
QUALIFIED GROUPS. You may group purchases in the following personal
accounts together:
- Your individual account.
- Your spouse's account.
- Your children's accounts.
- Your employee benefit plan accounts if they are exclusively for your
benefit. This includes accounts such as IRAs, individual 403(b) plans or
single-participant Keogh-type plans but does not include plans that cover
more than one participant.
- A trust or trusts created for the primary benefit of you, your spouse or
your children.
Additionally, purchases made by members of any organized group meeting the
requirements listed below may be aggregated for purposes of determining sales
charges:
- The group has been in existence for more than six months.
- It is not organized for the purpose of buying redeemable securities of a
registered investment company.
- Purchases must be made through a central administration, or through a
single dealer, or by other means that result in economy of sales effort or
expense.
An organized group does not include a group of individuals whose sole
organizational connection is participation as credit card holders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
RIGHT OF ACCUMULATION
Sales charges for purchases of Fund shares into Piper Jaffray accounts will
be automatically calculated taking into account the dollar amount of any new
purchases along with the higher of current value or cost of
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SHAREHOLDER GUIDE TO INVESTING
shares previously purchased in any other mutual fund managed by the Adviser that
was sold with a sales charge. For other broker-dealer accounts, you should
notify your Investment Executive at the time of purchase of additional Piper
fund shares you may own.
LETTER OF INTENT
Your sales charge may be reduced by signing a non-binding Letter of Intent.
This Letter of Intent will state your intention to invest $100,000 or more in
any of the mutual funds managed by the Adviser that are sold with a sales charge
over a 13-month period, beginning not earlier than 90 days prior to the date you
sign the Letter. You will pay the lower sales charge applicable to the total
amount you plan to invest over the 13-month period. Part of your shares will be
held in escrow to cover additional sales charges that may be due if you do not
invest the planned amount. Please see "Purchase of Shares" in the Statement of
Additional Information for more details. You can contact your Piper Jaffray
Investment Executive or other broker-dealer for an application.
SPECIAL PURCHASE PLANS
For more information on any of the following special purchase plans, contact
your Piper Jaffray Investment Executive or other broker-dealer.
PURCHASES BY PIPER JAFFRAY COMPANIES INC., ITS SUBSIDIARIES AND ASSOCIATED
PERSONS
Piper Jaffray Companies Inc. and its subsidiaries may buy shares of the
Funds without incurring a sales charge. The following persons associated with
such entities also may buy Fund shares without paying a sales charge:
- Officers, directors and their spouses.
- Employees, retirees and their spouses.
- Sales representatives and their spouses.
- Children, grandchildren, parents, grandparents or siblings of any of the
above, or spouses of any of these persons.
- Any trust, pension, profit-sharing or other benefit plan for any of the
above.
All persons in the first four groups set forth above may continue to add to
their accounts even after their company relationships have ended.
PURCHASES BY BROKER-DEALERS
Employees of broker-dealers who have entered into sales agreements with the
Distributor, and spouses and children under the age of 21 of such employees, may
buy shares of the Funds without incurring a sales charge.
PURCHASES BY OTHER INDIVIDUALS WITHOUT A SALES CHARGE
The following other individuals and entities may also buy Fund shares
without paying a sales charge:
- Clients of the Adviser buying shares of the Funds in their advisory
accounts.
- Trust companies, including Piper Trust Company, and bank trust departments
using funds over which they exercise discretionary investment authority
and which are held in a fiduciary, agency, advisory, custodial or similar
capacity.
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SHAREHOLDER GUIDE TO INVESTING
- Investors purchasing shares through a Piper Jaffray Investment Executive
if the purchase of such shares is funded by the proceeds from the sale of
shares of any non-money market open-end mutual fund that is not managed by
the Adviser. This privilege is available for 30 days after the sale.
- Former shareholders of American Government Term Trust Inc. may invest the
distributions received by them in connection with the dissolution of such
fund in shares of the Funds without payment of a sales charge.
- Investors purchasing shares through a wrap fee account established by the
Distributor or by another broker-dealer who has entered into a selected
dealer agreement with the Distributor.
PURCHASES BY EMPLOYEE BENEFIT PLANS
- Shares of the Funds will be sold at net asset value, without a sales
charge, to employee benefit plans containing an actively maintained
qualified cash or deferred arrangement under Section 401(k) of the
Internal Revenue Code of 1986, as amended (the "Code") (a "401(k) Plan").
In the event a 401(k) Plan of an employer has purchased shares in the
Funds or any other series of the Company (other than a money market fund)
during any calendar quarter, any other employee benefit plan of such
employer that is a qualified plan under Section 401(a) of the Code also
may purchase shares of the Funds during such quarter without incurring a
sales charge.
HOW TO REDEEM SHARES
NORMAL REDEMPTION
You may redeem all or a portion of your shares on any day that a Fund values
its shares. (Please refer to "Valuation of Shares" below for more information.)
Your shares will be redeemed at the net asset value next calculated after the
receipt of your instructions in good form by your Piper Jaffray Investment
Executive or other broker-dealer as explained below.
PIPER JAFFRAY INC. ACCOUNTS. To redeem your shares, please contact your
Piper Jaffray Investment Executive with an oral request to redeem your shares.
OTHER BROKER-DEALER ACCOUNTS. To redeem your shares, you may either contact
your broker-dealer with an oral request or send a written request directly to
the Funds' transfer agent, IFTC. This request should contain: the dollar amount
or number of shares to be redeemed, your Fund account number and either a social
security or tax identification number (as applicable). You should sign your
request in exactly the same way the account is registered. If there is more than
one owner of the shares, all owners must sign. A signature guarantee is required
for redemptions over $25,000. Please contact IFTC or refer to "Redemption of
Shares" in the Statement of Additional Information for more details.
CONTINGENT DEFERRED SALES CHARGE
If you invest $500,000 or more and, as a result, pay no front-end sales
charge, you may incur a contingent deferred sales charge if you redeem within 12
months. For all redemptions made during the 12-month period this charge will be
equal to .50%, in the case of Government Fund, and .30%, in the case of Bond
Fund and ARMS Fund, of the lesser of the net asset value of the shares at the
time of purchase or at the time of redemption. The contingent deferred sales
charge does not apply to amounts representing an increase in the value of Fund
shares due to capital appreciation or to shares acquired through reinvestment of
dividend or capital gain distributions. In determining whether a contingent
deferred sales charge is payable,
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SHAREHOLDER GUIDE TO INVESTING
shares that are not subject to any deferred sales charge will be redeemed first,
and other shares will then be redeemed in the order purchased.
LETTER OF INTENT. In the case of a Letter of Intent, the 12-month period
begins on the date the Letter of Intent is completed.
SPECIAL PURCHASE PLANS. If you purchased your shares through one of the
plans described above under "Special Purchase Plans," the contingent deferred
sales charge will be waived. In addition, the contingent deferred sales charge
will be waived in the event of:
- The death or disability (as defined in Section 72(m)(7) of the Code) of
the shareholder. (This waiver will be applied to shares held at the time
of death or the initial determination of disability of either an
individual shareholder or one who owns the shares as a joint tenant with
the right of survivorship or as a tenant in common.)
- A lump sum distribution from an employee benefit plan qualified under
Section 401(a) of the Code, an individual retirement account under Section
408(a) of the Code or a simplified employee pension plan under Section
408(k) of the Code.
- Systematic withdrawals from any such plan or account if the shareholder is
at least 59 1/2 years old.
- A tax-free return of the excess contribution to an individual retirement
account under Section 408(a) of the Code.
- Involuntary redemptions effected pursuant to the right to liquidate
shareholder accounts having an aggregate net asset value of less than
$200.
EXCHANGES. If you exchange your shares, no contingent deferred sales charge
will be imposed. However, the charge will apply if you subsequently redeem the
new shares within 12 months of the original purchase.
REINSTATEMENT PRIVILEGE. If you elect to use the Reinstatement Privilege
(please see "Shareholder Services" below), any contingent deferred sales charge
you paid will be credited to your account (proportional to the amount
reinvested). Please see "Redemption of Shares" in the Statement of Additional
Information for more details.
PAYMENT OF REDEMPTION PROCEEDS
After your shares have been redeemed, the cash proceeds will normally be
sent to you or your broker-dealer within three business days. In no event will
payment be made more than seven days after receipt of your order in good form.
However, payment may be postponed or the right of redemption suspended for more
than seven days under unusual circumstances, such as when trading is not taking
place on the New York Stock Exchange. Payment of redemption proceeds may also be
delayed if the shares to be redeemed were purchased by a check drawn on a bank
which is not a member of the Federal Reserve System, until such checks have
cleared the banking system (normally up to 15 days from the purchase date).
INVOLUNTARY REDEMPTION
Each Fund reserves the right to redeem your account at any time the net
asset value of the account falls below $200 as the result of a redemption or
exchange request. You will be notified in writing prior to any such redemption
and will be allowed 30 days to make additional investments before the redemption
is processed.
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SHAREHOLDER GUIDE TO INVESTING
SHAREHOLDER SERVICES
AUTOMATIC MONTHLY INVESTMENT PROGRAM
You may arrange to make additional automated purchases of shares of the
Funds or certain other mutual funds managed by the Adviser. You can
automatically transfer $100 or more per month from your bank, savings and loan
or other financial institution to purchase additional shares. In addition, if
you hold your shares in a Piper Jaffray account you may arrange to make such
additional purchases by having $25 or more automatically transferred each month
from any of the money market fund series of Piper Funds. You should contact your
Piper Jaffray Investment Executive or IFTC to obtain authorization forms or for
additional information.
REINSTATEMENT PRIVILEGE
If you have redeemed shares of any of the Funds, you may be eligible to
reinvest in shares of any fund managed by the Adviser without payment of an
additional sales charge. The reinvestment request must be made within 30 days of
the redemption. This privilege is subject to the eligibility of share purchases
in your state as well as the minimum investment requirements and any other
applicable terms in the prospectus of the fund being acquired. You may reinvest
through a broker-dealer other than the Distributor only if there is a valid
sales agreement between your broker-dealer and the Distributor for the fund in
which you wish to invest.
EXCHANGE PRIVILEGE
If your investment goals change, you may prefer a fund with a different
objective. If you are considering an exchange into another mutual fund managed
by the Adviser, you should carefully read the appropriate prospectus for
additional information about that fund. A prospectus may be obtained through
your Piper Jaffray Investment Executive, your broker-dealer or the Distributor.
To exchange your shares, please contact your Piper Jaffray Investment Executive,
your broker-dealer or IFTC.
You may exchange your shares for shares of any other mutual fund managed by
the Adviser. For funds offering multiple classes of shares, such exchanges may
be made only into Class A shares. Exchanges are made on the basis of the net
asset values of the funds involved, except that investors exchanging into a fund
which has a higher sales charge must pay the difference. However, exchanges of
ARMS Fund shares received in the Merger will be permitted without payment of an
additional sales charge.
If you hold your Fund shares through a broker-dealer other than the
Distributor, the exchange privilege may not be available. Exchanges will be
permitted only if there is a valid sales agreement between your broker-dealer
and the Distributor for the fund into which you wish to exchange.
All exchanges are subject to the eligibility of share purchases in your
state as well as the minimum investment requirements and any other applicable
terms in the prospectus of the fund being acquired. The Company reserves the
right to change or discontinue the exchange privilege, or any aspect of the
privilege, upon 60 days' written notice.
TELEPHONE TRANSACTION PRIVILEGES
PIPER JAFFRAY INC. ACCOUNTS. If you hold your shares in a Piper Jaffray
account, you may telephone your Investment Executive to execute any transaction
or to apply for many shareholder services. In some cases, you may be required to
complete a written application.
OTHER BROKER-DEALER ACCOUNTS. If you hold your shares in an account with
your broker-dealer or at IFTC, you may authorize telephone privileges by
completing the Account Application and Services Form.
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SHAREHOLDER GUIDE TO INVESTING
Please contact your broker-dealer or IFTC (800-874-6205) for an application or
for more details. The Funds will employ reasonable procedures to confirm that a
telephonic request is genuine, including requiring that payment be made only to
the address of record or the bank account designated on the Account Application
and Services Form and requiring certain means of telephonic identification. A
Fund employing such procedures will not be liable for following instructions
communicated by telephone that it reasonably believes to be genuine. If a Fund
does not employ such procedures, it may be liable for any losses due to
unauthorized or fraudulent telephone transactions. It may be difficult to reach
the Funds by telephone during periods when market or economic conditions lead to
an unusually large volume of telephone requests. If you cannot reach the Funds
by telephone, you should contact your broker-dealer or issue written
instructions to IFTC at the address set forth herein. See "Management--Transfer
Agent, Dividend Disbursing Agent and Custodian." The Funds reserve the right to
suspend or terminate their telephone services at any time without notice.
DIRECTED DIVIDENDS
You may direct income dividends and capital gains distributions to be
invested in any other mutual fund managed by the Adviser (other than a money
market fund) that is offered in your state. For funds offering multiple classes
of shares, dividends and distributions may be directed only into the Class A
shares. This investment will be made at net asset value. It will not be subject
to a minimum investment amount except that you must hold shares in such fund
(including the shares being acquired with the dividend or distribution) with a
value at least equal to such fund's minimum initial investment amount. This
privilege may not be available if you hold your Fund shares through a
broker-dealer other than the Distributor. Distributions may be invested in
another mutual fund managed by the Adviser only if there is a valid sales
agreement for that fund between your broker-dealer and the Distributor.
SYSTEMATIC WITHDRAWAL PLAN
If your account has a value of $5,000 or more, you may establish a
Systematic Withdrawal Plan for any of the Funds. This plan will allow you to
receive regular periodic payments by redeeming as many shares from your account
as necessary. As with other redemptions, a redemption to make a withdrawal is a
sale for federal income tax purposes. Payments made under a Systematic
Withdrawal Plan cannot be considered as actual yield or income since part of the
payments may be a return of capital.
A request to establish a Systematic Withdrawal Plan must be submitted in
writing to your Piper Jaffray Investment Executive or other broker-dealer. There
are no service charges for maintenance; the minimum amount that you may withdraw
each period is $100. You will be required to have any income dividends and any
capital gains distributions reinvested. You may choose to have withdrawals made
monthly, quarterly or semiannually. Please contact your Piper Jaffray Investment
Executive, other broker-dealer or IFTC for more information.
You should be aware that additional investments in an account that has an
active Systematic Withdrawal Plan may be inadvisable due to sales charges and
tax liabilities. Please refer to "Redemption of Shares" in the Statement of
Additional Information for additional details.
ACCOUNT PROTECTION
If your Fund shares are held in a Piper Jaffray account, they are protected
in the unlikely event of Piper Jaffray's financial failure. Piper Jaffray is a
member of the Securities Investor Protection Corporation ("SIPC"), whose primary
purpose is to protect the customers of its members against losses of up to
$500,000 ($100,000 on claims for cash) in the event of a member's liquidation.
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In addition to the $500,000 SIPC protection, Piper Jaffray clients have
additional protection provided by Aetna Casualty and Surety Company. Your
investments in the Funds held in a Piper Jaffray PRIME or PAT Plus account are
protected up to $49.5 million beyond the coverage provided by SIPC for total
account protection of $50 million. Investments held in all other Piper Jaffray
accounts are protected up to $24.5 million beyond the coverage provided by SIPC
for total account protection of $25 million. This protection does NOT cover any
declines in the net asset value of Fund shares.
CONFIRMATION OF TRANSACTIONS AND REPORTING OF OTHER INFORMATION
Each time there is a transaction involving your Fund shares, such as a
purchase, redemption or dividend reinvestment, you will receive a confirmation
statement describing that activity. This information will be provided to you
from either Piper Jaffray, your broker-dealer or IFTC. In addition, you will
receive various IRS forms after the first of each year detailing important tax
information and each Fund is required to supply annual and semiannual reports
that list securities held by the Fund and include the current financial
statements of the Fund.
HOUSEHOLDING. If you have multiple accounts with Piper Jaffray, you may
receive some of the above information in combined mailings. This will not only
help to reduce Fund expenses, it will help the environment by saving paper.
Please contact your Piper Jaffray Investment Executive for more information.
DIVIDENDS AND DISTRIBUTIONS
Dividends from the net investment income of each Fund will be declared daily
and paid monthly. Net realized capital gains, if any, will be distributed at
least once annually. Each daily dividend is payable to Fund shareholders of
record at the time of its declaration. "Shareholders of record" includes holders
of shares purchased for which payment has been received by the Distributor or
IFTC, as appropriate, and excludes holders of shares redeemed on that day.
Shares redeemed will earn dividends through the day prior to settlement of the
redemption.
DISTRIBUTION OPTIONS. All net investment income dividends and net realized
capital gains distributions for a Fund generally will be payable in additional
shares of that Fund at net asset value ("Reinvestment Option"). If you wish to
receive your distributions in cash, you must notify your Piper Jaffray
Investment Executive or other broker-dealer. You may elect either to receive
income dividends in cash and capital gains distributions in additional shares of
the Fund at net asset value ("Split Option"), or to receive both income
dividends and capital gains distributions in cash ("Cash Option"). You may also
direct income dividends and capital gains distributions to be invested in
another mutual fund managed by the Adviser. See "Shareholder Services--Directed
Dividends" above. The taxable status of income dividends and/or net capital
gains distributions is not affected by whether they are reinvested or paid in
cash.
35
<PAGE>
VALUATION OF SHARES
The Funds compute their net asset value on each day the New York Stock
Exchange (the "Exchange") is open for business. The calculation is made as of
the regular close of the Exchange (currently 4:00 p.m. New York time) after the
Funds have declared any applicable dividends.
The net asset value per share for each Fund is determined by dividing the
value of the securities owned by the Fund plus any cash and other assets
(including interest accrued and dividends declared but not collected) less all
liabilities by the number of Fund shares outstanding. For the purposes of
determining the aggregate net assets of the Funds, cash and receivables will be
valued at their face amounts. Interest will be recorded as accrued.
The value of certain fixed-income securities will be provided by an
independent pricing service, which determines these valuations at a time earlier
than the close of the Exchange. Pricing services consider such factors as
security prices, yields, maturities, call features, ratings and developments
relating to specific securities in arriving at securities valuations. Fixed
income securities for which prices are not available from an independent pricing
service but where an active market exists will be valued using market quotations
obtained from one or more dealers that make markets in the securities.
Occasionally events affecting the value of such securities may occur between the
time valuations are determined and the close of the Exchange. If events
materially affecting the value of such securities occur during such period, or
if a Fund's management determines for any other reason that valuations provided
by the pricing service are inaccurate, such securities will be valued at their
fair value according to procedures decided upon in good faith by the Board of
Directors. In addition, any securities or other assets of a Fund for which
market prices are not readily available will be valued at their fair value in
accordance with such procedures.
TAX STATUS
Each Fund is treated as a separate corporation for federal income tax
purposes under the Internal Revenue Code of 1986, as amended (the "Code").
Therefore, each Fund is treated separately in determining whether it qualifies
as a regulated investment company under the Code and for purposes of determining
the net ordinary income (or loss), net realized capital gains (or losses) and
distributions necessary to relieve such Fund of any federal income tax
liability. Each Fund qualified as a regulated investment company during its last
taxable year and each Fund intends to so qualify during the current taxable
year. If so qualified, a Fund will not be liable for federal income taxes to the
extent it distributes its taxable income to shareholders. Each Fund will,
however, be subject to a nondeductible excise tax equal to 4% of the excess, if
any, of the amount required to be distributed pursuant to the Code for each
calendar year over the amount actually distributed. In order to avoid imposition
of this excise tax, a Fund generally must declare dividends by the end of a
calendar year representing 98% of the Fund's ordinary income for the calendar
year and 98% of its capital gain net income (both long-term and short-term
capital gains) for the 12-month period ending October 31 of the calendar year.
Bond Fund retained income subject to the 4% excise tax for the 1995, 1994, 1993
and 1992 excise tax years. Bond Fund intends hereafter to distribute sufficient
amounts to avoid payment of the excise tax.
Distributions by a Fund are generally taxable to the shareholders, whether
received in cash or additional shares of the Fund (or shares of another mutual
fund managed by the Adviser). Distributions of net capital gains (designated as
"capital gain dividends") are taxable to shareholders as long-term capital
gains, regardless of the length of time the shareholder has held the shares of
the Fund.
36
<PAGE>
A shareholder will recognize a capital gain or loss upon the sale or
exchange of shares in a Fund if, as is normally the case, the shares are capital
assets in the shareholder's hands. This capital gain or loss will be long-term
if the shares have been held for more than one year.
The foregoing relates to federal income taxation as in effect as of the date
of this Prospectus. For a more detailed discussion of the federal income tax
consequences of investing in shares of the Funds, see "Taxation" in the
Statement of Additional Information. Before investing in the Funds, you should
check the consequences of your local and state tax laws.
PERFORMANCE COMPARISONS
Advertisements and other sales literature for the Funds may refer to a
Fund's "average annual total return" and "cumulative total return." In addition,
each Fund may provide yield calculations in advertisements and other sales
literature. All such yield and total return quotations are based upon historical
earnings and are not intended to indicate future performance. The return on and
principal value of an investment in any of the Funds will fluctuate, so that an
investor's shares, when redeemed, may be worth more or less than their original
cost.
Yield calculations will be based upon a 30-day period stated in the
advertisement and will be calculated by dividing the net investment income per
share (as defined under Securities and Exchange Commission rules and
regulations) earned during the advertised period by the offering price per share
(including the maximum sales charge) on the last day of the period. The result
will then be "annualized" using a formula that provides for semi-annual
compounding of income.
Average annual total return is the average annual compounded rate of return
on a hypothetical $1,000 investment made at the beginning of the advertised
period. Cumulative total return is calculated by subtracting a hypothetical
$1,000 payment to a Fund from the redeemable value of such payment at the end of
the advertised period, dividing such difference by $1,000 and multiplying the
quotient by 100. In calculating average annual and cumulative total return, the
maximum sales charge is deducted from the hypothetical investment and all
dividends and distributions are assumed to be reinvested. Such total return
quotations may be accompanied by quotations which do not reflect the reduction
in value of the initial investment due to the sales charge, and which thus will
be higher.
Comparative performance information also may be used from time to time in
advertising the Funds' shares. For example, advertisements may compare the
Funds' performance to that of various unmanaged market indices, or may include
performance data from Lipper Analytical Services, Inc., Morningstar, Inc. or
other entities or organizations which track the performance of investment
companies.
For additional information regarding comparative performance information and
the calculation of yield, average annual total return and cumulative total
return, see "Performance Comparisons" in the Statement of Additional
Information.
GENERAL INFORMATION
Piper Funds, which was organized under the laws of State of Minnesota in
1986, is authorized to issue a total of 10 trillion shares of common stock, with
a par value of $.01 per share. Three hundred and ninety billion of these shares
have been authorized by the Board of Directors to be issued in twelve separate
series, as follows: Growth Fund, Emerging Growth Fund, Small Company Growth Fund
(formerly Equity Strategy Fund), Growth and Income Fund, Balanced Fund,
Government Income Fund, Intermediate Bond Fund (formerly Institutional
Government Income Portfolio), National Tax-Exempt Fund and Minnesota Tax-
37
<PAGE>
Exempt Fund, each of which has ten billion authorized shares, and Money Market
Fund, Tax-Exempt Money Market Fund and U.S. Government Money Market Fund, each
of which has one hundred billion authorized shares.
Piper Funds II, which was organized under the laws of the State of Minnesota
on April 10, 1995, is authorized to issue a total of 100 billion shares of
common stock, with a par value of $.01 per share. Ten billion of those shares
have been designated as Series A Common Shares, which are the shares of common
stock of ARMS Fund. Currently, Series A is the only outstanding series of shares
of Piper Funds II.
For both Piper Funds and Piper Funds II, the Board of Directors is empowered
under the Articles of Incorporation to issue additional series of common stock
without shareholder approval. In addition, the Board of Directors may, without
shareholder approval, create and issue one or more additional classes of shares
within each Fund, as well as within any series of Piper Funds or Piper Funds II
created in the future. See "Capital Stock and Ownership of Shares" in the
Statement of Additional Information.
All shares, when issued, will be fully paid and nonassessable and will be
redeemable. All shares have equal voting rights. They can be issued as full or
fractional shares. A fractional share has pro-rata the same kind of rights and
privileges as a full share. The shares possess no preemptive or conversion
rights.
Each share of a series has one vote (with proportionate voting for
fractional shares) irrespective of the relative net asset value of the series'
shares. On some issues, such as the election of directors, all shares of Piper
Funds or Piper Funds II vote together as one series. On an issue affecting only
a particular series, the shares of the affected series vote separately.
Cumulative voting is not authorized. This means that the holders of more than
50% of the shares voting for the election of directors can elect 100% of the
directors if they choose to do so, and, in such event, the holders of the
remaining shares will be unable to elect any directors.
The Bylaws of both Piper Funds and Piper Funds II provide that shareholder
meetings be held only with such frequency as required under Minnesota law.
Minnesota corporation law requires only that the Board of Directors convene
shareholder meetings when it deems appropriate. In addition, Minnesota law
provides that if a regular meeting of shareholders has not been held during the
immediately preceding 15 months, a shareholder or shareholders holding 3% or
more of the voting shares of a corporation may demand a regular meeting of
shareholders by written notice given to the chief executive officer or chief
financial officer of the corporation. Within 30 days after receipt of the
demand, the Board of Directors shall cause a regular meeting of shareholders to
be called, which meeting shall be held no later than 90 days after receipt of
the demand, all at the expense of the corporation. In addition, the 1940 Act
requires a shareholder vote for all amendments to fundamental investment
policies and restrictions, for all amendments to investment advisory contracts
and for certain amendments to Rule 12b-1 distribution plans.
PENDING LEGAL PROCEEDINGS
Complaints have been brought against the Adviser and the Distributor
relating to Bond Fund, to the closed-end investment companies that merged into
Piper Funds II and to other investment companies for which the Adviser acts or
has acted as investment adviser or subadviser. These lawsuits do not involve
Government Fund.
A number of complaints have been brought in federal and state court relating
to Bond Fund (formerly named Institutional Government Income Portfolio
("PJIGX")). A consolidated class action lawsuit was settled in February 1996.
Two complaints remain pending. The first complaint was brought on April 11, 1995
by Frank R. Berman, Trustee of Frank R. Berman Professional CP Pension Plan
Trust. The action was filed in the Minnesota State District Court, Hennepin
County, and removed to United States District Court, District of Minnesota.
Defendants are the Company, the Distributor and certain individuals affiliated
or
38
<PAGE>
formerly affiliated with the Adviser and the Distributor. The second complaint
was filed on June 22, 1995 in the Montana Thirteenth Judicial District Court,
Yellowstone County, by Beverly Muth against the Distributor and an affiliated
individual. In addition, a number of actions have been commenced in arbitration
relating to PJIGX.
Complaints also have been filed in state and federal court relating to a
number of other closed-end investment companies managed by the Adviser and two
open-end investment companies for which the Adviser has acted as sub-adviser. A
consolidated class action lawsuit against four closed-end investment companies
which merged into ARMS Fund in September 1995 was settled in September 1996. The
Adviser and the Distributor also are subject to regulatory inquiries related to
various funds or assets managed by the Adviser. Certain regulatory inquiries
have been settled, including inquiries by the National Association of Securities
Dealers, Inc. and the State of Minnesota. See "Pending Litigation" in the
Statement of Additional Information.
The Adviser and the Distributor do not believe that the settlements
discussed above, any agreement-in-principle to settle, or any outstanding
complaint, action in arbitration or regulatory inquiry will have a material
adverse effect on their ability to perform under their agreements with Piper
Funds or Piper Funds II or a material adverse effect on the Funds.
NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS (AND/OR IN THE STATEMENT OF ADDITIONAL INFORMATION REFERRED TO ON THE
COVER PAGE OF THIS PROSPECTUS), AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUNDS
OR PIPER JAFFRAY INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR
SOLICITATION BY ANYONE IN ANY STATE IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION.
39
<PAGE>
PIPER FUNDS INC.
