<PAGE>
[KEYSTONE COVER]
KEYSTONE
[PHOTO -- WOMAN AND BABY UNDER AMERICAN FLAG]
GOVERNMENT
SECURITIES FUND
[logo]
ANNUAL REPORT
JULY 31, 1996
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Keystone Government Securities Fund
Seeks the highest possible current income consistent with safety of principal
and maintenance of liquidity from investments in U.S. government securities.
Dear Shareholder:
We would like to take this opportunity to report on your Fund's performance and
review market events for the twelve-month period which ended July 31, 1996.
Following our letter we have included a discussion with your Fund's manager.
Performance
Your Fund provided the following returns, including price changes and reinvested
dividends, for the twelve-month period ended July 31, 1996:
Class A shares returned 4.51%.
Class B shares returned 3.63%.
Class C shares returned 3.62%.
The Lehman Intermediate Government Bond Index, a broad unmanaged index of
government bonds with intermediate maturities, returned 5.20% for the same
twelve-month period.
Your Fund's returns reflect the performance of the bond markets during the
period. Declining interest rates in 1995 resulted in price appreciation during
the first half of the period and rising rates in 1996 resulted in bond price
declines during the second half.
Changes in interest rates typically have a direct effect on the performance
of U.S. government securities. As a result, we consider current and anticipated
interest rates, economic growth and inflation in actively managing your Fund's
portfolio. We attempt to take advantage of the cyclical opportunities presented
by a changing environment.
Market environment
In the second half of 1995, the economy grew at a slow-to-moderate pace,
corporate profits remained strong, and inflation was under control. This was a
favorable environment for bonds with few worries about accelerating inflation,
which can reduce real yields to bond holders. As a result, interest rates
declined and bond prices rose. At the beginning of 1996, this favorable
environment changed. There were concerns that the economy might be growing more
rapidly than expected. The first confirmation of stronger growth was in February
1996 when monthly employment figures were reported substantially above
expectations. This was a turning point for the bond market as economic
statistics in subsequent months continued to reflect the stronger growth of the
first half of 1996.
Because of the two distinct economic environments, we pursued two strategies
during the twelve-month period. In the moderate growth environment of 1995, we
lengthened maturities and purchased U.S. Treasuries to lock-in yields to benefit
from the declining interest rate environment. When it appeared that the economy
was strengthening, we moved to a more defensive strategy. We decreased our U.S.
Treasury holdings and purchased mortgage-backed securities in an attempt to
generate more income and minimize price declines in the rising rate environment.
Our outlook
We expect a favorable environment for U.S. government securities in the second
half of 1996. We believe concerns about revived inflationary pressures are
overstated and the economy should eventually slow down in the fourth quarter.
However, we think there is the potential for some short-term price volatility.
Changes in interest rates and the economic environment will continue to
affect the performance of government securities. Over the interest rate cycle we
will continue to seek attractive income from investments in government
securities
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Keystone Government Securities Fund
which have virtually no credit risk. Because we believe that consistent
performance is more important than short-term performance, we will continue to
seek investments that lead to attractive returns over the long term.
We are pleased to inform you that Keystone has agreed to be acquired by First
Union Corporation. The acquisition is subject to a number of conditions,
including approvals of investment advisory agreements with Keystone by fund
shareholders. First Union is a financial services firm based in Charlotte, North
Carolina. It is the nation's sixth largest bank holding company with assets of
approximately $140 billion. First Union, through its wholly-owned subsidiary
Evergreen Asset Management Corp., manages more than $16 billion in 36 mutual
funds. Keystone will remain a separate entity after its acquisition and will
continue to provide investment advisory and management services to the Fund. We
believe First Union's acquisition of Keystone should strengthen the investment
management services we provide to you.
Thank you for your continued support of Keystone Government Securities Fund.
If you have questions or comments about your investment, we encourage you to
write us.
Sincerely,
/s/Albert H. Elfner, III
Albert H. Elfner, III
Chairman and President
Keystone Investments, Inc.
/s/George S. Bissell
George S. Bissell
Chairman of the Board
Keystone Funds
September 1996
[PHOTO OF ALBERT H. ELFNER, III]
Albert H. Elfner, III
[PHOTO OF GEORGE S. BISSELL]
George S. Bissell
[DALBAR LOGO]
Dalbar Key Honors
Honoring Commitment to Excellence
Keystone was recently recognized by Dalbar, an independent mutual fund rating
organization, for demonstrating a commitment to serving the needs of customers.
The award is intended to distinguish companies who are committed to investors
and have a proven ability to provide good service.
[TELEPHONE LOGO]
Keystone Introduces Investment Insight Line for Shareholders
Now you can keep up-to-date on your fund's current strategy and outlook by
calling Keystone Investment Insight Line. You can hear Keystone portfolio
managers discuss their latest strategies or listen to Keystone's overall market
outlook from James McCall, chief investment officer. Of course, your financial
adviser can provide you with more complete information on Keystone Funds. This
service is available 24 hours a day, seven days a week and updated at least
monthly.
Keystone Investment Insight Line
1-800-346-3858, Press 2 after the greeting
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A Discussion With
Your Fund Manager
[PHOTO OF CHRISTOPHER P. CONKEY]
Christopher P. Conkey is portfolio manager of your Fund and heads Keystone's
high grade bond team. A Chartered Financial Analyst, Mr. Conkey has 12 years of
experience managing fixed-income investments. He holds a BA in economics from
Clark University and an MBA in finance from Boston University. Together with
senior portfolio manager Barbara McCue and analysts David J. Bowers and Gary E.
Pzegeo, the team evaluates the economic environment in selecting U.S.
government bonds for your Fund.
Q. Please describe the economic environment over the past twelve months which
ended July 31, 1996.
A. We experienced two very different economic scenarios during the Fund's fiscal
year. In the first half of the year, we saw slow economic growth, weak consumer
activity and falling interest rates. However, in February, economic reports
began to indicate that the economy was actually stronger than expected. Job
growth, consumer spending and housing market conditions strengthened. In
response, interest rates rose. Rates continued to rise over the last six months
of the Fund's fiscal period.
Q. How did this type of environment impact the market for government bonds?
A. Because government bonds involve virtually no credit risk, they are primarily
influenced by changes in interest rates. When interest rates were falling and
the economy appeared slow last year, the bond market reacted favorably. However,
uncertainty surrounding the federal budget negotiations limited price gains. In
contrast, interest rates rose and bond prices declined during the first quarter
of 1996. When the economy shows strength, as it did in early 1996, rates have
historically risen. Over the last quarter, interest rates have changed little,
despite considerable intra-period volatility.
Q. How did you manage the Fund in this challenging market?
A. In 1995, we attempted to take advantage of declining rates by increasing our
position in U.S. Treasuries and cutting back on mortgage-backed securities.
