AMERICAN AADVANTAGE SHORT-TERM INCOME FUND
Prospectus
March 1, 1997
This Prospectus contains important information about the
American AAdvantage Short-Term Income Fund (the "Fund"), a
portfolio of the American AAdvantage Funds(R) (the "Trust").
The Trust is a no-load, open-end management investment company
organized as a Massachusetts business trust on January 16,
1987, consisting of nine separate investment portfolios. The
Fund is a non-diversified portfolio which seeks current income
and relative principal stability through investments in high
quality money market obligations and variable rate obligations.
There is no guarantee that the Fund will achieve its investment
objective. Prospective investors considering the purchase of
the Fund should read this Prospectus carefully before making an
investment decision and retain it for future reference.
In addition to this Prospectus, a Statement of Additional
Information ("SAI") dated March 1, 1997 has been filed with the
Securities and Exchange Commission and is incorporated herein
by reference. The SAI contains more detailed information about
the Fund. For a free copy of the SAI, call AMR Investment
Services, Inc. (the "Manager") at (817) 967-3509.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR
ANY SUCH STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<S> <C>
Table of Fees and Expenses 2
Investment Objective, Policies and 2
Risks
Investment Restrictions 8
Yields and Total Returns 8
Management and Administration of the 9
Trust
Purchase, Redemption and Valuation of 10
shares
Information Concerning Shares of the 12
Fund
General Information 13
</TABLE>
TABLE OF FEES AND EXPENSES
Annual Operating Expenses (as a percentage of average net
assets):
<TABLE>
<S> <C>
Management Fees 0.10%
Other Expenses (1) 0.05%
Total Fund Operating 0.15%
Expenses
</TABLE>
(1)Due to the Fund's lack of an operating history, other
expenses have been estimated.
<TABLE>
<CAPTION>
Examples 1 yr. 3 yrs.
<S> <C> <C>
An investor in the Fund would pay on a
cumulative basis the following expenses on a
$1,000 investment assuming a 5% annual return: $ 1 $ 5
</TABLE>
The purpose of the table above is to assist a potential
investor in understanding the various costs and expenses to be
incurred directly or indirectly as a shareholder in the Fund.
Additional information may be found under "Management and
Administration of the Trust" .
THE FOREGOING EXAMPLES SHOULD NOT BE CONSIDERED A
REPRESENTATION OF PAST OR FUTURE EXPENSES OR PERFORMANCE.
ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN AND
PERFORMANCE MAY BE BETTER OR WORSE THAN THE 5% ANNUAL RETURN
ASSUMED IN THE EXAMPLES.
INVESTMENT OBJECTIVE, POLICIES AND RISKS
The investment objective and the policies of the Fund are
described below. The investment policies may be changed at any
time by the Trust's Board of Trustees ("Board"). However, the
Fund's investment objective may not be changed without a
majority vote of the Fund's outstanding shares, which is
defined as the lesser of (a) 67% of the shares of the Fund
present or represented if the holders of more than 50% of the
shares are present or represented at a shareholders meeting, or
(b) more than 50% of the shares of the Fund (hereinafter
"majority vote").
The Fund's investment objective is to seek current income
and relative principal stability. The Fund seeks its investment
objective by investing primarily in high quality money market
obligations and variable rate long-term obligations.
Portfolio Maturity
The maximum permissible maturity of any fixed rate obligation
in which the Fund may invest is 397 days, except that fixed
rate obligations with maturities greater than 397 days may be
purchased if the Fund simultaneously enters into an interest
rate swap transaction in order for the obligation to have the
same characteristics as a variable rate obligation. The
maximum permissible final maturity or "expected life" (i.e.
anticipated maturity of obligations which reduce principal) of
any variable rate obligation is five years and the maximum
permissible dollar-weighted average maturity of the Fund is 90
days. For purposes of determining dollar-weighted average
maturity, the maturity of any obligation is deemed to be the
shortest of the following: (1) the stated maturity date or
"expected life" of the obligation; (2) the next interest reset
for variable rate obligations which will have a rate of
interest based on a leading money market index of not greater
than three months.; or (3) the next put exercise date (for
obligations with put features). For purposes of determining
maturity of repurchase agreements, the end date of the
agreement, and not the maturity of the underlying obligations,
will be used.
Money Market Obligations
Money market obligations are debt securities with maturities
of 397 days or less. The Fund may invest in high quality, U.S.
dollar-denominated money market obligations, which include, but
are not limited to: (1) obligations of the U.S. Government and
its agencies and instrumentalities; (2) loan participation
interests, and structured notes (3) domestic, Yankeedollar and
Eurodollar certificates of deposit, time deposits, bankers'
acceptances, commercial paper, bearer deposit notes and other
promissory notes, including floating or variable rate
obligations issued by U.S. or foreign bank holding companies
and their bank subsidiaries, branches and agencies; and (4)
repurchase agreements involving the obligations listed above.
These issuers or instruments at the time of purchase will: (1)
have received one of the two highest short-term ratings by at
least two nationally recognized statistical rating
organizations ("NRSROs"), such as A-1 or A-2 by Standard &
Poor's or P-1 or P-2 by Moody's Investors Service, Inc.; (2) be
single rated and have received one of the two highest short-
term ratings by that NRSRO; or (3) be unrated, but are
determined to be of comparable quality by the Manager. See the
SAI for definitions of certain of the foregoing securities and
a description of debt ratings. All money market obligations
which do not possess the highest short-term rating by at least
two NRSROs will be limited to a maturity of 91 days or less.
Long-Term Obligations
Long-term obligations are obligations deemed to have
maturities greater than 397 days. The Fund may invest in long-
term obligations which include, but are not limited to: (1)
obligations of the U.S. Government and its agencies and
instrumentalities; (2) municipal, corporate, trust or bank
obligations; (3) mortgage-backed securities, asset-backed
securities, medium-term notes, master notes, and other
promissory notes (including structured notes); and (4) funding
agreements and interest rate swap agreements. Such obligations
may have a fixed or variable rate of interest and: (1) will be
rated "A" or better by at least two NRSROs at the time of
purchase; (2) will be single rated and have received a rating
of "A" or better by that NRSRO; or (3) if unrated, will be
deemed to be of comparable quality by the Manager. See the SAI
for definitions of certain of the foregoing securities and for
a description of debt ratings. Principal and/or interest
payments for obligations of U.S. Government agencies or
instrumentalities may or may not be backed by the full faith
and credit of the U.S. Government.
Other Investment Companies
The Fund may invest in the securities of other investment
companies to the extent permitted by law.
Non-Diversification
The Fund is "non-diversified" as defined in the Investment
Company Act of 1940 (the "1940 Act"), but intends to qualify as
a "regulated investment company" ("RIC") for federal income tax
purposes. This means, in general, that more than 5% of the
Fund's total assets may be invested in the securities of a
single issuer, but only if, at the close of each quarter of the
Fund's taxable year, the aggregate amount of such holdings does
not exceed 50% of the value of its total assets and no more
than 25% of the value of its total assets is invested in the
securities of a single issuer. Although "non-diversified", the
Fund will not invest more than 10% of its total assets (taken
at market value) in obligations of any one issuer, other than
obligations issued by the U.S. Government, its agencies and
instrumentalities. However, up to 25% of the Fund's total
assets may be invested in issuers holding over 10% of the
Fund's total assets. To the extent that it holds the
securities of fewer issuers than if it were "diversified", the
Fund will be subject to greater risk than a fund that invests
in a broader range of securities because changes in the
financial condition or market valuation of a single issuer may
cause greater fluctuations in the Fund's total return and the
net asset value of its shares.
Foreign Investments
The Fund may invest in U.S. dollar-denominated obligations of
foreign issuers. The Fund may also invest up to 25% of its
total assets at the time of purchase in obligations denominated
in foreign currencies. The Fund typically will hedge its
foreign currency exposure. See "Strategic Transactions" below
for a further description of foreign currency hedging
instruments. Investing in foreign issuers carries potential
risks not associated with domestic investments. Such risks
include but are not limited to: (1) political and financial
instability abroad, including risk of nationalization or
expropriation of assets and the risk of war; (2) less liquidity
and greater volatility of foreign investments; (3) less public
information regarding foreign issuers; (4) lack of uniform
accounting, auditing and financial reporting standards; (5)
delays in transaction settlement in some foreign markets; (6)
possible imposition of confiscatory foreign taxes; (7) possible
limitation on the removal of securities or other assets of the
Fund; (8) restrictions on foreign investments and repatriation
of capital; (9) currency fluctuations; (10) costs and possible
restrictions of currency conversion; and (11) withholding taxes
on interest in foreign countries. These risks are often greater
for investments in emerging or developing countries.
Funding Agreements
The Fund may enter into funding agreements which are
contracts with insurance companies that return principal and
interest at a guaranteed rate or fixed spread to an index.
Generally, funding agreements pay interest at set intervals and
mature on specified dates. Funding agreements generally allow
for certain withdrawals to be made without penalty and are
otherwise non-surrenderable. Funding agreements are considered
to be illiquid securities and accordingly will be subject to
the Fund's limitation on investing in illiquid securities.
Strategic Transactions
The Fund may implement strategies using instruments described
below as hedging instruments to reduce various market risks of
its investments, to alter their duration, or to enhance
specific return characteristics. The Fund's ability to use
these instruments may be limited by market conditions,
regulatory limits and tax considerations.
In pursuing these strategies, the Fund may: purchase and sell
financial futures contracts and options thereon; purchase and
sell forward contracts; enter into swap agreements, including
interest rate swaps and caps, collars and floors; and enter
into various currency transactions, including currency futures
contracts, options on currency futures, currency options,
currency forward contracts and currency swaps, caps, collars
and floors (collectively, "Strategic Transactions"). Strategic
transactions may be used without limit in altering the exposure
of a particular investment or portion of the Fund's portfolio
to fluctuations in interest rates or currency exchange rates,
to preserve a return or spread, to lock in unrealized market
value gains or losses, to facilitate the sale or purchase of
securities, to manage the duration of securities, to uncap a
capped security, or to convert a fixed rate security to a
variable rate security.
Any, all or none of these strategies may be used at any time
and in any combination, and no assurance can be given that any
strategy used will succeed. If the Manager incorrectly
forecasts interest rates, currency exchange rates, market
values or other economic factors, the use of strategic
transactions might have more adverse results than if the Fund
had not used such transactions. The Fund will enter into
swaps, caps, collars and floors only with banks and recognized
securities dealers believed by the Manager to present minimal
credit risks in accordance with guidelines established by the
Board. If there is a default by the other party, the Fund will
have to rely on its contractual remedies (which may be limited
by bankruptcy, insolvency or similar laws) pursuant to the
agreement relating to the transaction. See the SAI for a
further discussion of Strategic Transactions. Strategic
Instruments may be referred to as "derivative instruments".
The Fund will comply with SEC guidelines regarding cover for
Strategic Instruments and will, if the guidelines so require,
set aside cash, U.S. Government securities or other liquid,
high-grade debt securities in a segregated account with its
custodian in the prescribed amount. Assets used as cover or
held in a segregated account cannot be sold while the position
in the corresponding Strategic Instrument is open, unless they
are replaced with other appropriate assets. As a result, the
commitment of a large portion of the Fund's assets to cover or
segregated accounts could impede portfolio management or the
Fund's ability to meet redemption requests or other current
obligations.
