<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Highlights 2
Fund Expenses 3
Financial Highlights 4
Performance Information 5
Investment Objectives and Policies 6
How You Can Invest in the Fund 15
How Your Shareholder Account is Maintained 16
How You Can Redeem Your Fund Shares 16
How Net Asset Value is Determined 17
Dividends and Other Distributions 18
Taxes 18
Shareholder Services 19
The Fund's Board of Directors,
Manager and Investment Adviser 21
The Fund's Distributor 21
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent 22
Description of the Corporation and its
Shares 22
Appendix A 23
Appendix B 24
</TABLE>
ADDRESSES
DISTRIBUTOR:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000 800 (Bullet) 822 (Bullet) 5544
TRANSFER AND SHAREHOLDER SERVICING AGENT:
Boston Financial Data Services
P.O. Box 953, Boston, MA 02103
COUNSEL:
Kirkpatrick & Lockhart
1800 M Street, N.W., Washington, DC 20036
INDEPENDENT ACCOUNTANTS:
Coopers & Lybrand L.L.P.
217 E. Redwood Street, Baltimore, MD 21202
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS OR THE STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THE PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY THE FUND OR
BY THE PRINCIPAL UNDERWRITER IN ANY JURISDICTION IN WHICH SUCH OFFERING
MAY NOT LAWFULLY BE MADE.
PRINTED ON RECYCLED PAPER
LMF-053
PROSPECTUS
MAY 1, 1995
LEGG MASON
HIGH
YIELD
PORTFOLIO
PUTTING YOUR FUTURE FIRST
(Legg Mason logo appears here)
<PAGE>
THE LEGG MASON HIGH YIELD PORTFOLIO
PROSPECTUS
The Legg Mason High Yield Portfolio ("Fund") is a professionally
managed portfolio seeking to provide investors with a high level of
current income. As a secondary objective, the Fund seeks capital
appreciation. The Fund is a separate portfolio of Legg Mason Income Trust,
Inc. ("Corporation"), a diversified open-end investment company which
currently has four portfolios.
IN SEEKING TO ACHIEVE THE FUND'S OBJECTIVE, THE FUND'S INVESTMENT
ADVISER, WESTERN ASSET MANAGEMENT COMPANY ("ADVISER"), UNDER NORMAL
CIRCUMSTANCES, WILL INVEST A MAJORITY OF THE FUND'S TOTAL ASSETS IN
LOWER-RATED, FIXED-INCOME SECURITIES (COMMONLY KNOWN AS "JUNK BONDS");
THAT IS, INCOME-PRODUCING DEBT SECURITIES AND PREFERRED STOCKS OF ALL
TYPES, INCLUDING (BUT NOT LIMITED TO) CORPORATE DEBT SECURITIES AND
PREFERRED STOCK. IN ADDITION TO OTHER RISKS, THESE BONDS ARE SUBJECT TO
GREATER FLUCTUATIONS IN VALUE AND RISK OF LOSS OF INCOME AND PRINCIPAL DUE
TO DEFAULT BY THE ISSUER THAN ARE HIGHER-RATED BONDS; THEREFORE, INVESTORS
SHOULD CAREFULLY ASSESS THE RISKS ASSOCIATED WITH AN INVESTMENT IN THIS
FUND. SEE "RISK FACTORS" ON PAGE 8.
The Fund may invest up to 25% of its total assets in securities
restricted as to their disposition, which may include securities for which
the Fund believes there is a liquid market. No more than 15% of the Fund's
net assets will be invested in securities deemed by the Fund to be
illiquid.
An investment in the Fund does not constitute a complete investment
program and is not appropriate for persons unwilling or unable to assume a
high degree of risk.
No initial sales charge is payable on purchases, and no redemption
charge is payable on sales of Fund shares. The Fund pays management fees
to Legg Mason Fund Adviser, Inc. ("Manager") and distribution fees to Legg
Mason Wood Walker, Incorporated ("Legg Mason") as described on pages 21
and 22 of this Prospectus.
This Prospectus sets forth concisely the information about the Fund
that a prospective investor ought to know before investing. It should be
retained for future reference. A Statement of Additional Information about
the Fund dated May 1, 1995 has been filed with the Securities and Exchange
Commission ("SEC") and, as amended or supplemented from time to time, is
incorporated herein by reference. The Statement of Additional Information
is available without charge upon request from Legg Mason (address and
telephone numbers listed below).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Dated: May 1, 1995
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000
800 (Bullet) 822 (Bullet) 5544
<PAGE>
PROSPECTUS HIGHLIGHTS
THE LEGG MASON HIGH YIELD PORTFOLIO
The following summary is qualified in its entirety by the more
detailed information appearing in the body of this Prospectus.
FUND TYPE:
The Fund is a separate portfolio of Legg Mason Income Trust, Inc., an
open-end, diversified management investment company. You may purchase or
redeem shares of the Fund through a brokerage account with Legg Mason or
certain of its affiliates. See "How You Can Invest in the Fund," page 15,
and "How You Can Redeem Your Fund Shares," page 16.
FUND STARTED:
February 1, 1994
NET ASSETS:
Over $57.5 million as of February 28, 1995
INVESTMENT OBJECTIVES, POLICIES AND RISKS:
The Fund's primary investment objective is to provide investors with a
high level of current income. As a secondary objective, the Fund seeks
capital appreciation. Under normal circumstances, the Fund will invest at
least 65% of its total assets in high yield, fixed-income securities
(including those commonly known as "junk bonds "). Such securities are
considered speculative and involve increased risk of exposure to adverse
business and economic conditions. The value of debt instruments held by
the Fund, and thus the net asset value of Fund shares, also generally
fluctuates inversely with movements in market interest rates.
The Fund may invest up to 25% of its total assets in foreign
securities. Investment in foreign securities entails certain additional
risks, including risks arising from currency fluctuation, accounting
systems and disclosure regulations that differ from those in the U.S., and
political and economic changes in foreign countries. The Fund may have
limited recourse against a foreign governmental issuer in the event of a
default. The Fund's participation in hedging and option income strategies
also involves certain risks. See "Investment Objectives and Policies,"
page 6, and "Risk Factors," page 8.
DISTRIBUTOR :
Legg Mason Wood Walker, Incorporated
MANAGER AND ADVISER :
Legg Mason Fund Adviser, Inc. serves as the Fund's manager, and
Western Asset Management Company serves as investment adviser to the Fund.
TRANSFER AND SHAREHOLDER SERVICING AGENT :
Boston Financial Data Services
CUSTODIAN:
State Street Bank and Trust Company
EXCHANGE PRIVILEGE:
All funds in the Legg Mason Family of Funds registered in your state.
See "Exchange Privilege," page 19.
DIVIDENDS:
Declared and paid monthly. See "Dividends and Other Distributions,"
page 18.
REINVESTMENT :
All dividends and other distributions are automatically reinvested in
Fund shares unless cash payments are requested.
INITIAL PURCHASE:
$1,000 minimum, generally.
SUBSEQUENT PURCHASES:
$100 minimum, generally. See "How You Can Invest in the Fund," page
15.
PURCHASE METHODS:
Send bank/personal check or wire federal funds.
PUBLIC OFFERING PRICE PER SHARE:
Net asset value
2
<PAGE>
FUND EXPENSES
The purpose of the following table is to assist an investor in understanding
the various costs and expenses that an investor in the Fund will bear directly
or indirectly. The expenses and fees set forth in the table are based on average
net assets and annual Fund operating expenses for the period February 1, 1994
(commencement of operations) to December 31, 1994.
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum sales charge on purchases or
reinvested dividends None
Redemption or exchange fees None
ANNUAL FUND OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Management fees 0.65 %
12b-1 fees 0.50 %
Other expenses 0.44 %
Total operating expenses 1.59 %
</TABLE>
Because the Fund pays a 12b-1 fee, long-term shareholders may pay more in
distribution expenses than the economic equivalent of the maximum front-end
sales charge permitted by the National Association of Securities Dealers, Inc.
("NASD").
For further information concerning Fund expenses, see "The Fund's Board of
Directors, Manager and Investment Adviser," page 21.
