PAGE 1
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Keystone Intermediate Term Bond Fund
Seeks current income by investing primarily in a broad range of investment
quality debt 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 to you 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 4.95%.
Class B shares returned 4.10%.
Class C shares returned 4.10%.
The Lehman Intermediate Government/Corporate Bond Index, a broad unmanaged
index of government and corporate bonds with intermediate maturities, returned
5.30% 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.
Keystone Intermediate Term Bond Fund was designed to seek current income by
investing primarily in investment grade bonds with maturities between three and
ten years. In managing your Fund to meet these objectives, we consider current
and anticipated interest rates, economic growth and inflation. 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 numbers were reported to be 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.
In this changed environment, we employed three main strategies. First, as
interest rates began to rise in 1996, we decreased our U.S. Treasury holdings
and purchased collateralized-mortgage obligations (CMOs) in an attempt to take
advantage of higher rates and preservation of capital. Secondly, we increased
the Fund's diversification and quality by adding government bonds from Spain,
Germany and Canada. These bonds were protected from currency fluctuations by
hedging into U.S. dollars. Finally, we invested in investment grade industrial
bonds to benefit from improvements in credit quality resulting from strong
earnings in that sector.
Our outlook
We expect a favorable environment for intermediate term bonds in the second half
of 1996 both in the U.S. and in selected foreign markets. We believe concerns
about revived inflationary pressures in the U.S. have been overstated and the
economy should eventually slow in the fourth quarter. However, there is the
potential for some short-term price volatility.
(continued on next page)
<PAGE>
PAGE 2
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Keystone Intermediate Term Bond Fund
Changes in interest rates and the economic environment will continue to affect
the performance of bonds. Over the interest rate cycle we will continue to seek
attractive income from intermediate term, investment grade bonds. We believe
that these bonds are attractive because historically they have delivered most of
the yield of long-term bonds with significantly less price volatility.
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 Intermediate Term Bond 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] Albert H. Elfner, III
[PHOTO] 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.
<PAGE>
PAGE 3
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A Discussion With
Your Fund's 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 intermediate
term 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 bond market?
A 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. These securities provide a consistent income
stream because they cannot be redeemed before maturity. But 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 collateralized mortgage obligations (CMOs). These securities
offer very high credit quality and higher yields than U.S. Treasuries. As of
July 31, 1996, the Fund held 29.8% in CMOs, while U. S. government holdings
were reduced to 13.4% of net assets.
Fund Profile
Objective: Seeks current income by investing primarily in a broad range of
investment quality debt securities.
Commencement of investment operations: April 14, 1987
Average maturity: 11 years
Net assets: $38 million
<PAGE>
PAGE 4
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Keystone Intermediate Term Bond Fund
Asset Allocation
as of July 31, 1996
Collateralized mortgage obligations (29.8%)
Foreign bonds (US$) (6.6%)
Foreign bonds (non-US$) (15.7%)
Mortgage pass-through certificates (5.8%)
Cash(1) (1.9%)
U.S. government obligations (13.4%)
Corporate bonds (26.8%)
(as a percentage of net assets)
(1) Includes short-term investments and net other assets and liabilities.
Q You added foreign government bonds from Germany, Canada and Spain to the
portfolio. What made them attractive?
A These countries represent stable governments and their securities markets are
large and liquid. They have been using fiscal restraint to keep inflation low
and reduce deficits. Their economies have been behind the U.S. in terms of
growth, but all have been under pressure to improve monetary policies and
economic growth. More specifically, the provinces of Canada have been paying
down debt. In addition, Canada's credit quality has been improving and the
currency has been rising. Spain has a newly-elected government that is committed
to lowering the budget deficit. Germany's economy has been in a recession, but
is working to get their fiscal house in order.
Q What type of bonds did you add?
A Our foreign bond holdings were government guaranteed, which added excellent
credit quality to the portfolio. In addition, we hedged our foreign bond
holdings into U.S. dollars to protect them from currency fluctuations. As of
July 31, 1996, the Fund held 15.7% of net assets in foreign government bonds.
Q Besides government bonds, what other sectors did you invest in?
A We have focused on investment grade industrial bonds and the banking and
financial sectors. For example, Ford Motor Company, John Deere and Tenneco are
corporations that tend to perform well in growing economies. As the economy
grows and their earnings rise, so does the credit quality and value of bond
issues. Banking and finance bonds generally benefit from declining interest
rates--which is what we expect over the next six months.
Q With interest rates falling, and then rising again, what has happened to the
Fund's yield?