Mortgage-related Securities
The Fund is permitted to invest in mortgage-related
securities, subject to the quality requirements specified
above. Mortgage pass-through securities are securities
representing interests in "pools" of mortgages in which
payments of both interest and principal on the securities are
made monthly, in effect, "passing through" monthly payments
made by the individual borrowers on the mortgage loans which
underlie the securities (net of fees paid to the issuer or
guarantor of the securities). Early repayment of principal on
mortgage pass-through securities (arising from prepayments of
principal due to sale of the underlying property, refinancing
or foreclosure, net of fees and costs which may be incurred)
may expose the Fund to a lower rate of return upon reinvestment
of principal. Also, if a security subject to prepayment has
been purchased at a premium, the value of the premium would be
lost in the event of prepayment. Like other fixed-income
securities, when interest rates rise, the value of mortgage-
related securities generally will decline; however, when
interest rates decline, the value of the mortgage-related
securities with prepayment features may not increase as much as
other fixed-income securities. In recognition of this
prepayment risk to investors, the Public Securities Association
(the "PSA") has standardized the method of measuring the rate
of mortgage loan principal prepayments. The PSA formula, the
Constant Prepayment Rate and other similar models that are
standard in the industry will be used by the Fund in
calculating maturity for purposes of investment in mortgage-
related securities.
Payment of principal and interest on some mortgage pass-
through securities (but not the market value of the securities
themselves) may be guaranteed by the full faith and credit of
the U.S. Government (in the case of securities guaranteed by
the Government National Mortgage Association ("GNMA")) or
guaranteed by agencies or instrumentalities of the U.S.
Government (in the case of securities guaranteed by the Federal
National Mortgage Association ("FNMA") or the Federal Home Loan
Mortgage Corporation ("FHLMC"), which are supported only by the
discretionary authority of the U.S. Government to purchase the
agency's obligations). Mortgage pass-through securities
created by non-governmental issuers (such as commercial banks,
savings institutions, private mortgage insurance companies,
mortgage bankers and other secondary market issuers) may be
supported by various credit enhancements such as pool
insurance, a guarantee issued by a governmental entity, or a
letter of credit from a bank or senior/subordinated structures.
Collateralized mortgage obligations ("CMOs") are hybrid
instruments with characteristics of both mortgage-backed bonds
and mortgage pass-through securities. Similar to mortgage pass-
through securities, interest and prepaid principal on a CMO are
paid, in most cases, monthly. CMOs may be collateralized by
whole mortgage loans, but are more typically collateralized by
portfolios of mortgage pass-through securities guaranteed by
GNMA, FHLMC or FNMA. CMOs are structured in multiple classes,
with each class bearing a different stated maturity or interest
rate.
Asset-backed Securities
The Fund is permitted to invest in asset-backed securities,
subject to its rating and quality requirements. Through the
use of trusts and special purpose subsidiaries, various types
of assets, primarily home equity loans, automobile and credit
card receivables, and other types of receivables or other
assets as well as purchase contracts, financing leases and
sales agreements entered into by municipalities, are being
securitized in pass-through structures similar to the mortgage
pass-through structures described above.
Asset-backed securities involve certain risks that are not
posed by mortgage-related securities, resulting mainly from the
fact that asset-backed securities do not usually contain the
benefit of a complete security interest in the related
collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a
number of state and federal consumer credit laws, some of which
may reduce the ability to obtain full payment. In the case of
automobile receivables, due to various legal and economic
factors, proceeds from repossessed collateral may not always be
sufficient to support payments on the securities. The risks
associated with asset-based securities are often reduced by the
addition of credit enhancements such as a letter of credit from
a bank, excess collateral or a third-party guarantee.
Master Notes
Master notes in which the Fund may invest are unsecured notes
that permit the indebtedness thereunder to vary, and provide
for periodic adjustments in the interest rate. Because master
notes are direct lending arrangements between the Fund and the
issuer, there is no secondary market for the notes. However,
generally either the maturity of a master note shall not exceed
seven days or the master note will have a put feature which
will permit payment of principal and accrued interest within
seven days. To the extent this period is exceeded, the note in
question would be considered illiquid and will be subject to
the Fund's limitation on illiquid investments. Issuers of
master notes must satisfy the same creditworthiness criteria as
set forth for other promissory notes (e.g., commercial paper).
The Fund will invest in master notes only when such notes are
determined by the Manager to be of comparable quality to rated
issuers or instruments eligible for investment by the Fund.
Structured Notes
Structured notes are debt instruments for which the interest
rate and/or the principal are indexed to an unrelated
indicator. The Fund will only utilize structured notes that
have the characteristics of permissible variable rate notes and
that have a rate of interest based on a leading money market
index not greater than three months. Structured notes are
often issued by high-grade corporate issuers. An underlying
swap is often entered into in connection with a structured note
pursuant to which the issuer will receive payments that match
its obligations under the structured note (usually from an
investment bank that puts the transaction together) and, in
turn, makes more "traditional" payments to the investment bank
(e.g., fixed-rate or ordinary floating rate payments). In such
cases the Fund would not be involved in the swap and the issuer
of the note would remain obligated even if its counterparty
defaulted. Structured notes are considered a type of
derivative investment.
Trust Obligations
Trust obligations are debt instruments issued by a trust
established solely for the purpose of owning the underlying
assets purchased from the selling company ("originator"). The
trust is structured to ensure assets sold to the trust are not
subject to bankruptcy proceedings against the originators. The
debt instruments issued by the trust represent a pro rata
undivided interest in the trust assets.
When-Issued Securities and Forward Commitment Transactions
The Fund may purchase or sell securities on a "when-issued"
basis or "forward commitment" basis. The purchase or sale of
when-issued securities enables an investor to hedge against
anticipated changes in interest rates and prices by locking in
a favorable price or yield. The price of when-issued
securities is fixed at the time the commitment to purchase or
sell is made, but delivery and payment for the when-issued
securities take place at a later date, normally one to two
months after the date of purchase. During the period between
purchase and settlement, no payment is made by the purchaser to
the issuer and no interest accrues to the purchaser. Such
transactions therefore involve a risk of loss if the value of
the security to be purchased declines prior to the settlement
date or if the value of the security to be sold increases prior
to the settlement date. A sale of a when-issued security also
involves the risk that the other party will be unable to settle
the transaction.
Purchase and sale of securities on a "forward commitment"
basis involve a commitment to purchase or sell securities with
payment and delivery to take place at some future date,
normally one to two months after the date of the transaction.
As with when-issued securities, these transactions involve
certain risks, but they also enable an investor to hedge
against anticipated changes in interest rates and prices. When
purchasing securities on a when-issued or forward commitment
basis, a segregated account of liquid assets at least equal to
the value of purchase commitments for such securities will be
maintained until the settlement date.
Securities Lending
The Fund may lend securities to broker-dealers or other
institutional investors pursuant to agreements requiring that
the loans be continuously secured by any combination of cash,
securities of the U.S. Government and its agencies and approved
bank letters of credit that at all times equals at least 100%
of the market value of the loaned securities. Such loans will
not be made if, as a result, the aggregate amount of all
outstanding securities loans by the Fund would exceed 33 1/3%
of its total assets. The Fund normally pays lending fees and
related expenses from the interest earned on invested
collateral, but continues to receive interest on the securities
loaned and simultaneously earns either interest on the
investment of the cash collateral or fee income if the loan is
otherwise collateralized. Should the borrower of the
securities fail financially, there is a risk of delay in
recovery of the securities or loss of rights in the collateral.
However, loans are made only to borrowers which are deemed by
the Manager to be of good financial standing. For purposes of
complying with the Fund's investment policies and restrictions,
collateral received in connection with securities loans will be
deemed an asset of the Fund to the extent required by law. See
the SAI for further information regarding loan transactions.
Repurchase Agreements
A repurchase agreement is an agreement under which securities
are acquired by the Fund from financial institutions such as
banks and broker/dealers subject to resale at an agreed upon
date and price. The Fund bears the risk of loss in the event
that the other party to a repurchase agreement defaults on its
obligations and the Fund is delayed or prevented from
exercising its rights to dispose of the collateral securities.
However, the Manager will enter into repurchase agreements only
with financial institutions that are deemed to be of good
financial standing and that have been approved by the Board.
See the SAI for more information regarding repurchase
agreements.
Reverse Repurchase Agreements
The Fund may borrow funds for temporary purposes by entering
into reverse repurchase agreements. Pursuant to such
agreements, the Fund would sell portfolio securities to
financial institutions such as banks and broker/dealers and
agree to repurchase them at a mutually agreed-upon date and
price. At the time the Fund enters into a reverse repurchase
agreement, it will place in a segregated custodial account
assets such as liquid high quality debt securities having a
value not less than 100% of the repurchase price (including
accrued interest), and will subsequently monitor the account to
ensure that such required value is maintained. Reverse
repurchase agreements involve the risk that the market value of
the securities sold by the Fund may decline below the price at
which the Fund is obligated to repurchase the securities.
Reverse repurchase agreements are considered to be borrowings
by an investment company under the 1940 Act.
Portfolio Transactions
The Manager will place its own orders to execute securities
transactions of the Fund. In placing such orders, the Manager
will seek the best available price and most favorable
execution. The full range and quality of services offered by
the executing broker or dealer is considered when making these
determinations. High portfolio activity increases the Fund's
transaction costs. The Fund normally will not incur any
brokerage commissions on its transactions because debt
instruments are generally traded on a "net" basis with dealers
acting as principal for their own accounts without a stated
commission. The price of the obligation, however, usually
includes a profit to the dealer. Obligations purchased in
underwritten offerings include a fixed amount of compensation
to the underwriter, generally referred to as the underwriter's
concession or discount. No commissions or discounts are paid
when securities are purchased directly from an issuer.
INVESTMENT RESTRICTIONS
The following investment restrictions of the Fund may be
changed only by the majority vote of the Fund's outstanding
shares. The Fund may not:
-Invest more than 25% of its total assets in the obligations
of companies primarily engaged in any one industry other
than the U.S. Government, its agencies and
instrumentalities. Finance companies as a group are not
considered a single industry for purposes of this policy.
-Borrow money, except from banks or through reverse
repurchase agreements for temporary purposes in an
aggregate amount not to exceed 10% of the value of its
total assets at the time of borrowing.
As a non-fundamental investment restriction which may be
changed only by a vote of the Board, the Fund may not invest
more than 15% of its net assets in illiquid securities,
including master notes, time deposits and repurchase agreements
which mature in more than seven days.
The above percentage limits are based upon asset values at
the time of the applicable transaction; accordingly, a
subsequent change in asset values will not affect a transaction
which was in compliance with the investment restrictions at the
time such transaction was effected. See the SAI for other
investment limitations.
YIELDS AND TOTAL RETURNS
Advertised yield for the Fund will be computed by dividing
the net investment income per share earned during the relevant
time period by the offering price per share on the last day of
the period. Total return quotations advertised by the Fund
may reflect the average annual compounded (or aggregate
compounded) rate of return during the designated time period
based on a hypothetical initial investment and the redeemable
value of that investment at the end of the period.
Additionally, the Fund may advertise a "monthly distribution
rate". This rate is based on an annualized monthly dividend
accrual rate per share compared with the Fund's month-end net
asset value per share. The Fund may at times compare its
performance to applicable published indices, and may also
disclose its performance as ranked by certain ranking entities.