Treasuries provide a consistent income stream because they cannot be redeemed
before maturity, while mortgage-backed securities tend to underperform in a
declining interest rate environment. However, when the economy showed signs of
strength and interest rates rose in early 1996, we moved to a more defensive
strategy. That is, we reduced our U.S. Treasury holdings and purchased more
mortgage-backed securities.
Fund Profile
Objective: Seeks the highest possible current income consistent with safety of
principal and maintenance of liquidity from investments in U.S. government
securities.
Commencement of investment operations: April 14, l987
Average maturity: 12 years
Average quality: AAA
Net assets: $51 million
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Keystone Government Securities Fund
Asset Allocation
as of July 31, 1996
[PIE CHART]
Treasury securities
(45.2%)
Agency issues
(46.8%)
Collateralized mortgage
obligations
(6.2%)
Cash(1)
(1.8%)
(as a percentage of net assets)
- -------------
1 Includes short-term investments and net other assets and liabilities.
These securities usually offer higher yields than U.S. Treasuries and are less
likely to be prepaid if interest rates are rising. As of July 31, 1996,
mortgage-backed securities comprised 53% of net assets, U.S. Treasuries
comprised 45%, and cash and other assets and liabilities comprised 2%.
Q. What other strategies did you use?
A. We bought Government National Mortgage Association (Ginnie Mae) discount
coupon bonds which offer longer average maturities and Adjustable Rate Mortgage
Securities (ARMS) for their short maturities. We believed that very short and
very long maturities would outperform intermediate maturity bonds in the rising
interest rate environment of 1996. We believe this "barbelled" strategy allowed
the Fund to preserve capital in a declining market.
We also invested in Ginnie Mae and Federal Housing Agency (FHA) project
loans. These are bonds that are backed by the cash flows from a specific
property such as a nursing home or an apartment complex. They carry a government
guarantee on the principal and interest which makes them attractive long-term
investments. Also, project loans typically cannot be prepaid for a specific
period of time.
Q. What has happened to the Fund's income during the period?
A. After a period of falling interest rates for most of 1995, the Fund's
dividend was reduced in February. While we try to avoid unnecessary reductions
in income, lower yields were a reality for nearly every investor in this
environment. Since then we have maintained a steady income level.
Q. What is your outlook for government bonds?
A. We believe we are in a prolonged moderate growth cycle that may experience
both inflationary and recessionary scares at different times. We anticipate
slower Gross Domestic Product (GDP) growth of about 3% in the second half of the
year. Government bonds continue to offer historically attractive yields after
subtracting inflation. We believe that yields will
[LINE CHART]
[PLOT POINTS]
9/29/89 8.24
10/31/89 7.9
11/30/89 7.82
12/29/89 7.91
1/31/90 8.41
2/28/90 8.51
3/30/90 8.63
4/30/90 9.02
5/31/90 8.59
6/29/90 8.41
7/31/90 8.34
8/31/90 8.84
9/28/90 8.8
10/31/90 8.63
11/30/90 8.24
12/31/90 8.05
1/31/91 8.01
2/28/91 8.02
3/28/91 8.05
4/30/91 8
5/31/91 8.05
6/28/91 8.22
7/31/91 8.13
8/30/91 7.81
9/30/91 7.44
10/31/91 7.45
11/29/91 7.37
12/31/91 6.69
1/31/92 7.36
2/28/92 7.29
3/31/92 7.54
4/30/92 7.56
5/29/92 7.32
6/30/92 7.12
7/31/92 6.69
8/31/92 6.61
9/30/92 6.35
10/30/92 6.88
11/30/92 6.99
12/31/92 6.74
1/29/93 6.45
2/26/93 6.11
3/31/93 6.12
4/30/93 6.11
5/28/93 6.19
6/30/93 5.8
7/30/93 5.83
8/31/93 5.52
9/30/93 5.44
10/29/93 5.47
11/30/93 5.83
12/31/93 5.83
1/31/94 5.64
2/28/94 6.14
3/31/94 6.75
4/29/94 7.08
5/31/94 7.2
6/30/94 7.38
7/29/94 7.16
8/31/94 7.22
9/30/94 7.64
10/31/94 7.83
11/30/94 7.95
12/30/94 7.88
1/31/95 7.65
2/28/95 7.21
3/31/95 7.19
4/28/95 7.19
5/31/95 6.32
6/30/95 6.17
7/31/95 6.53
8/31/95 6.39
9/29/95 6.28
10/31/95 6.09
11/30/95 5.75
12/29/95 5.57
1/31/96 5.6
2/29/96 6.12
3/29/96 6.32
4/30/96 6.64
5/31/96 6.84
6/28/96 6.71
7/31/96 6.79
8/30/96 6.94
U.S. Treasury 10-year bond yield
July 31, 1989 to July 31, 1996
Interest rates declined during the first half of the fiscal period then
rebounded during the second half.
Source: Fact Set
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Your Fund's Performance
[MOUNTAIN CHART]
Growth of an investment in
Keystone Government Securities Fund Class A
In Thousands
Total Value: $18,929
[PLOT POINTS]
Initial Investment Reinvested Distributions
4/87 9658 9658
9801 9868
7/88 9334 10210
9687 11430
7/90 9521 12211
9763 13398
7/92 10230 15057
9953 16789
7/94 9029 16670
9153 18111
7/96 8963 18928
A $10,000 investment in Keystone Government Securities Fund Class A made on
April 14, 1987 with all distributions reinvested was worth $18,929 on July 31,
1996. Past performance is no guarantee of future results.
Twelve-Month Performance as of July 31, 1996
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Class A Class B Class C
Total returns* 4.51% 3.63% 3.62%
Net asset
value 7/31/95 $9.61 $9.61 $9.62
7/31/96 $9.41 $9.40 $9.41
Dividends $ .63 $ .56 $ .56
Capital gain None None None
* Before deduction of front-end or contingent deferred sales
charge (CDSC).
Historical Record as of July 31, 1996
- --------------------------------------------------------------
Cumulative total returns Class A Class B Class C
1-year w/o sales charge 4.51% 3.63% 3.62%
1-year -0.45% -0.29% 3.62%
5-year 34.56% -- --
Life of class 89.29% 12.53% 15.38%
Average annual total returns
1-year w/o sales charge 4.51% 3.63% 3.62%
1-year -0.45% -0.29% 3.62%
5-year 6.12% -- --
Life of class 7.10% 3.43% 4.17%
rise somewhat over the next few months but then move down toward the end of the
year. We believe Keystone Government Securities Fund is well-positioned to take
advantage of this economic scenario and produce generous income for its
shareholders.
[DIAMOND]
Class A shares were introduced April 14, 1987. Performance is reported at the
current maximum front-end sales charge of 4.75%.
Class B shares were introduced on February 1, 1993. Shares purchased after
June 1, 1995 are subject to a contingent deferred sales charge (CDSC) that
declines from 5% to 1% over six years from the month purchased. Performance
assumes that shares were redeemed after the end of a one-year holding period and
reflects the deduction of a 4% CDSC.