INVESTMENT ADVISER
Piper Capital Management Incorporated
DISTRIBUTOR
Piper Jaffray Inc.
CUSTODIAN AND TRANSFER AGENT
Investors Fiduciary Trust Company
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
LEGAL COUNSEL
Dorsey & Whitney LLP
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
Introduction........................... 2
Fund Expenses.......................... 4
Financial Highlights................... 6
Investment Objectives and Policies..... 8
Characteristics and Risks of Securities
and Special Investment Methods........ 13
Management............................. 25
Distribution of Fund Shares............ 27
SHAREHOLDER GUIDE TO INVESTING
How to Purchase Shares............... 28
Reducing Your Sales Charge........... 29
Special Purchase Plans............... 30
How to Redeem Shares................. 31
Shareholder Services................. 33
Dividends and Distributions.......... 35
Valuation of Shares.................... 36
Tax Status............................. 36
Performance Comparisons................ 37
General Information.................... 37
</TABLE>
- ----------------------------------------------------------
Prospectus
[LOGO]
------------------------------
Income Funds
Government Income Fund
Intermediate Bond Fund
Adjustable Rate Mortgage
Securities Fund
November 6, 1996
As Supplemented February 18, 1997
------------------------------------------
#30400 117-97
<PAGE>
PROSPECTUS DATED NOVEMBER 27, 1996
AS SUPPLEMENTED FEBRUARY 18, 1997
NATIONAL TAX-EXEMPT FUND
MINNESOTA TAX-EXEMPT FUND
SERIES OF PIPER FUNDS INC.
PIPER JAFFRAY TOWER
222 SOUTH NINTH STREET, MINNEAPOLIS, MINNESOTA 55402-3804
(800) 866-7778 (TOLL FREE)
NATIONAL TAX-EXEMPT FUND AND MINNESOTA TAX-EXEMPT FUND (the "Funds") are
series of Piper Funds Inc. (the "Company"), an open-end mutual fund whose shares
are currently offered in twelve series.
NATIONAL TAX-EXEMPT FUND ("National Fund") has an investment objective of
maximum current income that is exempt from federal income taxes, consistent with
prudent investment risk and preservation of capital. During periods of normal
market conditions, National Fund will invest at least 80% of its net assets in
securities that generate interest that is not includable in gross income for
federal income tax purposes and is not an item of tax preference for purposes of
the federal alternative minimum tax. Such securities include, but are not
limited to, securities of states, territories and possessions of the United
States and the District of Columbia and their agencies, instrumentalities and
political subdivisions, and may also include derivative tax-exempt securities.
MINNESOTA TAX-EXEMPT FUND ("Minnesota Fund") has an investment objective of
maximum current income that is exempt from both federal and State of Minnesota
income taxes, consistent with prudent investment risk and preservation of
capital. During periods of normal market conditions, Minnesota Fund will invest
at least 80% of its net assets in securities that generate interest that is not
includable in federal gross income or in State of Minnesota taxable net income
(except for State of Minnesota franchise tax on corporations and financial
institutions, which is measured by income) and is not an item of tax preference
for purposes of the federal or State of Minnesota alternative minimum tax. Such
securities include, but are not limited to, securities of the State of
Minnesota, its agencies, instrumentalities and political subdivisions, and
certain securities of United States territories and possessions, and may also
include derivative tax-exempt securities. At least 95% of the exempt-interest
dividends paid by Minnesota Fund will be derived from such sources.
PLEASE REMEMBER, YOU COULD LOSE MONEY WITH THIS INVESTMENT. NEITHER SAFETY
OF PRINCIPAL NOR STABILITY OF INCOME IS GUARANTEED.
This Prospectus concisely describes the information about the Funds that you
ought to know before investing. Please read it carefully and retain it for
future reference.
A Statement of Additional Information about the Funds dated November 27,
1996, as supplemented February 18, 1997, is available free of charge. Write to
the Funds at Piper Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota
55402 or telephone (800) 866-7778 (toll free). The Statement of Additional
Information has been filed with the Securities and Exchange Commission and is
incorporated in its entirety by reference in this Prospectus.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR
HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
<PAGE>
INTRODUCTION
Piper Funds Inc. (the "Company") is an open-end management investment
company, or mutual fund, whose shares may be issued in separate diversified and
nondiversified series. Each series in effect represents a separate fund with its
own investment objectives and policies. This Prospectus relates to National Tax-
Exempt Fund ("National Fund") and Minnesota Tax-Exempt Fund ("Minnesota Fund")
(collectively, the "Funds"), which are classified as diversified and
nondiversified funds, respectively. A nondiversified fund such as Minnesota Fund
may have a larger position in a single issuer than would be the case if it were
diversified. The share price of such a fund may therefore be subject to greater
fluctuation as a result of changes in the financial condition or the market's
assessment of an individual issuer.
THE INVESTMENT ADVISER
The Company is managed by Piper Capital Management Incorporated (the
"Adviser"), a wholly owned subsidiary of Piper Jaffray Companies Inc. Each Fund
pays the Adviser a fee for managing its investment portfolio at an annual rate
of .50% on net assets up to $250 million. For each Fund, the fee is scaled
downward as net assets increase in size above $250 million. See "Management --
Investment Adviser."
THE DISTRIBUTOR
Piper Jaffray Inc. ("Piper Jaffray"), a wholly owned subsidiary of Piper
Jaffray Companies Inc. and an affiliate of the Adviser, serves as Distributor of
the Funds' shares.
OFFERING PRICE
Shares of the Funds are offered to the public at the next determined net
asset value after receipt of an order by a shareholder's Piper Jaffray
Investment Executive or other broker-dealer, plus a maximum sales charge of 2%
of the offering price (2.04% of the net asset value) on purchases of less than
$100,000. The sales charge is reduced on a graduated scale on purchases of
$100,000 or more. In connection with purchases of $500,000 or more, there is no
initial sales charge; however, a .50% contingent deferred sales charge will be
imposed in the event of a redemption transaction occurring within 12 months
following such a purchase. DURING THE SPECIAL OFFERING PERIOD WHICH EXTENDS
THROUGH JUNE 30, 1997, SHARES OF THE FUNDS ARE BEING OFFERED TO THE PUBLIC
WITHOUT AN INITIAL SALES CHARGE. HOWEVER, FOR ANY PURCHASE THAT WOULD BE SUBJECT
TO A SALES CHARGE OUTSIDE OF THE SPECIAL OFFERING PERIOD, THE FUNDS WILL IMPOSE
A CONTINGENT DEFERRED SALES CHARGE OF 2% ON REDEMPTIONS DURING THE FIRST 12
MONTHS AFTER PURCHASE, AND 1% ON REDEMPTIONS DURING THE SECOND 12 MONTHS. SEE
"HOW TO PURCHASE SHARES -- PURCHASE PRICE" AND "HOW TO REDEEM SHARES --
CONTINGENT DEFERRED SALES CHARGE."
MINIMUM INITIAL AND SUBSEQUENT INVESTMENTS
The minimum initial investment for each Fund is $250. There is no minimum
for subsequent investments. See "How to Purchase Shares -- Minimum Investments."
EXCHANGES
You may exchange your shares for shares of any other mutual fund managed by
the Adviser which is eligible for sale in your state of residence. All exchanges
are subject to the minimum investment requirements and other applicable terms
set forth in the prospectus of the fund whose shares you acquire. See
"Shareholder Services--Exchange Privilege."
REDEMPTION PRICE
Shares of either Fund may be redeemed at any time at their net asset value
next determined after a redemption request is received by your Piper Jaffray
Investment Executive or other broker-dealer. A contingent deferred sales charge
will be imposed upon the redemption of certain shares initially purchased
2
<PAGE>
without a sales charge. See "How to Redeem Shares -- Contingent Deferred Sales
Charge." Each Fund reserves the right, upon 30 days' written notice, to redeem
your account if the net asset value of the shares falls below $200. See "How to
Redeem Shares -- Involuntary Redemption."
CERTAIN RISK FACTORS TO CONSIDER
An investment in either Fund is subject to certain risks, as set forth in
detail under "Investment Objectives and Policies" and "Special Investment
Methods." As with other mutual funds, there can be no assurance that either Fund
will achieve its objective. Each Fund is subject to interest rate risk (the risk
that rising interest rates will make bonds issued at lower interest rates worth
less). As a result, the value of each Fund's shares will vary. Each Fund is also
subject to credit risk (the risk that a bond issuer will fail to make timely
payments of interest or principal). In addition, if the bonds in a Fund's
portfolio contain call provisions that are currently exercisable, these
securities are likely to be redeemed during a period of declining interest rates
and the Fund most likely will have to reinvest the proceeds in lower yielding
securities. Each Fund, to the extent set forth under "Special Investment
Methods," may engage in the following investment practices: the use of
repurchase agreements and reverse repurchase agreements, the purchase and sale
of securities on a when-issued or delayed delivery basis, which may increase the
volatility of a Fund's net asset value, and the use of futures contracts and
options on futures contracts for hedging purposes. All of these techniques may
increase the volatility of a Fund's net asset value. Each Fund may purchase
derivative tax-exempt securities, including inverse floating obligations, which
may be more volatile than traditional fixed-rate tax-exempt securities. Recent
market experience has shown that certain derivative securities may be extremely
sensitive to changes in interest rates and, as a result, the prices of such
securities may be highly volatile.
SHAREHOLDER INQUIRIES
Any questions or communications regarding a shareholder account should be
directed to your Piper Jaffray Investment Executive or, in the case of shares
held through another broker-dealer, to IFTC at (800) 874-6205. General inquiries
regarding the Funds should be directed to the Funds at the telephone number set
forth on the cover page of this Prospectus.
3
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
NATIONAL MINNESOTA
FUND FUND
----------- ------------
<S> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Charge Imposed on Purchases (as a percentage of offering price)............ 2.00% 2.00%
ANNUAL FUND OPERATING EXPENSES (as a percentage of average net assets)
Management Fees.......................................................................... .50% .50%
Rule 12b-1 Fees (after voluntary fee limitation)*........................................ .24% .24%
Other Expenses........................................................................... .32% .19%
----------- ------
Total Fund Operating Expenses (after voluntary fee limitations).......................... 1.06% .93%
</TABLE>
- ---------
* See the discussion below for an explanation of voluntary Rule 12b-1 fee
limitations.
EXAMPLE
You would pay the following expenses on a $1,000 investment assuming a 5%
annual return and redemption at the end of each time period:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
National Fund.............................................. $ 31 $ 53 $ 77 $ 147
Minnesota Fund............................................. $ 29 $ 49 $ 70 $ 132
</TABLE>
The purpose of the above Fund Expenses table is to assist you in
understanding the various costs and expenses that investors in the Funds will
bear directly or indirectly. THE EXAMPLE CONTAINED IN THE TABLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE
GREATER OR LESS THAN THOSE SHOWN.
The information set forth in the table is based on actual expenses incurred
by the Funds during the fiscal year ended September 30, 1996, except that Rule
12b-1 fees reflect a voluntary limitation by the Distributor of amounts payable
to it under each Fund's Rule 12b-1 Plan to .24% of average daily net assets for
the fiscal year ending September 30, 1997. The Distributor limited Rule 12b-1
fees to .21% of each Fund's average daily net assets for the fiscal year ended
September 30, 1996. Absent such limitation, Total Fund Operating Expenses for
National Fund and Minnesota Fund for the fiscal year ended September 30, 1996
would have been 1.13% and 0.99%, respectively, of average daily net assets. The
voluntary Rule 12b-1 fee limitation may be revised or terminated at any time
after the fiscal 1997 year end. The Adviser may or may not assume additional
expenses of the Funds from time to time, in its discretion, while retaining the
ability to be reimbursed by the Funds for expenses assumed during a fiscal year
prior to the end of such year. The foregoing policy will have the effect of
lowering a Fund's overall expense ratio and increasing yield to investors when
such amounts are assumed or the inverse when such amounts are reimbursed. For
additional information, including a more complete explanation of management and
Rule 12b-1 fees, see "Management -- Investment Adviser" and "Distribution of
Fund Shares."
4
<PAGE>
FINANCIAL HIGHLIGHTS
The following financial highlights show certain per share data and selected
information for a share of capital stock outstanding during the indicated
periods for each Fund. This information has been audited by KPMG Peat Marwick
LLP, independent auditors, and should be read in conjunction with the financial
statements of each Fund contained in its annual report. An annual report of each
Fund is available without charge by contacting the Funds at 800-866-7778 (toll
free). In addition to financial statements, the annual reports contain further
information about the performance of the Funds.
NATIONAL FUND
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988*
------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period.............. $10.69 10.22 11.76 10.94 10.51 9.91 9.99 10.03 10.00
------ ------ ------ ------ ------ ------ ------ ------ ------
Operations:
Net investment income........................... 0.56 0.60 0.57 0.61 0.66 0.68 0.68 0.71 0.12
Net realized and unrealized gains (losses) on
investments................................... 0.12 0.47 (1.21) 0.94 0.43 0.60 (0.08) (0.04) 0.03
------ ------ ------ ------ ------ ------ ------ ------ ------
Total from operations......................... 0.68 1.07 (0.64) 1.55 1.09 1.28 0.60 0.67 0.15
------ ------ ------ ------ ------ ------ ------ ------ ------
Distributions from net investment income++........ (0.56) (0.60) (0.57) (0.61) (0.66) (0.68) (0.68) (0.71) (0.12)
Distributions from realized capital gains--net.... -- -- (0.33) (0.12) -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------
Total distributions........................... (0.56) (0.60) (0.90) (0.73) (0.66) (0.68) (0.68) (0.71) (0.12)
------ ------ ------ ------ ------ ------ ------ ------ ------
Net asset value, end of period.................... $10.81 10.69 10.22 11.76 10.94 10.51 9.91 9.99 10.03
------ ------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------ ------
Total return(%)+.................................. 6.42 10.30 (5.72) 14.76 10.68 13.31 6.15 6.82 1.50
Net assets, end of period (in millions)........... $ 46 57 68 79 59 46 36 36 5
Ratio of expenses to average daily net
assets(%)+++.................................... 1.03 1.01 0.93 0.94 0.94 0.92 0.86 0.80 0.80 **
Ratio of net investment income to average daily
net assets(%)+++................................ 5.15 5.37 5.25 5.42 6.13 6.59 6.78 6.56 5.90 **
Portfolio turnover rate (excluding short-term
securities)(%).................................. 43 28 65 43 35 59 80 57 10
</TABLE>
- ------------
* Period from 7/11/88 (commencement of operations) to 9/30/88.
** Adjusted to an annual basis.
+ Total return is based on the change in net asset value during the year,
assumes reinvestment of all distributions and does not reflect a sales
charge.
++ Amounts included in distributions from net investment income that are
taxable for federal income tax purposes are $0.001, $0.002, $0.013 and
$0.03 per share for the years ended September 30, 1991, 1990 and 1989 and
the period ended September 30, 1988, respectively.
+++ During the periods reflected above, the Adviser and the Distributor
voluntarily waived fees and expenses. Had the maximum Rule 12b-1 fee of
.30% been in effect and had the Fund paid all fees and expenses, the ratios
of expenses and net investment income to average daily net assets would
have been: 1.13%/5.05% in fiscal 1996, 1.09%/5.29% in fiscal 1995,
1.03%/5.15% in fiscal 1994, 1.04%/5.32% in fiscal 1993, 1.10%/5.97% in
fiscal 1992, 1.15%/6.36% in fiscal 1991, 1.13%/6.51% in fiscal 1990,
1.62%/5.74% in fiscal 1989 and 2.76%/3.94% in fiscal 1988. Beginning in
fiscal 1995, the expense ratio reflects the effect of gross expenses paid
indirectly by the Fund. Prior period expense ratios have not been adjusted.
5
<PAGE>
MINNESOTA FUND
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988*
------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period.............. $10.81 10.28 11.43 10.79 10.46 9.92 10.06 9.94 10.00
------ ------ ------ ------ ------ ------ ------ ------ ------
Operations:
Net investment income........................... 0.59 0.66 0.61 0.62 0.64 0.66 0.66 0.68 0.12
Net realized and unrealized gains (losses) on
investments................................... 0.07 0.53 (0.95) 0.68 0.33 0.54 (0.14) 0.12 (0.06)
------ ------ ------ ------ ------ ------ ------ ------ ------
Total from operations......................... 0.66 1.19 (0.34) 1.30 0.97 1.20 0.52 0.80 0.06
------ ------ ------ ------ ------ ------ ------ ------ ------
Distributions from net investment income++........ (0.58) (0.66) (0.61) (0.62) (0.64) (0.66) (0.66) (0.68) (0.12)
Distributions from realized capital gains--net.... -- -- (0.20) (0.04) -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------
Total distributions........................... (0.58) (0.66) (0.81) (0.66) (0.64) (0.66) (0.66) (0.68) (0.12)
------ ------ ------ ------ ------ ------ ------ ------ ------
Net asset value, end of period.................... $10.89 10.81 10.28 11.43 10.79 10.46 9.92 10.06 9.94
------ ------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------ ------
Total return(%)+.................................. 6.24 11.38 (3.14) 12.52 9.56 12.49 5.30 8.23 0.58
Net assets, end of period (in millions)........... $ 126 134 162 169 132 83 63 51 9
Ratio of expenses to average daily net
assets(%)+++.................................... 0.90 0.91 0.89 0.91 0.93 0.92 0.87 0.80 0.80 **
Ratio of net investment income to average daily
net assets(%)+++................................ 5.38 5.80 5.61 5.62 6.00 6.44 6.58 6.45 5.91 **
Portfolio turnover rate (excluding short-term
securities)(%).................................. 35 30 44 29 35 22 41 54 12
</TABLE>
- ------------
* Period from 7/11/88 (commencement of operations) to 9/30/88.
** Adjusted to an annual basis.
+ Total return is based on the change in net asset value during the year,
assumes reinvestment of all distributions and does not reflect a sales
charge.
++ Amounts included in distributions from net investment income that are
taxable for federal income tax purposes are $0.003, $0.001, $0.012, $0.011
and $0.020 per share for the years ended September 30, 1992, 1991, 1990 and
1989 and the period ended September 30, 1988, respectively.
+++ During the periods reflected above, the Adviser and the Distributor
voluntarily waived fees and expenses. Had the maximum Rule 12b-1 fee of
.30% been in effect and had the Fund paid all fees and expenses, the ratios
of expenses and net investment income to average daily net assets would
have been: 0.99%/5.29% in fiscal 1996, 0.99%/5.72% in fiscal 1995,
0.99%/5.51% in fiscal 1994, 1.00%/5.53% in fiscal 1993, 1.01%/5.92% in
fiscal 1992, 1.05%/6.31% in fiscal 1991, 1.06%/6.39% in fiscal 1990,
1.33%/5.92% in fiscal 1989 and 1.97%/4.74% in fiscal 1988. Beginning in
fiscal 1995, the expense ratio reflects the effect of gross expenses paid
indirectly by the Fund. Prior period expense ratios have not been adjusted.
6
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives listed below cannot be changed without shareholder
approval. The investment policies and techniques employed in pursuit of the
Funds' objectives may be changed without shareholder approval, unless such
policy or technique is designated as "fundamental," in which case shareholder
approval is required.
National Fund has an investment objective of maximum current income that is
exempt from federal income taxes, consistent with prudent investment risk and
preservation of capital. During periods of normal market conditions, National
Fund will invest at least 80% of its net assets in Tax-Exempt Securities (as
defined in the following section) the interest payable on which, in the opinion
of bond counsel, is not includable in gross income for federal income tax
purposes under existing laws and is not an item of tax preference for purposes
of the federal alternative minimum tax. Such securities include, but are not
limited to, securities issued by states, territories and possessions of the
United States and the District of Columbia and their agencies, instrumentalities
and political subdivisions.
Minnesota Fund has an investment objective of maximum current income that is
exempt from both federal and State of Minnesota income taxes, consistent with
prudent investment risk and preservation of capital. During periods of normal
market conditions, Minnesota Fund will invest at least 80% of its assets in
Tax-Exempt Securities the interest payable on which, in the opinion of bond
counsel, is not includable in federal gross income or in State of Minnesota
taxable net income under existing laws (except for State of Minnesota franchise
tax on corporations and financial institutions, which is measured by income) and
is not an item of tax preference for purposes of the federal or State of
Minnesota alternative minimum tax. Such securities include, but are not limited
to, securities issued by the State of Minnesota, its agencies, instrumentalities
and political subdivisions, and certain securities issued by United States
territorial possessions. Ninety-five percent or more of the exempt-interest
dividends paid by Minnesota Fund will be derived from interest income on
obligations of the State of Minnesota or its political or governmental
subdivisions, municipalities, governmental agencies or instrumentalities.
There are risks in any investment program, and there is no assurance that
the investment objective of either Fund will be achieved. The net asset value of
the shares issued by each Fund will fluctuate with changes in the market values
of each Fund's investments. See "Investment Objectives and Policies --
Investment Risks," below.
Both Funds intend to emphasize investments in Tax-Exempt Securities with
long-term maturities. The Tax-Exempt Securities purchased by each Fund will be
securities rated, at the time of purchase, within the following grades assigned
by either Moody's Investors Services, Inc. ("Moody's") (Aaa, Aa, A or Baa for
long-term bonds; MIG-1 or MIG-2 for notes and other short-term obligations
having fixed maturities; VMIG-1 or VMIG-2 for notes and other short-term
obligations having a demand feature; and Prime-1 and Prime-2 for commercial
paper) or Standard & Poor's Ratings Services ("Standard & Poor's") (AAA, AA, A
or BBB for municipal bonds; SP-1 and SP-2 for state and municipal notes; and A-1
and A-2 for commercial paper) or will be unrated Tax-Exempt Securities which, at
the time of purchase, are judged by the Adviser to be of comparable quality.
Securities rated Baa or BBB have speculative characteristics and changes in
economic conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than is the case with higher
grade bonds. If the rating of a bond held by one of the Funds drops below Baa or
BBB, the Fund will conduct a credit analysis of the bond prior to determining
whether to retain or dispose of it. In no event, however, will more than 5% of a
Fund's net assets consist of securities that have been down-graded to a rating
lower than BBB or Baa or, if unrated, that are no longer of a quality comparable
to at least a BBB or Baa rating, as determined by the Adviser. The ratings of
Moody's and
7
<PAGE>
Standard & Poor's represent their opinions as to the quality of the Tax-Exempt
Securities which they undertake to rate. It should be emphasized, however, that
ratings are general, and not absolute, standards of quality. Consequently,
Tax-Exempt Securities of the same maturity, interest rate and rating may have
different yields, while Tax-Exempt Securities of the same maturity and interest
rate with different ratings may have the same yield. For a discussion of the
various ratings assigned by Moody's and Standard & Poor's see Appendix A to the
Statement of Additional Information.
Rated as well as unrated Tax-Exempt Securities will be analyzed by the
Adviser on the basis of available information as to creditworthiness and with a
view to various qualitative factors and trends affecting Tax-Exempt Securities
generally. It should be noted, however, that the amount of information about the
financial condition of an issuer of Tax-Exempt Securities may not be as
extensive as that which is made available by many issuers whose securities are
more actively traded.
During normal market conditions, each Fund may invest up to 20% of its net
assets in taxable obligations. Additionally, during periods of abnormal market
conditions when a defensive investment posture is warranted, each Fund
temporarily may invest up to 100% of its net assets in taxable obligations. Such
taxable obligations, whether purchased for liquidity or temporary defensive
purposes, may include the following: Tax-Exempt Securities rated within the
grades set forth above (or unrated and of comparable quality) that generate
interest that is an item of tax preference for purposes of the federal or State
of Minnesota alternative minimum tax; taxable municipal obligations rated within
the grades set forth above for Tax-Exempt Securities (or unrated and of
comparable quality); obligations of the United States government, its agencies
or instrumentalities (such as Treasury bills, notes and bonds); corporate bonds
rated within the three highest grades by either Moody's or Standard & Poor's;
commercial paper rated within the two highest grades by either of such rating
services; certificates of deposit and bankers' acceptances of domestic banks and
savings institutions having total assets at the time of investment in excess of
$1 billion or certificates of deposit of other domestic banks or savings
institutions which are fully insured by the Bank Insurance Fund or the Savings
Association Insurance Fund administered by the Federal Deposit Insurance
Corporation; and repurchase agreements with respect to any of the securities in
which the Fund may invest. The Funds may also hold their assets in cash.
National Fund does not intend to invest more than 25% of its total assets in
securities of governmental units located in any one state, territory or
possession of the United States. In addition, neither Fund will invest more than
25% of its total assets in limited obligation bonds payable only from revenues
derived from facilities or projects within a single industry, provided that
bonds that have been refunded with escrowed U.S. Government securities will not
be subject to this limitation. As to utility companies, gas, electric, water and
telephone companies will be considered as separate industries.
TAX-EXEMPT SECURITIES
Tax-Exempt Securities, as the term is used in this prospectus, include
Municipal Obligations, Derivative Municipal Obligations and Municipal Lease
Obligations, as defined below.
MUNICIPAL OBLIGATIONS. Municipal Obligations include debt obligations
issued by states, cities, local authorities, and possessions and certain
territories of the United States, to obtain funds for various public purposes,
including the construction of such public facilities as airports, bridges,
highways, housing, hospitals, mass transportation, schools, streets and water
and sewer works. Other public purposes for which Municipal Obligations may be
issued include the refinancing of outstanding obligations and the obtaining of
funds for general operating expenses and for loans to other public institutions
and facilities. In addition, certain industrial development, private activity
and pollution control bonds may be included within the term Municipal
Obligations if the interest paid thereon qualifies as exempt from federal income
tax. Municipal
8
<PAGE>
Obligations include long-term obligations, often called municipal bonds, as well
as short-term municipal notes and tax-exempt commercial paper. As noted above,
however, the Funds intend to emphasize investments in Tax-Exempt Securities with
long-term maturities.
The two principal classifications of municipal bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable only from the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise tax or other specific revenue source. Industrial
development, private activity and pollution control bonds are in most cases
revenue bonds and do not generally constitute the pledge of the credit or taxing
power of the issuer of such bonds. There are, of course, variations in the
security of Municipal Obligations, both within a particular classification and
between classifications, depending on numerous factors.
Certain Municipal Obligations may carry variable or floating rates of
interest whereby the rate of interest is not fixed but varies with changes in
specified market rates or indexes, such as a bank prime rate or a tax-exempt
money market index. Accordingly, the yield on such obligations can be expected
to fluctuate with changes in prevailing interest rates.
Other Municipal Obligations are zero coupon securities, which are debt
obligations which do not entitle the holder to any periodic payments prior to
maturity and are issued and traded at a discount from their face amounts. The
discount varies depending on the time remaining until maturity, prevailing
interest rates, liquidity of the security and perceived credit quality of the
issuer. The market prices of zero coupon securities are generally more volatile
than the market prices of securities that pay interest periodically and are
likely to respond to changes in interest rates to a greater degree than do
securities having similar maturities and credit quality that do pay periodic
interest.
DERIVATIVE MUNICIPAL OBLIGATIONS. Each Fund may also acquire Derivative
Municipal Obligations, which are custodial receipts or certificates underwritten
by securities dealers or banks that evidence ownership of future interest
payments, principal payments or both on certain Municipal Obligations. The
underwriter of these certificates or receipts typically purchases Municipal
Obligations and deposits the securities in an irrevocable trust or custodial
account with a custodian bank, which then issues receipts or certificates that
evidence ownership of the periodic unmatured coupon payments and the final
principal payment on the obligations. Although under the terms of a custodial
receipt a Fund typically would be authorized to assert its rights directly
against the issuer of the underlying obligation, the Fund could be required to
assert through the custodian bank those rights as may exist against the
underlying issuer. Thus, in the event the underlying issuer fails to pay
principal and/or interest when due, a Fund may be subject to delays, expenses
and risks that are greater than those that would have been involved if the Fund
had purchased a direct obligation of the issuer. In addition, in the event that
the trust or custodial account in which the underlying security has been
deposited is determined to be an association taxable as a corporation, instead
of a non-taxable entity, it would be subject to state income tax (but not
federal income tax) on the income it earned on the underlying security, and the
yield on the security paid to the Fund and its shareholders would be reduced by
the amount of taxes paid. Furthermore, amounts paid by the trust or custodial
account to a Fund would lose their tax-exempt character and become taxable, for
federal and state purposes, in the hands of the Fund and its shareholders.