See the SAI for more information about the calculation of
yields and total returns.
MANAGEMENT AND ADMINISTRATION OF THE TRUST
Management Agreement
The Trust is governed by its Board which provides broad
supervision over the Trust's affairs. The Trust and the
Manager entered into a Management Agreement (the "Agreement")
which obligates the Manager to provide or oversee all
administrative, investment advisory and portfolio management
services for the Fund. The Agreement was approved with respect
to the Fund by the Fund's sole initial shareholder on November
28, 1995. The Manager provides the Trust with office space,
office equipment and personnel necessary to manage and
administer Trust operations. This includes complying with
reporting requirements; corresponding with shareholders;
maintaining internal bookkeeping, accounting and auditing
services and records; and supervising the provision of services
to the Trust by third parties. The Manager also develops and
implements the investment program for the Fund. The Manager,
located at 4333 Amon Carter Boulevard, MD5645, Fort Worth,
Texas 76155, is a wholly owned subsidiary of AMR Corporation
("AMR"), the parent company of American Airlines, Inc., and was
organized in 1986 to provide business management, advisory,
administrative and asset management consulting services to the
American AAdvantage Funds and other investors. As of December
31, 1996, the Manager had assets under management of
approximately $16.0 billion including approximately $5.7
billion under active management and $9.3 billion as named
fiduciary or fiduciary adviser. Of the total, approximately
$11.9 billion of assets are related to AMR and its primary
subsidiary, American Airlines, Inc.
As compensation for providing these services to the Fund, the
Manager receives from the Trust an annualized fee ("Management
Fee"), which is calculated and accrued daily, equal to .10% of
the net assets of the Fund. Such fees are payable quarterly in
arrears.
The Agreement will continue in effect provided that annually
such continuance is specifically approved by a vote of the
Board, including the affirmative votes of a majority of the
Trustees who are not parties to the Agreement or "interested
persons" as defined in the 1940 Act of any such party, cast in
person at a meeting called for the purpose of considering such
approval, or by the vote of shareholders. The Agreement may be
terminated at any time, without penalty, by a majority vote of
outstanding Fund shares on sixty (60) days' written notice to
the Manager, or by the Manager, on sixty (60) days' written
notice to the Trust. The Agreement will automatically terminate
in the event of its "assignment" as defined in the 1940 Act.
Portfolio Managers
Michael W. Fields is responsible for the portfolio management
oversight of the Fund. Mr. Fields has been with AMR Investment
Services, Inc. since it was founded in 1986 and currently
serves as Vice President-Fixed Income Investments. Benjamin L.
Mayer is responsible for the day-to-day portfolio management of
the Fund. Mr. Mayer has served as Senior Portfolio Manager of
AMR Investment Services since May 1995. Prior to that time, he
was a Vice President of Institutional Fixed Income Sales at
Merrill Lynch, Pierce, Fenner & Smith from January 1994 to
April 1995 and Vice President, Regional Senior Strategist from
April 1989 to January 1994.
Fund Expenses
Expenses paid by the Fund may include, but are not limited to
audits by independent auditors; transfer agent, custodian,
dividend disbursing agent and shareholder recordkeeping
services; obtaining quotations for calculating the value of the
Fund's net assets; taxes, if any, and the preparation of the
Fund's tax returns; brokerage fees and commissions; interest;
costs of Trustee and shareholder meetings; printing and mailing
prospectuses and reports to existing shareholders; fees for
filing reports with regulatory bodies and the maintenance of
the Trust's existence; legal fees; fees to federal and state
authorities for the registration of Fund shares; fees and
expenses of Trustees who are not directors, officers, employees
or stockholders of the Manager or its affiliates; insurance and
fidelity bond premiums; and any extraordinary expenses of a non-
recurring nature.
Custodian and Transfer Agent
NationsBank of Texas, N.A., Dallas, Texas serves as custodian
for the Trust and transfer agent for the Fund.
Independent Auditor
The independent auditor for the Fund is Ernst & Young LLP,
Dallas, Texas.
Principal Underwriter
Brokers Transaction Services, Inc. ("BTS"), 7001 Preston
Road, Dallas, Texas 75205, serves as principal underwriter of
the Trust.
PURCHASE, REDEMPTION AND VALUATION OF SHARES
Purchasing Shares of the Fund
Shares of the Fund are offered without a sales charge and are
sold on a continuous basis. Shares are sold at the net asset
value next determined after acceptance by the transfer agent of
a purchase order. Shares are offered and purchase orders are
accepted for the Fund on each day the Federal Reserve System
and the custodian/transfer agent are open for business
("Business Day"). The Trust reserves the right to reject any
order for the purchase of shares and to limit or suspend,
without prior notice, the offering of shares. The minimum
investment required to open an account is generally $50
million.
Payment for the purchase of shares must be in the form of
federal funds. Purchase orders are only accepted on a Business
Day by 3:00 p.m. Eastern time and will be executed on that same
day if accompanied by payment. Certificates representing
shares ordinarily will not be issued.
Fund shares may be purchased and redeemed as follows:
By Wire_Purchases may be made by wiring federal funds. To
ensure prompt receipt of a transmission by wire, the investor
should: telephone the transfer agent at (214) 508-5038 and
specify that it will be purchasing shares of the Short-Term
Income Fund; provide the name, address, telephone number, and
account number of the investor; and identify the amount being
wired and by which bank. If the investor is opening a new
account, the transfer agent will then provide the investor with
an account number. The investor should instruct its bank to
designate the account number that the transfer agent has
assigned to the investor and to transmit the federal funds to:
Federal Reserve Bank, Dallas for NationsBank of Texas, N.A.,
ABA #111-000-025, Corporate Trust Suspense No. 0180019810,
reference American AAdvantage Short-Term Income Fund,
Attention: Fund Account Services.
By Depositing Securities_Shares of the Fund may be purchased
in exchange for an investor's securities if the Manager
determines that the securities are acceptable and satisfy the
Fund's investment objective and policies. Investors interested
in exchanging securities must first contact the Manager and
obtain instructions regarding submission of a written
description of the securities that the investor wishes to
exchange. The investor must represent that all such securities
offered to the Fund are not subject to any sale restrictions.
Within five business days after receipt of the written
description, the Manager will advise the investor whether the
securities to be exchanged are acceptable. There is no charge
for this review by the Manager. Securities accepted by the Fund
must have a readily ascertainable value. Securities are valued
in the manner described for valuing Fund assets in the section
entitled "Valuation of Shares". Acceptance of such orders may
occur on any day during the five-day period afforded the
Manager to review the acceptability of the securities. Upon
acceptance of such orders, the securities must be delivered in
fully negotiable form within five days. The Manager will
provide delivery instructions at the time of acceptance. A
gain or loss for federal income tax purposes may be realized by
the investor upon the securities exchange, depending upon the
adjusted tax basis and value of the securities tendered. The
Fund will accept securities in this manner only for investment
purposes, and not for resale.
By Mail_Share purchases of the Fund may be made by mail by
sending a check or other negotiable bank draft payable to the
Fund to "NationsBank of Texas, N.A., 11th Floor, Elm Place,
P.O. Box 830840, Dallas, Texas 75283-0840, Attention: American
AAdvantage Short-Term Income Fund". Subsequent purchases of
shares should be accompanied by the shareholder's account
number. Purchase checks are accepted subject to collection at
full face value in U.S. funds and must be drawn in U.S. dollars
on a U.S. bank.
Redemption of Shares
Fund shares may be redeemed on any Business Day by writing
directly to NationsBank of Texas, N.A. at the address above
under "Purchase of Shares_By Mail". The redemption price will
be the net asset value per share next determined after receipt
by NationsBank of Texas, N.A. of all required documents in good
order. "Good order" means that the request must include a
letter of instruction or stock assignment specifying the number
of shares or dollar amount to be redeemed, signed by an
authorized signatory for the owner of the shares, and
accompanied by such other supporting legal documents which may
be required by the Trust.
Payment for redeemed shares will be made in cash within seven
days after the receipt of a redemption request in good order.
The Fund's yield will less likely by adversely affected if the
Fund receives redemption notification seven days prior to the
redemption. However, the Fund reserves the right to suspend
redemptions or postpone the date of payment (a) for any periods
during which the Federal Reserve System or the transfer agent
are closed (other than for customary weekend and holiday
closings), (b) at such time as an emergency exists as
determined by the Securities and Exchange Commission so that
disposal of the Fund's investments or determination of its net
asset value is not reasonably practicable, or (c) for such
other periods as the Securities and Exchange Commission by
order may permit for protection of the Fund's shareholders.
Shares purchased by check may not be redeemed until the funds
have cleared, which may take up to 15 days. During periods
when there are substantial redemption requests, the Fund will
generally take the full seven days to make payment.
Redemption in Kind
Although the Fund intends to redeem shares in cash, it
reserves the right to pay the redemption price in whole or in
part by a distribution of readily marketable securities from
the Fund's portfolio. However, shareholders always will be
entitled to redeem shares for cash up to the lesser of $250,000
or 1% of the Fund's net asset value during any 90-day period.
Redemption in kind is not as liquid as a cash redemption. In
addition, if redemption is made in kind, shareholders who
receive securities and sell them could receive less than the
redemption value of their securities and could incur certain
transaction costs.
Valuation of Shares
The net asset value of the Fund's shares is determined as of
4:00 p.m. Eastern time on each Business Day. Debt securities
(other than short-term securities) are normally valued on the
basis of prices provided by a pricing service and may take into
account appropriate factors such as institution-size trading in
similar groups of securities, yield, quality, coupon rate,
maturity, type of issue, trading characteristics and other
market data. In some cases, the prices of debt securities may
be determined using quotes obtained from brokers. Securities
and other assets for which market quotations are not readily
available are valued at fair value, as determined in good faith
and pursuant to procedures approved by the Board. Obligations
with 60 days or less to maturity held by the Fund are valued
using the amortized cost method as described in the SAI.
INFORMATION CONCERNING SHARES OF THE FUND
Dividends and Capital Gain Distributions
Dividends, consisting of substantially all of the Fund's net
investment income, are normally declared on each Business Day
immediately prior to the determination of net asset value. Any
net short-term capital gain may be distributed over a period of
time, as determined by the Manager. Dividends generally are
paid monthly, in cash or in Fund shares, on the first day of
the following month. Any net capital gain (the excess of net
long-term capital gain over net short-term capital loss) that
may be realized will be distributed once every year. Should
the Fund anticipate or incur any unusual expenses, loss or
depreciation that would adversely affect the net asset value
per share or income for a particular period, the Board may at
that time consider whether to adhere to the dividend policy
described above or to revise it in the light of the prevailing
circumstances.
Unless a shareholder otherwise elects on the account
application, all dividends and other distributions are
automatically declared and paid in additional Fund shares based
on the net asset value per share next determined on the payment
date. However, a shareholder may choose to have distributions
of net capital gain paid in shares and dividends paid in cash,
or to have all such distributions and dividends paid in cash.
An election may be changed at any time by delivering written
notice which is received by the transfer agent at least ten
days prior to the payment date for a dividend or other
distribution.