A As you can see from the chart below, yields see-sawed over the Fund's fiscal
period. We believe the Fund provided a competitive level of income during this
period, but the rate declines of 1995 outweighed
[1-LINE CHART]
U.S. Treasury 10-year bond yield
[PLOT POINTS]
9/29/89
10/31/89
11/30/89
12/29/89
1/31/90
2/28/90
3/30/90
4/30/90
5/31/90
6/29/90
7/31/90
8/31/90
9/28/90
10/31/90
11/30/90
12/31/90
1/31/91
2/28/91
3/28/91
4/30/91
5/31/91
6/28/91
7/31/91
8/30/91
9/30/91
10/31/91
11/29/91
12/31/91
1/31/92
2/28/92
3/31/92
4/30/92
5/29/92
6/30/92
7/31/92
8/31/92
9/30/92
10/30/92
11/30/92
12/31/92
1/29/93
2/26/93
3/31/93
4/30/93
5/28/93
6/30/93
7/30/93
8/31/93
9/30/93
10/29/93
11/30/93
12/31/93
1/31/94
2/28/94
3/31/94
4/29/94
5/31/94
6/30/94
7/29/94
8/31/94
9/30/94
10/31/94
11/30/94
12/30/94
1/31/95
2/28/95
3/31/95
4/28/95
5/31/95
6/30/95
7/31/95
8/31/95
9/29/95
10/31/95
11/30/95
12/29/95
1/31/96
2/29/96
3/29/96
4/30/96
5/31/96
6/28/96
7/31/96
8/30/96
8.24
7.9
7.82
7.91
8.41
8.51
8.63
9.02
8.59
8.41
8.34
8.84
8.8
8.63
8.24
8.05
8.01
8.02
8.05
8
8.05
8.22
8.13
7.81
7.44
7.45
7.37
6.69
7.36
7.29
7.54
7.56
7.32
7.12
6.69
6.61
6.35
6.88
6.99
6.74
6.45
6.11
6.12
6.11
6.19
5.8
5.83
5.52
5.44
5.47
5.83
5.83
5.64
6.14
6.75
7.08
7.2
7.38
7.16
7.22
7.64
7.83
7.95
7.88
7.65
7.21
7.19
7.19
6.32
6.17
6.53
6.39
6.28
6.09
5.75
5.57
5.6
6.12
6.32
6.64
6.84
6.71
6.79
6.94
5-10% July 31, 1989 to July 31, 1996
7/89 7/90 7/91 7/92 7/93 7/94 7/95 7/96
Interest rates declined during the first half of the fiscal period, then
rebounded during the second half.
Source: Fact Set
<PAGE>
PAGE 5
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Portfolio Quality Summary
as of July 31, 1996
A (25%)
AA (18%)
AAA (25%)
U.S. government obligations (14%)
Not rated (7%)
BBB (11%)
(as a percentage of portfolio assets)
the increases of 1996. The slow growth, low inflation environment of 1995 was
difficult for many income-seeking investors because it meant less income for
nearly every investor. In seeking income for shareholders, we allocate the
portfolio based on the relative attractiveness of each sector and our overall
market and economic outlook.
Q What is your outlook for the U. S. bond market over the next six months?
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 2.5% in the second half of
the year. Government and corporate bonds continue to offer historically
attractive yields after subtracting inflation. We believe that yields will rise
somewhat over the next few months but then move down toward the end of the year.
Overseas, we expect interests rates may decline in selected countries which
should be positive for bond prices. In this environment, we believe that
Keystone Intermediate Term Bond Fund is positioned to meet its objective of
producing current income.
[DIAMOND]
This column is intended to answer questions about your Fund.
If you have a question you would like answered, please write to:
Keystone Investment Distributors Company
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street, Boston, Massachusetts 02116-5034.
<PAGE>
PAGE 6
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Keystone Intermediate Term Bond Fund
Your Fund's Performance
[MOUNTAIN CHART]
Growth of an investment in
Keystone Intermediate Term Bond Fund Class A
In Thousands 0-$25
Reinvested Distributions
Initial Investment
[PLOT POINTS]
4/87 9477 9477
9220 9286
7/88 8677 9552
8744 10444
7/90 8248 10715
8296 11738
7/92 8839 13555
9010 14894
7/94 8420 14852
8458 16004
7/96 8315 16797
Total Value: $16,797
A $10,000 investment in Keystone Intermediate Term Bond Fund Class A made on
April 14, 1987 with all distributions reinvested was worth $16,797 on July 31,
1996. Past performance is no guarantee of future results.
Twelve-Month Performance as of July 31, 1996
- -----------------------------------------------------------------------
Class A Class B Class C
Total returns* 4.95% 4.10% 4.10%
Net asset value 7/31/95 $8.88 $8.89 $8.89
7/31/96 $8.73 $8.74 $8.74
Dividends $ .58 $ .51 $ .51
Capital gains 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 4.95% 4.10% 4.10%
1-year -0.03% 0.17% 4.10%
5-year 36.30% -- --
Life of Class 67.97% 12.14% 14.95%
Average Annual Total Returns
1-year w/o sales charge 4.95% 4.10% 4.10%
1-year -0.03% 0.17% 4.10%
5-year 6.39% -- --
Life of Class 5.74% 3.33% 4.06%
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.