However, custodial receipts in which the Funds will invest will be accompanied
by a tax opinion stating that interest payable on the receipts is tax exempt. If
a Fund invests in custodial receipts, it is possible that a portion of the
discount at which the Fund purchases the receipts might have to be accrued as
taxable income during the period that the Fund holds the receipts. See "Tax
Status -- Federal Taxation."
9
<PAGE>
The principal and interest payments on the Municipal Obligations underlying
custodial receipts may be allocated in a number of ways. For example, payments
may be allocated such that certain custodial receipts may have variable or
floating interest rates and others may be stripped securities which pay only the
principal or interest due on the underlying Municipal Obligations. The Funds
currently do not invest in "interest only" or "principal only" custodial
receipts. The Funds may invest in floating rate custodial receipts without
limitation. Each Fund may also invest up to 20% of its total assets in custodial
receipts which are "inverse floating obligations" (also sometimes referred to as
"residual interest bonds"). These securities pay interest rates that vary
inversely to changes in the interest rates of specified short-term Municipal
Obligations or an index of short-term Municipal Obligations. The interest rates
on inverse floating obligations will typically decline as short-term tax-exempt
market interest rates increase and increase as short-term tax-exempt market
rates decline. Such securities have the effect of providing a degree of
investment leverage, since the interest rates on such securities will generally
change at a rate which is a multiple (typically two) of the change in the
interest rates of the specified short-term Municipal Obligations or index. As a
result, the market values of inverse floating obligations will generally be more
volatile than the market values of fixed-rate Municipal Obligations and
investments in these types of obligations will increase the volatility of the
net asset value of shares of the Funds.
Types of Derivative Municipal Obligations other than those described above
can be expected to be developed and marketed from time to time. Consistent with
their investment limitations, the Funds expect to invest in those new types of
Derivative Municipal Obligations that the Adviser believes may assist the Funds
in achieving their investment objectives. Each Fund will notify its shareholders
to the extent that it intends to invest more than 5% of its net assets in such
obligations.
MUNICIPAL LEASE OBLIGATIONS. Also included within the general category of
Tax-Exempt Securities are lease obligations or installment purchase contract
obligations and participations therein issued by tax-exempt issuers such as
state and local governments and their agencies and instrumentalities to finance
the acquisition of equipment and facilities (hereinafter collectively called
"Municipal Lease Obligations"). Each Fund may invest up to 20% of the value of
its net assets in Municipal Lease Obligations. Although Municipal Lease
Obligations do not constitute general obligations of the issuer for which such
issuer's taxing power is pledged, a Municipal Lease Obligation is ordinarily
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the obligation. However, certain Municipal Lease Obligations contain
"non-appropriation" clauses which provide that the issuer has no obligation to
make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. In the case of a
"non-appropriation" lease, the Fund's ability to recover under the lease in the
event of non-appropriation or default will be limited solely to the repossession
of the leased property, without recourse to the general credit of the lessee,
and disposition of the property in the event of foreclosure might prove
difficult. In determining Municipal Lease Obligations in which the Funds will
invest, the Adviser will carefully evaluate the outstanding credit rating of the
issuer (and the probable secondary market acceptance of such credit rating).
Additionally, the Adviser may require that certain municipal lease obligations
be issued or backed by a letter of credit or put arrangement with an independent
financial institution.
SPECIAL CONSIDERATIONS REGARDING INVESTMENTS IN MINNESOTA TAX-EXEMPT SECURITIES
As described herein, except during temporary defensive periods, Minnesota
Fund will invest in Minnesota Tax-Exempt Securities. The Fund is therefore
susceptible to political, economic or regulatory factors affecting issuers of
Minnesota Tax-Exempt Securities. The following information provides only a brief
summary of the complex factors affecting the financial situation in Minnesota.
This information is derived from sources that are generally available to
investors and is based in part on information obtained from various State and
local agencies in Minnesota. It should be noted that the creditworthiness of
obligations
10
<PAGE>
issued by local Minnesota issuers may be unrelated to the creditworthiness of
obligations issued by the State of Minnesota, and that there is no obligation on
the part of the State to make payment on such local obligations in the event of
default. For further information, see "Investment Objectives, Policies and
Restrictions" in the Statement of Additional Information.
Minnesota's constitutionally prescribed fiscal period is a biennium, and
Minnesota operates on a biennial budget basis. Legislative appropriations for
each biennium are prepared and adopted during the final legislative session of
the immediately preceding biennium. Prior to each fiscal year of a biennium, the
State's Department of Finance allots a portion of the applicable biennial
appropriation to each agency or other entity for which an appropriation has been
made. An agency or other entity may not expend monies in excess of its
allotment. If revenues are insufficient to balance total available resources and
expenditures, the State's Commissioner of Finance, with the approval of the
Governor, is required to reduce allotments to the extent necessary to balance
expenditures and forecasted available resources for the then current biennium.
The Governor may prefer legislative action when a large reduction in
expenditures appears necessary, and if the State's legislature is not in session
the Governor is empowered to convene a special session.
Frequently in recent years, legislation has been required to eliminate
projected budget deficits by raising additional revenue, reducing expenditures,
including aids to political subdivisions and higher education, reducing the
State's budget reserve, imposing a sales tax on purchases by local governmental
units, and making other budgetary adjustments. The Minnesota Department of
Finance November 1996 Forecast projects that, under current laws, the State will
complete its current biennium June 30, 1997 with a $522 million surplus, plus a
$350 million cash flow account balance, a $261 million budget reserve, and $186
million in other dedicated accounts. Total General Fund expenditures and
transfers for the biennium are projected to be $18.8 billion. The Forecast for
the biennium ending June 30, 1999 show a General Fund surplus of $1.4 billion,
after funding a $350 million cash flow account, a $261 million budget reserve,
and $186 million in other dedicated accounts, if current law is not changed.
Under current law spending caps, State expenditures for education finance
(K-12), human services, and corrections in the biennium ending June 30, 1999 may
not be sufficient to maintain program levels of the previous biennium. The State
is party to a variety of civil actions that could adversely affect the State's
General Fund. In addition, substantial portions of State and local revenues are
derived from federal expenditures, and reductions in federal aid to the State
and its political subdivisions and other federal spending cuts may have
substantial adverse effects on the economic and fiscal condition of the State
and its local governmental units. Risks are inherent in making revenue and
expenditure forecasts. Economic or fiscal conditions less favorable than those
reflected in state budget forecasts and planning estimates may create additional
budgetary pressures.
State grants and aids represent a large percentage of the total revenues of
cities, towns, counties and school districts in Minnesota. Even with respect to
bonds that are revenue obligations of the issuer and not general obligations of
the State, there can be no assurance that the fiscal problems referred to above
will not adversely affect the market value or marketability of the bonds or the
ability of the respective obligors to pay interest on and principal of the
bonds.
Both possible future changes in federal and State income tax laws, including
rate reductions, and recent Minnesota tax legislation could adversely affect the
value and marketability of Minnesota municipal bonds that are held by the Fund.
See "Tax Status -- Minnesota Taxation" below.
INVESTMENT RISKS
As mutual funds investing in debt securities, each Fund is subject to
interest rate risk, which is the potential for a decline in the prices of
fixed-income securities in which the Funds invest due to rising interest rates.
When interest rates rise, the prices of long-term fixed-income securities
generally fall. Conversely,
11
<PAGE>
when interest rates fall, the prices of such securities generally rise. The
magnitude of these fluctuations will generally be greater at times when a Fund's
average maturity is longer. Each Fund is also subject to credit risk. Credit
risk, also known as default risk, is the possibility that an issuer of a
security will fail to make timely payments of interest or principal. Changes by
recognized rating services in the credit ratings of Tax-Exempt Securities, as
well as changes in the perception of the ability of an issuer to make payments
of interest and principal, will also affect the value of the Funds' investments.
Changes in the value of a Fund's portfolio securities will not affect interest
income derived from those securities but will affect the Fund's net asset value.
The Funds are also subject to call risk. Certain Tax-Exempt Securities which
may be held by the Funds permit the issuer at its option to "call," or redeem,
its securities. If an issuer were to redeem Tax-Exempt Securities held by a Fund
during a time of declining interest rates, the Fund might not be able to
reinvest the proceeds in Tax-Exempt Securities providing as high a level of
investment return as the securities redeemed.
Investments in inverse floating obligations also subject the Funds to risk.
Interest rates on these securities typically decline as short-term market
interest rates increase and increase as short-term market rates decline. As
discussed above, such securities have the effect of providing a degree of
investment leverage and, as a result, the market values of such securities will
generally be more volatile than the market values of fixed-rate Tax-Exempt
Securities. See "Investment Objectives and Policies -- Tax-Exempt Securities --
Derivative Municipal Obligations."
Each Fund may invest in unrated Tax-Exempt Securities determined by the
Adviser, at the time of investment, to be of comparable quality to the rated
securities in which the Fund invests. The Funds will be more dependent upon the
Adviser's investment analysis of such non-rated Tax-Exempt Securities than in
the case of rated securities.
The Adviser believes that, in general, the secondary market for Tax-Exempt
Securities is less liquid than that for taxable fixed-income securities.
Consequently, the ability of a Fund to buy and sell Tax-Exempt Securities may,
at any particular time and with respect to any particular securities, be
limited. The amount of information about the financial condition of an issuer of
Tax-Exempt Securities may not be as extensive as information about corporations
whose securities are publicly traded. Obligations of issuers of Tax-Exempt
Securities may be subject to provisions of bankruptcy, insolvency and other laws
affecting the rights and remedies of creditors, such as the United States
Bankruptcy Code and applicable state laws, which could limit the ability of a
Fund to recover payments of principal or interest on such obligations.
Minnesota Fund is a "nondiversified" fund under the 1940 Act. This means
that it may invest its assets in the securities of a limited number of issuers.
Under the Internal Revenue Code, however, the Fund generally may not invest more
than 25% of its assets in securities of any one issuer, other than U.S.
Government securities. Also with respect to 50% of its total assets, the Fund
may not invest more than 5% of its total assets in the securities of any one
issuer (other than U.S. Government securities). Because of the relatively small
number of issuers of Minnesota Tax-Exempt Securities, Minnesota Fund is more
likely to invest a higher percentage of its assets in the securities of a single
issuer or of a limited number of issuers than a diversified investment company
that invests in a broader range of securities. This practice involves an
increased risk of loss to the Fund if the issuers are unable to make interest or
principal payments or if the market values of such securities decline.
The investment techniques used by each Fund also pose certain risks. See
"Special Investment Methods."
12
<PAGE>
Because of the risks associated with fixed-income investments, the Funds are
intended to be long-term investment vehicles and are not designed to provide
investors with a means of speculating on short-term interest rate movements. No
assurance can be given that the Funds will achieve their objectives or that
shareholders will be protected from the risk of loss that is inherent in
fixed-income investing.
SPECIAL INVESTMENT METHODS
The following discussion describes some of the investment management
practices that the Funds may employ from time to time to facilitate portfolio
management. Certain of these practices could be considered "derivative
transactions." The term "derivatives" has been used to identify a variety of
financial instruments; there is no discrete class of instruments that is covered
by the term. A "derivative" is commonly defined as a financial instrument whose
value is based upon, or derived from, an underlying index, reference rate (e.g.,
interest rates or currency exchange rates), security, commodity or other asset.
Options on securities, futures contracts, options on futures contracts and
when-issued securities transactions are derivative contracts. These derivative
contracts involve varying degrees and types of risk as set forth below.
REPURCHASE AGREEMENTS
Each Fund may enter into repurchase agreements with respect to securities
issued or guaranteed as to payment of principal and interest by the U.S.
Government, its agencies or instrumentalities. A repurchase agreement involves
the purchase by a Fund of securities with the condition that after a stated
period of time the original seller (a member bank of the Federal Reserve System
or a recognized securities dealer) will buy back the same securities
("collateral") at a predetermined price or yield. Repurchase agreements involve
certain risks not associated with direct investments in securities. In the event
the original seller defaults on its obligation to repurchase, as a result of its
bankruptcy or otherwise, the Fund will seek to sell the collateral, which action
could involve costs or delays. In such case, the Fund's ability to dispose of
the collateral to recover such investment may be restricted or delayed. While
collateral will at all times be maintained in an amount equal to the repurchase
price under the agreement (including accrued interest due thereunder), to the
extent proceeds from the sale of collateral were less than the repurchase price
a Fund would suffer a loss. Repurchase agreements maturing in more than seven
days are considered illiquid and subject to each Fund's restriction on investing
in illiquid securities. See "-- Illiquid Securities" below. Additionally,
interest earned by a Fund from repurchase agreements will not be treated for
federal or State of Minnesota income tax purposes as tax-exempt interest. For
additional information concerning repurchase agreements, see "Investment
Policies and Restrictions" in the Statement of Additional Information.
REVERSE REPURCHASE AGREEMENTS
The Funds may engage in "reverse repurchase agreements" with banks and
securities dealers. Reverse repurchase agreements are ordinary repurchase
agreements in which the Fund is the seller of, rather than the investor in,
securities and agrees to repurchase them at an agreed upon time and price. Use
of a reverse repurchase agreement may be preferable to a regular sale and later
repurchase of the securities because it avoids certain market risks and
transaction costs. Because certain of the incidents of ownership of the security
are retained by the Fund, reverse repurchase agreements are considered a form of
borrowing by the Fund from the buyer, collateralized by the security. At the
time a Fund enters into a reverse repurchase agreement, cash or liquid
securities having a value sufficient to make payments for the securities to be
repurchased will be segregated, and will be maintained throughout the period of
the obligation. Reverse repurchase agreements may be used as a means of
borrowing for investment purposes. This speculative technique is referred to as
leveraging. Leveraging may exaggerate the effect on net asset value of any
increase or decrease in the market value of a Fund's portfolio. Money borrowed
for leveraging will be subject to interest costs which may not be deductible for
tax purposes and which could possibly exceed interest income
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earned by the Fund on the investment of such borrowed money. No more than 25% of
the total assets of either Fund will at any time be subject to reverse
repurchase agreements.
BORROWING
Each Fund may borrow money from banks for temporary or emergency purposes in
an amount up to 10% of the value of its total assets. Interest paid by a Fund on
borrowed funds would decrease the net earnings of that Fund. Neither Fund will
purchase portfolio securities while outstanding borrowings (other than reverse
repurchase agreements) exceed 5% of the value of the Fund's total assets. Each
Fund may mortgage, pledge or hypothecate its assets in an amount not exceeding
10% of the value of its total assets to secure temporary or emergency borrowing.
The policies set forth in this paragraph are fundamental and may not be changed
without the approval of a majority of a Fund's shares.
WHEN-ISSUED SECURITIES
Each Fund may purchase and sell Tax-Exempt Securities on a when-issued or
delayed delivery basis. When-issued and delayed delivery transactions arise when
securities are purchased or sold with payment and delivery beyond the regular
settlement date. (When-issued transactions normally settle within 30-45 days.)
On such transactions the payment obligation and the interest rate are fixed at
the time the buyer enters into the commitment. Pending delivery of the
securities, each Fund maintains in a segregated account cash or liquid
securities in an amount sufficient to meet its purchase commitments. The
commitment to purchase securities on a when-issued or delayed delivery basis
involves an element of risk because the value of the securities is subject to
market fluctuation. No interest accrues to the purchaser prior to the settlement
of the transaction and at the time of delivery the market value of the
securities may be less than cost. Purchasing securities on a when-issued or
delayed delivery basis involves the additional risk that the return available in
the market when the delivery takes place will be higher than that obtained in
the transaction itself. These risks could result in increased volatility of a
Fund's net asset value to the extent that the Fund purchases securities on a
when-issued or delayed delivery basis while remaining substantially fully
invested. Although the Funds will only make commitments to purchase such
obligations with the intention of actually acquiring the securities, the Funds
may each sell these securities before the settlement date. If a Fund sells a
when-issued or delayed delivery security before the settlement date, any gain or
loss would not be exempt from federal or Minnesota income tax. For purposes of
the Funds' investment policies, the purchase of securities with a settlement
date occurring on the Public Securities Association approved settlement date is
considered a normal delivery and not a when-issued or delayed delivery purchase.
For additional information concerning when-issued and delayed delivery
transactions, see "Investment Objectives, Policies and Restrictions" in the
Statement of Additional Information.
PUTS
Each Fund may purchase Tax-Exempt Securities which provide for the right to
resell them to the issuer, a bank or a broker-dealer at a specified price within
a specified period of time prior to the maturity date of such obligations. Such
a right to resell, which is commonly known as a "put," may be sold, transferred
or assigned only with the underlying security or securities. Each Fund may pay a
higher price for a Tax-Exempt Security with a put than would be paid for the
same security without a put. The primary purpose of purchasing Tax-Exempt
Securities with puts is to permit each Fund to be as fully invested as
practicable in Tax-Exempt Securities while at the same time providing the Fund
with appropriate liquidity. For additional information concerning puts, see
"Investment Objectives, Policies and Restrictions" in the Statement of
Additional Information.
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FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Funds may purchase and sell municipal bond index futures contracts and
interest rate futures contracts. The futures contracts in which the Funds may
invest have been developed by and are traded on national commodity exchanges.
Municipal bond index futures contracts are based upon The Bond Buyer Municipal
Bond Index, an index comprised of tax-exempt bonds rated A- or higher by
Standard & Poor's or A or higher by Moody's, with remaining maturities of 19
years or more. A buyer entering into a municipal bond index futures contract
will, on a specified future date, pay or receive a final cash payment equal to
the difference between the actual value of the index on the last day of the
contract and the value of the index established by the contract. An interest
rate futures contract is an agreement to purchase or sell an agreed upon amount
of debt securities at a set price for delivery on a future date.
The purpose of the acquisition or sale of a futures contract by a Fund is to
hedge against fluctuations in the value of its portfolio without actually buying
or selling securities. For example, if interest rates are expected to increase,
a Fund might sell futures contracts. If interest rates did increase, the value
of the securities in the Fund's portfolio would decline, but the value of the
Fund's futures contracts would increase at approximately the same rate, thereby
keeping the net asset value of the Fund from declining as much as it otherwise
would have. If, on the other hand, the Fund held cash reserves and short-term
investments pending anticipated investment in long-term obligations and interest
rates were expected to decline, the Fund might purchase interest rate or
municipal bond index futures contracts. Since the behavior of such contracts
would generally be similar to that of long-term securities, the Fund could take
advantage of the anticipated rise in the value of long-term securities without
actually buying them until the market had stabilized. At that time, the Fund
could accept delivery under the futures contracts or the futures contracts could
be liquidated and the Fund's reserves could then be used to buy long-term
securities in the cash market. The Funds will engage in such transactions only
for hedging purposes, on either an asset-based or a liability-based basis, in
each case in accordance with the rules and regulations of the Commodity Futures
Trading Commission. See Appendix B to the Statement of Additional Information.
The Funds may also purchase and sell put and call options on futures
contracts and enter into closing transactions with respect to such options to
terminate existing positions. The Funds may use such options on futures
contracts in connection with their hedging strategies in lieu of purchasing and
selling the underlying futures contracts.
There are risks in using futures contracts and options on futures contracts
as hedging devices. The primary risks associated with the use of futures
contracts and options thereon are (a) the prices of futures contracts and
options may not correlate perfectly with the market value of the securities
subject to the hedge and (b) the possible lack of a liquid secondary market for
a futures contract and the resulting inability to close a futures position prior
to its maturity date. With respect to municipal bond index futures contracts,
the degree of correlation will depend, among other things, upon the differences
between the municipal securities being hedged and the municipal securities
underlying the municipal bond index futures contract. The risk that a Fund will
be unable to close out a futures position will be minimized by entering into
such transactions on a national exchange with an active and liquid secondary
market.
Additional information with respect to futures contracts and options on
futures contracts is set forth in Appendix B to the Statement of Additional
Information.
OTHER HEDGING INSTRUMENTS
The Funds expect that new types of futures contracts, options thereon, and
put and call options on municipal securities and indexes may be developed in the
future that will further enable the Funds to hedge against changes in the value
of their portfolio securities. As new types of hedging futures and options
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instruments are developed and offered to investors, the Adviser will, consistent
with each Fund's investment objective, policies and quality standards, be
permitted to invest in such new types of instruments, provided that any decision
to so invest will be followed by supplementation of this Prospectus.
ILLIQUID SECURITIES
As a nonfundamental investment restriction which may be changed at any time
without shareholder approval, each Fund may invest up to 15%, of its net assets
in illiquid securities. A security is considered illiquid if it cannot be sold
in the ordinary course of business within seven days at approximately the price
at which it is valued. Illiquid securities may offer a higher yield than
securities which are more readily marketable, but they may not always be
marketable on advantageous terms.
The sale of illiquid securities often requires more time and results in
higher brokerage charges or dealer discounts than does the sale of securities
eligible for trading on national securities exchanges or in the over-the-counter
markets. A Fund may be restricted in its ability to sell such securities at a
time when the Adviser deems it advisable to do so. In addition, in order to meet
redemption requests, a Fund may have to sell other assets, rather than such
illiquid or restricted securities, at a time which is not advantageous.
"Restricted securities" are securities which were originally sold in private
placements and which have not been registered under the Securities Act of 1933
(the "1933 Act"). Such securities generally have been considered illiquid, since
they may be resold only subject to statutory restrictions and delays or if
registered under the 1933 Act. In 1990, however, the SEC adopted Rule 144A under
the 1933 Act, which provides a safe harbor exemption from the registration
requirements of the 1933 Act for resales of restricted securities to "qualified
institutional buyers," as defined in the rule. The result of this rule has been
the development of a more liquid and efficient institutional resale market for
restricted securities. Thus, restricted securities are no longer necessarily
illiquid. Neither Fund is subject to any limitation on its ability to invest in
securities simply because such securities are restricted. The Funds may
therefore invest in Rule 144A securities and treat them as liquid when they have
been determined to be liquid by the Board of Directors of the Company or by the
Adviser subject to the oversight of and pursuant to procedures adopted by the
Board of Directors. See "Investment Objectives, Policies and Restrictions --
Illiquid Securities" in the Statement of Additional Information. Similar
determinations may be made with respect to commercial paper issued in reliance
upon the so-called "private placement" exemption from registration under Section
4(2) of the 1933 Act and with respect to municipal lease obligations.
PORTFOLIO TURNOVER
While it is not the policy of either Fund to trade actively for short-term
profits, each Fund will dispose of securities without regard to the time they
have been held when such action appears advisable to the Adviser. In the case of
each Fund, frequent changes may result in higher transaction and other costs for
the Fund. The method of calculating portfolio turnover rate is set forth in the
Statement of Additional Information under "Investment Objectives, Policies and
Restrictions -- Portfolio Turnover." Portfolio turnover rates for the Funds are
set forth in "Financial Highlights."
INVESTMENT RESTRICTIONS
Each Fund has adopted certain fundamental and nonfundamental investment
restrictions in addition to those set forth above. Included among these
restrictions is the nonfundamental investment restriction, which may be changed
at any time without shareholder approval, that neither Fund will invest more
than 5% of its total assets in foreign securities. A list of each Fund's
fundamental and nonfundamental investment restrictions is set forth in the
Statement of Additional Information.
Except for each Fund's policy regarding borrowing, if a percentage
restriction set forth under "Investment Objectives and Policies" or under
"Special Investment Methods" is adhered to at the time of an investment, a later
increase or decrease in percentage resulting from changes in values or assets
will not constitute a violation of such restriction.
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MANAGEMENT
BOARD OF DIRECTORS
The Company's Board of Directors has the primary responsibility for
overseeing the overall management of the Company and electing its officers.
INVESTMENT ADVISER
Piper Capital Management Incorporated has been retained under an Investment
Advisory and Management Agreement with the Company to act as the Funds'
investment adviser subject to the authority of the Board of Directors.
In addition to acting as the investment adviser for the other series of the
Company, the Adviser furnishes investment advice to a number of other open-end
and closed-end investment companies and to various other concerns including
pension and profit sharing funds, corporate funds and individuals. As of January
31, 1997, the Adviser rendered investment advice regarding approximately $9
billion of assets. The Adviser is a wholly owned subsidiary of Piper Jaffray
Companies Inc., a publicly held corporation which is engaged through its
subsidiaries in various aspects of the financial services industry. The address
of the Adviser is Piper Jaffray Tower, 222 South Ninth Street, Minneapolis,
Minnesota 55402.
The Adviser furnishes each Fund with investment advice and supervises the
management and investment programs of the Funds. The Adviser furnishes at its
own expense all necessary administrative services, office space, equipment and
clerical personnel for servicing the investments of the Funds. The Adviser also
provides investment advisory facilities and executive and supervisory personnel
for managing the investments and effecting the portfolio transactions of the
Funds. In addition, the Adviser pays the salaries and fees of all officers and
directors of the Company who are affiliated with the Adviser.
Under the Investment Advisory and Management Agreement, the Funds pay the
Adviser monthly advisory fees. The fee for each Fund is paid at an annual rate
of .50% on average daily net assets up to $250 million, .45% on average daily
net assets over $250 million and up to $500 million and .40% on average daily
net assets over $500 million.
PORTFOLIO MANAGEMENT
Ronald R. Reuss and Douglas J. White have shared primary responsibility for
the day-to-day management of the Funds since they commenced operations in 1988.
Mr. Reuss has been a Senior Vice President of the Adviser since 1989. He is the
Adviser's chief economist and also manages other open-end and closed-end mutual
funds and private accounts. Mr. Reuss earned an MA from Cleveland State
University and has 28 years of investment experience.
Mr. White has been a Senior Vice President of the Adviser since 1991, prior
to which he had been a Vice President since 1989. Mr. White manages other
open-end and closed-end mutual funds and private accounts. He is a Chartered
Financial Analyst, earned an MBA from the University of Minnesota and has 14
years of investment experience.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND CUSTODIAN
Investors Fiduciary Trust Company ("IFTC"), 127 West Tenth Street, Kansas
City, Missouri 64105, (800) 874-6205, serves as Custodian for the Funds'
portfolio securities and cash and as Transfer Agent and Dividend Disbursing
Agent for the Funds.
The Company has entered into Shareholder Account Servicing Agreements with
the Distributor and Piper Trust Company, an affiliate of the Distributor and the
Adviser. Under these agreements the Distributor
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and Piper Trust Company provide transfer agent and dividend disbursing agent
services for certain shareholder accounts. For more information, see "Investment
Advisory and Other Services -- Transfer Agent and Dividend Disbursing Agent" in
the Statement of Additional Information.
PORTFOLIO TRANSACTIONS AND BROKERAGE COMMISSIONS
The Adviser selects brokers or futures commission merchants to use for the
Funds' portfolio transactions. In making its selection, the Adviser may consider
a number of factors, which are more fully discussed in the Statement of
Additional Information, including, but not limited to, research services,
favorableness of net price, the reasonableness of commissions, and quality of
services and execution. A broker's sales of shares of any series of the Company
may also be considered a factor if the Adviser is satisfied that a Fund would
receive from that broker the most favorable price and execution then available
for a transaction. Transactions in Tax-Exempt Securities will generally be with
the issuer or with dealers acting on a principal basis. However, portfolio
transactions for the Funds which are executed on an agency basis may be effected
through the Distributor. For more information, see "Portfolio Transactions and
Allocation of Brokerage" in the Statement of Additional Information.
DISTRIBUTION OF FUND SHARES
Piper Jaffray acts as the principal distributor of the Funds' shares. The
Company has adopted a Distribution Plan (the "Plan") as required by Rule 12b-1
under the 1940 Act. Under the Plan, the Distributor is paid a total fee in
connection with the servicing of each Fund's shareholder accounts and in
connection with distribution related services provided with respect to each
Fund. This fee is calculated daily and paid quarterly at an annual rate equal to
.30% of the average daily net assets of each Fund.