Tax Information
The Fund is treated as a separate corporation for federal
income tax purposes and intends to qualify for treatment as a
RIC under the Internal Revenue Code of 1986, as amended. In
each taxable year that the Fund so qualifies, the Fund (but not
its shareholders) will be relieved of federal income tax on
that part of its investment company taxable income (generally,
net investment income plus any net short-term capital gain and
gain from certain foreign currency transactions) and net
capital gain that it distributes to its shareholders. However,
the Fund will be subject to a nondeductible 4% excise tax to
the extent that it fails to distribute by the end of any
calendar year substantially all of its ordinary income for that
calendar year and capital gain net income for the one-year
period ending on October 31 of that year, plus certain other
amounts. For these and other purposes, dividends and other
distributions declared by the Fund in October, November or
December of any year and payable to shareholders of record on a
date in one of those months will be deemed to have been paid by
the Fund and received by the shareholders on December 31 of
that year if they are paid by the Fund during the following
January. The Fund intends to satisfy the above described
distribution requirements.
Dividends from the Fund's investment company taxable income
will be taxable to its shareholders as ordinary income to the
extent of the Fund's earnings and profits, whether received in
cash or paid in additional Fund shares. Distributions of the
Fund's net capital gain (whether received in cash or paid in
additional Fund shares), when designated as such, generally
will be taxable to those shareholders as long-term capital
gain, regardless of how long they have held their Fund shares.
A capital gain distribution from the Fund may also be offset by
capital losses from other sources. If shares are purchased
shortly before the record date for a dividend or other
distribution, the investor will pay full price for the shares
and receive some portion of the price back as a taxable
distribution. The Fund will notify its shareholders following
the end of each calendar year of the amount of dividends and
other distributions paid (or deemed paid) during that year.
Redemption of Fund shares may result in taxable gain or loss
to the redeeming shareholder, depending upon whether the fair
market value of the redemption proceeds exceeds or is less than
the shareholder's adjusted basis for the redeemed shares. If
shares of the Fund are redeemed at a loss after being held for
six months or less, the loss will be treated as long-term,
instead of short-term, capital loss to the extent of any
capital gain distributions received on those shares.
The Fund is required to withhold 31% of all dividends,
capital gain distributions and redemption proceeds payable to
individuals and certain other non-corporate shareholders who do
not provide the Fund with a correct taxpayer identification
number or (except with respect to redemption proceeds) who
otherwise are subject to back-up withholding.
The foregoing is only a summary of some of the important tax
considerations generally affecting the Fund and its
shareholders. Prospective investors are urged to consult their
own tax advisers regarding specific questions as to the effect
of federal, state or local income taxes on any investment in
the Fund. For further tax information, see the SAI.
GENERAL INFORMATION
The Fund is comprised of one class of shares that may be
issued in an unlimited number. Each share represents an equal
proportionate beneficial interest in the Fund and each is
entitled to one vote. Shares of the Fund may vote on matters
affecting the Fund. All shares of the Trust vote on matters
affecting the Trust as a whole. Share voting rights are not
cumulative, and shares have no preemptive or conversion rights.
Shares of the Trust are non-transferable.
Shares are distributed through the Trust's principal
underwriter, BTS. BTS is compensated by the Manager and not
the Trust. Any distribution expenses incurred by the Manager
related to the Fund are borne by the Manager. The Trust does
not intend to compensate the Manager or any other party, either
directly or indirectly, for the distribution of Fund shares.
As a Massachusetts business trust, the Trust is not obligated
to conduct annual shareholder meetings. However, the Trust will
hold special shareholder meetings whenever required to do so
under the federal securities laws or the Trust's Declaration of
Trust or By-Laws. Trustees can be removed by a shareholder vote
at special shareholder meetings.
Shareholders will receive periodic reports, including annual
and semi-annual reports, which will include financial
statements showing the results of the Fund's operations and
other information. The financial statements relating to the
Fund will be audited by Ernst & Young LLP, independent auditor,
at least annually. Shareholder inquiries should be made by
writing to the Fund at P.O. Box 619003, DFW Airport, TX 75261-
9003, or by calling (817) 967-3509.
No person has been authorized to give any information or to
make any representations other than those contained in this
Prospectus and in sales literature specifically approved by
officers of the Trust for use in connection with the offer of
any Fund shares, and, if given or made, such other information
or representations must not be relied upon as having been
authorized by the Fund. This Prospectus does not constitute an
offer in any jurisdiction in which, or to any person to whom,
such offering may not lawfully be made.
American AAdvantage Funds is a registered service mark of AMR
Corporation.
STATEMENT OF ADDITIONAL INFORMATION
AMERICAN AADVANTAGE SHORT-TERM INCOME FUND
March 1, 1997
The American AAdvantage Short-Term Income Fund (the "Fund")
is a no-load, non-diversified portfolio of the American
AAdvantage Funds (the "Trust"). The Fund consists of one class
of shares. The Trust currently consists of nine separate
investment portfolios, each with distinct investment
objectives, purposes and strategies. This Statement of
Additional Information ("SAI") pertains solely to the Fund and
is authorized for distribution to prospective investors only if
preceded or accompanied by a current Prospectus ("Prospectus")
dated March 1, 1997. This SAI should be read in conjunction
with the Prospectus of the Fund . A Prospectus may be obtained
without charge by calling AMR Investment Services, Inc. (the
"Manager") at (817) 967-3509.
INVESTMENT RESTRICTIONS
In addition to the investment limitations noted in the
Prospectus, the following restrictions have been adopted by the
Fund and may be changed only by the majority vote of the Fund's
outstanding shares, which as used herein means the lesser of
(a) 67% of the shares of the Fund present at the shareholders'
meeting if the holders of more than 50% of the shares are
present and represented at the meeting or (b) more than 50% of
the shares of the Fund. The Fund may not:
1.Purchase or sell real estate or real estate limited
partnership interests, provided, however, that the Fund may
invest in securities secured by real estate or interests
therein or issued by companies which invest in real estate
or interests therein when consistent with the other
policies and limitations described in the Prospectus.
2.Purchase or sell commodities (including direct interests
and/or leases in oil, gas or minerals) or commodities
contracts, except that the Fund may purchase and sell
financial futures contracts (such as interest rate, bond
index and foreign currency futures contracts), options
(such as options on securities, indices, foreign currencies
and futures contracts), forward currency contracts, swaps,
caps, collars and floors, and may engage in transactions in
foreign currencies and "when-issued" securities.
3.Engage in the business of underwriting securities issued
by others except to the extent that, in connection with
disposition of securities, the Fund may be deemed an
underwriter under federal securities laws.
4.Make loans to any person or firm, provided, however, that
the making of a loan shall not be construed to include (i)
the acquisition for investment of bonds, debentures, notes
or other evidences of indebtedness of any corporation or
government which are publicly distributed or (ii) the entry
into repurchase agreements; and further provided, however,
that the Fund may lend its portfolio securities to broker-
dealers or other institutional investors in accordance with
the guidelines stated in the Prospectus and SAI.
5.Issue senior securities, except that the Fund may
purchase and sell financial futures contracts (such as
interest rate, bond index and foreign currency futures
contracts), options (such as options on securities,
indices, foreign currencies and futures contracts), forward
currency contracts, swaps, caps, collars and floors, and
engage in when-issued securities and forward commitment
transactions.
The following non-fundamental investment restrictions apply
to the Fund and may be changed with respect to the Fund only by
a majority vote of the Board of Trustees of the Trust
("Board"). Accordingly, the Fund may not:
1. Purchase securities on margin or effect short sales
(except that the Fund may (i) obtain such short-term
credits as may be necessary for the clearance of
purchases or sales of securities) and (ii) make margin
deposits and short sales and maintain short positions in
connection with its use of options, futures contracts,
forward currency contracts, swaps, caps, collars and
floors and options on futures contracts.
2. Invest more than 10% of its total assets in the
securities of other investment companies.
TRUSTEES AND OFFICERS
The Board provides broad supervision over the Trust's
affairs. The Manager is responsible for the management of
Trust assets, and the Trust's officers are responsible for the
Trust's operations. The Trustees and officers are listed below
together with their principal occupations during the past five
years. All Trustees are also Trustees of the AMR Investment
Services Trust and the American AAdvantage Mileage Funds. All
officers of the Trust are also officers of the AMR Investment
Services Trust and the American AAdvantage Mileage Funds.
Unless otherwise indicated, the address of each person listed
below is 4333 Amon Carter Boulevard, MD 5645, Fort Worth, Texas
76155.
<TABLE>
<CAPTION>
Position
Name, Address and Age with Principal Occupation During
the Trust Past 5 Years
<S> <C> <C>
William F. Quinn*(49) Trustee and President, AMR Investment
President Services, Inc. (November 1986-
Present); Chairman, American
Airlines Employees Federal
Credit Union (October 1989-
Present); Trustee, American
Performance Funds (September
1990-July 1994); Director,
Crescent Real Estate Equities,
Inc. (April 1994 - Present);
Trustee, American AAdvantage
Mileage Funds (1995-Present).
Alan D. Feld (59) Trustee Partner, Akin, Gump, Strauss,
1700 Pacific Avenue Hauer & Feld, LLP (1960-
Suite 4100 Present)#; Director, Clear
Dallas, Texas 75201 Channel Communications (1984-
Present); Director,
CenterPoint Properties, Inc.
(1994-Present); Trustee,
American AAdvantage Mileage
Funds (1996-Present).
Ben J. Fortson (64) Trustee President and CEO, Fortson Oil
301 Commerce Street Company (1958-Present);
Suite 3301 Director, Kimbell Art
Fort Worth, Texas 76102 Foundation (1964-Present);
Director, Burnett Foundation
(1987-Present); Honorary
Trustee, Texas Christian
University (1986-Present);
Trustee, American AAdvantage
Mileage Funds (1996-Present).
John S. Justin (80) Trustee Chairman and Chief Executive
2821 West Seventh Street Officer, Justin Industries,
Fort Worth, Texas 76107 Inc. (a diversified holding
company) (1969-Present);
Executive Board Member Blue
Cross/Blue Shield of Texas,
(1985-Present); Board Member,
Zale Lipshy Hospital (June
1993 - Present); Trustee,
Texas Christian University
(1980 - Present); Director and
Executive Board Member,
Moncrief Radiation Center
(1985 - Present); Director,
Texas New Mexico Enterprises
(1984-1993); Director, Texas
New Mexico Power Company (1979-
1993); Trustee, American
AAdvantage Mileage Funds (1995-
Present).
Stephen D. O'Sullivan* Trustee Consultant (July 1994-
(61) Present); Vice President and
5730 E 105th Street Controller (April 1985-June
Tulsa, Oklahoma 74137 1994), American Airlines,
Inc.; Trustee, American
AAdvantage Mileage Funds (1995-
Present).
Roger T. Staubach (55) Trustee Chairman of the Board and
6750 LBJ Freeway Chief Executive Officer of The
Dallas, Texas 75240 Staubach Company (a commercial
real estate company) (1983-
present); Director,
Halliburton Company (1991-
Present).; Director, First
USA, Inc.(1993-Present);
Director, Brinker
International (1993-Present);
Director, Columbus Realty
Trust (1994 - present); Member
of the Advisory Board, The
Salvation Army; Trustee,
Institute for Aerobic
Research; Member of Executive
Council, Daytop/Dallas; former
quarterback of the Dallas
Cowboys professional football
team; Trustee, American
AAdvantage Mileage Funds (1995-
Present).