<PAGE>
PAGE 7
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[3-LINE CHART]
Growth of an Investment
Comparison of change in value of a $10,000 investment in Keystone Intermediate
Term Bond Fund Class A, the Lehman Intermediate Government/Corporate 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 -0.03% 6.39% 5.74%
Class B 0.17% - 3.33%
Class C 4.10% - 4.06%
0-$24
[PLOT POINTS]
4/87 9477 10000 10000
9286 9936 10152
7/88 9552 10650 10571
10444 12006 11097
7/90 10715 12862 11632
11738 14178 12150
7/92 13555 16183 12533
14894 17574 12881
7/94 14852 17738 13238
16004 19301 13604
7/96 16796 20324 14005
LIGCBI $20,324
Class A $16,797
CPI $14,005
[line] Class A [line] Lehman Intermediate Government/Corporate Index (LIGCBI)
[line] Consumer Price Index (CPI)
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 for Class A 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/Corporate Bond 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 Intermediate Term Bond Fund
The Fund seeks current income by investing primarily in a broad range of
investment quality debt 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/Corporate Bond Index (LIGCBI)
The LIGCBI is a broad-based, unmanaged fixed-income index of U.S. corporate
bonds, mortgage, and 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
<PAGE>
PAGE 8
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Keystone Intermediate Term Bond Fund
other important financial considerations such as safety, stability and
consistency.
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 advisor. 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 advisor, 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.
<PAGE>
PAGE 9
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SCHEDULE OF INVESTMENTS--July 31, 1996
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- ----------------------------------- ------------------------ ------ ------ --------- -----------
<S> <C> <C> <C> <C> <C>
FIXED INCOME (98.1%)
COLLATERALIZED MORTGAGE OBLIGATIONS (29.8%)
Chase Mortgage Finance Corp.
(Est. Mat. 2005) (a) Series 1994-L Class B1 7.872% 2025 $ 487,428 $ 467,931
Criimi Mae Financial Corp.
(Est. Mat. 2004) (a) Series 1A 7.000 2033 497,504 469,209
DeBartolo Capital Partnership
(Est. Mat. 2000) (a) (b) Class B1 7.610 2004 1,000,000 1,012,500
FHLMC (Est. Mat. 1996) (a) Series 41 Class E 10.000 2019 40,956 40,918
FNMA (Est. Mat. 2004) (a) Series 1993-248 Class SA 3.258 2023 1,000,000 675,312
Merrill Lynch Mortgage Investors,
Inc. (Est. Mat. 2001) (a) Series 1995-C2 Class C 7.930 2021 964,448 957,215
Morgan Stanley Capital
(Est. Mat. 2001) (a) (b) Series 96-BKU1 Class A 6.475 2027 991,860 955,595
Paine Webber Mortgage Acceptance
Corp. IV (Est. Mat. 2004) (a) Series 1993-4 Class M1 7.500 2023 966,002 936,307
Resolution Trust Corp.
(Est. Mat. 2000) (a) Series 1995-1 Class A2C 7.500 2028 1,250,000 1,241,797
Ryland Acceptance Corp. Four
(Est. Mat. 2000) (a) Series 88 Class E 7.950 2019 1,416,681 1,410,483
Shearson Lehman CMO Inc. (Est.
Mat. 2002) (a) Series V Class 5 7.500 2019 1,500,000 1,482,188
Structured Asset Securities Corp.
(Est. Mat. 2001) (a) Series 1996-CFL Class B 6.303 2028 985,750 938,619
U.S. Home Equity Loan
(Est. Mat. 1997) (a) Series 1991-2 Class B 9.125 2021 750,000 761,948
- ----------------------------------- ----------------------- ----- ----- -------- ---------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost--$11,580,893) 11,350,022
- --------------------------------------------------------------- ----- ----- -------- ---------
FOREIGN BONDS (NON-U.S. DOLLARS) (15.7%)
Canada Government 7.500 2003 2,250,000 1,648,449
Canadian Dollars
Canada Government 8.750 2005 2,600,000 2,043,424
Canadian Dollars
Germany Federal Republic 6.500 2003 1,435,000 999,197
Deutsche Mark
Kingdom of Spain 10.150 2006 150,000,000 1,284,327
Spanish Peseta
- ----------------------------------- ----------------------- ----- ----- ----------------------
TOTAL FOREIGN BONDS (NON-U.S. DOLLARS) (Cost--$5,983,958) 5,975,397
- --------------------------------------------------------------- ----- ----- -------- ---------
BANK & FINANCE BONDS & NOTES (14.3%)
Amsouth Bancorporation Sub. Debentures Putable 2005 6.750 2025 1,000,000 960,090
Chase Manhattan Corp. Notes (Subord.) 9.375 2001 1,250,000 1,364,450
Grand Metro Investment Corp. Putable 2005 7.450 2035 1,000,000 1,019,650