EXAMPLE OF EFFECT OF FUND EXPENSES
The following example illustrates the expenses that you would pay on a
$1,000 investment over various time periods assuming (1) a 5% annual rate of
return and (2) full redemption at the end of each time period. As noted in the
table above, the Fund charges no redemption fees of any kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
<S> <C> <C> <C>
$ 16 $50 $87 $189
</TABLE>
This example assumes that all dividends and other distributions are
reinvested and that the percentage amounts listed under "Annual Fund Operating
Expenses" remain the same over the time periods shown. The above tables and the
assumption in the example of a 5% annual return are required by regulations of
the SEC applicable to all mutual funds. THE ASSUMED 5% ANNUAL RETURN IS NOT A
PREDICTION OF, AND DOES NOT REPRESENT, THE FUND'S PROJECTED OR ACTUAL
PERFORMANCE. THE ABOVE TABLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. The
Fund's actual expenses will depend upon, among other things, the level of
average net assets, the levels of sales and redemptions of shares and the extent
to which the Fund incurs variable expenses, such as transfer agency costs.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights for the period February 1, 1994 (commencement
of operations) to December 31, 1994 have been derived from financial
statements which have been audited by Coopers & Lybrand L.L.P., independent
accountants. The Fund's financial statements for the period February 1,
1994 (commencement of operations) to December 31, 1994 and the report of
Coopers & Lybrand L.L.P. thereon are included in the Fund's annual report
and are incorporated by reference in the Statement of Additional
Information. The annual report is available to shareholders without charge
by calling your Legg Mason or affiliated investment executive or Legg
Mason's Funds Marketing Department at 800-822-5544.
<TABLE>
<CAPTION>
FEBRUARY 1, 1994*
TO
DECEMBER 31, 1994
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $15.00
Net investment income 1.02
Net realized and unrealized loss on investments (1.44)
Total from investment operations (0.42)
Distributions to shareholders from net investment income (1.01)
Net asset value, end of period $13.57
Total return (2.90)%(1)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses 1.59%(2)
Net investment income 8.41%(2)
Portfolio turnover rate 67.39%(2)
Net assets, end of period (in thousands) $53,424
</TABLE>
* COMMENCEMENT OF OPERATIONS.
(1) NOT ANNUALIZED.
(2) ANNUALIZED.
4
<PAGE>
PERFORMANCE INFORMATION
From time to time the Fund may quote its total return in advertisements or
in reports or other communications to shareholders. A mutual fund's TOTAL RETURN
is a measurement of the overall change in value, including changes in share
price and assuming reinvestment of dividends and capital gain distributions of
an investment in the fund. CUMULATIVE TOTAL RETURN shows the fund's performance
over a specific period of time. AVERAGE ANNUAL TOTAL RETURN is the average
annual compounded return that would have produced the same cumulative total
return if the fund's performance had been constant over the entire period.
Performance figures, including total return and yield figures, reflect past
performance and are not intended to indicate future performance. Average annual
returns tend to smooth out variations in a fund's return, so they differ from
actual year-by-year results.
The Fund's total return as of December 31, 1994 was as follows:
<TABLE>
<CAPTION>
CUMULATIVE
TOTAL RETURN
<S> <C>
Life of Fund(dagger) -2.90%
</TABLE>
(dagger) Fund's inception -- February 1, 1994.
No adjustment has been made for any income taxes payable by shareholders.
The investment return and principal value of an investment in the Fund will
fluctuate so that an investor's shares, when redeemed, may be worth more or less
than their original cost.
The Fund may also advertise its yield or effective yield. Yield reflects net
investment income per share (as defined by applicable SEC regulations) over a
30-day (or one-month) period, expressed as an annualized percentage of net asset
value at the end of the period. The effective yield, although calculated
similarly, will be slightly higher than the yield because it assumes that income
earned from the investment is reinvested (I.E., the compounding effect of
reinvestment). Yield computations differ from other accounting methods and
therefore may differ from dividends actually paid or reported net income.
Further information about the Fund's performance is contained in the annual
report to shareholders, which may be obtained without charge by calling your
Legg Mason or affiliated investment executive or Legg Mason's Funds Marketing
Department at 800-822-5544.
5
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is to provide investors with a
high level of current income. As a secondary objective, the Fund seeks
capital appreciation. The investment objectives of the Fund may not be
changed without a vote of Fund shareholders; however, except as otherwise
noted, the investment policies of the Fund described below may be changed
by the Corporation's Board of Directors without a shareholder vote. There
can be no assurance that the Fund's investment objectives will be
achieved.
In seeking its objectives, the Fund, under normal conditions, invests
at least 65% of its total assets in high yield, fixed-income securities,
that is, income producing debt securities and preferred stocks of all
types, including (but not limited to) corporate debt securities and
preferred stock, convertible securities, zero coupon securities, deferred
interest securities, mortgage-backed securities and asset-backed
securities. The Fund's remaining assets may be held in cash or money
market instruments, or invested in common stocks and other equity
securities when these types of investments are consistent with the primary
objective of high current income or are acquired as part of a unit
consisting of a combination of fixed-income securities and equity
investments. Such remaining assets may also be invested in fixed-income
securities rated above BBB by Standard & Poor's Ratings Group ("S&P") or
Baa by Moody's Investors Services, Inc. ("Moody's"), comparably rated by
another nationally recognized statistical rating organization ("NRSRO"),
or unrated securities deemed by the Adviser to be of equivalent quality.
Moreover, the Fund may hold cash or money market instruments without limit
for temporary defensive purposes or pending investment. Current yield is
the primary consideration used by the Fund's Adviser in the selection of
portfolio securities, although consideration may also be given to the
potential for capital appreciation.
Higher yields are generally available from securities rated BBB or
lower by S&P, Baa or lower by Moody's, securities comparably rated by
another NRSRO, or unrated securities of equivalent quality, and the Fund
may invest all or a substantial portion of its assets in such securities.
Debt securities rated below investment grade (i.e., below BBB/Baa) are
deemed by these agencies to be predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal and may involve
major risk of exposure to adverse conditions. The Fund may invest in
securities rated as low as "C" by Moody's or "D" by S&P, which ratings
indicate that the obligations are highly speculative and may be in default
or in danger of default as to principal and interest. See "Risk Factors,"
page 8. Ratings are only the opinions of the agencies issuing them and are
not absolute guarantees as to quality. The Adviser does not rely solely on
the ratings of rated securities in making investment decisions but also
evaluates other economic and business factors affecting the issuer. The
Appendix to this Prospectus describes the rating categories of securities
in which the Fund may invest.
Fixed-income securities in which the Fund may invest include preferred
stocks and all types of debt obligations of both domestic and foreign
issuers, commercial paper, and obligations issued or guaranteed by the
U.S. Government, foreign governments or of any of their respective
political subdivisions, agencies, or instrumentalities, including
repurchase agreements secured by such instruments.
Corporate debt securities may pay fixed or variable rates of interest,
or interest at a rate contingent upon some other factor, such as the price
of some commodity. These securities may be convertible into preferred or
common equity, or may be bought as part of a unit containing common stock.
The Fund may purchase common stock directly if such an investment meets
the primary investment objective of a high level of current income or the
secondary objective of capital appreciation potential. The Fund may also
purchase warrants or rights to purchase corporate or other securities. The
Fund may purchase corporate or other securities which are in default, in
cases where the Adviser feels that the returns potentially available in
those securities offset the lack of current income. The Fund may hold
common stock received under an exchange offer or plan of reorganization
made by an issuing corporation. No more than 25% of the Fund's total
assets will be invested in common stocks, warrants or rights.
6
<PAGE>
The Fund may invest up to 25% of its total assets in private
placements, securities traded pursuant to Rule 144A under the Securities
Act of 1933, or securities which, though not registered at the time of
their initial sale, are issued with registration rights. Some of these
securities may be deemed by the Adviser to be liquid, under guidelines
adopted by the Corporation's Board of Directors pursuant to SEC
regulations. No more than 15% of the Fund's net assets will be invested in
securities which are deemed illiquid, defined as securities that cannot be
sold within 7 days at approximately the price they are valued. The Fund
may also invest in "loan participations or assignments." In purchasing a
loan participation or assignment, the Fund acquires some or all of the
interest of a bank or other lending institution in a loan to a corporate
borrower. Many such loans are secured and most impose restrictive
covenants which must be met by the borrower and which are generally more
stringent than the covenants available in publicly traded debt securities.