Kneeland Youngblood, Trustee Physician (1982-Present);
M.D.(40) President (1983-Present),
2305 Cedar Springs Road Youngblood Enterprises, Inc.
Suite 401 (a health care investment and
Dallas, Texas 75201 management firm); Trustee,
Teachers Retirement System of
Texas (1993-Present);
Director, United States
Enrichment Corporation (1993-
Present), Director, Just For
the Kids (1995-Present);
Member, Council on Foreign
Relations (1995-Present);
Trustee, American AAdvantage
Mileage Funds (1996-Present).
Nancy A. Eckl (34) Vice Vice President AMR Investment
President Services, Inc.(1990-Present).
Michael W. Fields (43) Vice Vice President, AMR Investment
President Services, Inc. (1988-Present).
Barry Y. Greenberg (33) Vice Director - Legal and
President Compliance, AMR Investment
and Services, Inc. (1995-Present);
Assistant Branch Chief (1992- 1995) and
Secretary Staff Attorney (1988- 1992),
Securities and Exchange
Commission.
Rebecca L. Harris (30) Treasurer Director of Finance, 1995-
Present), Controller, (1991-
1995), AMR Investment
Services, Inc.
John B. Roberson (38) Vice Vice President (1991-Present),
President AMR Investment Services, Inc.
Thomas E. Jenkins, Jr. Assistant Senior Compliance Analyst, AMR
(30) Secretary Investment Services, Inc.
(1996-Present); Staff
Accountant (1994-1996) and
Compliance Examiner (1991-
1994), Securities and Exchange
Commission.
Adriana R. Posada (42) Assistant Senior Compliance Analyst
Secretary (1996-Present) and Compliance
Analyst (1993-Present), AMR
Investment Services, Inc.;
Special Sales Representative,
American Airlines, Inc. (1991-
1993).
Clifford J. Alexander Secretary Partner, Kirkpatrick &
(53) Lockhart LLP (law firm)
Robert J. Zutz (44) Assistant Partner, Kirkpatrick &
Secretary Lockhart LLP (law firm)
</TABLE>
# The law firm of Akin, Gump, Strauss, Hauer & Feld LLP
("Akin, Gump") provides legal services to American
Airlines, Inc., an affiliate of the Manager. Mr. Feld has
advised the Trusts that he has had no material involvement
in the services provided by Akin, Gump to American
Airlines, Inc. and that he has received no material benefit
in connection with these services. Akin, Gump does not
provide legal services to the Manager or AMR Corporation.
* Messrs. Quinn and O'Sullivan, by virtue of their current or
former positions, are deemed to be "interested persons" of
the Trust and AMR Trust as defined by the 1940 Act.
All Trustees and Officers as a group own less than 1% of
the outstanding shares of the Fund.
As compensation for their service to the Trust and the AMR
Trust, the Independent Trustees and their spouses receive free
air travel from American Airlines, Inc., an affiliate of the
Manager. The Trust and the AMR Trust do not pay for these
travel arrangements. However, the Trusts compensate each
Trustee with payments in an amount equal to the Trustees'
income tax on the value of this free airline travel. Mr.
O'Sullivan, who as a retiree of American Airlines, Inc. already
receives free airline travel, receives compensation annually of
up to three round trip airline tickets for each of his three
adult children. Trustees are also reimbursed for any expenses
incurred in attending Board meetings. These amounts are
reflected in the following table for the fiscal year ended
October 31, 1996.(1)
<TABLE>
<CAPTION>
Pension or
Retirement Total
Aggregate Benefits Estimated Compensation
Compensatio Accrued as Annual From
n Part of the Benefits AAdvantage
Name of From the Trust's Upon Fund
Trustee Trust Expenses Retirement Complex
<S> <C> <C> <C> <C>
John S. Justin $373 $0 $0 $1,492
William F.
Quinn $0 $0 $0 $0
Stephen D.
O'Sullivan $458 $0 $0 $1,832
Roger T.
Staubach $2,832 $0 $0 $11,330
</TABLE>
(1) Messrs. Feld and Fortson and Dr. Youngblood did not drve as
Trustees during the period.
DISTRIBUTION FEES
On September 1, 1995, Brokers Transaction Services, Inc.
("BTS"), as distributor of the Trust's Shares, began receiving
an annualized fee of $50,000 from the Manager for distributing
the Shares of the Trust and the American AAdvantage Mileage
Funds. Prior to this date, the Trust was self-distributing.
PORTFOLIO SECURITIES TRANSACTIONS
The Manager provides, in substance, that in executing
portfolio transactions and selecting brokers or dealers, the
principal objective of the Manager is to seek the best net
price and execution available. It is expected that securities
ordinarily will be purchased in the primary markets, and that
in assessing the best net price and execution available, the
Manager shall consider all factors it deems relevant, including
the breadth of the market in the security, the price of the
security and the financial condition and execution capability
of the broker or dealer, for the specific transaction and on a
continuing basis.
In selecting brokers or dealers to execute particular
transactions, the Manager is authorized to consider "brokerage
and research services" (as those terms are defined in Section
28(e) of the Securities Exchange Act of 1934), the provision of
statistical quotations (including the quotations necessary to
determine the Fund's net asset value), the sale of Trust shares
by such broker or the servicing of Trust shareholders by such
broker, and other information provided to the Fund and to the
Manager, provided, however, that the Manager determines that it
has received the best net price and execution available.
NET ASSET VALUE
The net asset value of the Fund is computed by dividing the
value of the Fund's assets, less its liabilities, by the number
of shares outstanding. The net asset value is computed each
day on which shares are offered and purchase or redemption
orders are accepted in accordance with procedures outlined in
the Prospectus.
The Fund's investment grade short-term obligations with 60
days or less to maturity are valued based on the amortized cost
valuation technique. This involves valuing an instrument at
its cost and thereafter assuming a constant amortization to
maturity of any discount or premium, even though the portfolio
security may increase or decrease in market value. Such market
fluctuations are generally in response to changes in interest
rates.
TAX INFORMATION
To qualify for treatment as a regulated investment company
under the Internal Revenue Code of 1986, as amended (the
"Code"), the Fund (which is treated as a separate corporation
for these purposes) must, among other requirements:
- Derive at least 90% of its gross income each taxable year
from dividends, interest, payments with respect to
securities loans and gains from the sale or other
disposition of securities or foreign currencies or
certain other income, including gains from options,
futures and forward contracts ("Income Requirement");
- Derive less than 30% of its gross income each taxable
year from the sale or other disposition of securities, or
any of the following, that were held for less than three
months; options, futures or forward contracts (other than
those on foreign currencies), or foreign currencies (or
options, futures or forward contracts thereon) that are
not directly related to the Fund's principal business of
investing in securities (or options and futures with
respect to securities) (the "Short-Short Limitation");
- Diversify its investments in securities within certain
statutory limits; and
- Distribute annually to its shareholders at least 90% of
its investment company income (generally, net investment
income plus net short-term capital gain and gains from
certain foreign currency transactions).
Hedging strategies, such as entering into forward
contracts, swap transactions and purchasing and selling options
and futures contracts, involve complex rules that determine for
income tax purposes the character and timing of recognition of
gains and losses the Fund realizes in connection therewith.
Income from foreign currencies (with the exception of certain
gains that may be excluded by future regulations), and income
from options, futures and forward contracts derived with
respect to the Fund's business of investing in securities or
foreign currencies, qualify as allowable income under the
Income Requirement. However, income from the disposition of
options or futures (other than those on foreign currencies)
will be subject to the Short-Short Limitation if they are held
for less than three months. Income from the disposition of
foreign currencies, (and options, futures and forward contracts
on foreign currencies), that are not directly related to the
Fund's principal business of investing in securities (or
options and futures with respect to securities) also will be
subject to the Short-Short Limitation if held for less than
three months.
For purposes of determining whether the Fund satisfies the
Short-Short Limitation, if the Fund satisfies certain
requirements, an increase in value of a position that is part
of a designated hedge will be offset by any decrease in value
(whether realized or not) of the contra hedging position during
the period of the hedge. Thus, only the net gain (if any) will
be included in gross income for purposes of that limitation.
For further detail, see "Other Information" under Strategic
Transactions.
Interest received by the Fund may be subject to income,
withholding or other taxes imposed by foreign countries and
U.S. possessions that would reduce the yield on its securities.
Tax treaties between certain countries and the United States
may reduce or eliminate these foreign taxes, however, and many
foreign countries do not impose taxes on capital gains on
investments by foreign investors.
The foregoing is only a summary of some of the important
federal tax considerations affecting the Fund and its
shareholders and is not intended as a substitute for careful
tax planning. Accordingly, prospective investors are advised
to consult their own tax advisers for more detailed information
regarding the above and for information regarding federal,
state and local taxes.
YIELD AND TOTAL RETURN QUOTATIONS
A quotation of yield of the Fund may appear from time to
time in advertisements and in communications to shareholders
and others. Quotations of yields are indicative of yields for
the limited historical period used but not for the future.
Yield will vary as interest rates and other conditions change.
Yield also depends on the quality, length of maturity and type
of instruments invested in by the Fund, and the Fund's
operating expenses. A comparison of the quoted yields offered
for various investments is valid only if yields are calculated
in the same manner. In addition, other similar investment
companies may have more or less risk due to differences in the
quality or maturity of securities held.
The advertised yield for the Fund is computed by dividing
the net investment income earned during a 30-day (or one month)
period less the aggregate fees that are charged to all
shareholder accounts in proportion to the 30-day (or one month)
period and the weighted average size of an account in the Fund
by the maximum offering price per share on the last day of the
period, according to the following formula:
6
yield = 2{((a-b)/(c*d)) +1) - 1}
where, with respect to the Fund, "a" is the dividends and
interest earned during the period; "b" is the sum of the
expenses accrued for the period (net of reimbursement, if any)
and the aggregate fees that are charged to all shareholder
accounts in proportion to the 30-day (or one month) period and
the weighted average size of an account; "c" is the average
daily number of shares outstanding during the period that were
entitled to receive dividends; and "d" is the maximum offering
price per share on the last day of the period.
The Fund may also advertise a monthly distribution rate.
The distribution rate gives the return of the Fund based solely
on the dividend payout if someone was entitled to the dividends
for an entire month. A monthly distribution rate is calculated
from the following formula:
monthly distribution rate = A/P*(365/n)
where, "A" is the dividend accrual per share during the month,
"P" is the share price at the end of the month and "n" is the
number of days in the month. The "monthly dividend rate" is a
non-standardized performance calculation and when used in an
advertisement will be accompanied by the appropriate
standardized SEC calculations.
The advertised total return for the Fund would be
calculated by equating an initial amount invested in the Fund
to the ending redeemable value, according to the following
formula:
n
P(1 + T) = ERV
where "P" is a hypothetical initial payment of $1,000; "T" is
the average annual total return for the Fund; "n" is the number
of years involved; and "ERV" is the ending redeemable value of
a hypothetical $1,000 payment made in the Fund at the beginning
of the investment period covered.
The Fund may also use "aggregate" total return figures for
various periods which represent the cumulative change in value
of an investment in the Fund for the specific period. Such
total returns reflect changes in share prices of the Fund and
assume reinvestment of dividends and distributions.