A portion of the total fee equal to 0.05% of each Fund's average daily net
assets is categorized as a distribution fee intended to compensate the
Distributor for its expenses incurred in connection with the sale of Fund
shares. The remaining portion of the fee, equal to .25% of each Fund's average
daily net assets, is categorized as a servicing fee intended to compensate the
Distributor for ongoing servicing and/or maintenance of shareholder accounts.
The Distributor has voluntarily agreed to limit the total fee payable under the
Plan to .24% of each Fund's average daily net assets. This limitation may be
revised or terminated at any time after fiscal 1997 year end. Payments made
under the Plan are not tied exclusively to expenses actually incurred by the
Distributor and may exceed such expenses. The Adviser and the Distributor, out
of their own assets, may pay for certain expenses incurred in connection with
the distribution of shares of the Funds. In particular, the Adviser may make
payments out of its own assets to Piper Jaffray Investment Executives and other
broker dealers in connection with their sales of shares of the Funds. See "How
to Purchase Shares -- Purchase Price." Further information regarding the Plan is
contained in the Statement of Additional Information.
The Distributor uses a portion of its servicing fee to make payments to
Investment Executives of the Distributor and broker-dealers which have entered
into sales agreements with the Distributor. If shares of a Fund are sold by a
representative of a broker-dealer other than the Distributor, the broker-dealer
is paid .20% of the average daily net assets of the Fund attributable to shares
sold by the broker-dealer's representative. If shares of a Fund are sold by an
Investment Executive of the Distributor, compensation is paid to the Investment
Executive in the manner set forth in a written agreement, in an amount not to
exceed .20% of the average daily net assets of the Fund attributable to shares
sold by the Investment Executive.
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SHAREHOLDER GUIDE TO INVESTING
HOW TO PURCHASE SHARES
GENERAL
The Funds' shares may be purchased at the public offering price from the
Distributor and from other broker-dealers who have sales agreements with the
Distributor. The address of the Distributor is that of the Funds. The
Distributor reserves the right to reject any purchase order. You should be aware
that, because the Funds do not issue stock certificates, Fund shares must be
kept in an account with the Distributor or with IFTC. All investments must be
arranged through your Piper Jaffray Investment Executive or other broker-dealer.
PURCHASE PRICE
You may purchase shares of the Funds at the net asset value per share next
calculated after receipt of your order by your Piper Jaffray Investment
Executive or other broker-dealer, plus a front-end sales charge as follows:
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE
AS A PERCENTAGE OF AS A PERCENTAGE OF
AMOUNT OF TRANSACTION AT OFFERING PRICE OFFERING PRICE NET ASSET VALUE
- ----------------------------------------------------- ------------------- -------------------
<S> <C> <C>
Less than $100,000................................... 2.00% 2.04%
$100,000 but less than $250,000...................... 1.25% 1.27%
$250,000 but less than $500,000...................... 0.50% 0.50%
$500,000 and over.................................... 0.00% 0.00%
</TABLE>
During the Special Offering Period, which extends through June 30, 1997, you
may purchase shares of the Funds without an initial sales charge. For any
purchase that would be subject to a sales charge outside of the Special Offering
Period, the Funds will impose a contingent deferred sales charge of 2% on
redemptions during the first 12 months after purchase, and 1% on redemptions
during the second 12 months. See "How to Redeem Shares -- Contingent Deferred
Sales Charge."
The Distributor and other broker-dealers who sell Fund shares receive
compensation from different sources. A portion of this compensation is typically
passed along to your Piper Jaffray Investment Executive or other sales
representative.
The Distributor receives the sales charge (as set forth in the table above)
that you pay upon purchasing shares of the Funds, and reallows a portion of this
to other broker-dealers who sell Fund shares. If the Fund share purchase is not
subject to an initial sales charge, the Distributor may receive a fee (equal to
a percentage of the purchase price) from the Adviser in connection with the
purchase. The Distributor also receives any contingent deferred sales charges
that may be imposed on redemptions of certain Fund shares that were not subject
to an initial sales charge.
The Distributor also receives the Rule 12b-1 fees that are paid out of each
Fund's assets and pays a portion of these fees to broker-dealers who sell Fund
shares. See "Distribution of Fund Shares" above. In addition, the Distributor or
the Adviser, at their own expense, provide promotional incentives to Investment
Executives of the Distributor and to broker-dealers who have sales agreements
with the Distributor in connection with sales of shares of the Funds, other
series of the Company and other mutual funds for which the Adviser acts as
investment adviser. In some instances, these incentives may be made available
only to certain Investment Executives or broker-dealers who have sold or may
sell significant amounts of such shares. The incentives may include payment for
travel expenses, including lodging at luxury resorts, incurred in connection
with sales seminars.
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SHAREHOLDER GUIDE TO INVESTING
PURCHASES OF $500,000 OR MORE
If you make a purchase of $500,000 or more (including purchases made under a
Letter of Intent), a 0.50% contingent deferred sales charge will be assessed in
the event you redeem shares within 12 months following the purchase. For more
information, please refer to the Contingent Deferred Sales Charge section of
"How To Redeem Shares."
MINIMUM INVESTMENTS
A minimum initial investment of $250 is required. There is no minimum for
subsequent investments. The Distributor, in its discretion, may waive the
minimum.
REDUCING YOUR SALES CHARGE
You may qualify for a reduced sales charge through one or more of several
plans. You must notify your Piper Jaffray Investment Executive or broker-dealer
at the time of purchase to take advantage of these plans.
AGGREGATION
Front-end or initial sales charges may be reduced or eliminated by
aggregating your purchase with purchases of certain related personal accounts.
In addition, purchases made by members of certain organized groups will be
aggregated for purposes of determining sales charges. Sales charges are
calculated by adding the dollar amount of your current purchase to the higher of
the cost or current value of shares of any Piper fund sold with a sales charge
that are currently held by you and your related accounts or by other members of
your group.
QUALIFIED GROUPS. You may group purchases in the following personal
accounts together:
-Your individual account.
-Your spouse's account.
-Your children's accounts.
-Your employee benefit plan accounts if they are exclusively for your
benefit. This includes accounts such as IRAs, individual 403(b) plans or
single-participant Keogh-type plans but does not include plans that cover
more than one participant.
-A trust or trusts created for the primary benefit of you, your spouse or
your children.
Additionally, purchases made by members of any organized group meeting the
requirements listed below may be aggregated for purposes of determining sales
charges:
-The group has been in existence for more than six months.
-It is not organized for the purpose of buying redeemable securities of a
registered investment company.
-Purchases must be made through a central administration, or through a
single dealer, or by other means that result in economy of sales effort or
expense.
An organized group does not include a group of individuals whose sole
organizational connection is participation as credit card holders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
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SHAREHOLDER GUIDE TO INVESTING
RIGHT OF ACCUMULATION
Sales charges for purchases of Fund shares into Piper Jaffray accounts will
be automatically calculated taking into account the dollar amount of any new
purchases along with the higher of current value or cost of shares previously
purchased in any other mutual fund managed by the Adviser that was sold with a
sales charge. For other broker-dealer accounts, you should notify your
Investment Executive at the time of purchase of additional Piper fund shares you
may own.
LETTER OF INTENT
Your sales charge may be reduced by signing a non-binding Letter of Intent.
This Letter of Intent will state your intention to invest $100,000 or more in
any of the mutual funds managed by the Adviser that are sold with a sales charge
over a 13-month period, beginning not earlier than 90 days prior to the date you
sign the Letter. You will pay the lower sales charge applicable to the total
amount you plan to invest over the 13-month period. Part of your shares will be
held in escrow to cover additional sales charges that may be due if you do not
invest the planned amount. Please see "Purchase of Shares" in the Statement of
Additional Information for more details. You can contact your Piper Jaffray
Investment Executive or other broker-dealer for an application.
SPECIAL PURCHASE PLANS
For more information on any of the following special purchase plans, contact
your Piper Jaffray Investment Executive or other broker-dealer.
PURCHASES BY PIPER JAFFRAY COMPANIES INC., ITS SUBSIDIARIES AND ASSOCIATED
PERSONS
Piper Jaffray Companies Inc. and its subsidiaries may buy shares of the
Funds without incurring a sales charge. The following persons associated with
such entities also may buy Fund shares without paying a sales charge:
-Officers, directors and their spouses.
-Employees, retirees and their spouses.
-Investment Executives and their spouses.
-Children, grandchildren, parents or siblings of any of the above, or
spouses of any of these persons.
-Any trust, pension, profit-sharing or other benefit plan for any of the
above.
All persons in the first four groups set forth above may continue to add to
their accounts after their company relationships have ended.
PURCHASES BY BROKER-DEALERS
Employees of broker-dealers who have entered into sales agreements with the
Distributor, and spouses and children under the age of 21 of such employees, may
buy shares of the Funds without incurring a sales charge.
PURCHASES BY OTHER INDIVIDUALS WITHOUT A SALES CHARGE
The following other individuals and entities may buy Fund shares without
paying a sales charge:
-Clients of the Adviser buying shares of the Funds in their advisory
accounts.
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SHAREHOLDER GUIDE TO INVESTING
-Trust companies, including Piper Trust Company, and bank trust departments
using funds over which they exercise discretionary investment authority and
which are held in a fiduciary, agency, advisory, custodial or similar
capacity.
-Investors purchasing shares through a Piper Jaffray Investment Executive if
the purchase of such shares is funded by the proceeds from the sale of
shares of any non-money market open-end mutual fund not managed by the
Adviser. This privilege is available for 30 days after the sale.
-Former shareholders of American Government Term Trust Inc. may invest the
distributions received by them in connection with the dissolution of such
fund in shares of the Funds without payment of a sales charge.
-Investors purchasing shares through a wrap fee account established by the
Distributor or by another broker-dealer who has entered into a selected
dealer agreement with the Distributor.
HOW TO REDEEM SHARES
NORMAL REDEMPTION
You may redeem all or a portion of your shares on any day that a Fund values
its shares. (Please refer to "Valuation of Shares" below for more information.)
Your shares will be redeemed at the net asset value next calculated after the
receipt of your instructions in good form by your Piper Jaffray Investment
Executive or other broker-dealer as explained below.
PIPER JAFFRAY INC. ACCOUNTS. To redeem your shares, please contact your
Piper Jaffray Investment Executive with an oral redemption request.
OTHER BROKER-DEALER ACCOUNTS. To redeem your shares, you may either contact
your broker-dealer with an oral request or send a written request directly to
the Funds' transfer agent, IFTC. This request should contain: the dollar amount
or number of shares to be redeemed, your Fund account number and either a social
security or tax identification number (as applicable). You should sign your
request in exactly the same way the account is registered. If there is more than
one owner of the shares, all owners must sign. A signature guarantee is required
for redemptions over $25,000. Please contact IFTC or refer to "Redemption of
Shares" in the Statement of Additional Information for more details.
CONTINGENT DEFERRED SALES CHARGE
If you invest $500,000 or more and, as a result, pay no front-end sales
charge, you may incur a contingent deferred sales charge if you redeem within 12
months. For all redemptions made during the 12-month period this charge will be
equal to .50% of the lesser of the net asset value of the shares at the time of
purchase or at the time of redemption. If you purchased shares during the
Special Offering Period and your purchase would otherwise have been subject to a
front-end sales charge, you will incur a contingent deferred sales charge if you
redeem within 24 months. The contingent deferred sales charge will be equal to
2% of the lesser of the net asset value at the time of purchase or at the time
of redemption for redemptions made during the first 12 months after purchase and
1% during the second 12 months. In both cases, the contingent deferred sales
charge does not apply to amounts representing an increase in the value of Fund
shares due to capital appreciation or to shares acquired through reinvestment of
dividend or capital gain distributions. In determining whether a contingent
deferred sales charge is payable, shares that are not subject to any deferred
sales charge will be redeemed first, and other shares will then be redeemed in
the order purchased.
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SHAREHOLDER GUIDE TO INVESTING
LETTER OF INTENT. In the case of a Letter of Intent, the 12-month period
begins on the date the Letter of Intent is completed.
SPECIAL PURCHASE PLANS. If you purchased your shares through one of the
plans described above under "Special Purchase Plans," the contingent deferred
sales charge will be waived. In addition, the contingent deferred sales charge
will be waived in the event of:
-The death or disability (as defined in Section 72(m)(7) of the Code) of the
shareholder. (This waiver will be applied to shares held at the time of
death or the initial determination of disability of either an individual
shareholder or one who owns the shares as a joint tenant with the right of
survivorship or as a tenant in common.)
-Involuntary redemptions effected pursuant to the right to liquidate
shareholder accounts having an aggregate net asset value of less than $200.
EXCHANGES. In the case of investments of $500,000 or more, if you exchange
your shares, no contingent deferred sales charge will be imposed. However, the
charge will apply if you subsequently redeem the new shares within 12 months of
the original purchase. If you exchange shares purchased from February 18, 1997
through the balance of the Special Offering Period, you must pay the sales
charge for the fund into which you are exchanging. However, except in the case
of an exchange into a money market fund, any contingent deferred sales charge on
your Fund shares will be waived.
REINSTATEMENT PRIVILEGE. If you elect to use the Reinstatement Privilege
(please see "Shareholder Services" below), any contingent deferred sales charge
you paid will be credited to your account (proportional to the amount
reinvested). Please see "Redemption of Shares" in the Statement of Additional
Information for more details.
PAYMENT OF REDEMPTION PROCEEDS
After your shares have been redeemed, proceeds will normally be sent to you
or your broker-dealer within three business days. In no event will payment be
made more than seven days after receipt of your order in good form. However,
payment may be postponed or the right of redemption suspended for more than
seven days under unusual circumstances, such as when trading is not taking place
on the New York Stock Exchange. Payment of redemption proceeds may also be
delayed if the shares to be redeemed were purchased by a check drawn on a bank
which is not a member of the Federal Reserve System, until such checks have
cleared the banking system (normally up to 15 days from the purchase date).
INVOLUNTARY REDEMPTION
Each Fund reserves the right to redeem your account at any time the net
asset value of the account falls below $200 as the result of a redemption or
exchange request. You will be notified in writing prior to any such redemption
and will be allowed 30 days to make additional investments before the redemption
is processed.
SHAREHOLDER SERVICES
AUTOMATIC MONTHLY INVESTMENT PROGRAM
You may arrange to make additional automated purchases of shares of the
Funds or certain other mutual funds managed by the Adviser. You can
automatically transfer $100 or more per month from your bank, savings and loan
or other financial institution to purchase additional shares. In addition, if
you hold your
23
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SHAREHOLDER GUIDE TO INVESTING
shares in a Piper Jaffray account you may arrange to make such additional
purchases by having $25 or more automatically transferred each month from any of
the money market fund series of the Company. You should contact your Piper
Jaffray Investment Executive or IFTC to obtain authorization forms or for
additional information.
REINSTATEMENT PRIVILEGE
If you have redeemed shares of a Fund, you may be eligible to reinvest in
shares of any fund managed by the Adviser without payment of an additional sales
charge. The reinvestment request must be made within 30 days of the redemption.
This privilege is subject to the eligibility of share purchases in your state as
well as the minimum investment requirements and any other applicable terms in
the prospectus of the fund being acquired.
EXCHANGE PRIVILEGE
If your investment goals change, you may prefer a fund with a different
objective. If you are considering an exchange into another mutual fund managed
by the Adviser, you should carefully read the appropriate prospectus for
additional information about that fund. A prospectus may be obtained through
your Piper Jaffray Investment Executive, your broker-dealer or the Distributor.
To exchange your shares, please contact your Piper Jaffray Investment Executive,
your broker-dealer or IFTC.
You may exchange your shares for shares of any other mutual fund managed by
the Adviser. For funds offering multiple classes of shares, such exchanges may
be made only into the Class A shares. All exchanges are subject to the
eligibility of share purchases in your state as well as the minimum investment
requirements and any other applicable terms in the prospectus of the fund being
acquired. Exchanges are made on the basis of the net asset values of the funds
involved, except that investors exchanging into a fund which has a higher sales
charge must pay the difference.
The Company reserves the right to change or discontinue the exchange
privilege, or any aspect of the privilege, upon 60 days' written notice.
TELEPHONE TRANSACTION PRIVILEGES
PIPER JAFFRAY INC. ACCOUNTS. If you hold your shares in a Piper Jaffray
account, you may telephone your Investment Executive to execute any transaction
or to apply for many shareholder services. In some cases, you may be required to
complete a written application.
OTHER BROKER-DEALER ACCOUNTS. If you hold your shares in an account with
your broker-dealer or at IFTC, you may authorize telephone privileges by
completing the Account Application and Services Form. Please contact your
broker-dealer or IFTC (800-874-6205) for an application or for more details. The
Funds will employ reasonable procedures to confirm that a telephonic request is
genuine, including requiring that payment be made only to the address of record
or the bank account designated on the Account Application and Services Form and
requiring certain means of telephonic identification. A Fund employing such
procedures will not be liable for following instructions communicated by
telephone that it reasonably believes to be genuine. If a Fund does not employ
such procedures, it may be liable for any losses due to unauthorized or
fraudulent telephone transactions. It may be difficult to reach the Funds by
telephone during periods when market or economic conditions lead to an unusually
large volume of telephone requests. If you cannot reach the Funds by telephone,
you should contact your broker-dealer or issue written instructions to IFTC at
the address set forth herein. See "Management -- Transfer Agent, Dividend
Disbursing Agent and Custodian." The Funds reserve the right to suspend or
terminate their telephone services at any time without notice.
24
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SHAREHOLDER GUIDE TO INVESTING
DIRECTED DIVIDENDS
You may direct income dividends and capital gains distributions to be
invested in any other mutual fund managed by the Adviser (other than a money
market fund) that is offered in your state. For funds offering multiple classes
of shares, dividends and distributions may be directed only into the Class A
shares. This investment will be made at net asset value. It will not be subject
to a minimum investment amount except that you must hold shares in such fund
(including the shares being acquired with the dividend or distribution) with a
value at least equal to such fund's minimum initial investment amount.
SYSTEMATIC WITHDRAWAL PLAN
If your account has a value of $5,000 or more, you may establish a
Systematic Withdrawal Plan for either Fund. This plan will allow you to receive
regular periodic payments by redeeming as many shares from your account as
necessary. As with other redemptions, a redemption to make a withdrawal is a
sale for federal income tax purposes. Payments made under a Systematic
Withdrawal Plan cannot be considered as actual yield or income since part of the
payments may be a return of capital.
A request to establish a Systematic Withdrawal Plan must be submitted in
writing to your Piper Jaffray Investment Executive or other broker-dealer. There
are no service charges for maintenance; the minimum amount that you may withdraw
each period is $100. You will be required to have any income dividends and any
capital gains distributions reinvested. You may choose to have withdrawals made
monthly, quarterly or semiannually. Please contact your Piper Jaffray Investment
Executive, other broker-dealer or IFTC for more information.
You should be aware that additional investments in an account that has an
active Systematic Withdrawal Plan may be inadvisable due to sales charges and
tax liabilities. Please refer to "Redemption of Shares" in the Statement of
Additional Information for additional details.
ACCOUNT PROTECTION
If your Fund shares are held in a Piper Jaffray account, they are protected
in the unlikely event of Piper Jaffray's financial failure. Piper Jaffray is a
member of the Securities Investor Protection Corporation ("SIPC"), whose primary
purpose is to protect the customers of its members against losses of up to
$500,000 ($100,000 on claims for cash) in the event of a member's liquidation.
In addition to the $500,000 SIPC protection, Piper Jaffray clients have
additional protection provided by Aetna Casualty and Surety Company. Your
investments in the Funds held in a Piper Jaffray PRIME or PAT Plus account are
protected up to $49.5 million beyond the coverage provided by SIPC for total
account protection of $50 million. Investments held in all other Piper Jaffray
accounts are protected up to $24.5 million beyond the coverage provided by SIPC
for total account protection of $25 million. This protection does NOT cover any
declines in the net asset value of Fund shares.
CONFIRMATION OF TRANSACTIONS AND REPORTING OF OTHER INFORMATION
Each time there is a transaction involving your Fund shares, such as a
purchase, redemption or dividend reinvestment, you will receive a confirmation
statement describing that activity. This information will be provided to you
from either Piper Jaffray, your broker-dealer or IFTC. In addition, you will
receive various IRS forms after the first of each year detailing important tax
information and each Fund is required to supply annual and semiannual reports
that list securities held by the Fund and include the current financial
statements of the Fund.
25
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SHAREHOLDER GUIDE TO INVESTING
HOUSEHOLDING. If you have multiple accounts with Piper Jaffray, you may
receive some of the above information in combined mailings. This will not only
help to reduce Fund expenses, it will help the environment by saving paper.
Please contact your Piper Jaffray Investment Executive for more information.
DIVIDENDS AND DISTRIBUTIONS
The net investment income of each Fund will be declared as dividends daily
and paid monthly. Net realized capital gains, if any, will be distributed at
least once annually. Each daily dividend is payable to Fund shareholders of
record at the time of its declaration. "Shareholders of record" includes holders
of shares purchased for which payment has been received by the Distributor or
IFTC, as appropriate, and excludes holders of shares redeemed on that day.
Shares redeemed will earn dividends through the day prior to settlement of the
redemption.
The Funds will not attempt to stabilize distributions and intend to
distribute to their shareholders substantially all of the net investment income
earned during any period. Thus, each Fund's dividends can be expected to vary
from month to month.
DISTRIBUTIONS OPTIONS. All net investment income dividends and net realized
capital gains distributions for a Fund generally will be payable in additional
shares of that Fund at net asset value ("Reinvestment Option"). If you wish to
receive your distributions in cash, you must notify your Piper Jaffray
Investment Executive or other broker-dealer. You may elect either to receive
income dividends in cash and capital gains distributions in additional shares of
the Fund at net asset value ("Split Option"), or to receive both income
dividends and capital gains distributions in cash ("Cash Option"). You may also
direct income dividends and capital gains distributions to be invested in
another mutual fund managed by the Adviser. See "Shareholder Services --
Directed Dividends," above. The taxable status of income dividends and/or net
capital gains distribution is not affected by whether they are reinvested or
paid in cash.
26
<PAGE>
VALUATION OF SHARES
The Funds compute their net asset value on each day the New York Stock
Exchange (the "Exchange") is open for business. The calculation is made as of
the regular close of the Exchange (currently 4:00 p.m., New York time) after the
Funds have declared any applicable dividends.
The net asset value per share for each Fund is determined by dividing the
value of the securities owned by the Fund plus any cash and other assets
(including interest accrued and dividends declared but not collected) less all
liabilities by the number of Fund shares outstanding. For purposes of
determining the aggregate net assets of the Funds, cash and receivables will be
valued at their face amounts. Interest will be recorded as accrued. Financial
futures are valued at the settlement price established each day by the board of
trade or exchange on which they are traded.
The value of certain fixed-income securities will be provided by an
independent pricing service, which determines these valuations at a time earlier
than the close of the Exchange. Pricing services consider such factors as
security prices, yields, maturities, call features, ratings and developments
relating to specific securities in arriving at securities valuations.
Fixed-income securities for which prices are not available from an independent
pricing service but where an active market exists will be valued using market
quotations obtained from one or more dealers that make markets in the
securities. Occasionally events affecting the value of such securities may occur
between the time valuations are determined and the close of the Exchange. If
events materially affecting the value of such securities occur during such
period, or if the Company's management determines for any other reason that
valuations provided by the pricing service or through dealer quotations are
inaccurate, such securities will be valued at their fair value according to
procedures decided upon in good faith by the Company's Board of Directors. In
addition, any securities or other assets of a Fund for which market prices are
not readily available will be valued at their fair value in accordance with such
procedures.
TAX STATUS
FEDERAL TAXATION
Each Fund is treated as a separate corporation for federal income tax
purposes under the Internal Revenue Code of 1986, as amended (the "Code").
Therefore, each Fund is treated separately in determining whether it qualifies
as a regulated investment company under the Code and for purposes of determining
the net ordinary income (or loss), net realized capital gains (or losses) and
distributions necessary to relieve such Fund of any federal income tax
liability. Each Fund qualified as a regulated investment company during the last
taxable year and each Fund intends to so qualify during the current taxable
year. If so qualified, a Fund will not be liable for federal income taxes to the
extent it distributes its taxable income to shareholders.
Each Fund intends to take all actions required under the Code to ensure that
it may pay "exempt interest dividends." If a Fund meets these requirements,
distributions of net interest income from tax-exempt obligations that are
designated by the Fund as exempt-interest dividends will be excludable from the
gross income of the Fund's shareholders. Each Fund's present policy is to
designate exempt-interest dividends annually. Shareholders are required for
information purposes to report exempt-interest dividends and other tax-exempt
interest on their tax returns. Distributions paid from other interest income and
from any net realized capital gains will be taxable to shareholders whether
received in cash or in additional shares. Capital gains from the sale or
exchange of shares are also subject to tax.
Exempt interest dividends attributable to interest income on certain
tax-exempt obligations issued after August 7, 1986 to finance private activities
are treated as an item of tax preference for purposes of computing the
alternative minimum tax for individuals, estates and trusts. Each Fund may
invest in such
27
<PAGE>
obligations, provided that at least 80% of the value of each Fund's net assets
will at all times be invested in tax-exempt obligations the interest on which is
not an item of tax preference. See "Taxation" in the Statement of Additional
Information.
If a Fund invests in custodial receipts (see "Investment Objectives and
Policies -- Tax-Exempt Securities -- Derivative Municipal Obligations"), it is
possible that a portion of the discount at which the Fund purchases the receipts
might have to be accrued as taxable income during the period that the Fund holds
the receipts. Because of the requirement that each Fund distribute 90% of its
net investment income to maintain its status as a regulated investment company,
the Fund would be obligated to distribute taxable income to shareholders in the
amount of its accrued taxable income.
The Tax Reform Act of 1986 imposed new requirements on certain tax-exempt
bonds which, if not satisfied, could result in loss of tax exemption for
interest on such bonds, even retroactively to the date of issuance of the bonds.
Proposals may be introduced before Congress in the future, the purpose of which
will be to further restrict or eliminate the federal income tax exemption for
Tax-Exempt Securities. The Funds cannot predict what additional legislation may
be enacted that may affect shareholders. The Funds will avoid investment in
Tax-Exempt Securities which, in the opinion of the Adviser, pose a material risk
of the loss of tax exemption. Further, if a Tax-Exempt Security in a Fund's
portfolio loses its exempt status, the Fund will make every effort to dispose of
such investment on terms that are not detrimental to the Fund.
The exclusion from federal gross income of exempt-interest dividends will
not necessarily result in exclusion under the income tax laws of any state or
local governmental unit.
MINNESOTA TAXATION
The portion of exempt-interest dividends that is derived from interest
income on obligations of the State of Minnesota or its political or governmental
subdivisions, municipalities, governmental agencies or instrumentalities is
excluded from the Minnesota taxable net income of individuals, estates and
trusts, provided that the portion of the exempt-interest dividends from such
Minnesota sources paid to all shareholders represents 95% or more of the
exempt-interest dividends paid by the Fund. The remaining portion of such
dividends, and dividends that are not exempt-interest dividends or capital gain
dividends, are included in the Minnesota taxable net income of individuals,
estates and trusts. Minnesota Fund intends to meet this 95% requirement, so that
the dividends it pays that are attributable to interest on Minnesota obligations
will be excludable from the Minnesota taxable income of shareholders that are
individuals, estates and trusts. National Fund, however, will not meet the 95%
requirement, and accordingly all exempt interest dividends paid by the National
Fund will be taxable in Minnesota. Exempt-interest dividends are not excluded
from the Minnesota taxable income of corporations and financial institutions.
Dividends qualifying for federal income tax purposes as capital gain dividends
are to be treated by shareholders as long-term capital gains under Minnesota
law. However, Minnesota has repealed the favorable treatment of long-term
capital gains, while retaining restrictions on the deductibility of capital
losses. As under federal law, the portion of Social Security benefits subject to
Minnesota income tax may be affected by the amount of exempt-interest dividends
received by the shareholders. Exempt-interest dividends attributable to interest
on certain private activity bonds issued after August 7, 1986 will be included
in Minnesota alternative minimum taxable income of individuals, estates and
trusts for purposes of computing Minnesota's alternative minimum tax.