These participations may also be purchased by the Fund when the borrowing
company is in default.
The Fund may purchase debt obligations on a "when-issued" or
"delayed-delivery" basis. Such securities are subject to market
fluctuation prior to delivery to the Fund and therefore may cause the Fund
to experience a gain or loss on the securities prior to their delivery.
However, the Fund does not have to pay for the obligations until they are
delivered. This is normally seven to 15 days later, but could be
considerably longer. Use of this practice would have a leveraging effect
on the Fund. Such securities generally do not earn interest until their
scheduled delivery date.
Foreign Securities
The Fund may invest up to 25% of its total assets in securities of
domestic and foreign issuers that are denominated in currencies other than
the U.S. dollar. To facilitate investment in foreign securities, the Fund
may hold positions in foreign currencies. In addition, for hedging
purposes, the Fund may purchase and write either listed or
over-the-counter put and call options on foreign currencies or may enter
into forward foreign currency exchange contracts.
Options Contracts
The Fund may write (sell) or purchase put and call options on domestic
and foreign securities, securities indices and on foreign currencies. Call
options written by the Fund give the holder the right to buy the
underlying securities or currencies from the Fund at a fixed exercise
price up to a stated expiration date, or in the case of certain options,
on such date. Put options give the holder the right to sell the underlying
security or currencies to the Fund during the term of the option at a
fixed exercise price up to a stated expiration date, or in the case of
certain options, on such date.
The Fund may also enter into options on the yield "spread" or yield
differential between two fixed-income securities, a transaction referred
to as a "yield curve" option, for hedging and non-hedging purposes.
Futures Contracts
The Fund may purchase and sell futures contracts on foreign
currencies, securities or indices of securities, including indices of
fixed-income securities which may become available for trading ("Futures
Contracts"). The Fund may also purchase and write options on such Futures
Contracts.
Interest Rate Swaps
The Fund may enter into interest rate swaps. An interest rate swap is
an agreement between two parties to pay each other interest or a certain
amount of principal; one of which pays an interest rate fixed until the
maturity of the obligation, while the other pays a rate which changes with
the changes in some other rate, such as the prime rate or the London
Interbank Offered Rate (LIBOR). Such swaps will be used when the Fund
wishes to effectively convert a floating rate asset into a fixed-rate
asset, or vice versa.
Mortgage Pass-Through Securities
The Fund may invest in mortgage pass-through securities. Mortgage
pass-through securities are securities representing interests in "pools"
of mortgage loans. Monthly payments of interest and principal by the
individual borrowers on mortgages are passed through to the holders of the
securities (net of fees paid to the issuer, guarantor or servicer of the
securities) as the mortgages in the underlying pools are paid off.
7
<PAGE>
The Fund may enter into mortgage "dollar roll" transactions with
selected banks and broker-dealers pursuant to which the Fund sells
mortgage-backed securities for delivery in the future (generally within 30
days) and simultaneously contracts to repurchase substantially similar
securities on a specified future date.
Collateralized Mortgage Obligations, Multiclass Pass-Through Securities
The Fund may invest a portion of its assets in collateralized mortgage
obligations ("CMO's"), which are debt obligations collateralized by
mortgage loans or mortgage pass-through securities. The Fund may also
invest a portion of its assets in multiclass pass-through securities which
are equity interests in a trust composed of mortgage assets.
Stripped Mortgage-Backed Securities
The Fund may also invest in stripped mortgage-backed securities, which
are derivative securities usually structured with two classes that receive
different proportions of the interest and principal distributions from an
underlying pool of mortgage assets. They may be issued by
instrumentalities of the U.S. Government or by private mortgage lenders.
The Fund may purchase securities representing only the interest payment
portion of the underlying mortgage pools (commonly referred to as "IOs")
or only the principal portion of the underlying mortgage pools (commonly
referred to as "POs").
Asset-Backed Securities
The Fund may invest in asset-backed securities. These securities,
issued by trusts and special purpose corporations, are backed by a pool of
assets, such as credit card, automobile loan, or other financial
receivables, representing the obligations of a number of different
parties. Asset-backed securities in which the Fund invests may include
asset-backed commercial paper.
New types of mortgage-backed and asset-backed securities, derivative
securities and hedging instruments are developed and marketed from time to
time and that, consistent with its investment limitations, the Fund may
invest in those new types of securities or instruments that the Adviser
believes may assist the Fund in achieving its investment objectives.
OTHER INVESTMENT POLICIES
The Fund may loan its portfolio securities to qualified borrowers who
deposit and maintain with the Fund cash collateral equal to at least 100%
of the market value of the securities loaned. The Fund may enter into
repurchase transactions, in which the Fund purchases a security subject to
resale to a bank or broker-dealer at an agreed-upon price and date. In
such a transaction, the obligation is collateralized by securities with a
market value at least equal to the value of the repurchase transaction.
The Fund will not invest more than 5% of its total assets in any one
issuer, except for issues of the U.S. Government, its agencies and
instrumentalities or repurchase agreements collateralized by such
securities; however, up to 25% of the Fund's total assets may be invested
in securities issued by Canadian provinces or by Crown Corporations whose
obligations are guaranteed by either the Canadian federal government or a
provincial government. No more than 25% of the Fund's total assets may be
invested in issuers having their principal business activity in the same
industry.
The Fund has adopted certain other fundamental investment limitations
that, like its investment objective, can be changed only by a vote of Fund
shareholders. These investment limitations are set forth in the Statement
of Additional Information under "Additional Information About Investment
Limitations and Policies." Except as expressly stated otherwise, the
investment policies and limitations contained in this prospectus are not
fundamental and can be changed without a shareholder vote.
RISK FACTORS
The investment income of the Fund is based on the income earned on the
securities it holds, less expenses incurred; thus, the Fund's investment
income may be expected to fluctuate in response to changes in such
expenses or income. For example, the investment income of the Fund may be
affected if it experiences a net inflow of new money that is then invested
in securities whose yield is higher or lower than that earned on then-
current investments.
High yield bonds offer a higher yield to maturity than bonds with
higher ratings, as compensation for holding an obligation that is subject
8
<PAGE>
to greater risk. During periods of rising interest rates, the values of
outstanding fixed-income securities generally fall, and vice versa. The
magnitude of these fluctuations will generally be greater for securities
with long maturities. Those changes will affect the values of the Fund's
portfolio securities, and therefore, its net asset value per share.
Because of their high coupon rates, high yield securities are generally
less price sensitive to changes in interest rates than U.S. Treasury
securities.
The principal risks of high yield securities include: (i) limited
liquidity and secondary market support, (ii) substantial market price
volatility resulting from changes in prevailing interest rates, (iii) the
fact that such obligations are often unsecured and are subordinated to the
claims of banks and other senior lenders in bankruptcy proceedings, (iv)
the operation of mandatory sinking fund or call/redemption provisions
during periods of declining interest rates, whereby the holder might
receive redemption proceeds at times when only lower-yielding portfolio
securities are available for investment, (v) the possibility that earnings
of the issuer may be insufficient to meet its debt service, (vi) the
issuer's low creditworthiness and potential for insolvency during periods
of rising interest rates and economic downturn, (vii) the fact that the
issuers are often highly leveraged and may not have access to more
traditional methods of financing and (viii) the possibility of adverse
publicity and investor perception, whether or not due to fundamental
analysis, which may result in widespread sales and declining market
prices. If the Fund is required to seek recovery upon a default in the
payment of principal or interest, it may incur additional expenses and may
have limited legal recourse in the event of a default.