In reports or other communications to shareholders or in
advertising material, the Fund may from time to time compare
its performance with that of other mutual funds in rankings
prepared by IBC Financial Data, Inc., Lipper Analytical
Services, Inc., Morningstar, Inc., and other similar
independent services which monitor the performance of mutual
funds, or publications such as the "New York Times" and the
"Wall Street Journal". The Fund may also compare its
performance with various indices prepared by reporting services
such as those of Morgan Stanley or Lehman Brothers.
DESCRIPTION OF THE TRUST
The Trust is an entity of the type commonly known as a
"Massachusetts business trust". Under Massachusetts law,
shareholders of such a trust may, under certain circumstances,
be held personally liable for its obligations. However, the
Trust's Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations of the Trust and
provides for indemnification and reimbursement of expenses out
of Trust property for any shareholder held personally liable
for the obligations of the Trust. The Declaration of Trust
also provides that the Trust may maintain appropriate insurance
(for example, fidelity bonding) for the protection of the
Trust, its shareholders, Trustees, officers, employees and
agents to cover possible tort and other liabilities. Thus, the
risk of a shareholder incurring financial loss due to
shareholder liability is limited to circumstances in which both
inadequate insurance existed and the Trust itself was unable to
meet its obligations. The Trust has not engaged in any other
business.
OTHER INFORMATION
Bank Deposit Notes-Bank deposit notes are obligations of a
bank, rather than bank holding company corporate debt. The
only structural difference between bank deposit notes and
certificates of deposit is that interest on bank deposit notes
is calculated on a 30/360 basis as are corporate notes/bonds.
Similar to certificates of deposit, deposit notes represent
bank level investments and, therefore, are senior to all bank
holding company corporate debt.
Bankers' Acceptances-Bankers' acceptances are short-term
credit instruments used to finance the import, export, transfer
or storage of goods. They are termed "accepted" when a bank
guarantees their payment at maturity.
Certificates of Deposit-Certificates of deposit are issued
against funds deposited in an eligible bank (including its
domestic and foreign branches, subsidiaries and agencies), are
for a definite period of time, earn a specified rate of return
and are normally negotiable.
Commercial Paper-Commercial paper refers to promissory
notes representing unsecured debt of a corporation or finance
company with a fixed maturity of no more than 270 days.
Eurodollar and Yankeedollar Obligations-Eurodollar
obligations are U.S. dollar obligations issued outside the
United States by domestic or foreign branches of U.S. banks.
Yankeedollar obligations are U.S. dollar obligations issued
inside the United States by foreign entities.
Loan Participation Interests-Loan participation interests
represent interests in bank loans made to corporations. The
contractual arrangement with the bank transfers the cash stream
of the underlying bank loan to the participating investor.
Because the issuing bank does not guarantee the participations,
they are subject to the credit risks generally associated with
the underlying corporate borrower. In addition, because it may
be necessary under the terms of the loan participation for the
investor to assert through the issuing bank such rights as may
exist against the underlying corporate borrower, in the event
the underlying corporate borrower fails to pay principal and
interest when due, the investor may be subject to delays,
expenses and risks that are greater than those that would have
been involved if the investor had purchased a direct obligation
(such as commercial paper) of such borrower. Moreover, under
the terms of the loan participation, the investor may be
regarded as a creditor of the issuing bank (rather than of the
underlying corporate borrower), so that the issuer may also be
subject to the risk that the issuing bank may become insolvent.
Further, in the event of the bankruptcy or insolvency of the
corporate borrower, the loan participation may be subject to
certain defenses that can be asserted by such borrower as a
result of improper conduct by the issuing bank. The secondary
market, if any, for these loan participations is extremely
limited and any such participations purchased by the investor
are regarded as illiquid.
Loan Transactions-Loan transactions involve the lending of
securities to a broker-dealer or institutional investor for its
use in connection with short sales, arbitrages or other
security transactions. The purpose of a qualified loan
transaction is to afford a lender the opportunity to continue
to earn income on the securities loaned and at the same time
earn fee income or income on the collateral held by it.
Securities loans will be made in accordance with the
following conditions: (1) the Fund must receive at least 100%
collateral in the form of cash or cash equivalents, securities
of the U.S. Government, its agencies or instrumentalities, and
letters of credit; (2) the borrower must increase the
collateral whenever the market value of the loaned securities
(determined on a daily basis) rises above the level of
collateral; (3) the Fund must be able to terminate the loan
after notice, at any time; (4) the Fund must receive reasonable
interest on the loan or a flat fee from the borrower, as well
as amounts equivalent to any dividends, interest or other
distributions on the securities loaned, and any increase in
market value of the loaned securities; (5) the Fund may pay
only reasonable custodian fees in connection with the loan; and
(6) voting rights on the securities loaned may pass to the
borrower, provided, however, that if a material event affecting
the investment occurs, the Board must be able to terminate the
loan and vote proxies or enter into an alternative arrangement
with the borrower to enable the Board to vote proxies.
While there may be delays in recovery of loaned securities
or even a loss of rights in collateral supplied should the
borrower fail financially, loans will be made only to firms
deemed by the Board to be of good financial standing and will
not be made unless the consideration to be earned from such
loans would justify the risk. Such loan transactions are
referred to in this SAI as "qualified" loan transactions.
The cash collateral so acquired through qualified loan
transactions may be invested only in those categories of high
quality liquid securities previously authorized by the Board.
Mortgage-backed Securities-Mortgage-backed securities
consist of both collateralized mortgage obligations and
mortgage pass-through certificates.
Collateralized Mortgage Obligations ("CMOs")-CMOs and real
estate mortgage investment conduits ("REMICs") are debt
securities collateralized by mortgages, or mortgage pass-
through securities. CMOs divide the cash flow generated from
the underlying mortgages or mortgage pass-through securities
into different groups referred to as "tranches," which are then
retired sequentially over time in order of priority. The
principal governmental issuers of such securities are the
Federal National Mortgage Association ("FNMA") and Federal Home
Loan Mortgage Corporation ("FHLMC"). CMOs are structured as
trusts or corporations established for the purpose of issuing
such CMOs and often have no assets other than those underlying
the securities and any credit support provided. REMICs are a
mortgage securities vehicle, authorized by the Tax Reform Act
of 1986, that holds residential or commercial mortgages and
issues securities representing interests in those mortgages. A
REMIC may be formed as a corporation, partnership, or
segregated pool of assets. The REMIC itself is generally
exempt from federal income tax, but the income from the
mortgages is reported by investors. For investment purposes,
REMIC securities are virtually indistinguishable from CMOs.
Mortgage Pass-through Certificates-Mortgage pass-through
certificates are issued by governmental, government-related and
private organizations which are backed by pools of mortgage
loans.
(1) Government National Mortgage Association ("GNMA")
Mortgage Pass-Through Certificates ("Ginnie Maes")-GNMA is a
wholly - owned U.S. Government Corporation within the
Department of Housing and Urban Development. Ginnie Maes
represent an undivided interest in a pool of mortgages that are
insured by the Federal Housing Administration or the Farmers
Home Administration or guaranteed by the Veterans
Administration. Ginnie Maes entitle the holder to receive all
payments (including prepayments) of principal and interest owed
by the individual mortgagors, net of fees paid to GNMA and to
the issuer which assembles the mortgage pool and passes through
the monthly mortgage payments to the certificate holders
(typically, a mortgage banking firm), regardless of whether the
individual mortgagor actually makes the payment. Because
payments are made to certificate holders regardless of whether
payments are actually received on the underlying mortgages,
Ginnie Maes are of the "modified pass-through" mortgage
certificate type. The GNMA is authorized to guarantee the
timely payment of principal and interest on the Ginnie Maes.
The GNMA guarantee is backed by the full faith and credit of
the United States, and the GNMA has unlimited authority to
borrow funds from the U.S. Treasury to make payments under the
guarantee. The market for Ginnie Maes is highly liquid because
of the size of the market and the active participation in the
secondary market of security dealers and a variety of
investors.
(2) FHLMC Mortgage Participation Certificates ("Freddie
Macs")-Freddie Macs represent interests in groups of specified
first lien residential conventional mortgages underwritten and
owned by the FHLMC. Freddie Macs entitle the holder to timely
payment of interest, which is guaranteed by the FHLMC. The
FHLMC guarantees either ultimate collection or timely payment
of all principal payments on the underlying mortgage loans. In
cases where the FHLMC has not guaranteed timely payment of
principal, the FHLMC may remit the amount due because of its
guarantee of ultimate payment of principal at any time after
default on an underlying mortgage, but in no event later than
one year after it becomes payable. Freddie Macs are not
guaranteed by the United States or by any of the Federal Home
Loan Banks and do not constitute a debt or obligation of the
United States or of any Federal Home Loan Bank. The secondary
market for Freddie Macs is highly liquid because of the size of
the market and the active participation in the secondary market
of the FHLMC, security dealers and a variety of investors.
(3) FNMA Guaranteed Mortgage Pass-Through Certificates
("Fannie Maes")-Fannie Maes represent an undivided interest in
a pool of conventional mortgage loans secured by first
mortgages or deeds of trust, on one family or two to four
family residential properties. The FNMA is obligated to
distribute scheduled monthly installments of principal and
interest on the mortgages in the pool, whether or not received,
plus full principal of any foreclosed or otherwise liquidated
mortgages. The obligation of the FNMA under its guarantee is
solely its obligation and is not backed by, nor entitled to,
the full faith and credit of the United States.
(4) Mortgage-related Securities Issued by Private
Organizations-Pools created by non-governmental issuers
generally offer a higher rate of interest than government and
government-related pools because there are no direct or
indirect government guarantees of payments in such pools.
However, timely payment of interest and principal of these
pools is often partially supported by various enhancements such
as over-collateralization and senior/subordination structures
and by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance. The
insurance and guarantees are issued by government entities,
private insurers and the mortgage poolers. Although the market
for such securities is becoming increasingly liquid, securities
issued by certain private organizations may not be readily
marketable.
Ratings of Long-term Obligations-The Fund utilizes ratings
provided by the following nationally recognized statistical
rating organizations in order to determine eligibility of long-
term obligations.
The three highest Moody's Investors Service, Inc.
("Moody's") ratings for long-term obligations (or issuers
thereof) are Aaa, Aa and A. Obligations rated Aaa are judged
by Moody's to be of the best quality. Obligations rated Aa are
judged to be of high quality by all standards. Together with
the Aaa group, such debt comprises what is generally known as
high-grade debt. Moody's states that debt rated Aa is rated
lower than Aaa debt because margins of protection or other
elements make long-term risks appear somewhat larger than for
Aaa debt. Obligations which are rated A by Moody's possess
many favorable investment attributes and are considered "upper
medium-grade obligations". Moody's also supplies numerical
indicators 1, 2, and 3 to rating categories. The modifier 1
indicates that the security is in the higher end of its rating
category; the modifier 2 indicates a mid-range ranking; and
modifier 3 indicates a ranking toward the lower end of the
category.
The three highest Standard & Poor's ("Standard & Poor's")
ratings for long-term obligations are AAA, AA and A.
Obligations rated AAA have the highest rating assigned by
Standard & Poor's. Capacity to pay interest and repay
principal is extremely strong. Obligations rated AA have a
very strong capacity to pay interest and repay principal and
differs from the highest rated issues only in a small degree.
Obligations rated A have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
Duff & Phelps' three highest ratings for long-term
obligations are AAA, AA and A. Obligations rated AAA have the
highest credit quality with risk factors being negligible.