Paine Webber Group, Inc. Notes 8.250 2002 1,100,000 1,140,887
Wachovia Corp. Notes (Subord.) Putable 2005 6.605 2025 1,000,000 958,520
- ----------------------------------- ----------------------- ----- ----- -------- ---------
TOTAL BANK & FINANCE BONDS & NOTES (Cost--$5,656,795) 5,443,597
- --------------------------------------------------------------- ----- ----- -------- ---------
UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (13.4%)
U.S. Treasury Notes 6.500 2005 3,125,000 3,066,906
U.S. Treasury Strips 0.000 2006 4,000,000 2,051,400
- ----------------------------------- ----------------------- ----- ----- -------- ---------
TOTAL UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (Cost--$5,150,397) 5,118,306
- ---------------------------------------------------------------------------------------------------------------
(continued on next page)
<PAGE>
PAGE 10
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Keystone Intermediate Term Bond Fund
SCHEDULE OF INVESTMENTS--July 31, 1996
Interest Maturity Par Market
Rate Date Value Value
- ----------------------------------- ------------------------ ------ ------ --------- -----------
INDUSTRIAL BONDS & NOTES (12.5%)
AUTOMOTIVE (4.3%)
Ford Motor Co. Deb. 9.000% 2001 $1,500,000 $ 1,621,695
--------------------------------- ----------------------- ----- ----- --------- ---------
DIVERSIFIED COMPANIES (3.0%)
Tenneco, Inc. Notes 10.375 2000 1,000,000 1,123,340
--------------------------------- ----------------------- ----- ----- --------- ---------
SERVICES (2.5%)
Olsten Corp. Sr. Notes 7.000 2006 1,000,000 967,390
--------------------------------- ----------------------- ----- ----- --------- ---------
UTILITIES (2.7%)
Missouri Pacific Railroad Co. Equip. Trust Cert. 15.000 1997 1,000,000 1,035,470
--------------------------------- ----------------------- ----- ----- --------- ---------
TOTAL INDUSTRIAL BONDS & NOTES (Cost--$5,031,455) 4,747,895
-------------------------------------------------------------- ----- ----- --------- ---------
FOREIGN BONDS (U.S. DOLLARS) (6.6%)
Fomento Economico Mexico Euro-Dollars 9.500 1997 1,250,000 1,264,063
Telecom Brasileiras Yankee Notes 10.375 1997 1,200,000 1,230,000
--------------------------------- ----------------------- ----- ----- --------- ---------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost--$2,424,549) 2,494,063
-------------------------------------------------------------- ----- ----- --------- ---------
MORTGAGE PASS-THROUGH CERTIFICATES (5.8%)
FNMA Pool #002497 11.000 2016 553,243 611,339
FNMA Pool #004534 10.750 2012 551,081 595,724
GNMA Pool #414739 6.500 2025 99,796 92,686
GNMA Pool #417294 6.500 2026 998,132 926,077
--------------------------------- ----------------------- ----- ----- --------- ---------
TOTAL MORTGAGE PASS-THROUGH CERTIFICATES (Cost--$2,223,436) 2,225,826
-------------------------------------------------------------- ----- ----- --------- ---------
TOTAL FIXED INCOME (Cost--$38,051,483) 37,355,106
-------------------------------------------------------------- ----- ----- --------- ---------
Maturity
Value
--------------------------------- ----------------------- ----- ----- --------- ---------
REPURCHASE AGREEMENTS (0.7%) (Cost--$278,000)
Keystone Joint Repurchase Agreement (Investments in repurchase
agreements, in a joint trading account, dated 7/31/96) (c) 5.687 08/01/96 278,044 278,000
-------------------------------------------------------------- ----- ----- --------- ---------
TOTAL INVESTMENTS (Cost--$38,329,483) (d) 37,633,106
OTHER ASSETS AND LIABILITIES--NET (1.2%) 442,811
---------------------------------------------------------------------------------- --------- ---------
NET ASSETS (100.0%) $38,075,917
---------------------------------------------------------------------------------- --------- ---------
</TABLE>
<PAGE>
PAGE 11
- -------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS-JULY 31, 1996
(a) 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 date.
(b) Securities that may be resold to "qualified institutional buyers" under Rule
144A or securities offered pursuant to Section 4(2) of the Securities Act of
1933, as amended. These securities have been determined to be liquid under
guidelines established by the Board of Trustees.
(c) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at July 31, 1996.