As a result of the limited liquidity of high yield securities, their
prices have at times experienced significant and rapid declines when a
significant number of holders of high yield securities simultaneously
decided to sell them. A decline is also likely in the high yield bond
market during an economic downturn. An economic downturn or an increase in
interest rates could severely disrupt the market for high yield securities
and adversely affect the value of outstanding securities and the ability
of the issuers to repay principal and interest. Because the market for
high yield securities is less liquid, the valuation of these securities
may require greater judgment than is necessary with respect to securities
for which more market information is available.
Although the prices of lower-rated bonds are generally less sensitive
to interest rate changes than are higher-rated bonds, the prices of lower-
rated bonds may be more sensitive to adverse economic changes and
developments regarding the individual issuer. Although the market for
lower-rated debt securities is not new, and the market has previously
weathered economic downturns, there has been in recent years a substantial
increase in the use of such securities to fund corporate acquisitions and
restructuring. Accordingly, the past performance of the market for such
securities may not be an accurate indication of its performance during
future economic downturns or periods of rising interest rates.
The table below provides a summary of ratings assigned to debt
holdings in the Fund's portfolio. These figures are dollar-weighted
averages of month-end portfolio holdings during the period February 1,
1994 (commencement of operations) to December 31, 1994, presented as a
percentage of total investments. These percentages are historical and are
not necessarily indicative of the quality of current or future portfolio
holdings, which may vary.
<TABLE>
<CAPTION>
MOODY'S S&P
RATINGS AVERAGE RATINGS AVERAGE
<S> <C> <C> <C>
Aaa/Aa/A 1.7% AAA/AA/A 1.7%
Baa 0.8% BBB --%
Ba 9.3% BB 16.0%
B 65.3% B 48.4%
Caa 3.3% CCC 14.3%
Ca 4.6% CC --%
C 0.4% C --%
NR 14.6% D 2.0%
NR 17.6%
</TABLE>
The dollar-weighted average of debt securities not rated by either
Moody's or S&P amounted to 12.0%. This may include securities rated by
other nationally recognized rating organizations, as well as unrated
securities. Unrated securities are not necessarily lower-quality
securities.
9
<PAGE>
Zero Coupon and Pay-In-Kind Bonds
Investments in zero coupon and pay-in-kind bonds involve additional
special considerations. Zero coupon bonds are debt obligations that do not
entitle the holder to any periodic payments of interest prior to maturity
or a specified cash payment date when the securities begin paying current
interest ("cash payment date") and therefore are issued and traded at a
discount from their face amount or par value. Pay-in-kind bonds pay
"interest" through the issuance of additional bonds, thereby adding debt
to the issuer's balance sheet. The market prices of both types of
securities are generally more volatile than the market prices of
securities that pay interest periodically and are likely to respond to
changes in interest rates to a greater degree than the prices of
securities paying interest currently and having similar maturities and
credit quality. Zero coupon and pay-in-kind bonds carry additional risk in
that, unlike bonds that pay interest throughout the period to maturity,
the Fund will realize no cash until the cash payment date unless a portion
of such securities is sold and the Fund may obtain no return at all on its
investment if the issuer defaults.
The holder of a zero coupon security or pay-in-kind bond must accrue
income with respect to these securities prior to the receipt of cash
payments thereon. To avoid liability for federal income and excise taxes
(see "Taxes" on page 18 and "Additional Tax Information" in the Statement
of Additional Information), the Fund will be required to distribute income
accrued with respect to these securities, even though the Fund has not
received that income in cash, and may be required to dispose of portfolio
securities under disadvantageous circumstances in order to generate cash
to satisfy these distribution requirements.
Mortgage-Related Securities
Mortgage-related securities represent interests in pools of mortgages
created by lenders such as commercial banks, savings and loan
institutions, mortgage bankers and others. Mortgage-related securities may
be issued by governments or government-related entities or by
non-governmental entities such as banks, savings and loan institutions,
private mortgage insurance companies, mortgage bankers and other secondary
market issuers.
Mortgage-related securities provide monthly payments which consist of
interest and, in most cases, principal. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on
their residential mortgage loans, net of any fees paid to the issuer or
guarantor of such securities. Additional payments to holders of
mortgage-related securities are caused by repayments resulting from the
sale of the underlying residential property, refinancing or foreclosure,
net of fees or costs which may be incurred. Some mortgage-related
securities are described as "modified pass-through." These securities
entitle the holders to receive all interest and principal payments owed on
the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.
Mortgage-backed securities issued by the Government National Mortgage
Association ("GNMA") are backed by the full faith and credit of the United
States Government. Those issued by the Federal National Mortgage
Association ("FNMA") and the Federal Home Loan Mortgage Corporation
("FHLMC") are supported only by the creditworthiness of the issuing
entity. Regardless of such support, government mortgage securities are
subject to the risks of market interest rate fluctuations and prepayments
described below.
Mortgage-related securities offered by private issuers include
pass-through securities comprised of pools of residential mortgage loans;
mortgage-backed bonds which are considered to be debt obligations of the
institution issuing the bonds and are collateralized by mortgage loans;
and bonds and CMOs which are collateralized by mortgage-related securities
issued by FHLMC, FNMA or GNMA or by pools of conventional mortgages.
CMOs are typically structured with two or more classes or series which
have different maturities and are generally retired in sequence. Although
full payoff of each class of obligations is contractually required by a
certain date, any or all classes of obligations may be paid off sooner
than expected because of an increase in the payoff speed of the pool.
Mortgage-related securities created by nongovernmental issuers
generally offer a higher rate of interest than government and
government-related securities because there are no direct or indirect
government guarantees of payment in the former
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securities, resulting in higher risks. However, many issuers or servicers
of mortgage-related securities guarantee timely payment of interest and
principal on such securities. Timely payment of principal may also be
supported by various forms of insurance, including individual loan, title,
pool and hazard policies. There can be no assurance that the private
issuers or insurers will be able to meet their obligations under the
relevant guarantees and insurance policies, and such guarantees and
policies often do not cover the full amount of the pool. Where privately
issued securities are collateralized by securities issued by FHLMC, FNMA
or GNMA, the timely payment of interest and principal is supported by the
government-related securities collateralizing such obligations. Some
mortgage-backed securities will be considered illiquid and will be subject
to the limitation that no more than 15% of the Fund's net assets may be
invested in illiquid securities.
Asset-Backed Securities
Payments or distributions of principal and interest on asset-backed
securities may be supported by credit enhancements, such as various forms
of cash collateral accounts or letters of credit. Like mortgage-related
securities, asset-backed securities are subject to the risk of prepayment.
The risk that recovery on repossessed collateral might be unavailable or
inadequate to support payments on asset-backed securities, however, is
greater than in the case of mortgage-backed securities. The value of such
securities depends in part on loan repayments by individuals, which may be
adversely affected during general downturns in the economy.
Prepayment Risk
The principal of most mortgage-backed and other asset-backed
securities may be prepaid at any time. As a result, if such securities are
purchased at a premium, a prepayment rate that is faster than expected
will reduce yield to maturity, while a prepayment rate that is slower than
expected will have the opposite effect. Conversely, if the securities are
purchased at a discount, prepayments faster than expected will increase
yield to maturity and prepayments slower than expected will decrease it.
Accelerated prepayments on securities purchased at a premium also impose a
risk of loss of principal because the premium may not have been fully
amortized at the time the principal is repaid in full. Accelerated
prepayments also reduce the yield because the Fund must reinvest the
assets at the then-current rates. When interest rates are declining, such
prepayments usually increase, and reinvestments of such principal
prepayments will be at a lower rate than that on the original
mortgage-related security. Increased prepayment of principal may limit the
Fund's ability to realize the appreciation in the value of such securities
that would otherwise accompany declining interest rates.
Stripped mortgage-backed securities are more sensitive to changes in
prepayment and interest rates and the market for such securities is less
liquid than is the case for traditional debt securities and
mortgage-backed securities. The yield on such IOs is extremely sensitive
to the rate of principal payments (including prepayments) on the
underlying mortgage assets, and a rapid rate of repayment may have a
material adverse effect on such securities' yield to maturity. If the
underlying mortgage assets experience greater than anticipated prepayments
of principal, the Fund will fail to recoup fully its initial investment in
these securities, even if they are rated high quality. Most IOs and POs
are regarded as illiquid and will be included in the Fund's 15% limit on
illiquid securities. U.S. government-issued IOs and POs backed by
fixed-rate mortgages may be deemed liquid by the Adviser, following
guidelines and standards established by the Corporation's Board of
Directors.