The Minnesota Legislature has enacted a statement of intent that interest on
obligations of Minnesota governmental units and Indian tribes be included in net
income of individuals, estates and trusts for Minnesota income tax purposes if a
court determines that Minnesota's exemption of such interest unlawfully
discriminates against interstate commerce because interest on obligations of
governmental issuers
28
<PAGE>
located in other states is so included. This provision applies to taxable years
that begin during or after the calendar year in which any such court decision
becomes final, irrespective of the date on which the obligations were issued.
Minnesota Fund is not aware of any decision in which a court has held that a
state's exemption of interest on its own bonds or those of its political
subdivisions or Indian tribes, but not of interest on the bonds of other states
or their political subdivisions or Indian tribes, unlawfully discriminates
against interstate commerce or otherwise contravenes the United States
Constitution. Nevertheless, Minnesota Fund cannot predict the likelihood that
interest on the Minnesota Tax-Exempt Securities held by the Fund would become
taxable under this Minnesota statutory provision.
The foregoing discussion relates to federal and Minnesota income taxation as
of the date of this Prospectus. For a more detailed discussion of the income tax
consequences of investing in shares of the Funds, see "Taxation" in the
Statement of Additional Information. Before investing in either of the Funds,
you should check for any further consequences under applicable local and state
tax laws.
PERFORMANCE COMPARISONS
Advertisements and other sales literature for the Funds may refer to their
"yield," "tax equivalent yield," "average annual total return" and "cumulative
total return." All such figures are based on historical earnings and are not
intended to indicate future performance. The return on and principal value of an
investment in the Funds will fluctuate, so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
The advertised yield of a Fund will be based upon a 30-day period stated in
the advertisement. Yield is calculated by dividing the net investment income per
share (as defined under Securities and Exchange Commission rules and
regulations) earned during the period by the maximum offering price per share on
the last day of the period. The result is then annualized using a formula that
provides for semiannual compounding of income.
Tax equivalent yield is calculated by applying the stated income tax rate
only to that portion of the yield that is exempt from taxation. The tax-exempt
portion of the yield is divided by the number 1 minus the stated income tax rate
(E.G., 1- 28% = 72%). The result is then added to that portion of the yield, if
any, that is not tax exempt.
The average annual total return is the average annual compounded rate of
return on a hypothetical $1,000 investment made at the beginning of the
advertised period. Cumulative total return is calculated by subtracting a
hypothetical $1,000 payment to a Fund from the redeemable value of such payment
at the end of the advertised period, dividing such difference by $1,000 and
multiplying the quotient by 100. In calculating average annual and cumulative
total return, the maximum sales charge is deducted from the hypothetical
investment and all dividends and distributions are assumed to be reinvested.
Such total return quotations may be accompanied by quotations which do not
reflect the reduction in value of the initial investment due to the sales
charge, and which thus will be higher.
Comparative performance information may also be used from time to time in
advertising the Funds' shares. For example, advertisements may compare a Fund's
performance to that of various unmanaged market indices, or may include
performance data from Lipper Analytical Services, Inc., Morningstar, Inc. or
other entities or organizations that track the performance of investment
companies.
For additional information regarding comparative performance information and
the calculation of a Fund's yield, tax equivalent yield and total return, see
"Performance Comparisons" in the Statement of Additional Information.
29
<PAGE>
Advertisements and other sales literature may also refer to a Fund's
effective duration. Effective duration estimates the interest rate risk (price
volatility) of a security, I.E., how much the value of the security is expected
to change with a given change in interest rates. The longer a security's
effective duration, the more sensitive its price is to changes in interest
rates. For example, if interest rates were to increase by 1%, the market value
of a bond with an effective duration of five years would decrease by about 5%,
with all other factors being constant. It is important to understand that, while
a valuable measure, effective duration is based upon certain assumptions and has
several limitations. It is most effective as a measure of interest rate risk
when interest rate changes are small, rapid and occur equally across all the
different points of the yield curve. In addition, effective duration is
difficult to calculate precisely, especially in the case of a bond that is
callable prior to maturity.
GENERAL INFORMATION
The Company, which was organized under the laws of the State of Minnesota in
1986, is authorized to issue a total of 10 trillion shares of common stock, with
a par value of $.01 per share. Three hundred and ninety billion of these shares
have been authorized by the Board of Directors to be issued in twelve separate
series, as follows: Growth Fund, Emerging Growth Fund, Growth and Income Fund,
Small Company Growth Fund (formerly Equity Strategy Fund), Balanced Fund,
Government Income Fund, Intermediate Bond Fund (formerly Institutional
Government Income Portfolio), National Tax-Exempt Fund and Minnesota Tax-Exempt
Fund, each of which has ten billion authorized shares, and Money Market Fund,
Tax-Exempt Money Market Fund and U.S. Government Money Market Fund, each of
which has one hundred billion authorized shares.
The Board of Directors is empowered under the Company's Articles of
Incorporation to issue additional series of the Company's common stock without
shareholder approval. In addition, the Board of Directors may, without
shareholder approval, create and issue one or more additional classes of shares
within each Fund, as well as within any other series of the Company or any
series created in the future. See "Capital Stock and Ownership of Shares" in the
Statement of Additional Information.
All shares, when issued, will be fully paid and nonassessable and will be
redeemable. All shares have equal voting rights. They can be issued as full or
fractional shares. A fractional share has pro rata the same kind of rights and
privileges as a full share. The shares possess no preemptive or conversion
rights.
Each share of a series has one vote (with proportionate voting for
fractional shares) irrespective of the relative net asset value of the series'
shares. On some issues, such as the election of directors, all shares of the
Company vote together as one series. Cumulative voting is not authorized. This
means that the holders of more than 50% of the shares voting for the election of
directors can elect 100% of the directors if they choose to do so, and, in such
event, the holders of the remaining shares will be unable to elect any
directors.
The Bylaws of the Company provide that shareholder meetings be held only
with such frequency as required under Minnesota law. Minnesota corporation law
requires only that the Board of Directors convene shareholder meetings when it
deems appropriate. In addition, Minnesota law provides that if a regular meeting
of shareholders has not been held during the immediately preceding 15 months, a
shareholder or shareholders holding 3% or more of the voting shares of the
Company may demand a regular meeting of shareholders by written notice given to
the chief executive officer or chief financial officer of the Company. Within 30
days after receipt of the demand, the Board of Directors shall cause a regular
meeting of shareholders to be called, which meeting shall be held no later than
90 days after receipt of the demand, all at the expense of the Company. In
addition, the 1940 Act requires a shareholder vote for all amendments to
30
<PAGE>
fundamental investment policies and restrictions and for certain amendments to
investment advisory contracts and Rule 12b-1 distribution plans.
PENDING LEGAL PROCEEDINGS
Complaints have been brought against the Adviser and the Distributor
relating to another series of the Company and to other investment companies for
which the Adviser acts or has acted as investment adviser or subadviser. These
lawsuits do not involve the Funds.
A number of complaints have been brought in federal and state court relating
to the Institutional Government Income Portfolio ("PJIGX") series of the Company
(such series has been renamed Intermediate Bond Fund). A consolidated class
action lawsuit was settled in February 1996. Two complaints remain pending. The
first complaint was brought on April 11, 1995 by Frank R. Berman, Trustee of
Frank R. Berman Professional CP Pension Plan Trust. The action was filed in the
Minnesota State District Court, Hennepin County, and removed to United States
District Court, District of Minnesota. Defendants are the Company, the
Distributor and certain individuals affiliated or formerly affiliated with the
Adviser and the Distributor. The second complaint was filed on June 22, 1995 in
the Montana Thirteenth Judicial District Court, Yellowstone County, by Beverly
Muth against the Distributor and an affiliated individual. In addition, a number
of actions have been commenced in arbitration relating to PJIGX.
Complaints also have been filed in state and federal court relating to a
number of closed-end investment companies managed by the Adviser and two
open-end investment companies for which the Adviser has acted as subadviser. The
Adviser and the Distributor also are subject to regulatory inquiries related to
various funds or assets managed by the Adviser. Certain regulatory inquiries
have been settled, including inquiries by the National Association of Securities
Dealers, Inc. and the State of Minnesota. See "Pending Litigation" in the
Statement of Additional Information.
The Adviser and the Distributor do not believe that any outstanding
complaint or action in arbitration or regulatory inquiry will have a material
adverse effect on their ability to perform under their agreements with the
Company or a material adverse effect on the Funds.
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<PAGE>
TAX-EXEMPT VS. TAXABLE INCOME
The tables below show the approximate yields that taxable securities must
earn to equal federally tax-exempt yields and yields that are exempt from both
federal and Minnesota income taxes under selected combined federal/Minnesota
income tax brackets, which reflect effective combined rates after deducting
Minnesota taxes from federal income. The combined federal/Minnesota tax brackets
assume the federal rate listed in the column above each combined bracket and a
Minnesota income tax rate of 8.5% (except the 33.8% combined rate, which assumes
a Minnesota rate of 8%). The 39.6% federal rate and the 8.5% Minnesota rate are
the highest rates currently scheduled to be in effect for individuals in 1997.
<TABLE>
<CAPTION>
NATIONAL TAX-EXEMPT FUND
EQUIVALENT TAXABLE YIELD
-----------------------------------------------------------------------------------
TAX-FREE 28% 31% 36% 39.6%
YIELD FEDERAL BRACKET FEDERAL BRACKET FEDERAL BRACKET FEDERAL BRACKET
-------- ----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
4.00 % 5.56% 5.80% 6.25% 6.62%
4.50 6.25 6.52 7.03 7.45
5.00 6.94 7.25 7.81 8.28
5.50 7.64 7.97 8.59 9.11
6.00 8.33 8.70 9.38 9.93
6.50 9.03 9.42 10.16 10.76
7.00 9.72 10.14 10.94 11.59
7.50 10.42 10.87 11.72 12.42
8.00 11.11 11.59 12.50 13.25
<CAPTION>
MINNESOTA TAX-EXEMPT FUND
EQUIVALENT TAXABLE YIELD
-----------------------------------------------------------------------------------
33.8% COMBINED 36.9% COMBINED 41.4% COMBINED 44.7% COMBINED
TAX-FREE FEDERAL/MINNESOTA FEDERAL/MINNESOTA FEDERAL/MINNESOTA FEDERAL/MINNESOTA
YIELD BRACKET BRACKET BRACKET BRACKET
-------- ----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
4.00 % 6.04% 6.34% 6.83% 7.23%
4.50 6.80 7.13 7.68 8.14
5.00 7.55 7.92 8.53 9.04
5.50 8.31 8.72 9.39 9.95
6.00 9.06 9.51 10.24 10.85
6.50 9.82 10.30 11.09 11.75
7.00 10.57 11.09 11.95 12.66
7.50 11.33 11.89 12.80 13.56
8.00 12.08 12.68 13.65 14.47
<CAPTION>
</TABLE>
These charts do not take into consideration any federal or Minnesota
alternative minimum tax. In addition, each chart is based upon yields that are
derived solely from tax-exempt income. To the extent a Fund's advertised yield
is derived from taxable income, the Fund's equivalent taxable yield will be less
than set forth in the chart. The tax-free yields used in these charts should not
be considered as representations of any particular rates of return and are for
purposes of illustration only.
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<PAGE>
COMPARISON OF THE EFFECT OF COMPOUNDING
ON TAXABLE AND TAX-EXEMPT INVESTMENTS
The graphs below demonstrate the effect that compounding has on taxable and
tax-exempt investments with similar dividend yields for selected federal tax
brackets and selected combined federal/Minnesota tax brackets. Dividends on an
after-tax basis are assumed to be invested and compounded monthly.
$10,000 Compounded at 5.10%
TAX-EXEMPT VERSUS A 6.50% BOND COMPOUNDED AFTER FEDERAL TAX
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
<S> <C> <C> <C>
FEDERAL TAX FREE AFTER TAX 6.50% BOND AFTER TAX 6.50% BOND
<CAPTION>
EARN 5.10% FEDERAL TAX BRACKET 31.0% FEDERAL TAX BRACKET 36.0%
<S> <C> <C> <C>
9/30/96 10,000 10,000 10,000
9/30/97 10,522 10,458 10,424
9/30/98 11,071 10,937 10,866
9/30/99 11,649 11,437 11,327
9/30/00 12,258 11,961 11,807
9/30/01 12,898 12,509 12,308
9/30/02 13,571 13,081 12,830
9/30/03 14,280 13,680 13,374
9/30/04 15,025 14,307 13,941
9/30/05 15,810 14,962 14,532
9/30/06 16,635 15,647 15,148
9/30/07 17,503 16,363 15,790
9/30/08 18,417 17,112 16,460
9/30/09 19,379 17,895 17,158
9/30/10 20,391 18,715 17,885
9/30/11 21,455 19,572 18,644
9/30/12 22,575 20,468 19,434
9/30/13 23,754 21,405 20,258
9/30/14 24,994 22,385 21,117
9/30/15 26,299 23,410 22,013
9/30/16 27,672 24,481 22,946
9/30/17 29,117 25,602 23,919
9/30/18 30,637 26,774 24,933
9/30/19 32,237 28,000 25,990
9/30/20 33,920 29,282 27,093
9/30/21 35,690 30,623 28,241
9/30/22 37,554 32,025 29,439
9/30/23 39,514 33,491 30,687
9/30/24 41,578 35,024 31,988
9/30/25 43,748 36,628 33,345
9/30/26 46,032 38,305 34,759
</TABLE>
$10,000 Compounded at 5.00%
DOUBLE TAX-EXEMPT VERSUS A 6.50% BOND COMPOUNDED AFTER FEDERAL AND
MINNESOTA TAX
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
MINNESOTA AND AFTER TAX 6.50% AFTER TAX 6.50%
FEDERAL TAX BOND MINNESOTA AND BOND MINNESOTA AND
FREE EARN 5.00% FEDERAL TAX BRACKET 36.9% FEDERAL TAX BRACKET 41.4%
<S> <C> <C> <C>
9/30/1996 10000 10000 10000
9/30/1997 10512 10418 10388
9/30/1998 11049 10853 10790
9/30/1999 11615 11307 11209
9/30/2000 12209 11780 11643
9/30/2001 12834 12272 12094
9/30/2002 13490 12785 12563
9/30/2003 14180 13319 13050
9/30/2004 14906 13876 13556
9/30/2005 15668 14456 14081
9/30/2006 16470 15060 14627
9/30/2007 17313 15689 15194
9/30/2008 18198 16345 15783
9/30/2009 19130 17028 16395
9/30/2010 20108 17740 17030
9/30/2011 21137 18481 17691
9/30/2012 22218 19254 18376
9/30/2013 23355 20058 19089
9/30/2014 24550 20897 19828
9/30/2015 25806 21770 20597
9/30/2016 27126 22680 21395
9/30/2017 28514 23628 22225
9/30/2018 29973 24616 23086
9/30/2019 31507 25644 23981
9/30/2020 33118 26716 24911
9/30/2021 34813 27833 25876
9/30/2022 36594 28996 26879
9/30/2023 38466 30208 27921
9/30/2024 40434 31470 29003
9/30/2025 42503 32786 30128
9/30/2026 44677 34156 31296
</TABLE>
Each graph assumes that dividend yield and taxable income remain constant
and that taxable dividend income earned does not put an investor into a higher
tax bracket. The assumed dividend yields used in these graphs should not be
considered as representations of any particular rates of return and are for
purposes of illustration only.
33
<PAGE>
NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS (AND/OR IN THE STATEMENT OF ADDITIONAL INFORMATION REFERRED TO
ON THE COVER PAGE OF THIS PROSPECTUS), AND, IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
FUNDS OR PIPER JAFFRAY INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR
SOLICITATION BY ANYONE IN THE STATE IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION.
34
<PAGE>
PIPER FUNDS INC.
INVESTMENT ADVISER
Piper Capital Management Incorporated
DISTRIBUTOR
Piper Jaffray Inc.
CUSTODIAN AND TRANSFER AGENT
Investors Fiduciary Trust Company
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
LEGAL COUNSEL
Dorsey & Whitney LLP
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
Introduction................................ 2
Fund Expenses............................... 4
Financial Highlights........................ 5
Investment Objectives and Policies.......... 7
Special Investment Methods.................. 13
Management.................................. 17
Distribution of Fund Shares................. 18
SHAREHOLDER GUIDE TO INVESTING
How to Purchase Shares.................... 19
Reducing Your Sales Charge................ 20
Special Purchase Plans.................... 21
How to Redeem Shares...................... 22
Shareholder Services...................... 23
Dividends and Distributions............... 26
Valuation of Shares......................... 27
Tax Status.................................. 27
Performance Comparisons..................... 29
General Information......................... 30
Tax-Exempt vs. Taxable Income............... 32
Comparison of the Effect of Compounding on
Taxable and Tax-Exempt Investments......... 33
</TABLE>
- ----------------------------------------------
Prospectus
[LOGO]
--------------------------
Tax-Exempt Income Funds
National Tax-Exempt Fund
Minnesota Tax-Exempt Fund
November 27, 1996
As Supplemented February 18, 1997
----------------------------------------
#30500 117-97
<PAGE>
PART B
NATIONAL TAX-EXEMPT FUND
MINNESOTA TAX-EXEMPT FUND
Series of Piper Funds Inc.
STATEMENT OF ADDITIONAL INFORMATION
November 27, 1996
As Supplemented February 18, 1997
Table of Contents
Page
----
Investment Policies and Restrictions . . . . . . . . . . . . . 2
Directors and Executive Officers . . . . . . . . . . . . . . . 6
Investment Advisory and Other Services. . . . . . . . . . . . . 10
Portfolio Transactions and Allocation of Brokerage. . . . . . . 15
Capital Stock and Ownership of Shares . . . . . . . . . . . . . 17
Net Asset Value and Public Offering Price . . . . . . . . . . . 18
Performance Comparisons . . . . . . . . . . . . . . . . . . . . 19
Purchase of Shares. . . . . . . . . . . . . . . . . . . . . . . 22
Redemption of Shares. . . . . . . . . . . . . . . . . . . . . . 22
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
General Information . . . . . . . . . . . . . . . . . . . . . . 26
Financial Statements. . . . . . . . . . . . . . . . . . . . . . 27
Pending Litigation. . . . . . . . . . . . . . . . . . . . . . . 27
Appendix A - Ratings of Tax-Exempt Securities and
Commercial Paper . . . . . . . . . . . . . . . . . . . . . . A-1
Appendix B - Futures Contracts and Options . . . . . . . . . . B-1
This Statement of Additional Information is not a prospectus. This
Statement of Additional Information relates to the Prospectus dated November 27,
1996, as supplemented February 18, 1997, and should be read in conjunction
therewith. A copy of the Prospectus may be obtained from the Funds at Piper
Jaffray Tower, 222 South Ninth Street, Minneapolis, Minnesota 55402.
-1-
<PAGE>
INVESTMENT POLICIES AND RESTRICTIONS
The shares of Piper Funds Inc. (the "Company") are currently offered in
twelve series. This Statement of Additional Information relates to two of those
series, National Tax-Exempt Fund ("National Fund") and Minnesota Tax-Exempt Fund
("Minnesota Fund") (sometimes referred to herein as a "Fund" or, collectively,
as the "Funds"). The investment objectives and policies of the Funds are set
forth in the Prospectus. Certain additional investment information is set forth
below.
REPURCHASE AGREEMENTS
Each Fund may invest in repurchase agreements. The Funds' custodian will
hold the securities underlying any repurchase agreement or such securities will
be part of the Federal Reserve Book Entry System. The market value of the
collateral underlying the repurchase agreement will be determined on each
business day. If at any time the market value of the collateral falls below the
repurchase price of the repurchase agreement (including any accrued interest),
the respective Fund will promptly receive additional collateral (so the total
collateral is an amount at least equal to the repurchase price plus accrued
interest).
The Funds have received from the Securities and Exchange Commission an
exemptive order permitting the Funds, along with the other series of the
Company, closed-end and other open-end investment companies managed by Piper
Capital Management Incorporated (the "Adviser"), and all future series of the
Company and all future investment companies advised by the Adviser or its
affiliates, to deposit uninvested cash balances into a single joint account to
be used to enter into one or more large repurchase agreements.
WHEN-ISSUED AND FORWARD COMMITMENT SECURITIES
Each Fund may purchase securities on a "when-issued" basis and may purchase
or sell securities on a "forward commitment" basis. When a Fund purchases
securities on a when-issued or forward commitment basis, it will maintain in a
segregated account with its custodian cash or liquid securities having an
aggregate value equal to the amount of such purchase commitments until payment
is made; the Fund will likewise segregate securities it sells on a forward
commitment basis.
PUTS
To help assure appropriate liquidity, each Fund may acquire Tax-Exempt
Securities (as defined in the Funds' Prospectus) which provide for the right to
resell them to the issuer, a bank or a broker-dealer at a specified price within
a specified period of time prior to the maturity date of such obligation. Such
a right to resell, which is commonly known as a "put," may be sold, transferred
or assigned only with the underlying security or securities. If an issuer, bank
or broker-dealer should default on its obligation to repurchase a security, a
Fund might be unable to recover all or a portion of any loss sustained from
having to sell the security elsewhere. It
-2-
<PAGE>
will be each Fund's policy to enter into puts only with issuers, banks or
broker-dealers that are determined by the Adviser to present minimal credit
risks.
DIVERSIFICATION
Although Minnesota Fund is characterized as a nondiversified fund under the
Investment Company Act of 1940, as amended (the "1940 Act"), the Fund must meet
certain diversification requirements in order to qualify as a regulated
investment company for federal income tax purposes. To so qualify, the Fund
must diversify its holdings so that, at the close of each quarter of its taxable
year, (a) at least 50% of the value of its total assets consists of cash, cash
items, securities issued by the U.S. Government, its agencies and
instrumentalities, the securities of other regulated investment companies, and
other securities limited generally with respect to any one issuer to not more
than 5% of the total assets of the Fund and not more than 10% of the outstanding
voting securities of such issuer, and (b) not more than 25% of the value of its
total assets is invested in the securities of any issuer (other than securities
issued by the U.S. Government, its agencies or instrumentalities or the
securities of other regulated investment companies), or in two or more issuers
that the Fund controls and that are engaged in the same or similar trades or
businesses.
ILLIQUID SECURITIES
As set forth in the Prospectus, the Funds may invest in Rule 144A
securities, commercial paper issued pursuant to Rule 4(2) under the Securities
Act of 1933, and municipal lease obligations, and treat such securities as
liquid when they have been determined to be liquid by the Board of Directors of
the Company or by the Adviser subject to the oversight of and pursuant to
procedures adopted by the Board of Directors. Under these procedures, factors
taken into account in determining the liquidity of a security include (a) the
frequency of trades and quotes for the security; (b) the number of dealers
willing to purchase or sell the security and the number of other potential
purchasers; (c) dealer undertakings to make a market in the security; and
(d) the nature of the security and the nature of the marketplace trades (e.g.,
the time needed to dispose of the security, the method of soliciting offers and
the mechanics of transfer). With respect to Rule 144A securities, investing in
such securities could have the effect of increasing the level of Fund
illiquidity to the extent that qualified institutional buyers become, for a
time, uninterested in purchasing these securities.
PORTFOLIO TURNOVER
Portfolio turnover is the ratio of the lesser of annual purchases or sales
of portfolio securities to the average monthly value of portfolio securities,
not including securities maturing in less than 12 months. A 100% portfolio
turnover rate would occur, for example, if the lesser of the value of purchases
or sales of portfolio securities for a particular year were equal to the average
monthly value of the portfolio securities owned during such year.
-3-
<PAGE>
INVESTMENT RESTRICTIONS
In addition to the investment objectives and policies set forth in the
Prospectus, each Fund is subject to certain fundamental and nonfundamental
investment restrictions, as set forth below. Fundamental investment
restrictions may not be changed without the vote of a majority of a Fund's
outstanding shares. "Majority," as used in the Prospectus and in this Statement
of Additional Information, means the lesser of (a) 67% of a Fund's outstanding
shares present at a meeting of the holders if more than 50% of the outstanding
shares are present in person or by proxy or (b) more than 50% of a Fund's
outstanding shares.
As fundamental investment restrictions, neither Fund will:
1. Issue any senior securities (as defined in the 1940 Act) other than as
set forth in restriction #2 below and except to the extent that using options
and futures contracts or purchasing or selling securities on a when-issued or
delayed delivery basis may be deemed to constitute issuing a senior security.
2. Borrow money (provided that each Fund may enter into reverse
repurchase agreements) except from banks for temporary or emergency purposes.
Each Fund may borrow money in an amount up to 10% of the value of its total
assets. With respect to each Fund, interest paid on borrowed funds will
decrease the net earnings of the Fund. Neither Fund will purchase portfolio
securities while outstanding borrowing exceeds 5% of the value of such Fund's
total assets. Neither Fund will borrow money for leverage purposes (provided
that each Fund may enter into reverse repurchase agreements for such purposes).
3. Mortgage, pledge or hypothecate its assets except in an amount not
exceeding 10% of the value of its total assets to secure temporary or emergency
borrowing. For purposes of this restriction, collateral arrangements for margin
deposits on futures contracts or with respect to the writing of options are not
deemed to be a pledge of assets.
4. Purchase or sell commodities or commodities futures contracts,
provided that each of the Funds may enter into financial futures contracts and
engage in related options transactions.
5. Purchase or sell real estate or real estate mortgage loans, except
that the Funds may invest in Tax-Exempt Securities secured by real estate or
interests therein.
6. Act as an underwriter of securities of other issuers, except insofar
as each Fund may be technically deemed an underwriter under the federal
securities laws in connection with the disposition of portfolio securities.
As nonfundamental investment restrictions that may be changed at any time
without shareholder approval, neither Fund will:
-4-
<PAGE>
1. Make short sales of securities, provided that each Fund for hedging
purposes may enter into financial futures contracts and engage in related
options transactions.
2. Purchase any securities on margin except to obtain such short-term
credits as may be necessary for the clearance of transactions and except that
the Funds may make margin deposits in connection with futures contracts.
3. Invest more than 15% of the value of its net assets in illiquid
securities.
4. Invest more than 5% of the value of its total assets in foreign
securities.
5. Invest in warrants.
The identification of the issuer of a Tax-Exempt Security depends on the
terms and conditions of the obligation. If the assets and revenues of an
agency, authority, instrumentality or other political subdivision are separate
from those of the government creating the subdivision, and the obligation is
backed only by the assets and revenues of the subdivision, such subdivision will
be regarded as the sole issuer. Similarly, in the case of a nongovernmental
user, such as an industrial corporation or a privately owned or operated
hospital, if the security is backed only by the assets and revenues of the
nongovernmental user then such non-governmental user will be deemed to be the
sole issuer. If in either case the creating government or another entity
guarantees an obligation, and the value of all securities issued or guaranteed
by the guarantor and owned by a Fund exceeds 10% of the value of such Fund's
total assets, the guarantee will be regarded as a separate security and treated
as an issue of such government or entity.
Any investment restriction or limitation referred to above or in the
Prospectus, except the borrowing policy, 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 an acquisition of securities or
utilization of assets and such excess results therefrom.
SPECIAL CONSIDERATIONS REGARDING INVESTMENTS IN MINNESOTA TAX-EXEMPT SECURITIES
As described in the Prospectus, except during temporary defensive periods,
Minnesota Fund will invest in Minnesota Tax-Exempt Securities. The Fund is
therefore susceptible to political, economic or regulatory factors affecting
issuers of Minnesota Tax-Exempt Securities. The following information, together
with the information set forth in the Prospectus, provides only a brief summary
of the complex factors affecting the financial situation in Minnesota. This
information is derived from sources that are generally available to investors
and is based in part on information obtained from various state and local
agencies in Minnesota. It should be noted that the creditworthiness of
obligations issued by local Minnesota issuers may be unrelated to the
creditworthiness of obligations issued by the State of Minnesota, and that there
is no obligation on the part of the State to make payment on such local
obligations in the event of default.