(d) The cost of investments for federal income tax purposes is $38,352,044.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost, at July 31, 1996 are as follows:
Gross unrealized appreciation $ 188,346
Gross unrealized depreciation (907,284)
----------
Net unrealized depreciation ($ 718,938)
==========
Legend of Portfolio Abbreviations:
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
GNMA--Government National Mortgage Association
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
Net Unrealized
Exchange U.S. Value at In Exchange Appreciation/
Date July 31, 1996 for U.S. $ Depreciation
- ---------- ------------------------------- -------------- ----------- --------------
<S> <C> <C> <C> <C>
Forward Foreign Currency Exchange Contracts to Sell
Contracts to Deliver
-------------------------------------------------
8/30/96 5,167,800 Canadian Dollars $3,761,954 $3,774,321 $ 12,367
8/12/96 1,555,000 German Marks 1,057,000 1,031,646 (25,354)
10/15/96 173,800,000 Spanish Pesetas 1,378,699 1,348,437 (30,262)
--------------
Net Unrealized Depreciation on Forward Foreign Currency Exchange
Contracts $(43,249)
==============
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 12
- -------------------------------------------------------------------------------
Keystone Intermediate Term Bond Fund
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
Year Ended July 31,
1996 1995 1994(d) 1993 1992
============================================ ======= ====== ====== ====== ========
<S> <C> <C> <C> <C> <C>
Net asset value beginning of year $8.88 $8.84 $9.46 $9.23 $8.64
-------------------------------------------- ------- ------ ------ ------ --------
Income from investment operations:
Net investment income 0.59 0.63 0.57 0.70 0.71
Net realized and unrealized gain (loss) on
investments, closed futures contracts and
foreign currency transactions (0.16) 0.02 (0.59) 0.18 0.60
-------------------------------------------- ------- ------ ------ ------ --------
Total from investment operations 0.43 0.65 (0.02) 0.88 1.31
-------------------------------------------- ------- ------ ------ ------ --------
Less distributions from:
Net investment income (0.58) (0.57) (0.57) (0.65) (0.71)
In excess of net investment income 0 (0.04) (0.02) 0 (0.01)
Tax basis return of capital 0 0 (0.01) 0 0
-------------------------------------------- ------- ------ ------ ------ --------
Total distributions (0.58) (0.61) (0.60) (0.65) (0.72)
-------------------------------------------- ------- ------ ------ ------ --------
Net asset value end of year $8.73 $8.88 $8.84 $9.46 $9.23
============================================ ======= ====== ====== ====== ========
Total return (b) 4.95% 7.76% (0.29%) 9.88% 15.65%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.10%(c) 1.00% 1.00% 1.52% 1.88%
Total expenses excluding reimbursement 1.54% 1.48% 1.80% 1.99% 1.88%
Net investment income 6.57% 7.13% 6.81% 7.48% 7.85%
Portfolio turnover rate 231% 149% 280% 160% 90%
-------------------------------------------- ------- ------ ------ ------ --------
Net assets end of year (thousands) $12,958 $14,558 $16,036 $18,032 $19,288
============================================ ======= ====== ====== ====== ========
</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 $8.60 $9.11 $9.05 $9.61 $10.00
-------------------------------------------- ------ ------ ------ ------ ------------------
Income from investment operations:
Net investment income 0.72 0.67 0.69 0.72 0.17
Net realized and unrealized gain (loss) on
investments, closed futures contracts and
foreign currency transactions 0.05 (0.45) 0.10 (0.45) (0.42)
-------------------------------------------- ------ ------ ------ ------ ------------------
Total from investment operations 0.77 0.22 0.79 0.27 (0.25)
-------------------------------------------- ------ ------ ------ ------ ------------------
Less distributions from:
Net investment income (0.72) (0.70) (0.73) (0.83) (0.14)
In excess of net investment income (0.01) (0.03) 0 0 0
Tax basis return of capital 0 0 0 0 0
-------------------------------------------- ------ ------ ------ ------ ------------------
Total distributions (0.73) (0.73) (0.73) (0.83) (0.14)
-------------------------------------------- ------ ------ ------ ------ ------------------
Net asset value end of year $8.64 $8.60 $9.11 $9.05 $9.61
============================================ ====== ====== ====== ====== ==================
Total return (b) 9.42% 2.71% 9.13% 2.95% (2.50%)
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.00% 2.00% 1.92% 1.30% 1.00%(a)
Total expenses excluding reimbursement 2.06% 2.33% 2.19% 2.65% 12.47%(a)
Net investment income 8.42% 7.90% 7.88% 7.48% 6.86%(a)
Portfolio turnover rate 76% 107% 148% 208% 14%
-------------------------------------------- ------ ------ ------ ------ ------------------
Net assets end of year (thousands) $20,227 $23,694 $30,337 $38,615 $ 1,679
============================================ ====== ====== ====== ====== ==================
</TABLE>
(a) Annualized for the period April 14, 1987 (Commencement of Investment
Operations) to July 31, 1987.
(b) Excluding applicable sales charges.
(c) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid expenses
for the year ended July 31, 1996, the expense ratio would have been 1.08%.
(d) Calculations based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
PAGE 13
- -------------------------------------------------------------------------------
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 (d) July 31, 1993
===================================================== ======= ====== ======== ====================
<S> <C> <C> <C> <C>
Net asset value beginning of year $8.89 $8.85 $9.47 $9.35
----------------------------------------------------- ------- ------ -------- --------------------
Income from investment operations:
Net investment income 0.52 0.56 0.49 0.29
Net realized and unrealized gain (loss) on
investments, closed futures contracts and foreign
currency transactions (0.16) 0.02 (0.58) 0.12
----------------------------------------------------- ------- ------ -------- --------------------
Total from investment operations 0.36 0.58 (0.09) 0.41
----------------------------------------------------- ------- ------ -------- --------------------
Less distributions from:
Net investment income (0.51) (0.51) (0.49) (0.29)
In excess of net investment income 0 (0.03) (0.03) 0
Tax basis return of capital 0 0 (0.01) 0
----------------------------------------------------- ------- ------ -------- --------------------
Total distributions (0.51) (0.54) (0.53) (0.29)
----------------------------------------------------- ------- ------ -------- --------------------
Net asset value end of year $8.74 $8.89 $8.85 $9.47
===================================================== ======= ====== ======== ====================
Total return (b) 4.10% 6.87% (1.05%) 4.42%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.85%(c) 1.75% 1.75% 1.76%(a)
Total expenses excluding reimbursement 2.32% 2.21% 2.36% 2.71%(a)
Net investment income 5.82% 6.38% 5.48% 5.67%(a)
Portfolio turnover rate 231% 149% 280% 160%
----------------------------------------------------- ------- ------ -------- --------------------
Net assets end of year (thousands) $16,034 $17,985 $17,819 $8,159
===================================================== ======= ====== ======== ====================
</TABLE>
(a) Annualized.