A "residual" represents an interest in any amount that may be
remaining in a mortgage-backed pool after all of the fixed commitments
have been paid. The value of residuals is extremely sensitive to market
interest rates and prepayment rates over the life of the pool, and the
owner of a residual may, in some circumstances, lose the entire
investment.
Callable Debt Securities
A debt security may be callable, I.E., subject to redemption at the
option of the issuer at a price established in the security's governing
instrument. If a debt security held by the Fund is called for redemption,
the Fund will be required to permit the issuer to redeem the security or
sell it to a third party. Either of these actions could have an
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adverse effect on the Fund's ability to achieve its investment objectives.
Preferred Stock
The Fund may purchase preferred stock as a substitute for debt
securities of the same issuer when, in the opinion of the Adviser, the
preferred stock is more attractively priced in light of the risks
involved. Preferred stock pays dividends at a specified rate and generally
has preference over common stock in the payment of dividends and the
liquidation of the issuer's assets but is junior to the debt securities of
the issuer in those same respects. Unlike interest payments on debt
securities, dividends on preferred stock are generally payable at the
discretion of the issuer's board of directors, and shareholders may suffer
a loss of value if dividends are not paid. Preferred shareholders
generally have no legal recourse against the issuer if dividends are not
paid. The market prices of preferred stocks are subject to changes in
interest rates and are more sensitive to changes in the issuer's
creditworthiness than are the prices of debt securities. Under ordinary
circumstances, preferred stock does not carry voting rights.
Convertible Securities
A convertible security is a bond, debenture, note, preferred stock or
other security that may be converted into or exchanged for a prescribed
amount of common stock of the same or a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt
or the dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Before conversion,
convertible securities ordinarily provide a stable stream of income with
generally higher yields than those of common stocks of the same or similar
issuers, but lower than the yield on non-convertible debt. Convertible
securities are usually subordinated to comparable-tier non-convertible
securities but rank senior to common stock in a corporation's capital
structure.
The value of a convertible security is a function of (1) its yield in
comparison with the yields of other securities of comparable maturity and
quality that do not have a conversion privilege and (2) its worth, at
market value, if converted into the underlying common stock. Convertible
securities are typically issued by smaller capitalized companies, whose
stock prices may be volatile. The price of a convertible security often
reflects such variations in the price of the underlying common stock in a
way that non-convertible debt does not. A convertible security may be
subject to redemption at the option of the issuer at a price established
in the convertible security's governing instrument, which could have an
adverse effect on the Fund's ability to achieve its investment objectives.
Foreign Securities
Investing in the securities of issuers in any foreign country involves
special risks and considerations not typically associated with investing
in U.S. companies. These include risks resulting from differences in
accounting, auditing and financial reporting standards; lower liquidity
than U.S. fixed-income or debt securities; the possibility of
nationalization, expropriation or confiscatory taxation; adverse changes
in investment or exchange control regulations (which may include
suspension of the ability to transfer currency out of a country); and
political instability. In many cases, there is less publicly available
information concerning foreign issuers than is available concerning U.S.
issuers. Additionally, purchases and sales of foreign securities and
dividends and interest payable on those securities may be subject to
foreign income and withholding taxes. Foreign securities generally exhibit
greater price volatility. Changes in foreign exchange rates will affect
the value of securities denominated or quoted in currencies other than the
U.S. dollar irrespective of the performance of the underlying investment.
Some foreign governments have defaulted on principal and/or interest
payments; in such cases, the Fund would have limited recourse to enforce
its rights under the instruments it holds.
Forward foreign currency contracts involve obligations to purchase or
sell a specific amount of a specific currency at a future date, which may
be any fixed number of days from the date of the contract agreed upon by
the parties, at a price set at the time of the contract. By entering into
a foreign currency contract, the Fund "locks in" the exchange rate between
the currency it will deliver and the currency it will receive for the
duration of
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the contract. The Fund may enter into these contracts for the purpose of
hedging against risk arising from the Fund's investment or anticipated
investment in securities denominated in foreign currencies. Forward
currency contracts involve certain risks, including the risk that
anticipated currency movements will not be accurately predicted causing
the Fund to sustain losses on these contracts.
The Fund may invest in fixed-income and other debt securities of
issuers based in emerging markets (including, but not limited to,
countries in Latin America, Eastern Europe, Asia and Africa). The risks of
foreign investment, described above, are greater for investments in
emerging markets. Debt securities of issuers in such countries will
typically be rated below investment grade or be of comparable quality.
Repurchase Agreements
A repurchase agreement is an agreement under which the Fund acquires
either U.S. government obligations or other high-quality liquid debt
securities from a securities dealer or bank subject to resale at an
agreed-upon price and date. The securities are held for the Fund by State
Street Bank and Trust Company ("State Street"), the Fund's custodian, as
collateral until resold and will be supplemented by additional collateral
if necessary to maintain a total value equal to or in excess of the value
of the repurchase agreement. The Fund bears a 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, which may decline in value in the interim.
The Fund will enter into repurchase agreements only with financial
institutions which are deemed by the Adviser to present minimal risk of
default during the term of the agreement based on guidelines established
by the Corporation's Board of Directors.
Restricted and Illiquid Securities
Restricted securities are securities subject to legal or contractual
restrictions on their resale, such as private placements. Such
restrictions might prevent the sale of restricted securities at a time
when sale would otherwise be desirable. The Fund will not acquire
securities for which there is not a readily available market ("illiquid
assets") if such acquisition would cause the aggregate value of illiquid
assets to exceed 15% of the Fund's net assets. Repurchase agreements
maturing in more than seven days are considered illiquid. Illiquid
securities may be difficult to value; and the Fund may have difficulty
disposing of such securities promptly.
Loan Participations and Assignments
Many of the loans in which the Fund may purchase an interest are
secured and most impose restrictive covenants which must be met by the
borrower and which are generally more stringent than the covenants
available in publicly traded debt securities. However, interests in some
loans may not be secured, and the Fund will be exposed to a risk of loss
if the borrower defaults. Loan participations may also be purchased by the
Fund when the borrowing company is already in default.
In purchasing a loan participation, the Fund may have less protection
under the federal securities laws than it has in purchasing traditional
types of securities. The Fund's ability to assert its rights against the
borrower will also depend on the particular terms of the loan agreement
among the parties. Interests in many loans are illiquid and would
therefore be subject to the Fund's 15% limit on illiquid investments.
Options and Futures; Foreign Currency Exchange Contracts
Many options on debt securities are traded primarily on the
over-the-counter market. Over-the-counter options differ from
exchange-traded options in that the former are two-party contracts with
price and other terms negotiated between buyer and seller and generally do
not have as much market liquidity as exchange-traded options. Thus, when
the Fund purchases an over-the-counter option, it relies on the dealer
from which it has purchased the option to make or take delivery of the
securities underlying the option. Failure by the dealer to do so would
result in the loss of the premium paid by the Fund as well as the loss of
the expected benefit of the transaction. Over-the-counter options may be
considered illiquid securities for purposes of the Fund's investment
limitations. Currency options traded on U.S. or other exchanges may be
subject to position limits
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which may limit the ability of the Fund to reduce foreign currency risk
using such options.
Most futures exchanges and boards of trade limit the amount of
fluctuation permitted in futures contract prices during a single day; once
the daily limit has been reached on a particular contract, no trades may
be made that day at a price beyond that limit. In addition, certain of
these instruments are relatively new and without a significant trading
history. As a result, there is no assurance that an active secondary
market will develop or continue to exist. Lack of a liquid market for any
reason may prevent the Fund from liquidating an unfavorable position, and
the Fund would remain obligated to meet margin requirements until the
position is closed. Purchase of such instruments for which there is no
liquid secondary market will be subject to the Fund's investment
limitation on illiquid securities.