-5-
<PAGE>
MINNESOTA ECONOMY. The State relies heavily on a progressive individual
income tax and a retail sales tax for revenue, which results in a fiscal system
unusually sensitive to economic conditions.
Diversity and a significant natural resource base are two important
characteristics of the Minnesota economy. Generally, the structure of the
State's economy parallels the structure of the United States economy as a whole.
There are, however, employment concentrations in durable goods and non-durable
goods manufacturing, particularly industrial machinery, instruments and
miscellaneous, food, paper and related industries, and printing and publishing.
During the period from 1980 to 1990, overall employment growth in Minnesota
lagged behind national employment growth, in large part due to declining
agricultural employment. The rate of non-farm employment growth in Minnesota
exceeded the rate of national growth, however, in the period of 1990 to 1995.
Since 1980, Minnesota per capita income generally has remained above the
national average. During 1994 and 1995, the State's monthly unemployment rate
was less than the national unemployment rate.
There can be no assurance that Minnesota's economy and fiscal condition
will not materially change in the future or that future difficulties will not
occur. Economic difficulties and the resultant impact on State and local
government finances may adversely affect the market value of obligations in the
portfolio of Minnesota Fund or the ability of respective obligors to make timely
payment of the principal and interest on such obligations.
DIRECTORS AND EXECUTIVE OFFICERS
The directors and officers of the Company and their principal occupations
during the past five years are set forth below. Unless otherwise indicated, all
positions have been held for more than five years. The Company's directors and
officers also serves as directors or officers of various closed-end and open-end
investment companies managed by the Adviser.
Name, Address and (Age) Position with the Company
----------------------- --------------------------
William H. Ellis* (54) Chairman of the Board of Directors
Piper Jaffray Tower
222 South Ninth Street
Minneapolis, Minnesota 55402
David T. Bennett (56) Director
3400 City Center
33 South Sixth Street
Minneapolis, Minnesota 55402
Jaye F. Dyer (69) Director
4670 Norwest Center
90 South Seventh Street
Minneapolis, Minnesota 55402
-6-
<PAGE>
Karol D. Emmerich (47) Director
7302 Claredon Drive
Edina, Minnesota 55439
Luella G. Goldberg (59) Director
7019 Tupa Drive
Edina, Minnesota 55435
David A. Hughey (65) Director
134 Powers Road
Meredith, NH 03253
George Latimer (61) Director
754 Linwood Avenue
St. Paul, MN 55105
Paul A. Dow (45) President
Piper Jaffray Tower
222 South Ninth Street
Minneapolis, Minnesota 55402
Robert H. Nelson (33) Vice President
Piper Jaffray Tower and Treasurer
222 South Ninth Street
Minneapolis, Minnesota 55402
Susan S. Miley (39) Secretary
Piper Jaffray Tower
222 South Ninth Street
Minneapolis, Minnesota 55402
________________
* Directors of the Company who are interested persons (as that term is
defined by the 1940 Act) of Piper Capital Management Incorporated and the
Funds.
William H. Ellis is President of Piper Jaffray Companies Inc.; Director and
Chairman of the Board of Piper Capital Management Incorporated ("the Adviser");
President of the Adviser since 1994; Director of Piper Jaffray Inc..
David T. Bennett is of counsel to the law firm of Gray, Plant, Mooty, Mooty
& Bennett, P.A., located in Minneapolis, Minnesota. Mr. Bennett is chairman of
a group of privately held companies and serves on the board of directors of a
number of nonprofit organizations.
Jaye F. Dyer has been President of Dyer Management Company, a private
management company, since 1991. Prior to that he was President and Chief
Executive Officer of Dyco Petroleum Corporation, a Minneapolis based oil and
natural gas development company he founded, from 1971 to March 1, 1989, and
Chairman of the Board until December 31, 1990. Mr. Dyer serves on the board of
directors of Northwestern National Life Insurance Company, The ReliaStar
-7-
<PAGE>
Financial Corp. (the holding company of Northwestern National Life Insurance
Company) and various privately held and nonprofit corporations.
Karol D. Emmerich has been President of The Paraclete Group, a consultant
to nonprofit organizations, since 1993. Prior to that she was Vice President,
Chief Accounting Officer and Treasurer of Dayton Hudson Corporation from 1980 to
1993. Ms. Emmerich is an Executive Fellow at the University of St. Thomas
Graduate School of Business and serves on the board of directors of a number of
privately held and nonprofit organizations.
Luella G. Goldberg serves on the board of directors of Northwestern
National Life Insurance Company (since 1976), The ReliaStar Financial Corp.
(since 1989), TCF Bank Savings fsb (since 1985), TCF Financial Corporation
(since 1988), and Hormel Foods Corp. (since 1993). Ms. Goldberg also serves as
a Trustee of Wellesley College, and as a director of a number of other
organizations, including the University of Minnesota Foundation and the
Minnesota Orchestral Association. Ms. Goldberg was Chairman of the Board of
Trustees of Wellesley College from 1985 to 1993 and acting President from July
1, 1993 to October 1, 1993.
David A. Hughey is a Trustee of Bentley College. Prior to September 1996,
he was Executive Vice President and Chief Administrative Officer of Dean Witter
InterCapital Inc., Dean Witter Services Company Inc. and Dean Witter
Distributors Inc.; Director, Executive Vice President and Chief Administrative
Officer of Dean Witter Trust Company; Vice President of Dean Witter Family of
Funds and TCW/DW Family of Funds; and Director of ICI Mutual Insurance Company.
George Latimer has been Chief Executive Officer of National Equity Fund,
Chicago, Illinois since November 1995; prior thereto, Mr. Latimer was Director,
Special Actions Office, Office of the Secretary, Department of Housing and Urban
Development since 1993, and prior thereto he had been Dean of Hamline Law
School, Saint Paul, Minnesota from 1990 to 1993. Mr. Latimer also serves on the
board of directors of Digital Biometrics, Inc. and Payless Cashways, Inc.
Paul A. Dow is Chief Investment Officer and Senior Vice President of the
Adviser.
Robert H. Nelson has been a Senior Vice President of the Adviser since
1993; prior thereto he had been a Vice President of the Adviser from 1991 to
1993.
Susan S. Miley has been Senior Vice President and General Counsel of the
Adviser since 1995 and Secretary of the Adviser since 1996; prior thereto she
was counsel for American Express Financial Advisors, Minneapolis, Minnesota from
1994 to 1995 and an attorney at Simpson Thatcher & Bartlett, New York, New York
from 1984 to 1992.
Ms. Emmerich, Ms. Goldberg and Mr. Hughey are members of the Audit
Committee of the Board of Directors. Ms. Emmerich acts as the chairperson of
such committee. The Audit Committee oversees the Company's financial reporting
-8-
<PAGE>
process, reviews audit results and recommends annually to the Company a firm of
independent certified public accountants.
The Board of Directors also has a Committee of the Independent Directors,
consisting of Mr. Bennett, who serves as chairperson, Messrs. Dyer, Hughey and
Latimer, Ms. Emmerich and Ms. Goldberg, and a Derivatives Subcommittee
consisting of Ms. Emmerich, who serves as chairperson, Ms. Goldberg and Mr.
Dyer.
The functions of the Committee of the Independent Directors are: (a)
recommendation to the full Board of approval of any management, advisory,
sub-advisory and/or administration agreements; (b) recommendation to the full
Board of approval of any underwriting and/or distribution agreements; (c) review
of the fidelity bond and premium allocation; (d) review of errors and omissions
and any other joint insurance policies and premium allocation; (e) review of,
and monitoring of compliance with, procedures adopted pursuant to certain rules
promulgated under the 1940 Act; and (f) such other duties as the independent
directors shall, from time to time, conclude are necessary or appropriate to
carry out their duties under the 1940 Act. The functions of the Derivatives
Subcommittee are: (a) to oversee practices, policies and procedures of the
Adviser in connection with the use of derivatives; (b) to receive periodic
reports from management; and (c) to report periodically to the Committee of the
Independent Directors and the Board of Directors.
The directors of the Company who are officers or employees of the Adviser
or of its affiliates receive no remuneration from the Company. Each of the
other directors currently receives a quarterly retainer of $3,625 that is
allocated among the Funds and all other open-end funds managed by the Adviser on
the basis of the total assets of each such fund. In addition, each director
receives a fee from the Company for each regular quarterly and in-person special
meeting of the Board of Directors attended. (The per-meeting fee is based on
the combined total assets of the Company and Piper Institutional Funds Inc.)
The per-meeting fee is based upon asset size and is $250 if assets are under
$200 million, $500 if assets are $200 million and over but less than $500
million, $750 if asses are $500 million and over but less than $1 billion,
$1,000 if assets are $1 billion and over but less than $5 billion, and $1,500 if
assets are $5 billion or over. Members of the Audit Committee who are not
affiliated with the Adviser receive $1,000 for each Audit Committee meeting
attended ($2,000 for the chairperson of the Committee), and the chairperson of
the Committee of the Independent Directors receives $1,000 for each meeting of
such committee attended, with such fees being allocated evenly between the
Company and all other closed-end and open-end investment companies managed by
the Adviser. Members of the Committee of the Independent Directors and the
Derivatives Subcommittee (other than the chairperson of the Committee of the
Independent Directors) currently receive no additional compensation. In
addition, each Director who is not affiliated with the Adviser is reimbursed for
expenses incurred in connection with attending meetings.
The following table sets forth the compensation received by each director
from the Company during the fiscal year ended September 30, 1996, as well as the
total compensation received by each director from the Company and all other
-9-
<PAGE>
registered investment companies managed by the Adviser or affiliates of the
Adviser during the calendar year ended December 31, 1995. Directors who are
officers or employees of the Adviser or any of its affiliates did not receive
any such compensation and are not included in the table. Mr. Hughey became a
director of the Company on September 3, 1996.
Aggregate Compensation Total Compensation
Director from the Company from Fund Complex*
- -------- ---------------------- ------------------
David T. Bennett $ 6,400 $ 61,700
Jaye F. Dyer $ 6,775 $ 67,700
Karol D. Emmerich $ 6,775 $ 67,700
Luella G. Goldberg $ 7,150 $ 70,700
George Latimer $ 6,400 $ 64,700
David A. Hughey $ 0 $ 0
_______________
* Currently consists of 20 registered investment companies managed by the
Adviser or an affiliate of the Adviser, including the Company. During the 1995
calendar year, the Fund Complex consisted of up to 27 such investment companies,
several of which were merged or consolidated during the year. Each director
included in the table serves on the board of each such open-end and closed-end
investment company.
INVESTMENT ADVISORY AND OTHER SERVICES
The investment adviser for the Funds is Piper Capital Management
Incorporated (the "Adviser"). Its affiliate, Piper Jaffray Inc. (the
"Distributor"), acts as the Funds' distributor. Each will act as such pursuant
to a written agreement which will be periodically approved by the directors or
the shareholders of the Funds. The address of both the Adviser and the
Distributor is Piper Jaffray Tower, 222 South Ninth Street, Minneapolis,
Minnesota 55402.
CONTROL OF THE ADVISER AND THE DISTRIBUTOR
The Adviser and the Distributor are both wholly owned subsidiaries of Piper
Jaffray Companies Inc., a publicly held corporation which is engaged through
its subsidiaries in various aspects of the financial services industry.
INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT
The Adviser acts as the investment adviser of the Funds under an Investment
Advisory and Management Agreement which has been approved by the Board of
Directors (including a majority of the directors who are not parties to the
agreement, or interested persons of any such party, other than as directors of
the Funds) and the shareholders of the Funds.
The Investment Advisory and Management Agreement will terminate
automatically in the event of its assignment. In addition, the agreement is
terminable at any time, without penalty, by the Board of Directors of the
Company or by vote of a majority of the Company's outstanding voting securities
on not more than 60 days' written notice to the Adviser, and by the Adviser on
60 days' written notice to the Company. The agreement may be terminated with
respect to a
-10-
<PAGE>
particular Fund at any time by a vote of the holders of a majority of the
outstanding voting securities of such Fund, upon 60 days' written notice to the
Adviser. Unless sooner terminated, the agreement shall continue in effect for
more than two years after its execution only so long as such continuance is
specifically approved at least annually by either the Board of Directors or by a
vote of a majority of the outstanding voting securities of the Company, provided
that in either event such continuance is also approved by a vote of a majority
of the directors who are not parties to such agreement, or interested persons of
such parties, cast in person at a meeting called for the purpose of voting on
such approval. If a majority of the outstanding voting securities of either
Fund approves the agreement, the agreement shall continue in effect with respect
to such approving Fund whether or not the shareholders of the other Fund approve
the agreement.
Pursuant to the Investment Advisory and Management Agreement, the Funds pay
the Adviser monthly advisory fees equal on an annual basis to a certain
percentage of each Fund's average net assets as set forth in the following
table.
Annual Advisory Fee
Average Net Asset Values as Percentage of
of each Fund Average Net Assets
------------------------ -------------------
On the first $250,000,000 .50%
On the next $250,000,000 .45%
On average assets of over
$500,000,000 .40%
For the fiscal years ended September 30, 1994, 1995 and 1996, National Fund
paid $368,373, $298,729 and $258,789, respectively, and Minnesota Fund paid
$852,616, $706,675 and $660,926, respectively, to the Adviser pursuant to the
Investment Advisory and Management Agreement.
Under the Investment Advisory and Management Agreement, the Adviser
provides each Fund with advice and assistance in the selection and disposition
of that Fund's investments. All investment decisions are subject to review by
the Board of Directors of the Company. The Adviser is obligated to pay the
salaries and fees of any affiliates of the Adviser serving as officers or
directors of the Funds.
The same security may be suitable for one or both of the Funds and/or for
other series of the Company or other funds or private accounts managed by the
Adviser or its affiliates. If and when two or more funds or accounts
simultaneously purchase or sell the same security, the transactions will be
allocated as to price and amount in accordance with arrangements equitable to
each fund or account. The simultaneous purchase or sale of the same securities
by both Funds or by either of the Funds and other series of the Company or other
funds or accounts may have a detrimental effect on a Fund, as this may affect
the price paid or received by that Fund or the size of the position obtainable
or able to be sold by that Fund.
-11-
<PAGE>
EXPENSES
The expenses of each Fund are deducted from their income before dividends
are paid. These expenses include, but are not limited to, organizational costs,
fees paid to the Adviser, fees and expenses of officers and directors who are
not affiliated with the Adviser, taxes, interest, legal fees, transfer agent,
dividend disbursing agent and custodian fees, audit fees, brokerage fees and
commissions, fees and expenses of registering and qualifying the Funds and their
shares for distribution under federal and state securities laws, expenses of
preparing prospectuses and statements of additional information and of printing
and distributing prospectuses and statements of additional information annually
to existing shareholders, the expenses of reports to shareholders, shareholders'
meetings and proxy solicitations, distribution expenses pursuant to the Rule
12b-1 plan, and other expenses which are not expressly assumed by the Adviser
under the Investment Advisory and Management Agreement. Any general expenses of
the Company that are not readily identifiable as belonging to a particular
series of the Company will be allocated among the series based upon the relative
net assets of the series at the time such expenses were incurred.
DISTRIBUTION PLAN
Rule 12b-1(b) under the 1940 Act provides that any payments made by the
Funds in connection with financing the distribution of their shares may only be
made pursuant to a written plan describing all aspects of the proposed financing
of distribution, and also requires that all agreements with any person relating
to the implementation of the plan must be in writing. Because some of the
payments described below to be made by the Funds are distribution expenses
within the meaning of Rule 12b-1, the Company has entered into an Underwriting
and Distribution Agreement with the Distributor pursuant to a Distribution Plan
adopted in accordance with such Rule.
Rule 12b-1(b)(1) requires that such plan be approved by a majority of a
Fund's outstanding shares, and Rule 12b-1(b)(2) requires that such plan,
together with any related agreements, be approved by a vote of the Board of
Directors and of the directors who are not interested persons of the Company and
who have no direct or indirect interest in the operation of the plan or in the
agreements related to the plan, cast in person at a meeting called for the
purpose of voting on such plan or agreement. Rule 12b-1(b)(3) requires that the
plan or agreement provide, in substance:
(a) that it shall continue in effect for a period of more than one
year from the date of its execution or adoption only so long as such
continuance is specifically approved at least annually in the manner
described in paragraph (b)(2) of Rule 12b-1;
(b) that any person authorized to direct the disposition of moneys
paid or payable by the Company pursuant to the plan or any related
agreement shall provide to the Company's Board of Directors, and the
directors shall review, at least quarterly, a written report of the amounts
so expended and the purposes for which such expenditures were made; and
-12-
<PAGE>
(c) in the case of a plan, that it may be terminated at any time by a
vote of a majority of the members of the Board of Directors of the Company
who are not interested persons of the Company and who have no direct or
indirect financial interest in the operation of the plan or in any
agreements related to the plan or by a vote of a majority of the
outstanding voting securities of a Fund.
Rule 12b-1(b)(4) requires that such a plan may not be amended to increase
materially the amount to be spent for distribution without shareholder approval
and that all material amendments of the plan must be approved in the manner
described in paragraph (b)(2) of Rule 12b-1.
Rule 12b-1(c) provides that the Company may rely upon Rule 12b-1(b) only if
the selection and nomination of the Company's disinterested directors are
committed to the discretion of such disinterested directors. Rule 12b-1(e)
provides that the Company may implement or continue a plan pursuant to Rule
12b-1(b) only if the directors who vote to approve such implementation or
continuation conclude, in the exercise of reasonable business judgment and in
light of their fiduciary duties under state law, and under Sections 36(a) and
(b) of the 1940 Act, that there is a reasonable likelihood that the plan will
benefit the Company and its shareholders. The Board of Directors has concluded
that there is a reasonable likelihood that the Distribution Plan will benefit
the Company and its shareholders.
Pursuant to the provisions of the Distribution Plan, each Fund pays a fee
to the Distributor at a monthly rate of 1/12 of .30% of such Fund's average
daily net assets in connection with servicing of the Fund's shareholder accounts
and in connection with distribution-related services provided with respect to
the Funds. A portion of the total fee (to be determined from time to time by
the Board of Directors) may be paid as a distribution fee and will be used by
the Distributor to cover expenses that are primarily intended to result in, or
that are primarily attributable to, the sale of shares of the Funds
("Distribution Expenses"), and the remaining portion of the fee may be paid as a
shareholder servicing fee and will be used by the distributor to provide
compensation for ongoing servicing and/or maintenance of shareholder accounts
with respect to the Funds ("Shareholder Servicing Costs"). Distribution
Expenses under the Plan include, but are not limited to, initial and ongoing
sales compensation (in addition to sales charges) paid to Investment Executives
of the Distributor and to other broker-dealers; expenses incurred in the
printing of prospectuses, statements of additional information and reports used
for sales purposes; expenses of preparation and distribution of sales
literature; expenses of advertising of any type; an allocation of the
Distributor's overhead; and payments to and expenses of persons who provide
support services in connection with the distribution of Fund shares.
Shareholder Servicing Costs include all expenses of the Distributor incurred in
connection with providing administrative or accounting services to shareholders,
including, but not limited to, an allocation of the Distributor's overhead and
payments made to persons, including employees of the Distributor, who respond to
inquiries of shareholders of the Funds regarding their ownership of shares or
their accounts with the Funds, or who provide other administrative or accounting
services not otherwise required to be provided by the Funds' Adviser or transfer
agent.
-13-
<PAGE>
For the fiscal years ended September 30, 1994, 1995 and 1996, the
Distributor voluntarily limited amounts payable under the Distribution Plan to
.20%, .22% and .22%, respectively, of average daily net assets for each Fund.
During such periods, National Fund paid distribution fees to the Distributor of
$147,349, $129,534 and $107,785 respectively, and Minnesota Fund paid
distribution fees to the Distributor of $341,046, $306,351 and $275,220,
respectively. The Distributor has voluntarily limited amounts payable under
the Distribution Plan during fiscal 1997 to an annual rate of .24% of the
average daily net assets of each Fund. The Distributor may terminate its
voluntary fee limitation at any time in its discretion.
Distribution fees for the fiscal year ended September 30, 1996, were used
by the Distributor as follows:
National Fund Minnesota Fund
------------- --------------
Advertising $ 5,133 $ 13,106
Printing and Mailing of
Prospectuses to Other Than
Current Shareholders -0- -0-
Compensation to Underwriters
(trail fees to Investment Executives) 102,652 262,114
Compensation to Dealers -0- -0-
Compensation to Sales Personnel
Interest, Carrying or Other
Financing Charges -0- -0-
Other (Specify) -0- -0-
--------------- ---------------
Total $ 107,785 $ 275,220
UNDERWRITING AND DISTRIBUTION AGREEMENT
Pursuant to the Underwriting and Distribution Agreement, the Distributor
has agreed to act as the principal underwriter for the Funds in the sale and
distribution to the public of shares of the Funds, either through dealers or
otherwise. The Distributor has agreed to offer such shares for sale at all
times when such shares are available for sale and may lawfully be offered for
sale and sold. As compensation for its services, in addition to receiving its
distribution fees pursuant to the Distribution Plan discussed above, the
Distributor receives the sales load on sales of Fund shares set forth in the
Prospectus.
The following table sets forth the aggregate dollar amount of underwriting
commissions paid by each Fund for the fiscal years ended September 30, 1994,
1995 and 1996, the amount of such commissions retained by the Distributor and
the total dollar amount of brokerage commissions paid by each Fund to the
Distributor.
<TABLE>
<CAPTION>
Underwriting Commissions Brokerage Commissions
Total Underwriting Commissions Retained by Distributor Paid to Distributor
--------------------------------- ---------------------------------- ----------------------------------
Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal
year year year year year year year year year
ended ended ended ended ended ended ended ended ended
9/30/94 9/30/95 9/30/96 9/30/94 9/30/95 9/30/96 9/30/94 9/30/95 9/30/96
-------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
National $181,043 $36,355 $ 35,016 $105,005 $21,086 $20,659 $850 $-0- $-0-
Minnesota 389,325 83,956 138,945 225,809 48,694 81,978 850 -0- -0-
</TABLE>
-14-
<PAGE>
TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
Investors Fiduciary Trust Company ("IFTC"), the transfer agent for the
Company, maintains certain omnibus shareholder accounts for each of the Funds.
Each such omnibus account represents the accounts of a number of individual
shareholders of a Fund. The Company has entered into Shareholder Account
Servicing Agreements with the Distributor and Piper Trust Company ("Piper
Trust"), pursuant to which the Distributor and Piper Trust provide certain
transfer agent and dividend disbursing agent services for the underlying
individual shareholder accounts held at the respective companies. Pursuant to
such Agreements, the Distributor and Piper Trust have agreed to perform the
usual and ordinary services of transfer agent and dividend disbursing agent not
performed by IFTC with respect to the underlying individual shareholder
accounts, including, without limitation, the following: maintaining all
shareholder accounts, preparing shareholder meeting lists, mailing shareholder
reports and prospectuses, tracking shareholder accounts for blue sky and Rule
l2b-1 purposes, withholding taxes on nonresident alien and foreign corporation
accounts, preparing and mailing checks for disbursement of income dividends and
capital gains distributions, preparing and filing U.S. Treasury Department Form
1099 for all shareholders, preparing and mailing confirmation forms to
shareholders and dealers with respect to all purchases, exchanges and
liquidations of series shares and other transactions in shareholder accounts for
which confirmations are required, recording reinvestments of dividends and
distributions in series shares, recording redemptions of series shares, and
preparing and mailing checks for payments upon redemption and for disbursements
to withdrawal plan holders. As compensation for such services, the Distributor
and Piper Trust are paid an annual fee of $7.50 per active shareholder account
(defined as an account that has a balance of shares) and $1.60 per closed
account (defined as an account that does not have a balance of shares, but has
had activity within the past 12 months) by each Fund. Such fee is payable on a
monthly basis at a rate of 1/12 of the annual per-account charge. Such fee
covers all services listed above, with the exception of preparing shareholder
meeting lists and mailing shareholder reports and prospectuses. These services,
along with proxy processing (if applicable) and other special service requests,
are billable as performed at a mutually agreed upon fee in addition to the
annual fee noted above, provided that such mutually agreed upon fee shall be
fair and reasonable in light of the usual and customary charges made by others
for services of the same nature and quality.
During the fiscal year ended September 30, 1996, National Fund paid $13,073
and Minnesota Fund paid $23,612 to the Distributor under the Shareholder Account
Servicing Agreement. The Funds did not make any payments to Piper Trust under
the Shareholder Account Servicing Agreement.
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
Because each Fund's portfolio is composed exclusively of debt, rather than
equity securities, most of the Funds' portfolio transactions are effected
without the payment of brokerage commissions, but at net prices which usually
include a markup. Most of the Funds' transactions are with the issuer or with
major dealers
-15-
<PAGE>
on a principal basis acting for their own account and not as brokers. However,
portfolio transactions for the Funds which are executed on an agency basis may
be effected through the Distributor on a securities exchange if the commissions,
fees or other remuneration received by the Distributor are reasonable and fair
compared to the commissions, fees or other remuneration paid to other brokers or
other futures commission merchants in connection with comparable transactions
involving similar securities or similar futures contracts or options on futures
contracts being purchased or sold on an exchange during a comparable period of
time. In effecting portfolio transactions through the Distributor, the Funds
intend to comply with Section 17(e)(1) of the 1940 Act.
The Adviser is responsible for effecting securities transactions for each
Fund. In placing orders for securities transactions, the primary criterion for
the selection of a broker-dealer is the ability of the broker-dealer, in the
opinion of the Adviser, to secure prompt execution of the transactions at the
most favorable net price, considering the state of the market at the time.
Frequently the Adviser selects a broker-dealer to effect a particular
transaction without contacting all broker-dealers who might be able to effect
such transaction, because of the volatility of the money market and the desire
to accept a particular price for a security because the price offered by the
broker-dealer meets a Fund's guidelines for profit, yield, or both.
When consistent with the objectives of prompt execution and favorable net
price, business may be placed with broker-dealers who furnish investment
research or services to the Adviser. Such research or services include advice,
both directly and in writing, as to the value of securities; the advisability of
investing in, purchasing or selling securities; and the availability of
securities, or purchasers or sellers of securities; as well as analyses and
reports concerning issues, industries, securities, economic factors and trends,
portfolio strategy and the performance of accounts. This allows the Adviser to
supplement its own investment research activities and enables the Adviser to
obtain the views and information of individuals and research staffs of many
different securities firms prior to making investment decisions for the Funds.
To the extent portfolio transactions are effected with broker-dealers who
furnish research services to the Adviser, the Adviser receives a benefit, not
capable of evaluation in dollar amounts, without providing any direct monetary
benefit to the Funds from these transactions. The Adviser believes that most
research services obtained by it generally benefit several or all of the
investment companies and private accounts which it manages, as opposed to solely
benefiting one specific managed fund or account. Normally, research services
obtained through managed funds or accounts investing in common stocks would
primarily benefit the managed funds or accounts which invest in common stock;
similarly, services obtained from transactions in fixed-income securities would
normally be of greater benefit to the managed funds or accounts which invest in
debt securities.
The Adviser has not entered into any formal or informal agreements with any
broker-dealers, nor does it maintain any "formula" which must be followed in
connection with the placement of the Funds' portfolio transactions in exchange
for research services provided the Adviser, except as noted below. However, the
Adviser does maintain an informal list of broker-dealers, which is used from
time
-16-
<PAGE>
to time as a general guide in the placement of the Funds' business, in order to
encourage certain broker-dealers to provide the Adviser with research services
which the Adviser anticipates will be useful to it. Because the list is merely
a general guide, which is to be used only after the primary criterion for the
selection of broker-dealers (discussed above) has been met, substantial
deviations from the list are permissible and may be expected to occur. In the
event any transactions are executed on an agency basis, the Adviser will
authorize the Funds to pay an amount of commission for effecting a securities
transaction in excess of the amount of commission another broker-dealer would
have charged only if the Adviser determines in good faith that such amount of
commission is reasonable in relation to the value of the brokerage and research
services provided by such broker-dealer, viewed in terms of either that
particular transaction or the Adviser's overall responsibilities with respect to
the accounts as to which it exercises investment discretion. If the Funds
execute any transactions on an agency basis, they will generally pay higher than
the lowest commission rates available.