(b) Excluding applicable sales charges.
(c) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid expenses
for the year ended July 31, 1996, the expense ratio would have been 1.83%.
(d) Calculations based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
PAGE 14
- -------------------------------------------------------------------------------
Keystone Intermediate Term Bond Fund
FINANCIAL HIGHLIGHTS--CLASS C 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 (d) July 31, 1993
===================================================== ======= ====== ======== ===================
<S> <C> <C> <C> <C>
Net asset value beginning of year $8.89 $8.85 $9.46 $9.35
----------------------------------------------------- ------- ------ -------- -------------------
Income from investment operations:
Net investment income 0.52 0.55 0.49 0.29
Net realized and unrealized gain (loss) on
investments, closed futures contracts and foreign
currency transactions (0.16) 0.03 (0.57) 0.11
----------------------------------------------------- ------- ------ -------- -------------------
Total from investment operations 0.36 0.58 (0.08) 0.40
----------------------------------------------------- ------- ------ -------- -------------------
Less distributions from:
Net investment income (0.51) (0.51) (0.49) (0.29)
In excess of net investment income 0 (0.03) (0.03) 0
Tax basis return of capital 0 0 (0.01) 0
----------------------------------------------------- ------- ------ -------- -------------------
Total distributions (0.51) (0.54) (0.53) (0.29)
----------------------------------------------------- ------- ------ -------- -------------------
Net asset value end of year $8.74 $8.89 $8.85 $9.46
===================================================== ======= ====== ======== ===================
Total return (b) 4.10% 6.87% (0.95%) 4.31%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.85%(c) 1.75% 1.75% 1.77%(a)
Total expenses excluding reimbursement 2.31% 2.23% 2.37% 2.61%(a)
Net investment income 5.82% 6.37% 5.44% 5.61%(a)
Portfolio turnover rate 231% 149% 280% 160%
----------------------------------------------------- ------- ------ -------- -------------------
Net assets end of year (thousands) $9,084 $10,185 $13,086 $7,522
===================================================== ======= ====== ======== ===================
</TABLE>
(a) Annualized.
(b) Excluding applicable sales charges.
(c) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid expenses
for the year ended July 31, 1996, the expense ratio would have been 1.83%.
(d) Calculations based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
PAGE 15
- -------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES--
July 31, 1996
<TABLE>
<CAPTION>
<S> <C>
Assets (Notes 1, 2 and 5)
Investments at market value (identified cost--$38,329,483) $37,633,106
Cash 79,379
Receivable for:
Investments sold 61,548
Fund shares sold 23,563
Interest 598,324
Net unrealized appreciation on forward foreign currency exchange
contracts 12,367
Receivable from investment adviser 18,920
Prepaid expenses 4,236
- ------------------------------------------------------------------------ ------------
Total assets 38,431,443
- ------------------------------------------------------------------------ ------------
Liabilities (Notes 1, 2 and 4)
Payable for:
Fund shares redeemed 190,216
Distributions to shareholders 68,752
Net unrealized depreciation on forward foreign currency exchange
contracts 55,616
Due to related parties 4,113
Other accrued expenses 36,829
- ------------------------------------------------------------------------ ------------
Total liabilities 355,526
- ------------------------------------------------------------------------ ------------
Net assets $38,075,917
======================================================================== ============
Net assets represented by (Notes 1 and 2)
Paid-in capital $42,769,604
Accumulated distributions in excess of net investment income (21,199)
Accumulated net realized loss on investments and foreign currency
related transactions (3,932,930)
Net unrealized depreciation on investments and foreign currency related
transactions (739,558)
- ------------------------------------------------------------------------ ------------
Total net assets $38,075,917
======================================================================== ============
Net Asset Value (Note 2):
Class A Shares
Net asset value of $12,958,274 / 1,484,576 shares outstanding $8.73
Offering price per share ($8.73 / 0.9525) (based on a sales charge of
4.75% of the offering price July 31, 1996) $9.17
Class B Shares
Net asset value of $16,033,767 / 1,833,529 shares outstanding $8.74
Class C Shares
Net asset value of $9,083,876 / 1,039,274 shares outstanding $8.74
======================================================================== ============
</TABLE>
STATEMENT OF OPERATIONS--
Year Ended July 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
Investment Income (Note 1)
Interest $3,205,120
Expenses (Notes 4 and 5)
Management fee $ 273,644
Transfer agent fees 106,796
Accounting, auditing and legal fees 53,538
Custodian fees 46,630
Distribution Plan expenses 312,408
Registration fees 41,731
Other 27,827
Reimbursement from investment adviser (191,096)
- -------------------------------------------------------------- -------- -----------
Total expenses 671,478
Less: Expenses paid indirectly (Note 6) (6,981)
- -------------------------------------------------------------- -------- -----------
Net expenses 664,497
- -------------------------------------------------------------- -------- -----------
Net investment income 2,540,623
- -------------------------------------------------------------- -------- -----------
Net realized and unrealized loss on investments (Notes 1 and 3)
Net realized gain (loss) on:
Investments (35,859)
Forward foreign currency transactions 62,463
- -------------------------------------------------------------- -------- -----------
Net realized gain on investments and forward foreign currency
transactions 26,604
- -------------------------------------------------------------- -------- -----------
Net change in unrealized depreciation on investments and