The Fund will establish segregated accounts or maintain covering
positions when engaging in the above strategies, to the extent required by
the SEC and staff positions. The Fund may write a call or put option only
if the option is "covered." A call option is covered if, so long as the
Fund is obligated under the option, it owns an offsetting position in the
underlying security, currency or futures contract, or a right to obtain
the security, currency or futures contract. A put option is covered if the
Fund maintains in a segregated account with the Fund's custodian, cash, or
liquid high-quality debt securities, with a value sufficient to cover its
potential obligations, as marked-to-market daily.
When the Fund purchases or sells a futures contract, the Fund is
required to deposit with its custodian (or a broker, if legally permitted)
a specified amount of cash or U.S. government securities ("initial
margin"). The use by the Fund of futures contracts or commodities option
positions for other than bona fide hedging purposes is restricted by
government regulations. (See the Statement of Additional Information.) If
the Fund writes an option or sells a futures contract and is not able to
close out that position prior to settlement date, the Fund may be required
to deliver cash or securities substantially in excess of these amounts.
The Fund might not employ any of the strategies described above, and
there can be no assurance that any strategy used will succeed. The Fund's
ability to engage in these practices may be limited by market conditions,
the rules and regulations of the Commodity Futures Trading Commission, tax
considerations and certain other legal considerations. Moreover, in the
event that an anticipated change in the price of the securities or
currencies that are the subject of the strategy does not occur, it may be
that the Fund would have been in a better position had it not used that
strategy at all.
The use of options, futures and forward currency exchange contracts
involves certain investment risks and transaction costs to which the Fund
might not be subject if it did not use such instruments. These risks
include (1) dependence on the adviser's ability to predict movements in
the prices of individual securities, fluctuations in the general
securities markets or in market sectors and movements in interest rates
and currency markets; (2) imperfect correlation between movements in the
price of options, currencies, futures contracts, forward currency exchange
contracts or options thereon and movements in the price of the securities
or currencies hedged or used for cover; (3) the fact that skills and
techniques needed to trade options, futures contracts and forward currency
exchange contracts are different from those needed to select the
securities in which the Fund invests; (4) lack of assurance that a liquid
secondary market will exist for any particular option or futures contract
at any particular time, which may result in unanticipated losses; (5) the
possibility that the use of cover or segregation involving a large
percentage of the Fund's assets could impede portfolio management or the
Fund's ability to meet redemption requests or other short-term
obligations; (6) the possible need to defer closing out certain options or
futures contracts in order to continue to qualify for the beneficial tax
treatment afforded regulated investment companies under the Internal
Revenue Code of 1986, as amended ("Code") (see "Additional Tax
Information" in the Statement of Additional Information); and (7) the
costs and commissions associated with such trades, which will reduce the
Fund's yield. The use of options for speculative purposes, I.E., to
enhance income or to increase the Fund's exposure to a particular security
or foreign currency, subjects the Fund to additional risk. The use of
futures or forward contracts to hedge an anticipated purchase (other
than a when-issued or delayed-delivery pur-
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<PAGE>
chase), also subjects the Fund to additional risk until the purchase is
completed or the position is closed out. Although the Fund generally will
not enter into such anticipatory hedges without the expectation of
completing the transaction, it is required to complete only 75% of them.
If the transaction is not completed, the risk of the anticipatory hedge is
the same as if the Fund had entered into the transaction for speculative
purposes.
The Statement of Additional Information contains a more detailed
description of futures, options and forward strategies.
New futures contracts, options thereon and other financial products
and risk management techniques continue to be developed. The Fund may
use these investments or techniques to the extent consistent with its
investment objectives and regulatory and federal tax considerations.
Portfolio Turnover
For the period February 1, 1994 (commencement of operations) to
December 31, 1994, the Fund's annualized portfolio turnover rate was
67.39%. The Fund may sell fixed-income securities and buy similar
securities to obtain yield and take advantage of market anomalies, a
practice which will increase the reported turnover rate of the Fund. High
turnover rates (100% or more) result in correspondingly greater
transaction costs, which will be borne directly by the Fund. It may also
increase the amount of short-term capital gains, if any, realized by the
Fund and would affect the tax treatment of distributions paid to
shareholders because distributions of net short-term capital gains are
taxable as ordinary income. The Fund will take these possibilities into
account as part of its investment strategy.
HOW YOU CAN INVEST IN THE FUND
You may purchase shares of the Fund through a brokerage account with
Legg Mason or with an affiliate that has a dealer agreement with Legg
Mason (Legg Mason is a wholly owned subsidiary of Legg Mason, Inc., a
financial services holding company). Your Legg Mason or affiliated
investment executive will be pleased to explain the shareholder services
available from the Fund and answer any questions you may have. Documents
available from your Legg Mason or affiliated investment executive should
be completed if you invest in shares of the Fund through an Individual
Retirement Account ("IRA"), Self-Employed Individual Retirement Plan
("Keogh Plan"), Simplified Employee Pension Plan ("SEP") or other
qualified retirement plan.
The minimum initial investment in the Fund for each account, including
investments made by exchange from other Legg Mason funds, is $1,000, and
the minimum investment for each purchase of additional shares is $100,
except as noted below. Initial investments in an IRA account established
on behalf of a nonworking spouse of a shareholder who has an IRA invested
in the Fund require a minimum amount of only $250. Subsequent investments
in an IRA or similar plan also require a minimum amount of $100. However,
once an account is established, the minimum amount for subsequent
investments will be waived if an investment in an IRA or similar plan will
bring the investment for the year to the maximum amount permitted under
the Code. For those investing through the Fund's Future First Systematic
Investment Plan, payroll deduction plans and plans involving automatic
payment of funds from financial institutions or automatic investment of
dividends from certain unit investment trusts, minimum initial and
subsequent investments are lower. The Fund may change these minimum amount
requirements at its discretion.
Fund shares purchased on behalf of an IRA, Keogh Plan, SEP or other
qualified retirement plan will be processed at the net asset value next
determined after Legg Mason's Funds Processing receives a check for the
amount of the purchase. Other share purchases will be processed at the net
asset value next determined after your Legg Mason or affiliated investment
executive has received your order; payment must be made within five
business days to Legg Mason. Beginning in June, 1995, payment must be made
within three business days to Legg Mason. Orders received by your Legg
Mason or affiliated investment executive before the close of business of
the New York Stock Exchange, Inc. ("Exchange") (normally 4:00 p.m. Eastern
time) ("close of the Exchange") on any day the Exchange is open will be
executed at the net asset value determined as of the close of the Exchange
on that day. Orders
15
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received by your Legg Mason or affiliated investment executive after the
close of the Exchange or on days the Exchange is closed will be executed
at the net asset value determined as of the close of the Exchange on the
next day the Exchange is open. See "How Net Asset Value is Determined" on
page 17. The Fund reserves the right to reject any order for shares of the
Fund or to suspend the offering of shares for a period of time.
You should always furnish your shareholder account number when
making additional purchases of shares.
There are three ways you can invest in the Fund:
1. THROUGH YOUR LEGG MASON OR AFFILIATED INVESTMENT EXECUTIVE
Fund shares may be purchased through any Legg Mason or affiliated
investment executive. An investment executive will be pleased to open an
account for you, explain to you the shareholder services available from
the Fund, and answer any questions you may have. After you have
established a Legg Mason or affiliated account, you can order shares of
the Fund from your investment executive in person, by telephone or by
mail.
2. THROUGH THE FUTURE FIRST SYSTEMATIC INVESTMENT PLAN
You may also buy shares in the Fund through the Future First
Systematic Investment Plan. Under this plan, you may arrange for automatic
monthly investments in the Fund of $50 or more by authorizing Boston
Financial Data Services ("BFDS"), the Fund's transfer agent, to prepare a
check each month drawn on your checking account. There is no minimum
initial investment. Please contact any Legg Mason or affiliated investment
executive for further information.
3. THROUGH AUTOMATIC INVESTMENTS
Arrangements may be made with some employers and financial
institutions, such as banks or credit unions, for regular automatic
monthly investments of $50 or more in shares of the Fund. In addition, it
may be possible for dividends from certain unit investment trusts to be
invested automatically in Fund shares. Persons interested in establishing
such automatic investment programs should contact the Fund through any
Legg Mason or affiliated investment executive.