Class C shares were introduced on February 1, 1993. Performance reflects the
return you would have received for holding shares for one year and redeeming
after the end of the period.
The investment return and principal value will fluctuate so that your shares,
when redeemed, may be worth more or less than the original cost.
Performance for each class will differ.
You may exchange your shares to another Keystone fund for a $10 fee by
contacting Keystone directly. The exchange fee is waived for individual
investors who make an exchange using Keystone's Automated Response Line (KARL).
The Fund reserves the right to change or terminate the exchange offer.
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Keystone Government Securities Fund
Growth of an Investment
[LINE CHART]
Comparison of change in value of a $10,000 investment in Keystone Government
Securities Fund Class A, the Lehman Intermediate Government Bond Index, and the
Consumer Price Index.
In Thousands April 14, 1987 through July 31, 1996
Average Annual Total Return
1 Year 5 Year Life of Class
Class A -0.45% 6.12% 7.10%
Class B -0.29% -- 3.43%
Class C 3.62% -- 4.17%
LIGBI Class A CPI
$20,017 $18,929 $14,005
[PLOT POINTS]
4/87 9658 10000 10000
9868 9939 10152
7/88 10210 10631 10571
11430 11977 11097
7/90 12211 12824 11632
13398 14129 12150
7/92 15057 16077 12533
16789 17393 12881
7/94 16670 17553 13238
18111 19027 13604
7/96 18928 20017 14005
Class A Lehman Intermediate Government
Consumer Price Index (CPI) Bond Index (LIGBI)
Past performance is no guarantee of future results. The performance of Class B
or Class C shares will be greater or less than the line shown based on
differences in loads and fees paid by the shareholder investing in the different
classes. Class B and Class C shares were introduced February 1, 1993. The
Consumer Price Index and Lehman Intermediate Government Index are from March
31, 1987.
This chart graphically compares your Fund's total return performance to certain
investment indexes. It is the result of fund performance guidelines issued by
the Securities and Exchange Commission. The intent is to provide investors with
more information about their investment.
Components of the chart
The chart is composed of several lines that represent the accumulated value
of an initial $10,000 investment for the period indicated. The lines
illustrate a hypothetical investment in:
1. Keystone Government Securities Fund
The Fund seeks the highest possible current income consistent with safety of
principal and maintenance of liquidity from investments in U.S. government
securities. The return is quoted after deducting sales charges (if
applicable), fund expenses, and transaction costs and assumes reinvestment of
all distributions.
2. Lehman Intermediate Government Bond Index (LIGBI)
The LIGBI is a broad-based, unmanaged fixed-income market index of U.S.
government and agency securities. It represents the price change and coupon
income of several hundred securities with intermediate (1- to 10-year)
maturities. Securities are selected and compiled by Lehman Brothers, Inc.
according to criteria that may be unrelated to your Fund's investment
objective. It would be difficult for most individual investors to duplicate
this index.
3. Consumer Price Index (CPI)
This index is a widely recognized measure of the cost of goods and services
produced in the U.S. The index contains factors such as prices of services,
housing, food, transportation and electricity which are compiled by the U.S.
Bureau of Labor Statistics. The CPI is generally considered a valuable benchmark
for investors who seek to outperform increases in the cost of living.
These indexes do not include transaction costs associated with buying and
selling securities, and do not hold cash to meet redemptions. It would be
difficult for most individual investors to duplicate these indexes.
Understanding what the chart means
The chart demonstrates your Fund's performance in relation to a well known
investment index and to increases in the cost of living. It is important to
understand what the chart shows and does not show.
This illustration is useful because it charts Fund and index performance over
the same time frame and over a long period. Long-term performance is a more
reliable and useful measure of performance than measurements of short-term
returns or temporary swings in the market. Your financial adviser can help you
evaluate fund performance in conjunction with the other important financial
considerations such as safety, stability and consistency.
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Page 7
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Limitations of the chart
The chart, however, limits the evaluation of Fund performance in several ways.
Because the measurement is based on total returns over an extended period of
time, the comparison often favors those funds which emphasize capital
appreciation when the market is rising. Likewise, when the market is declining,
the comparison usually favors those funds which take less risk.
Performance can be distorted
Funds which are more conservative in their orientation and which place an
emphasis on capital preservation will tend to compare less favorably when the
market is rising. In addition, funds which have income as one of their
objectives also will tend to compare less favorably to relevant indexes.
Indexes may also reflect the performance of some securities which a fund may
be prohibited from buying. A bond fund, for example, may be limited to
investments in only high quality bonds, or a stock fund may only be able to buy
stocks that have been traded on a stock exchange for a minimum number of years
or stocks that have a certain market capitalization. Indexes usually do not have
the same investment restrictions as your Fund.
Indexes do not include costs of investing
The comparison is further limited in its utility because the indexes do not take
into account any deductions for sales charges, transaction costs or other fund
expenses. Your Fund's performance figures do reflect such deductions. Sales
charges--whether up-front or deferred--pay for the cost of the investment advice
of your financial adviser. Transaction costs pay for the costs of buying and
selling securities for your Fund's portfolio. Fund expenses pay for the costs of
investment management and various shareholder services. None of these costs are
reflected in index total returns. The comparison is not completely realistic
because an index cannot be duplicated by an investor--even an unmanaged
index--without incurring some charges and expenses.
One of several measures
The chart is one of several tools you can use to understand your investment. It
should be read in conjunction with the Fund's prospectus, and annual and
semiannual reports. Also, your financial adviser, who understands your personal
financial situation, can best explain the features of your Keystone fund and how
it applies to your financial needs.
Future returns may be different
Shareholders also should be mindful that the long-run performance of either the
Fund or the indexes is not representative of what shareholders should expect to
receive from their Fund investment in the future; it is presented to illustrate
only past performance and is not a guarantee of future returns.
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Keystone Government Securities Fund
Glossary of Mutual Fund Terms
MUTUAL FUND--A company which combines the investment money of many people
whose financial goals are similar, and invests that money in a variety of
securities. A mutual fund allows the smaller investor the benefits of
diversification, professional management and constant supervision usually
available only to large investors.
PORTFOLIO MANAGER--An investment professional who is responsible for
managing a portfolio's assets prudently and making appropriate investment
decisions, such as which securities to buy, hold and sell, based on the
investment objectives of the portfolio.
STOCK--Equity or ownership interest in a corporation, which represents a
claim on the corporation's assets and earnings.
BOND--Security issued by a government or corporation to those from whom it
has borrowed money. A bond usually promises to pay interest income to the
bondholder at regular intervals and to repay the entire amount borrowed at
maturity date.
CONVERTIBLE SECURITY--A corporate security (usually preferred stock or bonds)
that is exchangeable for a set number of another security type (usually common
stocks) at a pre-stated price.