foreign currency related transactions (730,346)
- -------------------------------------------------------------- -------- -----------
Net realized and unrealized loss on investments and foreign
currency related transactions (703,742)
- -------------------------------------------------------------- -------- -----------
Net increase in net assets resulting from operations $1,836,881
============================================================== ======== ===========
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 16
- -------------------------------------------------------------------------------
Keystone Intermediate Term Bond Fund
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended July 31,
1996 1995
======================================================================= ========== ============
<S> <C> <C>
Operations
Net investment income $ 2,540,623 $ 2,911,914
Net realized gain (loss) on investments and foreign currency
transactions 26,604 (583,642)
Net change in unrealized appreciation (depreciation) on investments
and foreign currency transactions (730,346) 628,176
--------------------------------------------------------------------- --------- ----------
Net increase in net assets resulting from operations 1,836,881 2,956,448
--------------------------------------------------------------------- --------- ----------
Distributions to shareholders from (Note 1)
Net investment income
Class A Shares (898,299) (1,002,996)
Class B Shares (1,028,103) (1,010,554)
Class C Shares (576,335) (654,159)
In excess of net investment income
Class A Shares 0 (61,783)
Class B Shares 0 (62,249)
Class C Shares 0 (40,296)
--------------------------------------------------------------------- --------- ----------
Total distributions to shareholders (2,502,737) (2,832,037)
--------------------------------------------------------------------- --------- ----------
Net decrease from capital share transactions (Note 2)
Proceeds from shares sold:
Class A Shares 2,283,194 1,875,188
Class B Shares 4,965,806 4,978,695
Class C Shares 2,871,565 2,124,333
Payments from shares redeemed:
Class A Shares (4,141,580) (3,937,486)
Class B Shares (7,205,208) (5,447,096)
Class C Shares (4,177,736) (5,505,917)
Net asset value of shares issued in reinvestment of dividends and
distributions:
Class A Shares 469,775 533,202
Class B Shares 565,232 576,332
Class C Shares 382,466 465,630
--------------------------------------------------------------------- --------- ----------
Total decrease from capital share transactions (3,986,486) (4,337,119)
--------------------------------------------------------------------- --------- ----------
Total decrease in net assets (4,652,342) (4,212,708)
--------------------------------------------------------------------- --------- ----------
Net assets:
Beginning of year 42,728,259 46,940,967
--------------------------------------------------------------------- --------- ----------
End of year [Including accumulated distributions in excess of net
investment income as follows: 1996--($21,199) and 1995--
($94,328)](Note 1) $38,075,917 $42,728,259
===================================================================== ========= ==========
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 17
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies
Keystone Intermediate Term Bond 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") and
KMI is in turn a wholly-owned subsidiary of Keystone. 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 seeks current income by investing primarily in investment
quality debt securities. As a secondary objective, the Fund seeks to protect
capital.
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 may enter into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the 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 the custodian containing liquid assets having a value not less than
the repurchase price (including accrued interest). If the counterparty to the
transaction is rendered insolvent, the ultimate realiza-
<PAGE>
PAGE 18
- -------------------------------------------------------------------------------
Keystone Intermediate Term Bond Fund
NOTES TO FINANCIAL STATEMENTS
tion of the securities to be repurchased by the Fund may be delayed or
limited.
D. Foreign Currency
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into United States dollars as
follows: market value of investments, assets and liabilities at the daily rate
of exchange; purchases and sales of investments, income and expenses at the rate
of exchange prevailing on the respective dates of such transactions. Net
unrealized foreign exchange gain (loss) resulting from changes in foreign
currency exchange rates is a component of net unrealized appreciation
(depreciation) on investments and foreign currency transactions. Net realized
foreign currency gains and losses resulting from changes in exchange rates
include foreign currency gains and losses between trade date and settlement date
on investment securities transactions, foreign currency transactions and the
difference between the amounts of interest and dividends recorded on the books
of the Fund and the amount actually received. The portion of foreign currency
gains and losses related to fluctuations in exchange rates between the initial
purchase trade date and subsequent sale trade date is included in realized gain
(loss) on foreign currency transactions
E. Forward Foreign Currency Exchange Contracts
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio purchases and sales of securities denominated in
a foreign currency and to hedge certain foreign currency assets. Forward
contracts are recorded at the forward rate and marked-to-market daily. Realized
gains and losses arising from such transactions are included in net realized
gain (loss) on foreign currency related transactions. The Fund bears the risk of
an unfavorable change in the foreign currency exchange rate underlying the
forward contract and is subject to the credit risk that the other party will not
fulfill the obligations of the contract. Forward contracts involve elements of
market risk in excess of the amount reflected in the statement of assets and
liabilities.