HOW YOUR SHAREHOLDER ACCOUNT IS MAINTAINED
When you initially purchase Fund shares, a shareholder account is
established automatically for you. Any shares that you purchase or receive
as a dividend or other distribution will be credited directly to your
account at the time of purchase or receipt. No certificates are issued
unless you specifically request them in writing. Shareholders who elect to
receive certificates can redeem their shares only by mail. Certificates
will be issued in full shares only. No certificates will be issued for
shares prior to 15 business days after purchase of such shares by check
unless the Fund can be reasonably assured during that period that payment
for the purchase of such shares has been collected. Fund shares may not be
held in, or transferred to, an account with any brokerage firm other than
Legg Mason or its affiliates.
HOW YOU CAN REDEEM YOUR FUND SHARES
There are two ways you can redeem your Fund shares. First, you may
give your Legg Mason or affiliated investment executive an order for
repurchase of your shares. Please have the following information ready
when you call: the number of shares to be redeemed and your shareholder
account number. Second, you may send a written request for redemption to
"Legg Mason High Yield Portfolio, c/o Legg Mason Funds Processing, P.O.
Box 1476, Baltimore, Maryland 21203-1476."
Requests for redemption in "good order," as described below, received
by your Legg Mason or affiliated investment executive before the close of
the Exchange on any day when the Exchange is open, will be transmitted to
BFDS, transfer agent for the Fund, for redemption at the net asset value
per share determined as of the close of the Exchange on that day. Requests
for redemption received by your Legg Mason or affiliated investment
executive after the close of the Exchange will be executed at the net
asset value determined as of the close of the Exchange on its next trading
day. A redemption request received by your Legg Mason or affiliated
investment executive may be treated as a request for repurchase and, if it
is accepted by Legg Mason, the shares will be purchased at the net asset
value per share determined as of the next close of the Exchange.
Proceeds from your redemption will settle in your Legg Mason brokerage
account two business
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<PAGE>
days after trade date. However, the Fund reserves the right to take up to
seven days to make payment upon redemption if, in the judgment of the
Adviser, the Fund could be adversely affected by immediate payment. (The
Statement of Additional Information describes several other circumstances
in which the date of payment may be postponed or the right of redemption
suspended.) The proceeds of your redemption or repurchase may be more or
less than your original cost. If the shares to be redeemed or repurchased
were paid for by check (including certified or cashier's checks) within 15
business days of the redemption or repurchase request, the proceeds will
not be disbursed unless the Fund can be reasonably assured that the check
has been collected.
A redemption request will be considered to be received in "good order"
only if:
1. You have indicated in writing the number of shares to be redeemed
and your shareholder account number;
2. The written request is signed by you and by any co-owner of the
account with exactly the same name or names used in establishing the
account;
3. The written request is accompanied by any certificates representing
the shares that have been issued to you, and you have endorsed the
certificates for transfer or an accompanying stock power exactly as the
name or names appear on the certificates; and
4. The signatures on the written redemption request and on any
certificates for your shares (or an accompanying stock power) have been
guaranteed without qualification by a national bank,
a state bank, a member firm of a principal
stock exchange, or other entity described in
Rule 17Ad-15 under the Securities Exchange Act of 1934.
Other supporting legal documents may be required from corporations or
other organizations, fiduciaries or persons other than the shareholder of
record making the request for redemption or repurchase. If you have a
question concerning the redemption of Fund shares, contact your Legg Mason
or affiliated investment executive.
The Fund will not be responsible for the authenticity of redemption
instructions received by telephone, provided it follows reasonable
procedures to identify the caller. The Fund may request identifying
information from callers or employ identification numbers. The Fund may be
liable for losses due to unauthorized or fraudulent instructions if it
does not follow reasonable procedures. Telephone redemption privileges are
available automatically to all shareholders unless certificates have been
issued. Shareholders who do not wish to have telephone redemption
privileges should call their Legg Mason or affiliated investment executive
for further instructions.
To redeem your Fund retirement account, a Distribution Request Form
must be completed and returned to Legg Mason Client Services for
processing. This form can be obtained through your Legg Mason or
affiliated investment executive or Legg Mason Client Services in
Baltimore, Maryland.
Because of the relatively high cost of maintaining small accounts, the
Fund may elect to close any account with a current value of less than $500
by redeeming all of the shares in the account and mailing the proceeds to
you. However, the Fund will not redeem accounts that fall below $500
solely as a result of a reduction in net asset value per share. If the
Fund elects to redeem the shares in your account, you will be notified
that your account is below $500 and will be allowed 60 days in which to
make an additional investment in order to avoid having your account
closed.
HOW NET ASSET VALUE IS DETERMINED
Net asset value per Fund share is determined daily, as of the close of
the Exchange, on every day that the Exchange is open, by subtracting the
Fund's liabilities from its total assets and dividing the result by the
number of shares outstanding. Securities owned by the Fund for which
market quotations are readily available are valued at current market
value. In the absence of readily available market quotations, securities
are valued at fair value as determined by the Corporation's Board of
Directors. Where a security is traded on more than one market, which may
include foreign markets, the securities are generally valued on the market
considered by the Adviser to be the primary market. Securities with
remaining maturities of 60 days or less are valued at amortized cost. The
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Fund will value its foreign securities in U.S. dollars on the basis of the
then-prevailing exchange rates.
DIVIDENDS AND OTHER DISTRIBUTIONS
Dividends from net investment income are declared and paid monthly.
Shareholders begin to earn dividends on their Fund shares as of settlement
date, which is normally the fifth business day after their orders are
placed with their Legg Mason or affiliated investment executive. Beginning
in June, 1995, settlement date will normally be the third business day
after orders are placed with a Legg Mason or affiliated investment
executive. Dividends from net short-term capital gain and distributions of
substantially all net capital gain (the excess of net long-term capital
gain over net short-term capital loss) and any net gain from foreign
currency transactions generally are declared and paid after the end of the
taxable year in which the gain is realized. A second distribution of net
capital gain may be necessary in some years to avoid imposition of the
excise tax described under the heading "Additional Tax Information" in the
Statement of Additional Information. Dividends and other distributions, if
any, on shares held in an IRA, Keogh Plan, SEP or other qualified
retirement plan and by shareholders maintaining a Systematic Withdrawal
Plan generally are reinvested in Fund shares on the payment dates. Other
shareholders may elect to:
1. Receive both dividends and other distributions in Fund shares;
2. Receive dividends in cash and other distributions in Fund shares;
3. Receive dividends in Fund shares and other distributions in cash;
or
4. Receive both dividends and other distributions in cash.
In certain cases, you may reinvest your dividends and other
distributions in shares of another Legg Mason fund. Please contact your
Legg Mason or affiliated investment executive for additional information
about this option.
If no election is made, both dividends and other distributions will be
credited to your account in Fund shares at the net asset value of the
shares
determined as of the close of the Exchange on the reinvestment date.
Shares received pursuant to any of the first three (reinvestment)
elections above also will be credited to your account at that net asset
value. If you elect to receive dividends and/or other distributions in
cash, you will be sent a check or will have your Legg Mason account
credited after the payment date. You may elect at any time to change your
option by notifying the Fund in writing at: Legg Mason High Yield
Portfolio, c/o Legg Mason Funds Processing, P.O. Box 1476, Baltimore,
Maryland 21203-1476. Your election must be received at least 10 days
before the record date in order to be effective for dividends and other
distributions paid to shareholders as of that date.
TAXES
The Fund intends to continue to qualify for treatment as a regulated
investment company under the Code so that it will be relieved of federal
income tax on that part of its investment company taxable income and net
capital gain that is distributed to its shareholders.
Dividends from the Fund's investment company taxable income (whether
paid in cash or reinvested in Fund shares) are taxable to its shareholders
(other than IRAs, Keogh Plans, SEPs, other qualified retirement plans and
other tax-exempt investors) as ordinary income to the extent of the Fund's
earnings and profits. Distributions of the Fund's net capital gain
(whether paid in cash or reinvested in Fund shares), when designated as
such, are taxable to those shareholders as long-term capital gain,
regardless of how long they have held their Fund shares.