MONEY MARKET FUND--A mutual fund whose assets are invested in a diversified
portfolio of short-term securities, including commercial paper, bankers'
acceptances, certificates of deposit and other short-term instruments. The fund
pays income which can fluctuate daily. Liquidity and safety of principal are
primary objectives.
NET ASSET VALUE (NAV) PER SHARE--The value of one share of a mutual fund. The
NAV per share is determined by subtracting a fund's total liabilities from its
total assets, and dividing that amount by the number of fund shares outstanding.
DIVIDEND--A per share distribution of the income earned from the fund's
portfolio holdings. When a dividend distribution is made, the fund's net asset
value drops by the amount of the distribution because the distribution is no
longer considered part of the fund's assets.
CAPITAL GAIN--The profit from the sale of securities, less any losses.
Capital gains are paid to fund shareholders on a per share basis. When a capital
gain distribution is made, the fund's net asset value drops by the amount of the
distribution because the distribution is no longer considered part of the fund's
assets.
YIELD--The annualized rate of income as measured against the current net
asset value of fund shares.
TOTAL RETURN--The change in value of a fund investment over a specified
period of time, taking into account the change in a fund's market price and the
reinvestment of all fund distributions.
SHORT-TERM--An investment with a maturity of one year or less.
LONG-TERM--An investment with a maturity of greater than one year.
AVERAGE MATURITY--The average number of days until the notes, drafts,
acceptances, bonds or other debt instruments in a portfolio become due and
payable.
OFFERING PRICE--The offering price of a share of a mutual fund is the price
at which the share is sold to the public.
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Keystone Government Securities Fund
SCHEDULE OF INVESTMENTS--July 31, 1996
<TABLE>
<CAPTION>
Coupon Maturity Par Market
Rate Date Value Value
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. GOVERNMENT ISSUES (45.2%)
U.S. Treasury Bonds 7.875% 2021 $7,520,000 $ 8,188,603
U.S. Treasury Bonds 6.875 2025 1,200,000 1,178,628
U.S. Treasury Notes 7.750 1999 2,750,000 2,857,415
U.S. Treasury Notes 6.750 2000 4,000,000 4,031,880
U.S. Treasury Notes 7.750 2001 1,250,000 1,308,013
U.S. Treasury Notes 6.625 2001 2,000,000 2,004,380
U.S. Treasury Notes 7.500 2002 1,000,000 1,042,810
U.S. Treasury Notes 6.500 2005 500,000 491,170
U.S. Treasury Notes 6.875 2006 1,800,000 1,810,116
- ---------------------------------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT ISSUES (Cost--$23,824,790) 22,913,015
- ---------------------------------------------------------------------------------------------------------
GNMA (15.9%)
GNMA Pool #163934 9.000 2016 13,908 14,704
GNMA Pool #165633 9.000 2016 85,520 90,410
GNMA Pool #192803 9.500 2016 155,027 166,798
GNMA Pool #204238 9.500 2017 248,670 267,395
GNMA Pool #208850 9.500 2017 173,608 186,680
GNMA Pool #212897 9.500 2017 129,579 139,418
GNMA Pool #213635 9.500 2017 87,227 93,796
GNMA Pool #221645 9.500 2017 231,949 249,561
GNMA Pool #224848 9.500 2017 35,689 38,376
GNMA Pool #226032 9.500 2017 226,578 243,639
GNMA Pool #229824 9.500 2017 15,152 16,293
GNMA Pool #223682 9.500 2018 147,924 158,971
GNMA Pool #305224 9.500 2021 59,135 63,551
GNMA Pool #414739 6.500 2025 3,810,672 3,539,161
GNMA Pool #268164 10.250 2029 2,590,967 2,777,206
- ---------------------------------------------------------------------------------------------------------
TOTAL GNMA (Cost--$7,903,373) 8,045,959
- ---------------------------------------------------------------------------------------------------------
FHA (12.1%)
FHA Pool #2343143 9.125 2034 3,380,032 3,527,909
FHA Pool #2343143 10.250 2034 2,504,208 2,613,767
- ---------------------------------------------------------------------------------------------------------
TOTAL FHA (Cost--$6,227,919) 6,141,676
- ---------------------------------------------------------------------------------------------------------
FNMA (11.4%)
FNMA Pool #002497 11.000 2016 1,323,230 1,462,182
FNMA Pool #250407 7.000 2025 1,008,321 968,301
FNMA Pool #337532 7.000 2026 1,507,031 1,445,801
FNMA Pool #298163 7.000 2026 996,566 956,076
FNMA Pool #334520 7.000 2026 1,008,024 967,068
- ---------------------------------------------------------------------------------------------------------
TOTAL FNMA (Cost--$5,776,503) 5,799,428
- ---------------------------------------------------------------------------------------------------------
<PAGE>
Page 10
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Keystone Government Securities Fund
SCHEDULE OF INVESTMENTS--July 31, 1996
Coupon Maturity Par Market
Rate Date Value Value
- ---------------------------------------------------------------------------------------------------------
FHLMC (7.4%)
FHLMC Pool #430438 10.500% 2009 $ 57,675 $ 62,325
FHLMC Pool #607352 7.971 2022 3,528,673 3,669,079
- ---------------------------------------------------------------------------------------------------------
TOTAL FHLMC (Cost--$3,733,240) 3,731,404
- ---------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS (6.2%)
FNMA Series 93-248 5A (Est. Mat. 2004) (c) 3.258 2023 1,250,000 844,141
FNMA GT 95-T5A (Est. Mat. 2001) (c) 7.000 2035 845,186 801,342
Resolution Trust Corp. Series 95-1 A2C (Est. Mat. 2000)
(c) 7.500 2028 1,490,625 1,480,843
- ---------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost--$3,162,839) 3,126,326
- ---------------------------------------------------------------------------------------------------------
Maturity
Value
- ---------------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENT (0.5%) (Cost--$269,000)
Keystone Joint Repurchase Agreement (Investments in
repurchase agreements, in a joint trading account,
purchased 7/31/96) (b) 5.687 8/1/96 $ 269,042 269,000
- ---------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (Cost--$50,897,664) (a) 50,026,808
OTHER ASSETS AND LIABILITIES--NET (1.3%) 645,344
- ---------------------------------------------------------------------------------------------------------
NET ASSETS--(100.0%) $50,672,152
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(a) The cost of investments for federal income tax purposes is $50,946,234.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost, at July 31, 1996 are as follows:
Gross unrealized appreciation $ 241,659
Gross unrealized
depreciation (1,161,085)
-----------
Net unrealized depreciation $ (919,426)
===========
(b) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at
July 31, 1996.
(c) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest rates
can cause the estimated maturity to differ from the listed dates.
These estimated maturity dates are unaudited.
Legend of Portfolio Abbreviations
FHA--Federal Housing Association
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
GNMA--Government National Mortgage Association
See Notes to Financial Statements.