Obligations rated AA are of high credit quality and strong
protection factors. Risk is modest but may vary slightly from
time to time because of economic conditions. Obligations rated
A have average but adequate protections factors. However, risk
factors are more variable and greater in periods of economic
stress.
Thomson BankWatch long-term debt ratings apply to specific
issues of long-term debt and preferred stock. They
specifically assess the likelihood of an untimely repayment of
principal or interest over the term to maturity of the rated
instrument. BankWatch's three highest ratings for long-term
obligations are AAA, AA and A. Obligations rated AAA indicate
that the ability to repay principal and interest on a timely
basis is very high. Obligations rated AA indicate a superior
ability to repay principal and interest on a timely basis, with
limited incremental risk compared to issues rated in the
highest category. Obligations rated A indicate the ability to
repay principal and interest is strong. Issues rated A could
be more vulnerable to adverse developments (both internal and
external) than obligations with higher ratings.
Fitch Investors Service, Inc. investment grade bond ratings
provide a guide to investors in determining the credit risk
associated with a particular security. The ratings represent
Fitch's assessment of the issuer's ability to meet the
obligations of a specific debt issue or class of debt in a
timely manner. Obligations rated AAA are considered to be
investment grade and of the highest credit quality. The
obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonable
foreseeable events. Bonds rated AA are considered to be
investment grade and of very high credit quality. The
obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated AAA. Bonds
rated A are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and
repay principal is considered to be strong, but may be more
vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
IBCA's three highest long term obligation ratings are AAA,
AA and A. Obligations rated AAA are those for which there is
the lowest expectation of investment risk. Capacity for timely
repayment of principal and interest is substantial such that
adverse changes in business, economic or financial conditions
are unlikely to increase investment risk substantially. AA
obligations have a very low expectation of investment risk.
Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic, or
financial conditions may increase investment risk albeit not
very significantly. Obligations rated A have a low expectation
of investment risk. Capacity for timely repayment of principal
and interest is strong, although adverse changes in business,
economic, or financial conditions may lead to increased
investment risk.
Standard & Poor's, Duff & Phelps and Fitch apply indicators
"+","-," and no character to indicate relative standing within
the major rating categories.
Ratings of Short-term Obligations-The ratings P-1 and P-2
by Moody's are judged by Moody's to be of the "highest" quality
and "higher" quality respectively on the basis of relative
repayment capacity. Among the factors considered by Moody's in
assigning ratings are the following: (1) evaluations of the
management of the issuer; (2) economic evaluation of the
issuer's industry or industries and an appraisal of speculative-
type risks which may be inherent in certain areas; (3)
evaluation of the issuer's products in relation to competition
and customer acceptance; (4) liquidity; (5) amount and quality
of long-term debt; (6) trend of earnings over a period of ten
years; (7) financial strength of a parent company and the
relationships which exist with the issuer; and (8) recognition
by the management of obligations which may be present or may
arise as a result of public interest questions and preparations
to meet such obligations.
Short-term obligations (or issuers thereof) rated A-1 by
Standard & Poor's have the following characteristics.
Liquidity ratios are adequate to meet cash requirements. The
issuer has access to at least two additional channels of
borrowing. Basic earnings and cash flow have an upward trend
with allowance made for unusual circumstances. Typically, the
issuer's industry is well established and the issuer has a
strong position within the industry. The reliability and
quality of management are unquestioned. Relative strength or
weakness of the above factors determines whether the issuer's
short-term obligation is rated A-1, A-2, or A-3.
IBCA's short-term rating of A1 indicates obligations
supported by the highest capacity for timely repayment. Where
issues possess a particularly strong credit features, a rating
of A1+ is assigned. Obligations rated A2 are supported by a
good capacity for timely repayment.
The distinguishing feature of Duff & Phelps Credit Rating's
short-term rating is the refinement of the traditional 1
category. The majority of short-term debt issuers carry the
highest rating, yet quality differences exist within that tier.
Obligations rated D-1+ indicate the highest certainty of timely
payment. Safety is just below risk-free U.S. Treasury
obligations. Obligations rated D-1 have a very high certainty
of timely payment. Risk factors are minor. Obligations rated
D-1- have a high certainty of timely payment. Risk factors are
very small. Obligations rated D-2 have good certainty of
timely payment. Liquidity factors and company fundamentals are
sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good.
Risk factors are small.
Thomson BankWatch short-term ratings are intended to assess
the likelihood of an untimely or incomplete payment of
principal or interest. Obligations rated TBW-1 indicated a
very high likelihood that principal and interest will be paid
on a timely basis. While the degree of safety regarding timely
payment of principal and interest is strong for an obligation
rated TBW-2, the relative degree of safety is not as high as
for issues rated TBW-1.
Fitch's short-term ratings apply to debt obligations that
are payable on demand or have original maturities of generally
up to three years, including commercial paper, certificates of
deposit, medium-term notes, and municipal and investment notes.
A rating of F-1+ indicates exceptionally strong credit quality.
Issues assigned this rating are regarded as having the
strongest degree of assurance for timely payment. Obligations
rated F-1 have very strong credit quality. Issues assigned
this rating reflect an assurance of timely payment only
slightly less in degree than issues rated F-1+. Issues assigned
a rating of F-1 indicated good credit quality. Issues assigned
this rating have a satisfactory degree of assurance for timely
payment, but the margin of safety is not as great as for issues
assigned F-1+ and F-1 ratings.
Repurchase Agreements-A repurchase agreement, which
provides a means to earn income on funds for periods as short
as overnight, is an arrangement under which the purchaser
(i.e., the Fund) purchases securities and the seller agrees, at
the time of sale, to repurchase the securities at a specified
time and price. The repurchase price will be higher than the
purchase price, the difference being income to the purchaser,
or the purchase and repurchase prices may be the same, with
interest at a stated rate due to the purchaser together with
the repurchase price on repurchase. In either case, the income
to the purchaser is unrelated to the interest rate on the
securities subject to the repurchase agreement.
The Fund may enter into repurchase agreements with any bank
or registered broker-dealer who, in the opinion of the Board,
presents a minimum risk of bankruptcy during the term of the
agreement based upon guidelines which periodically are reviewed
by the Board. The Fund may enter into repurchase agreements as
a short-term investment of its idle cash in order to earn
income. The securities will be held by a custodian (or agent)
approved by the Board during the term of the agreement.
However, if the market value of the securities subject to the
repurchase agreement becomes less than the repurchase price
(including interest), the Fund will direct the seller of the
securities to deliver additional securities so that the market
value of all securities subject to the repurchase agreement
will equal or exceed the repurchase price.
In the event of the commencement of bankruptcy or
insolvency proceedings with respect to the seller of the
securities before the repurchase of the securities under a
repurchase agreement, the Fund may encounter a delay and incur
costs before being able to sell the security being held as
collateral. Delays may involve loss of interest or decline in
price of the securities. Apart from the risk of bankruptcy or
insolvency proceedings, there is also the risk that the seller
may fail to repurchase the securities, in which case the Fund
may incur a loss if the proceeds to the Fund from the sale of
the securities to a third party are less than the repurchase
price.
Strategic Transactions-As discussed in the Prospectus, the
Fund may use financial instruments ("Strategic Instruments"),
such as financial futures contracts (such as interest rate,
bond index and foreign currency futures contracts), options
(such as options on securities, indices, foreign currencies and
futures contracts), forward currency contracts and interest
rate and currency swaps, caps, collars and floors. Such
Strategic Instruments may be used without limit in altering the
exposure of a particular investment or portion of the Fund's
portfolio to fluctuations in interest rates or currency rates,
to preserve a return or spread, to lock in unrealized market
value gains or losses, to facilitate the sale or purchase of
securities, to manage the duration of securities, to uncap a
capped security or to convert a fixed rate security into a
variable rate security.
Strategic Instruments on securities generally are used to
hedge against price movements in one or more particular
securities positions that the Fund owns or intends to acquire.
Strategic Instruments on debt securities may be used to hedge
either individual securities or broad fixed-income market
sectors.
The use of these strategies involves certain risks,
including (1) the fact that skills used are different from
those needed to select securities, (2) possible imperfect
correlation between price movements of the investments being
hedged, (3) the fact that, while hedging strategies can reduce
the risk of loss, they can also reduce the opportunity for
gain, or even result in losses, by offsetting favorable price
movements in hedged investments, and (4) the possible inability
of the Fund to purchase or sell a security at a time when it
would be advantageous to do so, or the possible need for the
Fund to sell a security due to the need for the Fund to "cover"
or segregate securities in connection with those transactions
and the possible inability of the Fund to close out or
liquidate its position.
The use of Strategic Instruments is subject to applicable
regulations of the SEC, the several options and futures
exchanges upon which they are traded, the (CFTC) and various
state regulatory authorities. In addition, the Fund's ability
to use Strategic Instruments will be limited by tax
considerations. See "Tax Information."
In addition to the products, strategies and risks described
below and in the Prospectus, the Manager expects to discover
additional opportunities in connection with other Strategic
Instruments. These new opportunities may become available as
the Manager develops new techniques, as regulatory authorities
broaden the range of permitted transactions and as new
techniques are developed. The Manager may utilize these
opportunities to the extent that they are consistent with the
Fund's investment objective and permitted by the Fund's
investment limitations and applicable regulatory authorities.
The Fund's Prospectus or SAI will be supplemented to the extent
that new products or techniques involve materially different
risks than those described below or in the Prospectus.
Cover for Strategic Instruments-Transactions using
Strategic Instruments may expose the Fund to an obligation to
another party. The Fund will not enter into any such
transactions unless it owns either (1) an offsetting
("covered") position in securities, futures, options,
currencies or forward contracts or (2) cash and short-term
liquid debt securities with a value sufficient at all times to
cover its potential obligations to the extent not covered as
provided in (1) above.
Futures Contracts and Options on Futures Contracts-Futures
contracts obligate a purchaser to take delivery of a specific
amount of an obligation underlying the futures contract at a
specified time in the future for a specified price. Likewise,
the seller incurs an obligation to deliver the specified amount
of the underlying obligation. Futures are traded on both U.S.
and foreign commodities exchanges.
The purchase of futures or call options on futures can
serve as a long hedge, and the sale of futures or the purchase
of put options on futures can serve as a short hedge. Writing
call options on futures contracts can serve as a limited short
hedge, using a strategy similar to that used for writing call
options on securities or indices. Similarly, writing put
options on futures contracts can serve as a limited long hedge.
Futures strategies also can be used to manage the average
duration of the Fund's fixed-income portfolio. If the Manager
wishes to shorten the average duration of the Fund's fixed-
income portfolio, the Fund may sell a futures contract or a
call option thereon, or purchase a put option on that futures
contract. If the Manager wishes to lengthen the average
duration of the Fund's fixed-income portfolio, the Fund may buy
a futures contract or a call option thereon, or sell a put
option thereon.
No price is paid upon entering into a futures contract.
Instead, at the inception of a futures contract the Fund is
required to deposit "initial margin" consisting of cash or U.S.
Government Securities in an amount generally equal to 10% or
less of the contract value. Margin must also be deposited when
writing a call or put option on a futures contract, in
accordance with applicable exchange rules. Unlike margin in
securities transactions, initial margin on futures contracts
does not represent a borrowing, but rather is in the nature of
a performance bond or good-faith deposit that is returned to
the Fund at the termination of the transaction if all
contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, the Fund may
be required by an exchange to increase the level of its initial
margin payment.