Any portfolio transactions for the Funds executed on an agency basis,
including transactions in futures contracts and options thereon, may be effected
through the Distributor. In determining the commissions to be paid to the
Distributor in connection with transactions effected on a securities exchange,
it is the policy of the Funds that such commissions will, in the judgment of the
Adviser, subject to review by the Board of Directors, be both (a) at least as
favorable as those which would be charged by other qualified brokers or futures
commission merchants in connection with comparable transactions involving
similar securities being purchased or sold on an exchange during a comparable
period of time, and (b) at least as favorable as commissions contemporaneously
charged by the Distributor on comparable transactions for its most favored
comparable unaffiliated customers. While the Funds do not deem it practicable
and in their best interest to solicit competitive bids for commission rates on
each transaction, consideration will regularly be given to posted commission
rates as well as to other information concerning the level of commissions
charged on comparable transactions by other qualified brokers and futures
commission merchants.
For the fiscal year ended September 30, 1994, National Fund and Minnesota
Fund each paid $850 in brokerage commissions in connection with options and
futures transactions. For the fiscal years ended September 30, 1995 and 1996,
neither Fund paid any brokerage commissions.
From time to time the Funds may acquire the securities of their regular
brokers or dealers or parent companies of such brokers or dealers. Neither Fund
purchased securities of its regular brokers or dealers or parent companies of
such brokers or dealers during the 1996 fiscal year.
CAPITAL STOCK AND OWNERSHIP OF SHARES
The Board of Directors is empowered under the Company's Articles of
Incorporation to issue additional series of the Company's common stock without
shareholder approval. On an issue affecting only a particular series, the
shares of the affected series vote separately. An example of such an issue
would be a
-17-
<PAGE>
fundamental investment restriction pertaining to only one series. In voting on
the Investment Advisory and Management Agreement (the "Agreement"), approval of
the Agreement by the shareholders of a particular series would make the
Agreement effective as to that series whether or not it had been approved by the
shareholders of the other series.
The assets received by the Company for the issue or sale of shares of each
series, and all income, earnings, profits and proceeds thereof, subject only to
the rights of creditors, are allocated to such series, and constitute the
underlying assets of such series. The underlying assets of each series are
required to be segregated on the books of account, and are to be charged with
the expenses in respect to such series and with a share of the general expenses
of the Company. Any general expenses of the Company not readily identifiable as
belonging to a particular series shall be allocated among the series based upon
the relative net assets of the series at the time such expenses were accrued.
The Board of Directors may, without shareholder approval, create and issue
one or more additional classes of shares within the Fund, as well as within any
other series of the Company or any additional series created in the future. All
classes of shares in a Fund would be identical except that each class of shares
would be available through a different distribution channel and certain classes
might incur different expenses for the provision of distribution services or the
provision of shareholder services or administration assistance by institutions.
Shares of each class would share equally in the gross income of a series, but
any variation in expenses would be charged separately against the income of the
particular class incurring such expenses. This would result in variations in
net investment income accrued and dividends paid by and in the net asset value
of the different classes of a series. This ability to create multiple classes
of shares within each series of the Company will allow the Company in the future
the flexibility to better tailor its methods of marketing, administering and
distributing shares of the Funds to the needs of particular investors and to
allocate expenses related to such marketing, administration and distribution
methods to the particular classes of shareholders of the Fund incurring such
expenses.
As of February 11, 1997, no shareholder owns of record or was known by the
Funds to own beneficially 5% or more of the outstanding shares of either Fund.
The directors and officers of the Funds as a group owned less than 1% of the
outstanding shares of each Fund as of such date.
NET ASSET VALUE AND PUBLIC OFFERING PRICE
The method for determining the public offering price of Fund shares is
summarized in the Prospectus in the text following the headings "How to Purchase
Shares--Purchase Price" and "Valuation of Shares." The net asset value of each
Fund's shares is determined on each day on which the New York Stock Exchange is
open, provided that the net asset value need not be determined on days when no
Fund shares are tendered for redemption and no order for Fund shares is
received. The New York Stock Exchange is not open for business on the following
holidays (or on the nearest Monday or Friday if the holiday falls on a weekend):
New Year's
-18-
<PAGE>
Day, Presidents' Day, Good Friday, Memorial Day, July 4th, Labor Day,
Thanksgiving and Christmas.
The portfolio securities in which each Fund invests fluctuate in value, and
hence the net asset value per share of each Fund also fluctuates. On
September 30, 1996, the net asset value per share for each Fund was calculated
as follows:
NATIONAL FUND
Net Assets ($45,934,895) = Net Asset Value Per Share
------------------------------ ($10.81)
Shares Outstanding (4,247,615)
MINNESOTA FUND
Net Assets ($125,676,782) = Net Asset Value Per Share
------------------------------- ($10.89)
Shares Outstanding (11,537,228)
In each case, a sales charge of 4.17% of the net asset value (in the case
of sales of less than $100,000) will be added to the net asset value per share
to determine the public offering price per share.
PERFORMANCE COMPARISONS
Advertisements and other sales literature for the Funds may refer to
"yield," "tax equivalent yield," "average annual total return" and "cumulative
total return." Such amounts are calculated as follows:
Yield is computed by dividing the net investment income per share (as
defined under Securities and Exchange Commission rules and regulations) earned
during the computation period by the maximum offering price per share on the
last day of the period, according to the following formula:
6
YIELD = 2[(a-b + 1) - 1]
---
cd
Where: a = dividends and interest earned during the period;
b = expenses accrued for the period (net of
reimbursements);
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends; and
d = the maximum offering price per share on the last day of
the period.
National Fund's yield for the 30-day period ended September 30, 1996
was 5.03%. For the same period, Minnesota Fund's yield was 5.11%. Had the
Distributor not voluntarily waived a portion of its Rule 12b-1 fees, the 30-day
yield as of September 30, 1996 for National Fund and Minnesota Fund would have
been 4.93% and 5.02%, respectively.
-19-
<PAGE>
Tax equivalent yield is computed by dividing that portion of the yield of a
Fund (as computed pursuant to the above paragraph) which is tax-exempt by one
minus a stated income tax rate and adding the product to that portion, if any,
of the yield of the Fund that is not tax-exempt.
National Fund's tax equivalent yield for the 30-day period ended
September 30, 1996 was 7.29%, assuming a federal income tax rate of 31%. For
the same period, Minnesota Fund's tax equivalent yield was 8.46%, assuming a
combined federal/Minnesota income tax rate of 39.6%. Had the Distributor not
voluntarily waived a portion of its Rule 12b-1 fees, the 30-day tax-equivalent
yield as of September 30, 1996 for National Fund and Minnesota Fund would have
been 7.14% and 8.31%, respectively.
Average annual total return figures are computed by finding the average
annual compounded rates of return over the periods indicated in the
advertisement that would equate the initial amount invested to the ending
redeemable value, according to the following formula:
n
P(1+T) = ERV
Where: P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of
such period.
This calculation deducts the maximum sales charge from the initial hypothetical
$1,000 investment, assumes all dividends and capital gains distributions are
reinvested at net asset value on the appropriate reinvestment dates as described
in the Prospectus, and includes all recurring fees, such as investment advisory
and management fees, charged to all shareholder accounts.
During the periods for which average annual total return is calculated, the
Adviser waived or paid certain expenses of the Funds and/or the Distributor
voluntarily limited Rule 12b-1 fees, thereby increasing average annual total
return. These expenses may or may not be waived or paid in the future, in the
Adviser's and the Distributor's discretion.
The following table sets forth the average annual total return of each Fund
for various periods ended September 30, 1996:
-20-
<PAGE>
<TABLE>
<CAPTION>
Average Annual Total Return
-----------------------------------------------------------------
Absent Voluntary Fee Waivers
Actual and Expense Payments
------------------------------- ------------------------------
Since Since
1 Year 5 Year Inception 1 Year 5 Year Inception
------ ------ ---------- ------ ------ ----------
<S> <C> <C> <C> <C> <C> <C>
National Fund
(Inception 7/11/88) 2.16% 6.17% 7.11% 2.07% 6.05% 6.83%
Minnesota Fund
(Inception 7/11/88) 1.99% 6.28% 7.03% 1.89% 6.18% 6.84%
</TABLE>
Cumulative total return is computed by finding the cumulative compounded
rate of return over the period indicated in the advertisement that would equate
the initial amount invested to the ending redeemable value, according to the
following formula:
CTR = (ERV-P) 100
-----
P
Where: CTR = Cumulative total return
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of
such period; and
P = initial payment of $1,000
This calculation assumes all dividends and capital gain distributions are
reinvested at net asset value on the appropriate reinvestment dates as described
in the Prospectus and includes all recurring fees, such as investment advisory
and management fees, charged to all shareholder accounts.
The cumulative total returns for the period from July 11, 1988
(commencement of operations) through September 30, 1996 for National Fund and
Minnesota Fund were 75.95% and 74.90%, respectively. The Adviser waived or paid
certain expenses of the Funds and/or the Distributor voluntarily limited Rule
12b-1 fees during this time period and such expenses and fees may or may not be
waived or paid in the future. Absent any voluntary fee waivers or expense
payments, National Fund's cumulative total return for the same period would have
been 72.22% and Minnesota Fund's cumulative total return would have been 72.35%.
In addition to advertising total return and yield, comparative performance
information may be used from time to time in advertising the Funds' shares,
including data from Lipper Analytical Services, Inc. ("Lipper"), Morningstar,
other industry publications and other entities or organizations which track the
performance of investment companies. The performance of each Fund may be
compared to that of its unmanaged benchmark index and to the performance of
similar funds as reported by Lipper. Each Fund's benchmark index and comparison
group are set forth below.
Performance information for the Funds also may be compared to other
unmanaged indices. Unmanaged indices do not reflect deductions for
-21-
<PAGE>
administrative and management costs and expenses. The Funds may also include in
advertisements and communications to Fund shareholders evaluations of a Fund
published by nationally recognized ranking services and by financial
publications that are nationally recognized, such as BARRON'S, BUSINESS WEEK,
FORBES, INSTITUTIONAL INVESTOR, INVESTOR'S DAILY, MONEY, KIPLINGER'S PERSONAL
FINANCE MAGAZINE, MORNINGSTAR MUTUAL FUND VALUES, THE NEW YORK TIMES, USA TODAY
and THE WALL STREET JOURNAL.
The performance of National Fund may be compared to the performance of the
General Municipal Bond Funds Average, as reported by Lipper, and to the
performance of the Lehman Brothers Municipal Index. The performance of
Minnesota Fund may be compared to the performance of the Minnesota Municipal
Bond Funds Average, as reported by Lipper, and to the performance of the Lehman
Brothers Municipal Index.
PURCHASE OF SHARES
An investor may qualify for a reduced sales charge immediately by signing a
nonbinding Letter of Intent stating the investor's intention to invest within a
13-month period, beginning not earlier than 90 days prior to the date of
execution of the Letter, a specified amount which, if made at one time, would
qualify for a reduced sales charge. Reinvested dividends will be treated as
purchases of additional shares. Any redemptions made during the term of the
Letter of Intent will be subtracted from the amount of purchases in determining
whether the Letter of Intent has been completed. During the term of a Letter of
Intent, IFTC will hold shares representing 5% of the amount that the investor
intends to invest during the 13-month period in escrow for payment of a higher
sales charge if the full amount indicated in the Letter of Intent is not
purchased. Dividends on the escrowed shares will be paid to the shareholder.
The escrowed shares will be released when the full amount indicated has been
purchased. If the full indicated amount is not purchased within the 13-month
period, the investor will be required to pay, either in cash or by liquidating
escrowed shares, an amount equal to the difference in the dollar amount of sales
charge actually paid and the amount of sales charge the investor would have paid
on his or her aggregate purchases if the total of such purchases had been made
at a single time.
REDEMPTION OF SHARES
GENERAL
Redemption of shares, or payment, may be suspended at times (a) when the
New York Stock Exchange is closed for other than customary weekend or holiday
closings, (b) when trading on said Exchange is restricted, (c) when an emergency
exists, as a result of which disposal by the Funds of securities owned by them
is not reasonably practicable, or it is not reasonably practicable for the Funds
fairly to determine the value of their net assets, or (d) during any other
period when the Securities and Exchange Commission, by order, so permits,
provided that applicable rules and regulations of the Securities and Exchange
Commission shall govern as to whether the conditions prescribed in (b) or (c)
exist.
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Shareholders who purchased shares through a broker-dealer other than the
Distributor may also redeem such shares by written request to IFTC at the
address set forth in the Prospectus. To be considered in proper form, written
requests for redemption should indicate the dollar amount or number of shares to
be redeemed, refer to the shareholder's Fund account number, and give either a
social security or tax identification number. The request should be signed in
exactly the same way the account is registered. If there is more than one owner
of the shares, all owners must sign. If shares to be redeemed have a value of
$10,000 or more or redemption proceeds are to be paid to someone other than the
shareholder at the shareholder's address of record, the signature(s) must be
guaranteed by an "eligible guarantor institution," which includes a commercial
bank that is a member of the Federal Deposit Insurance Corporation, a trust
company, a member firm of a domestic stock exchange, a savings association or a
credit union that is authorized by its charter to provide a signature guarantee.
IFTC may reject redemption instructions if the guarantor is neither a member of
nor a participant in a signature guarantee program. Signature guarantees by
notaries public are not acceptable. The purpose of a signature guarantee is to
protect shareholders against the possibility of fraud. Further documentation
will be requested from corporations, administrators, executors, personal
representatives, trustees and custodians. Redemption requests given by
facsimile will not be accepted. Unless other instructions are given in proper
form, a check for the proceeds of the redemption will be sent to the
shareholder's address of record.
REINSTATEMENT PRIVILEGE
A shareholder who has redeemed shares of a Fund may reinvest all or part of
the redemption proceeds in shares of any Fund within 30 days without payment of
an additional sales charge. The Distributor will refund to any shareholder a
pro rata amount of any contingent deferred sales charge paid by such shareholder
in connection with a redemption of Fund shares if and to the extent that the
redemption proceeds are reinvested within 30 days of such redemption in any
mutual fund managed by the Adviser. Such refund will be based upon the ratio of
the net asset value of shares purchased in the reinvestment to the net asset
value of shares redeemed. Reinvestments will be allowed at net asset value
without the payment of a front-end sales charge, irrespective of the amounts of
the reinvestment, but shall be subject to the same pro rata contingent deferred
sales charge that was applicable to the earlier investment; however, the period
during which the contingent deferred sales charge shall apply on the newly
issued shares shall be the period applicable to the redeemed shares extended by
the number of days between the redemption and the reinvestment dates
(inclusive).
SYSTEMATIC WITHDRAWAL PLAN
To establish a Systematic Withdrawal Plan for any Fund and receive regular
periodic payments, an account must have a value of $5,000 or more. A request to
establish a Systematic Withdrawal Plan must be submitted in writing to an
investor's Piper Jaffray Investment Executive or other broker-dealer. There are
no service charges for maintenance; the minimum amount that may be withdrawn
each period is $100. (This is merely the minimum amount allowed and should not
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be interpreted as a recommended amount.) The holder of a Systematic Withdrawal
Plan will have any income dividends and any capital gains distributions
reinvested in full and fractional shares at net asset value. To provide funds
for payment, the appropriate Fund will redeem as many full and fractional shares
as necessary at the redemption price, which is net asset value. Redemption of
shares may reduce or possibly exhaust the shares in your account, particularly
in the event of a market decline. As with other redemptions, a redemption to
make a withdrawal payment is a sale for federal income tax purposes. Payments
made pursuant to a Systematic Withdrawal Plan cannot be considered as actual
yield or income since part of such payments may be a return of capital.
The maintenance of a Systematic Withdrawal Plan for a Fund concurrent with
purchases of additional shares of that Fund would be disadvantageous because of
the sales commission involved in the additional purchases. A confirmation of
each transaction showing the sources of the payment and the share and cash
balance remaining in the account will be sent. The plan may be terminated on
written notice by the shareholder or the appropriate Fund, and it will terminate
automatically if all shares are liquidated or withdrawn from the account or upon
the death or incapacity of the shareholder. The amount and schedule of
withdrawal payments may be changed or suspended by giving written notice to your
Piper Jaffray Investment Executive or other broker-dealer at least seven
business days prior to the end of the month preceding a scheduled payment.
TAXATION
Pursuant to the Internal Revenue Code of 1986 (the "Code"), each Fund will
be subject to a nondeductible excise tax equal to 4% of the excess, if any, of
the amount required to be distributed pursuant to the Code for each calendar
year over the amount actually distributed. In order to avoid the imposition of
this excise tax, each Fund generally must declare dividends by the end of a
calendar year representing 98% of the Fund's ordinary income for the calendar
year and 98% of its capital gain net income (both long-term and short-term
capital gains) for the 12-month period ending October 31 of the calendar year.
Ordinarily, distributions and redemption proceeds earned by a Fund
shareholder are not subject to withholding of federal income tax. However, 31%
of a Fund shareholder's distributions and redemption proceeds must be withheld
if a Fund shareholder fails to supply the Fund or its agent with such
shareholder's taxpayer identification number or if a Fund shareholder who is
otherwise exempt from withholding fails to properly document such shareholder's
status as an exempt recipient.
Any loss on the sale or exchange of shares of a Fund generally will be
disallowed to the extent that a shareholder acquires or contracts to acquire
shares of the same Fund within 30 days before or after such sale or exchange.
In addition, if a shareholder disposes of shares within 90 days of acquiring
such shares and purchases other shares of the Company or another mutual fund
managed by the Adviser at a reduced sales charge, the shareholder's tax basis
for determining gain or loss on the shares which are disposed of is reduced by
the lesser of the amount of the
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sales charge that was paid when the shares disposed of were acquired or the
amount by which the sales charge for the new shares is reduced. If a
shareholder's tax basis is so reduced, the amount of the reduction is treated as
part of the tax basis of the new shares.
Any loss on the sale or exchange of shares of a Fund held for six months or
less (although regulations may reduce this time period to 31 days) will be
disallowed for federal and Minnesota income tax purposes to the extent of the
amount of any exempt-interest dividend received with respect to such shares.
This loss disallowance rule applies to Minnesota taxpayers (including
corporations) even though all or a portion of such dividend is not excluded from
Minnesota taxable income. Certain deductions otherwise allowable to financial
institutions and property and casualty insurance companies will be eliminated or
reduced by reason of the receipt of certain exempt-interest dividends.
Under the Code, interest on indebtedness incurred or continued to purchase
or carry shares of an investment company paying exempt-interest dividends, such
as each Fund, will not be deductible by a shareholder in proportion to the ratio
of exempt-interest dividends to all dividends other than those treated as
long-term capital gains. Indebtedness may be allocated to shares of either Fund
even though not directly traceable to the purchase of such shares. Federal law
also restricts the deductibility of other expenses allocable to shares of each
Fund. Similar nondeductibility rules apply under Minnesota law to individuals,
estates and trusts, even as to exempt-interest dividends that are not excluded
from Minnesota taxable net income.
For federal income tax purposes, an alternative minimum tax ("AMT") is
imposed on taxpayers to the extent that such tax exceeds a taxpayer's regular
income tax liability (with certain adjustments). Exempt-interest dividends
attributable to interest income on certain tax-exempt obligations issued after
August 7, 1986 to finance certain private activities are treated as an item of
tax preference that is included in alternative minimum taxable income for
purposes of computing the federal alternative minimum tax for all taxpayers and
the federal environmental tax on corporations. The Funds may invest in
obligations the interest on which is treated as an item of tax preference, to
the extent set forth in the Prospectus. In addition, a portion of all other
tax-exempt interest received by a corporation, including exempt-interest
dividends, will be included in adjusted current earnings and earnings and
profits for purposes of determining the federal corporate alternative minimum
tax, the environmental tax imposed on corporations by Section 59A of the Code,
and the branch profits tax imposed on foreign corporations under Section 884 of
the Code.
Because liability for AMT will depend upon the regular tax liability and
tax preference items of a specific taxpayer, the extent, if any, to which any
tax preference items resulting from investment in a Fund will be subject to the
tax will depend upon each shareholder's individual situation. For shareholders
with substantial tax preferences, the AMT could reduce the after-tax economic
benefits of an investment in the Fund. Each shareholder is advised to consult
his or her tax adviser with respect to the possible effects of such tax
preference items.
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For shareholders who are or may become recipients of Social Security
benefits, exempt-interest dividends are includable in computing "modified
adjusted gross income" for purposes of determining the amount of Social Security
benefits, if any, that is required to be included in gross income. The maximum
amount of Social Security benefits includable in gross income is 85%.
The Code also forbids a regulated investment company from earning 30% or
more of its gross income from the sale or other disposition of securities,
futures contracts and options held less than three months.
The Code requires a regulated investment company to diversify its holdings.
The Internal Revenue Service has not made its position clear regarding the
treatment of futures contracts and options for purposes of the diversification
test, and the extent to which a Fund could buy or sell futures contracts and
options may be limited by this requirement.
Gain or loss on futures contracts and options is taken into account when
realized by entering into a closing transaction or by exercise. In addition,
with respect to many types of futures contracts and options held at the end of a
Fund's taxable year, unrealized gain or loss on such contracts is taken into
account at the then current fair market value thereof under a special
"marked-to-market, 60/40 system," and such gain or loss is recognized for tax
purposes. The gain or loss from such futures contracts and options (including
premiums on certain options that expire unexercised) is treated as 60% long-term
and 40% short-term capital gain or loss, regardless of their holding period.
The amount of any capital gain or loss actually realized by a Fund in a
subsequent sale or other disposition of such futures contracts will be adjusted
to reflect any capital gain or loss taken into account by the Fund in a prior
year as a result of the constructive sale under the "marked-to-market, 60/40
system." Notwithstanding the rules described above, with respect
to certain futures contracts, a Fund may make an election that will have the
effect of exempting all or a part of those identified futures contracts from
being treated for federal income tax purposes as sold on the last business day
of the Fund's taxable year. All or part of any loss realized by the Fund on any
closing of a futures contract may be deferred until all of the Fund's offsetting
positions with respect to the futures contracts are closed.
The foregoing relates only to federal and Minnesota income taxation.
Prospective shareholders should consult their tax advisers as to the possible
application of other state and local income tax laws to Fund distributions.
GENERAL INFORMATION
Minnesota has enacted legislation which authorizes corporations to
eliminate or limit the personal liability of a director to the corporation or
its shareholders for monetary damages for breach of the fiduciary duty of "care"
(the duty to act with the care an ordinarily prudent person in a like position
would exercise under similar circumstances). Minnesota law does not, however,
permit a corporation to eliminate or limit the liability of a director (a) for
any breach of the director's duty of "loyalty" to the corporation or its
shareholders (the duty to act in good faith and in a
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manner reasonably believed to be in the best interest of the corporation), (b)
for acts or omissions not in good faith or that involve intentional misconduct
or a knowing violation of law, (c) for authorizing a dividend, stock repurchase
or redemption or other distribution in violation of Minnesota law or for
violation of certain provisions of Minnesota securities laws, or (d) for any
transaction from which the director derived an improper personal benefit.
Minnesota law does not permit elimination or limitation of a director's
liability under the 1933 Act or the Securities Exchange Act of 1934, and the
1940 Act prohibits elimination or limitation of a director's liability for acts
involving willful malfeasance, bad faith, gross negligence or reckless disregard
of the duties of a director. The Articles of Incorporation of the Company limit
the liability of directors to the fullest extent permitted by Minnesota law and
the 1940 Act.
FINANCIAL STATEMENTS
The audited financial statements for the Funds as of September 30, 1996, as
set forth in the Fund's Annual Reports, are incorporated by reference into this
Statement of Additional Information. The audited financial statements are
provided in reliance on the report of KPMG Peat Marwick LLP, 4200 Norwest
Center, Minneapolis, Minnesota 55402, independent auditors of the Funds, given
on the authority of such firm as experts in accounting and auditing.
PENDING LITIGATION
Complaints have been brought in federal and state court relating to one
open-end and twelve closed-end investment companies managed by the Adviser and
to two open-end funds for which the Adviser has acted as sub-adviser. On
February 13, 1996, a Settlement Agreement became effective for the consolidated
class action lawsuit, titled IN RE: PIPER FUNDS INC. INSTITUTIONAL GOVERNMENT
INCOME PORTFOLIO LITIGATION. The Amended Consolidated Class Action Complaint
was filed on October 5, 1994, in the United States District Court, District of
Minnesota, against Institutional Government Income Portfolio (a series of Piper
Funds Inc.), the Adviser, the Distributor, William H. Ellis and Edward J.
Kohler, and had alleged the making of materially misleading statements in the
prospectus, common law negligent misrepresentation and breach of fiduciary duty.
The Settlement Agreement will provide approximately $67.5 million, together with
interest earned, less certain disbursements and attorney fees, to class members
in payments scheduled over approximately three years. Such payments will be
made by Piper Jaffray Companies Inc. and the Adviser and will not be an
obligation of Piper Funds Inc.
Two additional complaints relating to the Institutional Government Income
Portfolio remain pending. These complaints were brought by investors who
requested exclusion from the settlement class and are based on claims similar to
those asserted in the consolidated Class Action complaint. The first pending
complaint was brought on April 11, 1995, and filed in the Minnesota State
District Court, Hennepin County. This action was removed to United States
District Court, District of Minnesota. The plaintiff, Frank R. Berman, Trustee
of Frank R. Berman Professional CP Pension Plan Trust, sued individually and not
on behalf of any
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putative class. Defendants are the Distributor, Piper Funds Inc., Morton
Silverman and Worth Bruntjen. A second pending complaint relating to the
Institutional Government Income Portfolio was filed on June 22, 1995 in the
Montana Thirteenth Judicial District Court, Yellowstone County by Beverly Muth
against the Distributor and Teresa L. Darnielle. In addition to the above
complaints, a number of actions have been commenced in arbitration by some of
individual investors who requested exclusion from the settlement class in the IN
RE: PIPER FUNDS INC. action.
A complaint was filed by Herman D. Gordon on October 20, 1994, in the
United States District Court, District of Minnesota, against American Adjustable
Rate Term Trust Inc.--1998, American Adjustable Rate Term Trust Inc.--1999, the
Adviser, the Distributor, Piper Jaffray Companies Inc., Benjamin Rinkey, Jeffrey
Griffin, Charles N. Hayssen and Edward J. Kohler. A second complaint was filed
by Frank Donio, I.R.A. and other plaintiffs on April 14, 1995, in the United
States District Court, District of Minnesota, against American Adjustable Rate
Term Trust Inc.--1996, American Adjustable Rate Term Trust Inc.--1997, American
Adjustable Rate Term Trust Inc.--1998, American Adjustable Rate Term Trust
Inc.--1999, the Adviser, the Distributor, Piper Jaffray Companies Inc. and
certain associated individuals. Plaintiffs in both actions filed a Consolidated
Amended Class Action Complaint on May 23, 1995 and by Order dated June 8, 1995,
the Court consolidated the two putative class actions. The consolidated amended
complaint, which purports to be a class action, alleges certain violations of
federal and state securities laws, breach of fiduciary duty and negligent
misrepresentation. On August 23, 1996, the Court granted final approval to the
parties' agreement to settle all outstanding cliams of the purported class
action. The Effective Date of the Settlement Agreement was September 23, 1996.
The Settlement Agreement provides for $14 million in principal payments
consisting of $500,000 which was paid upon the Court's preliminary approval,
$1.5 million which was paid on the Effective Date of the Settlement Agreement,
and payments of $3 million on each anniversary of the Effective Date for the
next four years, with accrued interest payments of up to $1.8 million. A number
of actions have been commenced in arbitration by individual investors in the
American Adjustable Rate Term Trusts.