<PAGE>
Page 11
- -----------------------------------
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
Year Ended July 31,
1996 1995 1994(c) 1993 1992
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value beginning
of year $ 9.61 $ 9.48 $10.45 $10.58 $10.18
- -------------------------------------------------------------------------------
Income from investment
operations:
Net investment income 0.61 0.67 0.57 0.68 0.68
Net realized and
unrealized gain (loss)
on investments (0.18) 0.11 (0.63) 0.46 0.55
- -------------------------------------------------------------------------------
Total from investment
operations 0.43 0.78 (0.06) 1.14 1.23
- -------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.60) (0.65) (0.57) (0.68) (0.69)
In excess of net
investment income (0.03) 0 (0.02) (0.06) (0.04)
Tax basis return of
capital 0 0 (0.06) 0 0
Net realized gain on
investments 0 0 0 (0.53) (0.10)
In excess of net realized
gain on investments 0 0 (0.26) 0 0
- -------------------------------------------------------------------------------
Total distributions (0.63) (0.65) (0.91) (1.27) (0.83)
- -------------------------------------------------------------------------------
Net asset value end of
year $ 9.41 $ 9.61 $ 9.48 $10.45 $10.58
- -------------------------------------------------------------------------------
Total return (a) 4.51% 8.64% (0.71%) 11.51% 12.45%
Ratios/supplemental data
Ratios to average net
assets:
Total expenses 1.14%(b) 1.00% 1.00% 1.41% 1.93%
Total expenses excluding
reimbursement 1.41% 1.42% 1.35% 1.73% 1.93%
Net investment income 6.27% 7.11% 5.97% 6.49% 6.44%
Portfolio turnover rate 176% 182% 230% 189% 93%
Net assets end of year
(thousands) $24,685 $29,776 $38,541 $50,594 $47,892
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
February 13, 1987
(Commencement of
Operations) to
1991 1990 1989 1988 July 31, 1987
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value beginning
of year $ 10.01 $ 10.11 $ 9.74 $ 10.22 $10.00
- ---------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income 0.76 0.76 0.75 0.75 0.14
Net realized and
unrealized gain (loss)
on investments 0.17 (0.10) 0.35 (0.40) 0.22
- ---------------------------------------------------------------------------------------
Total from investment
operations 0.93 0.66 1.10 0.35 0.36
- ---------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.76) (0.76) (0.73) (0.83) (0.14)
In excess of net
investment income 0 0 0 0 0
Tax basis return of
capital 0 0 0 0 0
Net realized gain on
investments 0 0 0 0 0
In excess of net realized
gain on investments 0 0 0 0 0
- ---------------------------------------------------------------------------------------
Total distributions (0.76) (0.76) (0.73) (0.83) (0.14)
- ---------------------------------------------------------------------------------------
Net asset value end of
year $ 10.18 $ 10.01 $ 10.11 $ 9.74 $10.22
- ---------------------------------------------------------------------------------------
Total return (a) 9.62% 6.84% 11.89% 3.55% 3.60%
Ratios/supplemental data
Ratios to average net
assets:
Total expenses 1.92% 1.91% 1.90% 1.30% 1.00%(d)
Total expenses excluding
reimbursement 1.92% 1.91% 1.90% 1.30% 1.00%(d)
Net investment income 7.46% 7.61% 7.68% 7.29% 5.74%(d)
Portfolio turnover rate 72% 58% 171% 206% 60%
Net assets end of year
(thousands) $55,597 $61,744 $68,493 $73,757 $3,479
- ---------------------------------------------------------------------------------------
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid expenses,
the expense ratio would have been 1.13% for the year ended July 31, 1996.
(c) Calculation based on average shares outstanding.
(d) Annualized for the period April 14, 1987 (Commencement of Investment
Operations) to July 31, 1987.
See Notes to Financial Statements.
<PAGE>
Page 12
- -----------------------------------
Keystone Government Securities Fund
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
February 1, 1993
(Date of Initial
Year Ended July 31, Public Offering) to
1996 1995 1994(c) July 31, 1993
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net asset value beginning of year $ 9.61 $ 9.48 $ 10.45 $10.32
- ----------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income 0.53 0.59 0.50 0.26
Net realized and unrealized gain (loss)
on investments (0.18) 0.12 (0.63) 0.22
- ----------------------------------------------------------------------------------------------
Total from investment operations 0.35 0.71 (0.13) 0.48
- ----------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.53) (0.58) (0.49) (0.26)
In excess of net investment income (0.03) 0 (0.03) (0.09)
Tax basis return of capital 0 0 (0.06) 0
In excess of net realized gain on
investments 0 0 (0.26) 0
- ----------------------------------------------------------------------------------------------
Total distributions (0.56) (0.58) (0.84) (0.35)
- ----------------------------------------------------------------------------------------------
Net asset value end of year $ 9.40 $ 9.61 $ 9.48 $10.45
- ----------------------------------------------------------------------------------------------
Total return (a) 3.63% 7.81% (1.44%) 4.69%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.89%(b) 1.75% 1.75% 1.72%(d)
Total expenses excluding reimbursement 2.17% 2.09% 2.12% 2.28%(d)
Net investment income 5.52% 6.40% 5.32% 5.46%(d)
Portfolio turnover rate 176% 182% 230% 189%
Net assets end of year (thousands) $17,694 $18,064 $15,386 $9,223
- ----------------------------------------------------------------------------------------------
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid expenses,
the expense ratio would have been 1.88% for the year ended July 31, 1996.
(c) Calculation based on average shares outstanding.
(d) Annualized.
See Notes to Financial Statements.
<PAGE>
Page 13
- -----------------------------------
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
Year Ended July 31,
February 1, 1993
(Date of Initial
Year Ended July 31, Public Offering) to
1996 1995 1994(c) July 31, 1993
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net asset value beginning of year $ 9.62 $ 9.49 $ 10.46 $ 10.32
- ----------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income 0.54 0.61 0.50 0.25
Net realized and unrealized gain (loss)
on investments (0.19) 0.10 (0.63) 0.24
- ----------------------------------------------------------------------------------------------
Total from investment operations 0.35 0.71 (0.13) 0.49
- ----------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.53) (0.58) (0.50) (0.25)
In excess of net investment income (0.03) 0 (0.02) (0.10)
Tax basis return of capital 0 0 (0.06) 0
In excess of net realized gain on
investments 0 0 (0.26) 0
- ----------------------------------------------------------------------------------------------
Total distributions (0.56) (0.58) (0.84) (0.35)
- ----------------------------------------------------------------------------------------------
Net asset value end of year $ 9.41 $ 9.62 $ 9.49 $ 10.46
- ----------------------------------------------------------------------------------------------
Total return (a) 3.62% 7.81% (1.44%) 4.79%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.89%(b) 1.75% 1.75% 1.71%(d)
Total expenses excluding reimbursement 2.17% 2.17% 2.12% 2.17%(d)
Net investment income 5.53% 6.32% 5.32% 5.31%(d)
Portfolio turnover rate 176% 182% 230% 189%
Net assets end of year (thousands) $8,293 $9,101 $17,505 $13,286
- ----------------------------------------------------------------------------------------------
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid expenses,
the expense ratio would have been 1.88% for the year ended July 31, 1996.