Subsequent "variation margin" payments are made to and from
the futures broker daily as the value of the futures position
varies, a process known as "marking-to-market." Variation
margin does not involve borrowing, but rather represents a
daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a futures
contract, the premium paid plus transaction costs is all that
is at risk. In contrast, when the Fund purchases or sells a
futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be
substantial in the event of adverse price movements. If the
Fund has insufficient cash to meet daily variation margin
requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Purchasers and sellers of futures contracts and options
thereon can enter into offsetting closing transactions, similar
to closing transactions on options, by selling or purchasing,
respectively, an instrument identical to the instrument
purchased or sold. Positions in futures contracts and options
thereon may be closed only on an exchange or board of trade
that provides a secondary market. The Fund intends to enter
into futures contracts and options on futures only on exchanges
or boards of trade where there appears to be a liquid secondary
market. However, there can be no assurance that such a market
will exist for a particular contract at a particular time. In
such event, it may not be possible to close a futures contract
or options position.
Under certain circumstances, futures exchanges may
establish daily limits on the amount that the price of a
futures contract or option thereon can vary from the previous
day's settlement price; once that limit is reached, no trades
may be made that day at a price beyond the limit. Daily price
limits do not limit potential losses because prices could move
to the daily limit for several consecutive days with little or
no trading, thereby preventing liquidation of unfavorable
positions.
If the Fund were unable to liquidate a futures contract or
options thereon due to the absence of a liquid secondary market
or the imposition of price limits, it could incur substantial
losses. The Fund would continue to be subject to market risk
with respect to the position. In addition, except in the case
of purchased options on futures , the Fund would continue to be
required to make daily variation margin payments and might be
required to maintain the position being hedged by the futures
contract or option thereon or to maintain cash or securities in
a segregated account.
To the extent that the Fund enters into futures contracts,
options on futures contracts, or options on foreign currencies
traded on an exchange regulated by the Commodities Futures
Trading Commission ("CFTC"), in each case other than for bona
fide hedging purposes (as defined by the CFTC), the aggregate
initial margin and premiums required to establish those
positions (excluding the amount by which options are "in-the-
money" at the time of purchase) will not exceed 5% of the
liquidation value of the Fund's portfolio, after taking into
account unrealized profits and unrealized losses on any
contracts that the Fund has entered into. This policy does not
limit to 5% the percentage of the Fund's assets that are at
risk in futures contracts and options on futures contracts.
Foreign Currency Strategies - Special Considerations-The
Fund may use Strategic Instruments on foreign currencies, to
hedge against movements in the values of the foreign currencies
in which the Fund's securities are denominated. Such currency
hedges can protect against price movements in a security that
the Fund owns or intends to acquire that are attributable to
changes in the value of the currency in which it is
denominated. Such hedges do not, however, protect against
price movements in the securities that are attributable to
other causes.
The Fund might seek to hedge against changes in the value
of particular currency when no Strategic Instruments on that
currency are available or such Strategic Instruments are more
expensive than certain other Strategic Instruments. In such
cases, the Fund may hedge against price movements in that
currency by entering into transactions using Strategic
Instruments on another currency or a basket of currencies, the
values of which the Manager believes will have a high degree of
positive correlation to the value of the currency being hedged.
The risk that movements in the price of the Strategic
Instrument will not correlate perfectly with movements in the
price of the currency being hedged is magnified when this
strategy is used.
There is no systematic reporting of last sale information
for foreign currencies or any regulatory requirement that
quotations available through dealers or other market sources be
firm or revised on a timely basis. Quotation information
generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot
transactions where rates might be less favorable. The
interbank market in foreign currencies is a global, round-the-
clock market.
Settlement of transactions involving foreign currencies
might be required to take place within the country issuing the
underlying currency. Thus, the Fund might be required to
accept or make delivery of the underlying foreign currency in
accordance with any U.S. or foreign regulations regarding the
maintenance of foreign banking arrangements by U.S. residents
and might be required to pay any fees, taxes and charges
associated with such delivery assessed in the issuing country.
Forward Contracts-A forward foreign currency exchange
contract ("forward contract") is a contract to purchase or sell
a currency at a future date. The two parties to the contract
set the number of days and the price. Forward contracts are
used as a hedge against future movements in foreign exchange
rates. The Fund may enter into forward contracts to purchase
or sell foreign currencies for a fixed amount of U.S. dollars
or other foreign currency.
Forward contracts may serve as long hedges -- for example,
the Fund may purchase a forward contract to lock in the U.S.
dollar price of a security denominated in a foreign currency
that the Fund intends to acquire. Forward contracts may also
serve as short hedges -- for example, the Fund may sell a
forward contract to lock in the U.S. Dollar equivalent of the
proceeds from the anticipated sale of a security denominated in
a foreign currency or from anticipated dividend or interest
payments denominated in a foreign currency. The Manager may
seek to hedge against changes in the value of a particular
currency by using forward contracts on another foreign currency
or basket of currencies, the value of which the Manager
believes will bear a positive correlation to the value of the
currency being hedged.
The cost to the Fund of engaging in forward contracts
varies with factors such as the currency involved, the length
of the contract period and the market conditions then
prevailing. Because forward contracts are usually entered into
a principal basis, no fees or commissions are involved. When
the Fund enters into a forward contract, it relies on the
contra party to make or take delivery of the underlying
currency at the maturity of the contract. Failure by the
contra party to do so would result in the loss of any expected
benefit of the transaction.
Buyers and sellers of forward contracts can enter into
offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument
purchased or sold. Secondary markets generally do not exist
for forward contracts, with the result that closing
transactions generally can be made for forward contracts only
by negotiating directly with the contra party. Thus, there can
be no assurance that the Fund will in fact be able to close out
a forward contract at a favorable price prior to maturity. In
addition, in the event of insolvency of the contra party, the
Fund might be unable to close out a forward contract at any
time prior to maturity. In either event, the Fund would
continue to be subject to market risk with respect to the
position, and would continue to be required to maintain a
position in the securities or currencies that are the subject
of the hedge or to maintain cash or securities in a segregated
account.
The precise matching of forward currency contract amounts
and the value of the securities involved generally will not be
possible because the value of such securities measured in the
foreign currency will change after the forward contract has
been established. Thus, the Fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent
such foreign currencies are not covered by forward contracts.
The projection of short-term currency market movements is
extremely difficult, and the successful execution of a short-
term hedging strategy is highly uncertain.
Swaps, Caps, Collars and Floors-Swap agreements, including
interest rate and currency swaps, caps, collars and floors, may
be individually negotiated and structured to include exposure
to a variety of different types of investments or market
factors. Swaps involve two parties exchanging a series of cash
flows at specified intervals. In the case of an interest rate
swap, the parties exchange interest payments based on an agreed
upon principal amount (referred to as the "notional principal
amount"). Under the most basic scenario, Party A would pay a
fixed rate on the notional principal amount to Party B, which
would pay a floating rate on the same notional principal amount
to Party A. Depending on their structure, swap agreements may
increase or decrease the Fund's exposure to long or short-term
interest rates (in the U.S. or abroad), foreign currency
values, mortgage securities, corporate borrowing rates, or
other factors. Swap agreements can take many different forms
and are known by a variety of names.
In a typical cap or floor agreement, one party agrees to
make payments only under specified circumstances, usually in
return for payment of a fee by the other party. For example,
the buyer of an interest rate cap obtains the right to receive
payments to the extent that a specified interest rate exceeds
an agreed-upon level, while the seller of an interest rate
floor is obligated to make payments to the extent that a
specified interest rate falls below an agreed-upon level. An
interest rate collar combines elements of buying a cap and
selling a floor.
The Fund will set aside cash or appropriate liquid assets
to cover its current obligations under swap transactions. If
the Fund enters into a swap agreement on a net basis (that is,
the two payment streams are netted out, with the Fund receiving
or paying, as the case may be, only the net amount of the two
payments), the Fund will maintain cash or liquid assets with a
daily value at least equal to the excess, if any, of the Fund's
accrued obligations under the swap agreement over the accrued
amount the Fund is entitled to receive under the agreement. If
the Fund enters into a swap agreement on other than a net basis
or writes a cap, collar or floor, it will maintain cash or
liquid assets with a value equal to the full amount of the
Fund's accrued obligations under the agreement.
The most important factor in the performance of swap
agreements is the change in the specific interest rate,
currency exchange rate or other factor(s) that determine the
amounts of payments due to and from the Fund. If a swap
agreement calls for payments by the Fund, the Fund must be
prepared to make such payments when due. In addition, if the
contra party's creditworthiness declines, the value of a swap
agreement would likely decline, potentially resulting in
losses.
The Fund will enter into swaps, caps, collars and floors
only with banks and recognized securities dealers believed by
the Manager to present minimal credit risks in accordance with
guidelines established by the Board. If there is a default by
the other party to such a transaction, the Fund will have to
rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the
agreement relating to the transaction.
The swap market has grown substantially in recent years
with a large number of banks and investment banking firms
acting both as principals and as agents utilizing standardized
swap documentation. Caps, collars and floors are more recent
innovations for which documentation is less standardized and,
accordingly, they are less liquid than swaps.
U.S. Government Securities-U.S. Government securities are
issued or guaranteed by the U.S. Government and include U.S.
Treasury obligations (see definition below) and securities
issued by U.S. agencies and instrumentalities.
U. S. Government agencies or instrumentalities which issue
or guarantee securities include, but are not limited to, the
Federal Housing Administration, Farmers Home Administration,
Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association,
General Services Administration, Central Bank for Cooperatives,
Federal Home Loan Banks, Federal Home Loan Mortgage
Corporation, Federal Intermediate Credit Banks, Federal Land
Banks, Maritime Administration, Tennessee Valley Authority,
District of Columbia Armory Board, Inter-American Development
Bank, Asian-American Development Bank, Agency for International
Development, Student Loan Marketing Association and
International Bank of Reconstruction and Development.
Obligations of U.S. Government agencies and
instrumentalities may or may not be supported by the full faith
and credit of the United States. Some are backed by the right
of the issuer to borrow from the Treasury; others by
discretionary authority of the U.S. Government to purchase the
agencies' obligations; while still others, such as the Student
Loan Marketing Association, are supported only by the credit of
the instrumentality. In the case of securities not backed by
the full faith and credit of the United States, the investor
must look principally to the agency issuing or guaranteeing the
obligation for ultimate repayment, and may not be able to
assert a claim against the United States itself in the event
the agency or instrumentality does not meet its commitment.
U.S. Treasury Obligations-U.S. Treasury obligations include
bills, notes and bonds issued by the U.S. Treasury and
separately traded interest and principal component parts of
such obligations known as STRIPS.
Variable or Floating Rate Obligations-A variable rate
obligation is one whose terms provide for the adjustment of its
interest rate on set dates. A floating rate obligation is one
whose terms provide for the adjustment of its interest rate
whenever a specified interest rate changes.
TABLE OF CONTENTS
<TABLE>
<S> <C>
Investment Restrictions Page 1
Trustees and Officers Page 2
Distribution Fees Page 5
Portfolio Securities Transactions Page 6
Net Asset Value. Page 6
Tax Information Page 6
Yield and Total Return Quotations Page 7
Description of the Trust Page 8
Other Information Page 9
</TABLE>