A complaint was filed by Gary E. Nelson on June 28, 1995 in the United
States District Court for the Western District of Washington at Seattle against
American Strategic Income Portfolio Inc. -- II ("BSP"), the Adviser, the
Distributor, Piper Jaffray Companies Inc., Worth Bruntjen, Charles N. Hayssen,
Michael Jansen, William H. Ellis and Edward J. Kohler. A second complaint was
filed by the same individual in the same court on July 12, 1995 against American
Opportunity Income Fund Inc. ("OIF"), the Adviser, the Distributor, Piper
Jaffray Companies Inc., Worth Bruntjen, Charles N. Hayssen, Michael Jansen,
William H. Ellis and Edward J. Kohler. On September 7, 1995, Christian
Fellowship Foundation Peace United Church of Christ, Gary E. Nelson and Lloyd
Schmidt filed an amended complaint purporting to be a class action in the United
States District Court for the District of Washington. The complaint was filed
against American Government Income Portfolio, Inc. ("AAF"), American Government
Income Fund Inc. ("AGF"), American Government Term Trust, Inc., American
Strategic Income Portfolio Inc. ("ASP"), American Strategic Income Portfolio
Inc. -- II, American Strategic Income Portfolio Inc. -- III ("CSP"), American
Opportunity Income Fund Inc., American
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Select Portfolio Inc., Piper Jaffray Companies Inc., the Distributor, the
Adviser and certain associated individuals. By Order filed October 5, 1995, the
complaints were consolidated. Plaintiffs filed a second amended complaint on
February 5, 1996 and a third amended complaint on June 4, 1996. The third
amended third complaint alleges generally that the prospectus and financial
statements of each investment company were false and misleading. Specific
violations of various federal securities laws are alleged with respect to each
investment company. The complaint also alleges that the defendants violated the
Racketeer Influenced and Corrupt Organizations Act, the Washington State
Securities Act and the Washington Consumer Protection Act. The named plaintiffs
and defendants have reached an agreement-in-principle on a proposed settlement.
If approved by the Court, a settlement agreement consistent with the terms of
the agreement-in-principle would provide $15.5 million to class members in
payments by Piper Jaffray Companies Inc. and the Adviser over the next four
years. The settlement also includes an agreement that each of OIF, AAF, and AGF
would offer to repurchase up to 25% of their outstanding shares from current
shareholders at net asset value. If the discounts between net asset value and
market price of these funds do not decrease to 5% or less within approximately
two years after the effective date of the settlement, the fund boards may submit
shareholder proposals to convert these funds to an open-end format. Finally,
the agreement stipulates that each of ASP, BSP, CSP and SLA would offer to
repurchase up to 10% of their outstanding shares from current shareholders at
net asset value.
Four additional complaints are pending which involve the funds named as
defendants in the Nelson/Christian Fellowship Consolidated Action and are based
on claims similar to that action. The first additional complaint was filed
against the Distributor and Richard Tallent in Montana State District Court,
Silver Bow County on November 1, 1995 by plaintiff John Darlington. The second
complaint was filed against the Distributor and Richard Tallent on April 11,
1996 in Montana State District Court, Silver Bow County by plaintiff Kenneth
Schneider. The third complaint was filed against the Distributor and Richard
Tallent on April 11, 1996 in Montana State District Court, Silver Bow County by
plaintiff Margaret Nagel. The fourth complaint was filed against the
Distributor on August 7, 1996 by plaintiff Kenneth Gennerman as Trustee of the
Nicole Bowlin Trust in Wisconsin Circuit Court, Waukesha County. In addition to
the above complaints, a number of arbitrations have been commenced by individual
investors in the funds named as defendants in the Nelson/Christian Fellowship
Consolidated Action.
Complaints have also been filed relating to two open-end funds for which
the Adviser has acted as sub-adviser, Managers Intermediate Mortgage Fund and
Managers Short Government Fund. A complaint was filed on September 26, 1994 in
the United States District Court, District of Connecticut, by Florence R. Hosea,
Bobby W. Hosea, Getrud B. Dale and Peter M. Dale, Andrew Poffel and Diane Poffel
as tenants by the Entireties, Myrone Sarone, Donna M. DiPalo, Bernard B. Geltner
and Gail Geltner and Paul Delman. The complaint was filed against The Managers
Funds, The Managers Funds, L.P., Robert P. Watson, the Adviser, the Distributor,
an individual associated with the Adviser, Evaluation Associates, Inc. and
Managers Intermediate Mortgage Fund. The complaint, which is a putative class
action, alleges certain violations of federal securities laws, including the
making of false
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and misleading statements in the prospectus, and alleges negligent
misrepresentation, breach of fiduciary duty and common law fraud. A similar
complaint was filed as a putative class action in the same court on November 4,
1994. The complaint was filed by Karen E. Kopelman against The Managers Fund,
The Managers Funds, L.P., Robert P. Watson, the Adviser, the Distributor, Worth
Bruntjen, Evaluation Associates, Inc. and Managers Intermediate Mortgage Fund.
The two putative class actions were consolidated by court order on December 13,
1994. Plaintiffs filed an Amended and Restated Complaint on July 19, 1995. A
complaint relating to the Managers Short Government Fund was filed on
November 18, 1994 in the United States District Court, District of Minnesota.
The complaint was filed by Robert Fleck as a putative class action against The
Managers Funds, The Managers Funds, L.P., the Adviser, the Distributor, Worth
Bruntjen, Evaluation Associates, Inc., Robert P. Watson, John E. Rosati, William
M. Graulty, Madeline H. McWhinney, Steven J. Pasggioli, Thomas R. Schneeweis and
Managers Short Government Fund, F/K/A/ Managers Short Government Income Fund.
The complaint alleges certain violations of federal securities laws, including
the making of false and misleading statements in the prospectus, and negligent
misrepresentation. The named plaintiff and defendants have reached an
agreement-in-principle on a proposed settlement. If approved by the Court and a
sufficiently large percentage of the putative class members, a settlement
agreement consistent with the terms of the agreement-in-principle would provide
to class members up to a total of $1.5 million collectively from The Managers
Funds, L.P. and the Adviser on the effective date of the settlement. A third
complaint relating to both the Managers Intermediate Mortgage Fund and the
Managers Short Government Fund was filed on October 26, 1995 in Connecticut
State Superior Court, Stamford/Norwalk District. The complaint was filed by
First Commercial Trust Company, N.A. against the Managers Funds, Managers Short
Government Fund, Managers Intermediate Mortgage Fund, Managers Short and
Intermediate Bond Fund, The Managers Funds, L.P., EAIMC Holdings Corporation,
Evaluation Associates Holding Corporation, EAI Partners, L.P., Evaluation
Associates, Inc., Robert P. Watson, William W. Graulty, Madeline H. McWhinney,
Steven J. Paggioli, Thomas R. Schneeweis, William J. Crerend, the Adviser, Piper
Jaffray Companies Inc., Worth Bruntjen, Standish, Ayer & Wood, Inc., TCW Funds
Managements, Inc., and TCW Management Company. The complaint alleges claims
under Connecticut common law and violation of the Connecticut Securities Act and
the Connecticut Unfair and Deceptive Trade Practices Act.
The Adviser and Distributor do not believe that the settlements described
above, or any of the above lawsuits and arbitrations, will have a material
adverse effect upon their ability to perform under their agreements with the
Company, and they intend to defend the remaining lawsuits vigorously.
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APPENDIX A
RATINGS OF TAX-EXEMPT
SECURITIES AND COMMERCIAL PAPER
The four highest ratings of Moody's Investors Service, Inc. ("Moody's") for
tax exempt securities are Aaa, Aa, A and Baa. Tax exempt securities rated Aaa
are judged to be of the "best quality." The rating of Aa is assigned to tax
exempt securities which are of "high quality by all standards," but as to which
margins of protection or other elements make long term risks appear somewhat
larger than Aaa rated tax exempt securities. The Aaa and Aa rated tax exempt
securities comprise what are generally known as "high grade bonds." Tax exempt
securities which are rated A by Moody's possess many favorable investment
attributes and are considered "upper medium grade obligations." Factors giving
security to principal and interest of A rated tax exempt securities are
considered adequate, but elements may be present which suggest a susceptibility
to impairment sometime in the future. Tax exempt securities rated Baa are
considered as "medium grade" obligations. They are neither highly protected nor
poorly secured. Interest payments and principal security appear adequate for
the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such tax exempt
securities lack outstanding investment characteristics and in fact have
speculative characteristics as well. Those securities in the A and Baa groups
which Moody's believes possess the strongest investment attributes are
designated by the symbols A 1 and Baa 1. Other A and Baa securities comprise
the balance of their respective groups. These rankings (1) designate the
securities which offer the maximum in security within their quality group, (2)
designate securities which can be bought for possible upgrading in quality and
(3) additionally afford the investor an opportunity to gauge more precisely the
relative attractiveness of offerings in the market place.
Moody's ratings for state and municipal notes and other short-term loans
are designated Moody's Investment Grade (MIG). This distinction is in
recognition of the differences between short-term credit risk and long-term
risk. Factors affecting the liquidity of the borrower and short-term cyclical
elements are critical in short-term ratings, while other factors of major
importance in bond risk may be less important over the short run. A short-term
rating may also be assigned on an issue having a demand feature. Such ratings
will be designated as VMIG if the demand feature is rated. Short-term ratings
on issues with demand features are differentiated to reflect such
characteristics as payment upon periodic demand rather than fixed maturity dates
and payment relying on external liquidity. Loans bearing the MIG-1 or VMIG-1
designation are of the best quality, enjoying strong protection from established
cash flows of funds for their servicing or from established and broad-based
access to the market for refinancing, or both. Loans bearing the MIG-2 or
VMIG-2 designation are of high quality, with margins of protection ample
although not so large as in the preceding group. Loans bearing the MIG-3 or
VMIG-3 and MIG-4 or VMIG-4 designations are of lower quality.
The four highest ratings of Standard & Poor's Ratings Services ("Standard &
Poor's") for tax exempt securities are AAA, AA, A and BBB. Tax exempt
securities rated AAA bear the highest rating assigned by Standard & Poor's to a
debt obligation
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and indicates an extremely strong capacity to pay principal and interest. Tax
exempt securities rated AA also qualify as high-quality debt obligations.
Capacity to pay principal and interest is very strong, and in the majority of
instances they differ from AAA issues only in small degree. Securities rated A
have a strong capacity to pay principal and interest, although they are somewhat
more susceptible to the adverse effects of changes in circumstances and economic
conditions. The BBB rating, which is the lowest "investment grade" security
rating by Standard & Poor's, indicates an adequate capacity to pay principal and
interest. Whereas they normally exhibit adequate protection parameters, adverse
economic conditions or changing circumstances are more likely to lead to a
weakened capacity to pay principal and interest for securities in this category
than for securities in the A category.
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The designation SP-1 indicates a very strong
or strong capacity to pay principal and interest. The designation SP-2
indicates a satisfactory capacity to pay principal and interest.
Commercial paper ratings are graded by Standard & Poor's into four
categories, ranging from "A" for the highest quality obligations to "D" for the
lowest. Issues assigned the A rating are regarded as having the greatest
capacity for timely payment. Issues in this category are further refined with
designation 1, 2, and 3 to indicate the relative degree of safety. The "A-1"
designation indicates that the degree of safety regarding timely payment is very
strong. Those issues determined to possess overwhelming safety characteristics
will be denoted with a plus sign designation. The "A-2" designation indicates
that the degree of safety regarding timely payment is strong.
Moody's commercial paper ratings are opinions of the ability of the issuers
to repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's makes no representation that such obligations
are exempt from registration under the Securities Act of 1933, nor does it
represent that any specific note is a valid obligation of a rated issuer or
issued in conformity with any applicable law. Moody's employs the following
three designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated issuers:
Prime-1 Superior capacity for repayment of
short-term promissory obligations.
Prime-2 Strong capacity for repayment of
short-term promissory obligations.
Prime-3 Acceptable capacity for repayment of
short-term promissory obligations.
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APPENDIX B
FUTURES CONTRACTS AND OPTIONS
FUTURES CONTRACTS
Each Fund may purchase and sell interest rate futures contracts and options
thereon. An interest rate futures contract creates an obligation on the part of
the seller (the "short") to deliver, and an offsetting obligation on the part of
the purchaser (the "long") to accept delivery of, the type of financial
instrument called for in the contract in a specified delivery month for a stated
price. A majority of transactions in interest rate futures contracts, however,
do not result in the actual delivery of the underlying instrument, but are
settled through liquidation, i.e., by entering into an offsetting transaction.
The futures contracts to be traded by the Fund are traded only on commodity
exchanges--known as "contract markets"--approved for such trading by the
Commodity Futures Trading Commission ("CFTC"), and must be executed through a
futures commission merchant, or brokerage firm, which is a member of the
relevant contract market. These contract markets, through their clearing
corporations, guarantee that the contracts will be performed. Presently,
interest rate futures contracts are based on such debt securities as long-term
U.S. Treasury Bonds, Treasury Notes, Government National Mortgage Association
modified pass-through mortgage-backed securities, three-month U.S. Treasury
Bills and bank certificates of deposit.
Although most interest rate futures contracts by their terms call for
actual delivery or acceptance of commodities or securities, in most cases the
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a short position is effected by purchasing a futures
contract for the same aggregate amount of the specific type of financial
instrument or commodity and the same delivery month. If the price of the
initial sale of the futures contract exceeds the price of the offsetting
purchase, the seller is paid the difference and realizes a gain. Conversely, if
the price of the offsetting purchase exceeds the price of the initial sale, the
trader realizes a loss. Similarly, the closing out of a long position is
effected by the purchaser entering into a futures contract sale. If the
offsetting sale price exceeds the purchase price, the purchaser realizes a gain,
and if the purchase price exceeds the offsetting sale price, he realizes a loss.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead,
an amount of cash or securities acceptable to the Adviser and the relevant
contract market, which varies, but is generally about 5% of the contract amount,
must be deposited with the custodian in the name of the broker. This amount is
known as "initial margin," and represents a "good faith" deposit assuring the
performance of both the purchaser and the seller under the futures contract.
Subsequent payments to and from the broker, known as "variation margin," are
required to be made on a daily basis as the price of the futures contract
fluctuates, making the long or short positions in the futures contract more or
less valuable, a process known as "marking
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to the market." Prior to the settlement date of the futures contract, the
position may be closed out by taking an opposite position which will operate to
terminate the position in the futures contract. A final determination of
variation margin is then made, additional cash is required to be paid to or
released by the broker, and the purchaser realizes a loss or gain. In addition,
a commission is paid on each completed purchase and sale transaction.
Each Fund also may purchase and sell futures contracts on an index of
municipal securities. These instruments provide for the purchase or sale of a
hypothetical portfolio of municipal bonds at a fixed price in a stated delivery
month. Unlike most other futures contracts, however, a municipal bond index
futures contract does not require actual delivery of securities, but results in
a cash settlement based upon the difference in value of the index between the
time the contract was entered into and the time it is liquidated.
The municipal bond index underlying these futures contracts is The Bond
Buyer Municipal Bond Index, developed by THE BOND BUYER and the Chicago Board of
Trade ("CBT"), the contract market on which the futures contracts are traded.
The index is comprised of 40 tax-exempt term municipal revenue and general
obligation bonds. Each bond included in the index must be rated A- or higher by
Standard and Poor's or A or higher by Moody's and must have a remaining maturity
of 19 years or more. Twice a month new issues satisfying the eligibility
requirements are added to, and an equal number of old issues are deleted from,
the index. The value of the index is computed daily according to a formula
based upon the price of each bond in the index, as evaluated by four
dealer-to-dealer brokers.
The municipal bond index futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a nonprofit organization managed by the exchange
membership which is also responsible for handling daily accounting of deposits
or withdrawals of margin.
The purpose of the acquisition or sale of futures contracts by the Funds,
as holders of long-term municipal securities, is to hedge against fluctuations
in rates on such securities without actually buying or selling long-term
municipal securities. For example, if a Fund owns long-term bonds and interest
rates are expected to increase, the Fund might sell futures contracts. Such a
sale would have much the same effect as selling some of the long-term bonds in
the Fund's portfolio. If interest rates increase as anticipated by the Adviser,
the value of certain long-term securities in the portfolio would decline, but
the value of the Fund's futures contracts would increase at approximately the
same rate, thereby keeping the net asset value of the Fund from declining as
much as it otherwise would have. Of course, since the value of the securities
in each Fund's portfolio will far exceed the value of the futures contracts sold
by such Fund, an increase in the value of the futures contracts could only
mitigate--but not totally offset--the decline in the value of the portfolio.
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Similarly, when it is expected that interest rates may decline, futures
contracts could be purchased to hedge against a Fund's anticipated purchases of
long-term bonds at higher prices. Since the rate of fluctuation in the value of
futures contracts should be similar to that of long-term bonds, the Fund could
take advantage of the anticipated rise in the value of long-term bonds without
actually buying them until the market had stabilized. At that time, the futures
contracts could be liquidated and the Fund's cash could then be used to buy
long-term bonds on the cash market. The Fund could accomplish similar results
by selling bonds with long maturities and investing in bonds with short
maturities when interest rates are expected to increase or by buying bonds with
long maturities and selling bonds with short maturities when interest rates are
expected to decline. However, in circumstances when the market for bonds may
not be as liquid as that for futures contracts, the ability to invest in such
contracts could enable a Fund to react more quickly to anticipated changes in
market conditions or interest rates.
OPTIONS ON FUTURES CONTRACTS
The Funds may purchase and sell put and call options on interest rate and
municipal bond index futures contracts which are traded on a United States
exchange or board of trade as a hedge against changes in interest rates, and
will enter into closing transactions with respect to such options to terminate
existing positions. Options on interest rate futures contracts are currently
available with respect to Treasury bonds (direct obligations of the U.S.
Treasury which generally have maturities of greater than ten years). An options
contract based on the municipal bond index futures contract discussed above was
introduced on the CBT in June 1987. An option on a futures contract, as
contrasted with the direct investment in such a contract, gives the purchaser
the right, in return for the premium paid, to assume a position in a futures
contract at a specified exercise price at any time prior to the expiration date
of the option. Options on futures contracts are similar to options on
securities, which give the purchaser the right, in return for the premium paid,
to purchase or sell securities. A call option gives the purchaser of such
option the right to buy, and obliges its writer to sell, a specified underlying
futures contract at a stated exercise price at any time prior to the expiration
date of the option. A purchaser of a put option has the right to sell, and the
writer has the obligation to buy, such contract at the exercise price during the
option period. Upon exercise of an option, the delivery of the futures position
by the writer of the option to the holder of the option will be accompanied by
delivery of the accumulated balance in the writer's futures margin account,
which represents the amount by which the market price of the futures contract
exceeds, in the case of a call, or is less than, in the case of a put, the
exercise price of the option on the futures contract. If an option is exercised
on the last trading day prior to the expiration date of the option, the
settlement will be made entirely in cash equal to the difference between the
exercise price of the option and the closing price of the interest rate futures
contract on the expiration date. The potential loss related to the purchase of
an option on a futures contract is limited to the premium paid for the option
(plus transaction costs). Because the value of the option is fixed at the point
of sale, there are no daily cash
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payments to reflect changes in the value of the underlying contract; however,
the value of the option does change daily and that change would be reflected in
the net asset values of the Funds. In connection with the writing of options on
futures contracts, a Fund will make initial margin deposits and make or receive
maintenance margin payments that reflect changes in the market value of such
options. Premiums received from the writing of an option are included in
initial margin deposits.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS. A Fund will purchase put
options on futures contracts if the Adviser anticipates a rise in interest
rates. Because the value of an interest rate or municipal bond index futures
contract moves inversely in relation to changes in interest rates, a put option
on such a contract becomes more valuable as interest rates rise. By purchasing
put options on futures contracts at a time when the Adviser expects interest
rates to rise, a Fund will seek to realize a profit to offset the loss in value
of its portfolio securities.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS. A Fund will purchase call
options on futures contracts if the Adviser anticipates a decline in interest
rates. The purchase of a call option on an interest rate or municipal bond
index futures contract represents a means of obtaining temporary exposure to
market appreciation at limited risk. Because the value of an interest rate or
municipal bond index futures contract moves inversely in relation to changes to
interest rates, a call option on such a contract becomes more valuable as
interest rates decline. A Fund will purchase a call option on a futures
contract to hedge against a decline in interest rates in a market advance when
the Fund is holding cash. The Fund can take advantage of the anticipated rise
in the value of long-term securities without actually buying them until the
market is stabilized. At that time, the options can be liquidated and the
Fund's cash can be used to buy long-term securities.
WRITING CALL OPTIONS ON FUTURES CONTRACTS. A Fund will write call options
on futures contracts if the Adviser anticipates a rise in interest rates. As
interest rates rise, a call option on such a contract becomes less valuable. If
the futures contract price at expiration of the option is below the exercise
price, the option will not be exercised and the Fund will retain the full amount
of the option premium. Such amount provides a partial hedge against any decline
that may have occurred in the Fund's portfolio securities.
WRITING PUT OPTIONS ON FUTURES CONTRACTS. A Fund will write put options on
futures contracts if the Adviser anticipates a decline in interest rates. As
interest rates decline, a put option on an interest rate or municipal bond index
futures contract becomes less valuable. If the futures contract price at
expiration of the option has risen due to declining interest rates and is above
the exercise price, the option will not be exercised and the Fund will retain
the full amount of the option premium. Such amount can then be used by the Fund
to buy long-term securities when the market has stabilized.
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RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
HEDGING RISKS IN FUTURES CONTRACTS TRANSACTIONS. There are several risks
in using municipal bond index or interest rate futures contracts as hedging
devices. One risk arises because the prices of futures contracts may not
correlate perfectly with movements in the underlying municipal bond index or
fixed-income security due to certain market distortions. First, all
participants in the futures market are subject to initial margin and variation
margin requirements. Rather than making additional variation margin payments,
investors may close the contracts through offsetting transactions which could
distort the normal relationship between the index or security and the futures
market. Second, the margin requirements in the futures market are lower than
margin requirements in the securities market, and as a result the futures market
may attract more speculators than does the securities market. Increased
participation by speculators in the futures market may also cause temporary
price distortions. Because of possible price distortion in the futures market
and because of imperfect correlation between movements in the municipal bond
index or securities and movements in the prices of futures contracts, even a
correct forecast of general market trends may not result in a successful hedging
transaction over a very short period.
Another risk arises because of imperfect correlation between movements in
the value of the futures contracts and movements in the value of securities
subject to the hedge. For example, there can be no assurance that there will be
a correlation between movements in the price of the municipal bond index and
movements in the price of the municipal bonds which are the subject of the
hedge. The degree of imperfection or correlation depends upon, among other
things, the differences between the municipal securities being hedged and the
municipal securities underlying the municipal bond index futures contracts. For
example, each bond included in the municipal bond index must have a remaining
maturity of 19 years or more, whereas each Fund's portfolio probably will be
comprised of securities with an average aggregate maturity of less than 19
years. This risk of an imperfect correlation increases to the extent that
either Fund enters into futures contracts for other than municipal bonds since
the value of municipal bonds and other debt securities may not react exactly the
same to general changes in interest rates and may react differently to factors
other than changes in the general level of interest rates.
Successful use of futures contracts by a Fund is subject to the ability of
the Adviser to predict correctly movements in the direction of interest rates.
If a Fund has hedged against the possibility of an increase in interest rates
adversely affecting the value of fixed-income securities held in its portfolio
and interest rates decrease instead, the Fund will lose part or all of the
benefit of the increased value of its security which it has hedged because it
will have offsetting losses in its futures positions. In addition, in such
situations, if the Fund has insufficient cash, it may have to sell securities to
meet daily variation margin requirements. Such sales of securities may, but
will not necessarily, be at increased prices which reflect the
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decline in interest rates. The Fund may have to sell securities at a time when
it may be disadvantageous to do so.
LIQUIDITY OF FUTURES CONTRACTS. A Fund may elect to close some or all of
its contracts prior to expiration. The purpose of making such a move would be
to reduce or eliminate the hedge position held by the Fund. A Fund may close
its positions by taking opposite positions. Final determinations of variation
margin are then made, additional cash as required is paid by or to the Fund, and
the Fund realizes a loss or a gain.
Positions in futures contracts may be closed only on an exchange or board
of trade providing a secondary market for such futures contracts. Although the
Funds intend to enter into futures contracts only on exchanges or boards of
trade where there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular contract
at any particular time. The purchase of municipal bond index futures contracts
involves an additional risk since these are instruments with a relatively short
trading history. As a result, it is possible that trading in such futures
contracts will be less liquid than that in other futures contracts.
In addition, most domestic futures exchanges and boards of trade 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 contract, no trades may be made 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. It is possible that futures contract
prices could move 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. In such event, it
will not be possible to close a futures position and, in the event of adverse
price movements, the Fund would be required to make daily cash payments of
variation margin. In such circumstances, an increase in the value of the
portion of the portfolio being hedged, if any, may partially or completely
offset losses on the futures contract. However, as described above, there is no
guarantee that the price of the securities being hedged will, in fact, correlate
with the price movements in the futures contract and thus provide an offset to
losses on a futures contract.
RISKS OF OPTIONS ON FUTURES CONTRACTS. The use of options on futures
contracts also involves certain risks. Compared to the purchase or sale of
futures contracts, the purchase of call or put options on futures contracts
involves less potential risk to a Fund because the maximum amount at risk is the
premium paid for the options (plus transactions costs). The writing of a call
option on a futures contract generates a premium which may partially offset a
decline in the value of a
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Fund's portfolio assets. By writing a call option, the Fund becomes obligated
to sell a futures contract, which may have a value higher than the exercise
price. Conversely, the writing of a put option on a futures contract generates
a premium, but the Fund becomes obligated to purchase a futures contract, which
may have a value lower than the exercise price. Thus, the loss incurred by a
Fund in writing options on futures contracts may exceed the amount of the
premium received.
The effective use of options strategies is dependent, among other things,
on a Fund's ability to terminate options positions at a time when the Adviser
deems it desirable to do so. Although a Fund will enter into an option position
only if the Adviser believes that a liquid secondary market exists for such
option, there is no assurance that the Fund will be able to effect closing
transactions at any particular time or at an acceptable price. The Funds'
transactions involving options on futures contracts will be conducted only on
recognized exchanges.
A Fund's purchase or sale of put or call options on futures contracts will
be based upon predictions as to anticipated interest rates by the Adviser, which
could prove to be inaccurate. Even if the expectations of the Adviser are
correct, there may be an imperfect correlation between the change in the value
of the options and of the Fund's portfolio securities.
REGULATORY MATTERS
To the extent required to comply with applicable Securities and Exchange
Commission releases and staff positions, when entering into futures contracts,
the Fund will maintain, in a segregated account, cash or liquid high-grade debt
securities equal to the value of such contracts.
The Commodity Futures Trading Commission (the "CFTC"), a Federal agency,
regulates trading activity on the exchanges pursuant to the Commodity Exchange
Act, as amended. The CFTC requires the registration of "commodity pool
operators," defined as any person engaged in a business which is of the nature
of an Company, syndicate, or a similar form of enterprise, and who, in
connection therewith, solicits, accepts, or receives from others, funds,
securities, or property for the purpose of trading in any commodity for future
delivery on or subject to the rules of any contract market. The CFTC has
adopted Rule 4.5, which provides an exclusion from the definition of commodity
pool operator for any registered investment company which meets the requirements
of the Rule. Rule 4.5 requires, among other things, that an investment company
wishing to avoid commodity pool operator status use futures and options
positions only (a) for "bona fide hedging purposes" (as defined in CFTC
regulations) or (b) for other purposes so long as aggregate initial margins and
premiums required in connection with non-hedging positions do not exceed 5% of
the liquidation value of the investment company's portfolio.
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Any investment company wishing to claim the exclusion provided in Rule 4.5 must
file a notice of eligibility with both the CFTC and the National Futures
Association. Both Funds intend to file such a notice and to meet the
requirements of Rule 4.5, or such other requirements as the CFTC or its staff
may from time to time issue, in order to render registration as a commodity pool
operator unnecessary.
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