(c) Calculation based on average shares outstanding.
(d) Annualized.
See Notes to Financial Statements.
<PAGE>
Page 14
- -----------------------------------
Keystone Government Securities Fund
STATEMENT OF ASSETS AND LIABILITIES
July 31, 1996
<TABLE>
<CAPTION>
<S> <C>
Assets (Notes 1 and 5)
Investments at market value
(identified cost--$50,897,664) $50,026,808
Cash 446
Receivable for:
Investments sold 64,853
Fund shares sold 10,658
Interest 723,982
Due from investment adviser 16,959
Prepaid expenses and other assets 8,874
- ---------------------------------------------------------------
Total assets 50,852,580
- ---------------------------------------------------------------
Liabilities (Notes 2, 4 and 5)
Payable for:
Fund shares redeemed 43,604
Distributions to shareholders 94,763
Distribution fee payable 1,667
Accrued transfer agent fees 863
Accrued reimbursable expenses 2,000
Other accrued expenses 37,531
- ---------------------------------------------------------------
Total liabilities 180,428
- ---------------------------------------------------------------
Net assets $50,672,152
- ---------------------------------------------------------------
Net assets represented by (Note 1)
Paid-in capital $56,162,952
Accumulated distributions in excess of net
investment income (94,763)
Accumulated net realized loss on investments (4,525,181)
Net unrealized depreciation on investments (870,856)
- ---------------------------------------------------------------
Total net assets $50,672,152
- ---------------------------------------------------------------
Net asset value per share (Note 2)
Class A Shares
Net assets of $24,684,810 / 2,624,480 shares
outstanding $ 9.41
Offering price per share ($9.41 / 0.9525)
(based on a sales charge of 4.75% of the
offering price at July 31, 1996) $ 9.88
Class B Shares
Net assets of $17,693,939 / 1,881,535 shares
outstanding $ 9.40
Class C Shares
Net assets of $8,293,403 / 880,989 shares
outstanding $ 9.41
- ---------------------------------------------------------------
</TABLE>
STATEMENT OF OPERATIONS
Year Ended July 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
Investment income (Note 1)
Interest $4,163,554
- ------------------------------------------------------------
Expenses (Notes 4 and 5)
Management fee $ 365,012
Transfer agent fees 124,611
Accounting, auditing and legal
fees 54,966
Custodian fees 50,196
Distribution Plan expenses 350,078
Registration fees 45,479
Miscellaneous 18,595
Reimbursement from investment
advisor (152,919)
- ------------------------------------------------------------
Total expenses 856,018
Less: Expenses paid indirectly
(Note 6) (8,794)
- ------------------------------------------------------------
Net expenses 847,224
- ------------------------------------------------------------
Net investment income 3,316,330
- ------------------------------------------------------------
Net realized and unrealized loss on investments (Notes 1 and 3)
Net realized loss on investments (1,599)
Net change in unrealized
depreciation on investments (990,037)
- ------------------------------------------------------------
Net realized and unrealized loss
on investments (991,636)
- ------------------------------------------------------------
Net increase in net assets
resulting from operations $2,324,694
- ------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
<PAGE>
Page 15
- -----------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended July 31,
1996 1995
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Operations
Net investment income $ 3,316,330 $ 4,123,800
Net realized loss on investments and closed futures contracts (1,599) (426,554)
Net change in unrealized appreciation (depreciation) on investments (990,037) 684,236
- -------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 2,324,694 4,381,482
- -------------------------------------------------------------------------------------------------------------------
Distributions to shareholders from (Note 1)
Net investment income:
Class A Shares (1,727,494) (2,209,540)
Class B Shares (1,084,150) (956,018)
Class C Shares (473,896) (785,806)
In excess of net investment income:
Class A Shares (81,785) (14,410)
Class B Shares (51,327) (6,235)
Class C Shares (22,436) (5,125)
- -------------------------------------------------------------------------------------------------------------------
Total distributions to shareholders (3,441,088) (3,977,134)
- -------------------------------------------------------------------------------------------------------------------
Capital share transactions (Note 2)
Proceeds from shares sold:
Class A Shares 1,651,672 2,769,293
Class B Shares 5,962,724 7,568,772
Class C Shares 2,368,822 2,745,502
Payments for shares redeemed:
Class A Shares (7,382,633) (13,142,989)
Class B Shares (6,522,312) (5,680,735)
Class C Shares (3,283,434) (11,661,880)
Net asset value of shares issued in reinvestment of dividends and distributions:
Class A Shares 1,158,479 1,398,434
Class B Shares 617,384 567,452
Class C Shares 277,020 537,320
- -------------------------------------------------------------------------------------------------------------------
Net decrease in net assets resulting from capital share transactions (5,152,278) (14,898,831)
- -------------------------------------------------------------------------------------------------------------------
Total decrease in net assets (6,268,672) (14,494,483)
Net assets
Beginning of year 56,940,824 71,435,307
- -------------------------------------------------------------------------------------------------------------------
End of year {including accumulated distributions in excess of net investment
income as follows: 1996--($94,763) and 1995--($25,769)} (Note 1) $50,672,152 $ 56,940,824
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
<PAGE>
Page 16
- -----------------------------------
Keystone Government Securities Fund
NOTES TO FINANCIAL STATEMENTS (Unaudited)
(1.) Significant Accounting Policies
Keystone Government Securities Fund (the "Fund") is a Massachusetts business
trust for which Keystone Management, Inc. ("KMI") is the Investment Manager and
Keystone Investment Management Company ("Keystone") is the Investment Adviser.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. ("KII"). The
Fund is registered under the Investment Company Act of 1940, as amended (the
"1940 Act"), as a diversified open-end investment company. The Fund offers
several classes of shares. The Fund's investment objective is to seek the
highest possible level of current income, consistent with safety of principal
and maintenance of liquidity, by investing primarily in securities issued by or
guaranteed as to principal and interest by the full faith and credit of the U.S.
government.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles,
which require management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
A. Valuation of Securities
U.S. Government obligations held by the Fund are valued at the mean between
the over-the-counter bid and asked prices as furnished by an independent pricing
service. Listed corporate bonds, other fixed income securities, mortgage and
other asset-backed securities, and other related securities are valued at prices
provided by an independent pricing service. In determining value for normal
institutional-size transactions, the pricing service uses methods based on
market transactions for comparable securities and various relationships between
securities which are generally recognized by institutional traders. Security
valuations not available from an independent pricing service (including
restricted securities) are valued at fair value as determined in good faith
according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. Repurchase Agreements
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund, along with certain other Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized by
U.S. Treasury and/or Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the
collateral daily and will require the seller to provide additional collateral
in the event the market value of the securities pledged falls below the
carrying value of the repurchase agreement.