F. 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.
G. 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 also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required.
H. 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) and foreign currency transactions for
income tax purposes that have been recognized for financial statement purposes.
I. Class Allocations
Class A shares are offered at a public offering price which includes a maximum
sales charge of 4.75%
<PAGE>
PAGE 19
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
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.
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,
1996 1995
-------------------------------------------- -------- ----------
Class A Shares
Shares sold 258,497 214,382
Shares redeemed (465,961) (449,814)
Shares issued in reinvestment of dividends
and distributions 52,934 61,155
-------------------------------------------- -------- ----------
Net decrease (154,530) (174,277)
============================================ ======== ==========
Class B Shares
Shares sold 555,555 566,892
Shares redeemed (808,199) (624,636)
Shares issued in reinvestment of dividends
and distributions 63,537 66,016
-------------------------------------------- -------- ----------
Net increase (decrease) (189,107) 8,272
============================================ ======== ==========
Class C Shares
Shares sold 318,799 243,954
Shares redeemed (468,122) (630,936)
Shares issued in reinvestment of dividends
and distributions 42,997 53,388
-------------------------------------------- -------- ----------
Net decrease (106,326) (333,594)
============================================ ======== ==========
3. Securities Transactions
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) were as follows for the year ended July 31, 1996:
Cost of Proceeds
Purchases from Sales
------------------------------------------ ---------- ------------
Non-U.S.Government $38,312,368 $36,081,737
U.S. Government 55,172,328 60,295,556
========================================== ========== ============
As of July 31, 1996, the Fund had a capital loss carryover for federal income
tax purposes of approximately $3,752,000 which expires as follows:
$970,000--1999, $2,688,000--2002 and $94,000--2004.
The average daily balance of reverse repurchase agreements outstanding during
the year ended July 31, 1996 was approximately $1,404,100 at a weighted average
interest rate of 5.33%. The maximum amount of borrowing during the year was
$3,956,829 (including accrued interest).
<PAGE>
PAGE 20
- -------------------------------------------------------------------------------
Keystone Intermediate Term Bond Fund
NOTES TO FINANCIAL STATEMENTS
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 that 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 $31,314 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 $151,467 for Class B shares purchased before June 1, 1995
and $28,749 for Class B shares purchased on or after June 1, 1995. The Fund paid
$100,878 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 any Distribution
Plan, and subject to the discretion of the Independent Trustees, payments to
KIDC may continue as compensation for services that 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 $1,059,039 for Class B
shares purchased before June 1, 1995 and $225,787 for Class B shares purchased
on or after June 1, 1995. Unpaid distribution costs for Class C were $1,192,820
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 1.10% of its average daily net assets and has limited the
expenses of
<PAGE>
PAGE 21
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NOTES TO FINANCIAL STATEMENTS
Class B and C to 1.85% of the average daily net assets of each respective class.
Prior to October 2, 1995, Keystone voluntarily agreed to limit expenses of the
Fund to 1.00% for Class A shares and 1.75% for Class B and C shares. For the
year ended July 31, 1996, Keystone reimbursed the Fund $191,096.
During the year ended July 31, 1996, the Fund paid or accrued $23,963 to
Keystone for certain accounting services. The Fund paid or accrued $106,796 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 $46,630
and received a credit of $6,981 pursuant to this expense offset arrangement,
resulting in a net custody expense of $39,649. 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 $0.045 for Class A, $0.039 for Class
B and $0.039 for Class C were declared payable on September 6, 1996 to
shareholders of record on August 23, 1996. These distributions are not reflected
in the accompanying financial statements.
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>
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Keystone Intermediate Term Bond Fund
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Intermediate Term Bond Fund
We have audited the accompanying statement of assets and liabilities of Keystone
Intermediate Term Bond 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 for 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 and brokers. 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 Intermediate Term Bond 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 periods specified in the first paragraph above in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
September 6, 1996
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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 SHARES 0.58
==========
CLASS B SHARES 0.51
==========
CLASS C SHARES 0.51
==========
In January 1997 complete information on calendar year 1996 distributions will
be forwarded to you to assist in completing your 1996 federal income tax return.
<PAGE>
[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
ITBF-R-9/96
4.2M [RECYCLE LOGO]
-------------------------------
K E Y S T O N E
[GRAPHIC
OF
LONG DIRT ROAD WITH FENCE]
INTERMEDIATE TERM
BOND FUND
-------------------------------
[KEYSTONE LOGO]
ANNUAL REPORT
JULY 31, 1996