C. Reverse Repurchase Agreements
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the value of reverse repurchase agreements is based
upon competitive market rates at the time of issuance. At the time the Fund
enters into a reverse repurchase agreement, it will establish and maintain a
segregated account with its custodian containing liquid assets having a value
not less than the repurchase price (including accrued interest). If the
counterparty to the
<PAGE>
Page 17
- -----------------------------------
transaction is rendered insolvent, the ultimate realization of the securities
to be repurchased by the Fund may be delayed or limited
D. Futures Contracts
In order to gain exposure to or protect against changes in security values,
the Fund may buy and sell futures contracts.
The initial margin deposited with a broker when entering into a futures
transaction is subsequently adjusted by daily payments or receipts as the value
of the contract changes. Such changes are recorded as unrealized gains or
losses. Realized gains or losses are recognized on closing the contract.
The risks of entering into futures contracts include (i) the possibility
of an illiquid market for the contract, (ii) the possibility that a change in
the value of the contract may not correlate with changes in the value of the
underlying instrument or index, and (iii) the credit risk that the other
party will not fulfill the obligations of the contract. Futures contracts
also involve elements of market risk in excess of the amount reflected in the
statement of assets and liabilities.
E. Security Transactions and Investment Income
Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are computed on the
identified cost basis. Interest income is recorded on the accrual basis and
includes amortization of discounts and premiums.
F. Federal Income Taxes
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly,
no provision for federal income taxes is required.
G. Distributions
The Fund distributes net investment income monthly and net capital gains, if
any, annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally
accepted accounting principles. These differences are primarily due to
differing treatment for paydown gains (losses).
H. Class Allocations
Class A shares are offered at a public offering price which includes a
maximum sales charge of 4.75% payable at the time of purchase. Class B shares
are sold subject to a contingent deferred sales charge that is payable upon
redemption and decreases depending on how long the shares have been held. Class
B shares purchased on or after June 1, 1995 that have been outstanding for eight
years will automatically convert to Class A shares. Class B shares purchased
prior to June 1, 1995 that have been outstanding for seven years will
automatically convert to Class A shares. Class C shares are sold subject to a
contingent deferred sales charge payable on shares redeemed within one year of
purchase.
Income, expenses (other than class specific expenses) and realized and
unrealized gains and losses are prorated among the classes based on the relative
net assets of each class. Currently, class specific expenses are limited to
expenses incurred under the Distribution Plans for each class.
<PAGE>
Page 18
- -----------------------------------
Keystone Government Securities Fund
(2.) Capital Share Transactions
The Fund's Declaration of Trust authorizes the issuance of an unlimited
number of shares of beneficial interest with no par value. Shares of beneficial
interest of the Fund are currently divided into Class A, Class B and Class C.
Transactions in shares of the Fund were as follows:
Year ended July 31,
Class A 1996 1995
- ----------------------------------------------------
Shares sold 169,632 291,673
Shares redeemed (762,511) (1,409,532)
Shares issued in
reinvestment of
dividends and
distributions 120,093 149,602
- ----------------------------------------------------
Net decrease (472,786) (968,257)
- ----------------------------------------------------
Class B
- ----------------------------------------------------
Shares sold 614,502 804,244
Shares redeemed (676,246) (608,903)
Shares issued in
reinvestment of
dividends and
distributions 63,955 60,604
- ----------------------------------------------------
Net increase 2,211 255,945
- ----------------------------------------------------
Class C
- ----------------------------------------------------
Shares sold 245,017 295,567
Shares redeemed (338,579) (1,253,057)
Shares issued in
reinvestment of
dividends and
distributions 28,708 57,570
- ----------------------------------------------------
Net decrease (64,854) (899,920)
- ----------------------------------------------------
(3.) Securities Transactions
Cost of purchases and proceeds from sales of U.S. government securities
(excluding short-term securities) for the year ended July 31, 1996 were
$94,561,369 and $97,608,076, respectively.
The average daily balance of reverse repurchase agreements outstanding during
the year ended July 31, 1996 was approximately $3,190,700 at a weighted average
interest rate of 5.81%. The maximum amount of borrowing during the year was
$4,463,261 (including accrued interest).
As of July 31, 1996, the Fund has a capital loss carryover for federal income
tax purposes of approximately $3,703,000 which expires in 2002.
(4.) Distribution Plans
The Fund bears some of the costs of selling its shares under Distribution
Plans adopted by its Class A, B and C shares pursuant to Rule 12b-1 under the
1940 Act. Under the Distribution Plans, the Fund pays its principal underwriter,
Keystone Investment Distributors Company ("KIDC"), a wholly-owned subsidiary of
Keystone, amounts which are calculated and paid daily.
The Class A Distribution Plan provides for expenditures, which are currently
limited to 0.25% annually of the average net assets of the Class A shares, to
pay expenses related to the distribution of Class A shares. During the year
ended July 31, 1996, the Fund paid $66,218 to KIDC under the Class A
Distribution Plan.
Pursuant to the Fund's Class B and Class C Distribution Plans, the Fund pays
a distribution fee which may not exceed 1.00% of the average daily net assets of
Class B and Class C shares, respectively. Of that amount 0.75% is used to pay
distribution expenses and 0.25% is used to pay service fees.
During the year ended July 31, 1996, under the Class B Distribution Plans,
the Fund paid or accrued $150,440 for Class B shares purchased before June 1,
1995 and $46,694 for Class B shares purchased on or after June 1, 1995. The Fund
paid $86,726 under the Class C Distribution Plan.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of the respective class. However, after the termination of
<PAGE>
Page 19
- -----------------------------------
any Distribution Plan, and subject to the discretion of the Independent
Trustees, payments to KIDC may continue as compensation for services which had
been earned while the Distribution Plan was in effect.
KIDC intends, but is not obligated, to continue to pay distribution costs
that exceed the current annual payments from the Fund. KIDC intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof by the Class B or Class C shares would
be within permitted limits.
At July 31, 1996 total unpaid distribution costs were $1,068,462 for Class B
shares purchased before June 1, 1995 and $343,081 for Class B shares purchased
on or after June 1, 1995. Unpaid distribution costs for Class C were $1,543,638
at July 31, 1996.
Contingent deferred sales charges paid by redeeming shareholders are paid to
KIDC.
(5.) Investment Management Agreement and Other Affiliated Transactions
Under the terms of the Investment Management Agreement between KMI and the
Fund, KMI provides investment management and administrative services to the
Fund. In return, KMI is paid a management fee, computed and paid daily, at an
annual rate of 2.00% of the Fund's gross investment income plus an amount
determined by applying percentage rates starting at 0.50% and declining as net
assets increase to 0.25% per annum, to the net asset value of the Fund.
KMI has entered into an Investment Advisory Agreement with Keystone under
which Keystone provides investment advisory and management services to the Fund.
In return for its services, Keystone receives an annual fee equal to 85% of the
management fee received by KMI.
Effective October 2, 1995, Keystone has voluntarily limited the expenses of
Class A shares to 1.15% of its average daily net assets and has limited the
expenses of Class B and C to 1.90% of the average daily net assets of each
respective class. Prior to October 2, 1995, Keystone voluntarily limited the
expenses of Class A shares to 1.00% of its average daily net assets and limited
the expenses of Class B and C to 1.75% of the average daily net assets of each
respective class. In accordance with the voluntary expense limits, Keystone
reimbursed $152,919 to the Fund during the year ended July 31, 1996.
During the year ended July 31, 1996, the Fund paid or accrued $24,249 to
Keystone for certain accounting services. The Fund paid or accrued $124,611 to
Keystone Investor Resource Center, Inc., a wholly-owned subsidiary of Keystone,
for services rendered as the Fund's transfer and dividend disbursing agent.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund. Currently the Independent Trustees of the
Fund receive no compensation for their services.
(6.) Expense Offset Arrangement
The Fund has entered into an expense offset arrangement with its custodian.
For the year ended July 31, 1996, the Fund incurred total custody fees of
$50,196 and received a credit of $8,794 pursuant to this expense offset
arrangement, resulting in a net custody expense of $41,402. The assets deposited
with the custodian under this expense offset arrangement could have been
invested in income-producing assets.
(7.) Subsequent Distribution to Shareholders
Distributions from net investment income of $0.050 for Class A, $0.044 for
Class B and $0.044 for Class C were declared payable by September 6, 1996 to
shareholders of record on August 23, 1996. These distributions are not reflected
in the accompanying financial statements.
<PAGE>
Page 20
- -----------------------------------
Keystone Government Securities Fund
(8.) Subsequent Event
On September 6, 1996, Keystone Investments, Inc. entered into an Agreement
and Plan of Acquisition and Merger (the "Acquisition") with First Union
Corporation and First Union National Bank of North Carolina ("First Union")
whereby First Union would acquire all the assets and liabilities of Keystone
Investments, Inc. Subject to the receipt of the required regulatory and
shareholder approvals, the Acquisition is expected to take place in late
December 1996.
<PAGE>
Page 21
- -----------------------------------
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Government Securities Fund
We have audited the accompanying statement of assets and liabilities of Keystone
Government Securities Fund, including the schedule of investments, as of July
31, 1996, and the related statement of operations for the year then ended, the
statements of changes in net assets for each of the years in the two-year period
then ended, and the financial highlights for each of the years in the nine-year
period ended July 31, 1996 and the period from February 13, 1987 (Commencement
of Operations) to July 31, 1987 for Class A Shares and for each of the years in
the three-year period ended July 31, 1996 and the period from February 1, 1993
(Date of Initial Public Offering) to July 31, 1993, for Class B and Class C
Shares. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of July
31, 1996 by correspondence with the custodian. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Government Securities Fund as of July 31, 1996, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years or periods specified in the first paragraph above in
conformity with generally accepted accounting principles.
Boston, Massachusetts
September 6, 1996
KPMG Peat Marwick LLP
<PAGE>
Page 22
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Keystone Government Securities Fund
- --------------------------------------------------------------------------------
FEDERAL TAX STATUS--FISCAL 1996 DISTRIBUTIONS
(Unaudited)
- --------------------------------------------------------------------------------
The per share distributions paid to you for fiscal 1996, whether taken in
shares or cash, are as follows:
Income
Dividends
----------
Class A $0.63
Class B $0.56
Class C $0.56
In January 1997, complete information on the calendar year 1996 distributions
will be forwarded to you to assist you in completing your 1996 federal income
tax return.
<PAGE>
Page 23
- -----------------------------------
Keystone's Services for Shareholders
KEYSTONE AUTOMATED RESPONSE LINE (KARL) -- Receive up-to-date account
information on your balance, last transaction and recent Fund distribution. You
may also process transactions such as investments, redemptions and exchanges
using a touch-tone telephone as well as receive quotes on price, yield, and
total return of your Keystone Fund. Call toll-free, 1-800-346-3858.
EASY ACCESS TO INFORMATION ON YOUR ACCOUNT -- Information about your Keystone
account is available 24 hours a day through KARL. To speak with a Shareholder
Services representative about your account, call toll-free 1-800-343-2898
between 8:00 A.M. and 6:00 P.M. Eastern time. Retirement Plan investors should
call 1-800-247-4075.
ADDITIONS TO YOUR ACCOUNT -- You can buy additional shares for your account
at any time, with no minimum additional investment.
REINVESTMENT OF DISTRIBUTIONS -- You can compound the return on your
investment by automatically reinvesting your Fund's distributions at net asset
value with no sales charge.
EXCHANGE PRIVILEGE -- You may move your money among funds in the same Keystone
family quickly and easily for a nominal service fee. KARL gives you the added
ability to move your money any time of day, any day of the week. Keystone offers
a varity of funds with different investment objectives for your changing
investment needs.
ELECTRONIC FUNDS TRANSFER (EFT) -- Referred to as the "paper-less
transaction," EFT allows you to take advantage of a variety of preauthorized
account transactions, including automatic monthly investment and systematic
monthly or quarterly withdrawals. EFT is a quick, safe and accurate way to move
money between your bank account and your Keystone account.
CHECK WRITING -- Shareholders of Keystone Liquid TRust may exercise the check
writing privilege to draw from their accounts.
EASY REDEMPTION -- KARL makes redemption services available to you 24 hours
a day, every day of the year. The amount you receive may be more or less than
your original account value depending on the value of fund shares at time
of redemption.
RETIREMENT PLANS -- Keystone offers a full range of retirement plans,
including IRA, SEP-IRA, profit sharing, money purchase, and defined contribution
plans. For more information, please call Retirement Plan Services, toll-free at
1-800-247-4075.
Keystone is committed to providing you with quality, responsive account
service. We will do your best to assist you and your financial adviser in
carrying your your investment plans.
<PAGE>
[KEYSTONE BACK COVER]
KEYSTONE AMERICA
FAMILY OF FUNDS
[DIAMOND]
Balanced Fund II
California Insured Tax Free Fund
Capital Preservation and Income Fund
Florida Tax Free Fund
Fund for Total Return
Fund of the Americas
Global Opportunities Fund
Global Resources & Development Fund
Government Securities Fund
Hartwell Emerging Growth Fund, Inc.
Intermediate Term Bond Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Insured Tax Free Fund
Omega Fund
Pennsylvania Tax Free Fund
Small Company Growth Fund II
Strategic Income Fund
Tax Free Income Fund
World Bond Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied
by the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Keystone funds, contact your
financial adviser or call Keystone.
[KEYSTONE LOGO]
KEYSTONE INVESTMENTS
P.O. Box 2121
Boston, Massachusetts 02106-2121
GSF-R-9/96
5.1M
[RECYCLE LOGO]