The Fund sends each shareholder a notice following the end of each
calendar year specifying, among other things, the amounts of all dividends
and other distributions paid (or deemed paid) during that year. The Fund
is required to withhold 31% of all dividends, capital gain distributions
and redemption proceeds payable to any individuals and certain other
noncorporate shareholders who do not provide the Fund with a certified
taxpayer identification number. The Fund also is required to withhold 31%
of all dividends and capital gain distributions payable to such
shareholders who otherwise are subject to backup withholding.
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A redemption of Fund shares may result in taxable gain or loss to the
redeeming shareholder, depending on whether the redemption proceeds are
more or less than the shareholder's adjusted basis for the redeemed
shares. An exchange of Fund shares for shares of any other Legg Mason fund
generally will have similar tax consequences. See "Shareholder
Services -- Exchange Privilege," below. If Fund shares are purchased
within 30 days before or after redeeming other Fund shares at a loss, all
or part of that loss will not be deductible and instead will increase the
basis of the newly purchased shares.
A dividend or other distribution paid shortly after shares have been
purchased, although in effect a return of investment, is subject to
federal income tax. Accordingly, an investor should recognize that a
purchase of Fund shares immediately prior to the record date for a
dividend or other distribution could cause the investor to incur tax
liabilities and should not be made solely for the purpose of receiving the
dividend or other distribution.
The foregoing is only a summary of some of the important federal
income tax considerations generally affecting the Fund and its
shareholders; see the Statement of Additional Information for a further
discussion. In addition to federal income tax, you may also be subject to
state, local or foreign taxes on distributions from the Fund, depending on
the laws of your home state and locality. A portion of the dividends paid
by the Fund attributable to direct U.S. government obligations is not
subject to state and local income taxes in most jurisdictions. The Fund's
annual notice to shareholders regarding the amount of dividends identifies
this portion. Prospective shareholders are urged to consult their tax
advisers with respect to the effects of this investment on their own tax
situations.
SHAREHOLDER SERVICES
CONFIRMATIONS AND REPORTS
You will receive from the distributor a confirmation after each
transaction (except a reinvestment of dividends, capital gains and shares
purchased through the Future First Systematic
Investment Plan or through automatic investments). An account statement
will be sent to you monthly unless there has been no activity in the
account or you are purchasing shares through the Future First Systematic
Investment Plan or through automatic investments, in which case an account
statement will be sent quarterly. Reports will be sent to shareholders at
least semiannually showing the Fund's portfolio and other information; the
annual report will contain financial statements audited by the
Corporation's independent accountants.
Shareholder inquiries should be addressed to "Legg Mason High Yield
Portfolio, c/o Legg Mason Funds Processing, P.O. Box 1476, Baltimore,
Maryland 21203-1476."
SYSTEMATIC WITHDRAWAL PLAN
You may elect to make systematic withdrawals from your Fund account of
a minimum of $50 on a monthly basis if you are purchasing or already own
shares with a net asset value of $5,000 or more. Shareholders should not
purchase shares of the Fund while they are participating in the Systematic
Withdrawal Plan. Please contact your Legg Mason or affiliated investment
executive for further information.
EXCHANGE PRIVILEGE
As a Fund shareholder, you are entitled to exchange your shares of the
Fund for shares of the following funds in the Legg Mason Family of Funds,
provided that such shares are eligible for sale in your state of
residence:
Legg Mason Cash Reserve Trust
A money market fund seeking stability of principal and current income
consistent with stability of principal.
Legg Mason Tax Exempt Trust, Inc.
A money market fund seeking high current income exempt from federal
income tax, preservation of capital, and liquidity.
Legg Mason U.S. Government Money Market Portfolio
A money market fund seeking high current income consistent with
liquidity and conservation of principal.
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Legg Mason Value Trust, Inc.
A mutual fund seeking long-term growth of capital.
Legg Mason Special Investment Trust, Inc.
A mutual fund seeking capital appreciation by investing principally in
issuers with market capitalizations of less than $2.5 billion.
Legg Mason Total Return Trust, Inc.
A mutual fund seeking capital appreciation and current income in order
to achieve an attractive total investment return consistent with
reasonable risk.
Legg Mason American Leading Companies Trust
A mutual fund seeking long-term capital appreciation and current
income consistent with prudent investment risk.
Legg Mason Global Equity Trust
A mutual fund seeking maximum long-term total return, by investing in
common stocks of companies located in at least three different countries.
Legg Mason U.S. Government Intermediate-Term Portfolio
A mutual fund seeking high current income consistent with prudent
investment risk and liquidity needs, primarily by investing in debt
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, while maintaining an average dollar-weighted maturity
of between three and ten years.
Legg Mason Investment Grade Income Portfolio
A mutual fund seeking a high level of current income, primarily
through investment in a diversified portfolio of investment grade debt
securities.
Legg Mason Global Government Trust
A mutual fund seeking capital appreciation and current income by
investing principally in debt securities issued or guaranteed by foreign
governments, the U.S. Government, their agencies, instrumentalities and
political subdivisions.
Legg Mason Maryland Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal and Maryland state and local income taxes,
consistent with prudent investment risk and preservation of capital.
Legg Mason Pennsylvania Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax and Pennsylvania personal income
tax, consistent with prudent investment risk and preservation of capital.
Legg Mason Tax-Free Intermediate-Term Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax, consistent with prudent investment
risk.
*Shares of these funds are sold with an initial sales charge.
Investments by exchange into the Legg Mason funds sold without an
initial sales charge are made at the per share net asset value determined
on the same business day as redemption of the Fund shares you wish to
exchange. Investments by exchange into the Legg Mason funds sold with an
initial sales charge are made at the per share net asset value, plus the
applicable sales charge, determined on the same business day as redemption
of the Fund shares you wish to redeem; except that no sales charge will be
imposed upon proceeds from the redemption of Fund shares to be exchanged
that were originally purchased by exchange from a fund on which the same
or higher initial sales charge previously was paid. There is no charge for
the exchange privilege, but the Fund reserves the right to terminate or
limit the exchange privilege of any shareholder who makes more than four
exchanges from the Fund in one calendar year. To obtain further
information concerning the exchange privilege and prospectuses of other
Legg Mason funds, or to make an exchange, please contact your Legg Mason
or affiliated investment executive. To effect an exchange by telephone,
please call your Legg Mason or affiliated investment executive with the
information described in "How You Can Redeem Your Fund Shares" on page 16.
Please read the prospectus for the other funds carefully before you invest
by exchange. The Fund reserves the right to modify or terminate the
exchange privilege upon 60 days' notice to shareholders.
There is no assurance the money market funds will be able to maintain
a $1.00 share price. None
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of the funds is insured or guaranteed by the U.S. Government.
THE FUND'S BOARD OF DIRECTORS, MANAGER AND INVESTMENT ADVISER
BOARD OF DIRECTORS
The business and affairs of the Fund are managed under the direction
of the Corporation's Board of Directors.
MANAGER
Pursuant to a management agreement with the Fund ("Management
Agreement "), which was approved by the Corporation's Board of Directors,
Legg Mason Fund Adviser, Inc., a wholly owned subsidiary of Legg Mason,
Inc., serves as the Fund's manager. The Manager manages the non-investment
affairs of the Fund, directs all matters related to the operation of the
Fund and provides office space and administrative staff for the Fund. The
Fund pays the Manager, pursuant to the Management Agreement, a management
fee equal to an annual rate of 0.65% of the Fund's average daily net
assets.
The Manager acts as investment adviser, manager or consultant to
fifteen investment company portfolios (excluding the Fund) which had
aggregate assets under management of over $4.0 billion as of February 28,
1995. The Manager's address is 111 South Calvert Street, Baltimore,
Maryland 21202.
INVESTMENT ADVISER
Western Asset Management Company, another wholly owned subsidiary of
Legg Mason, Inc., serves as investment adviser to the Fund pursuant to the
terms of an Investment Advisory Agreement with the Manager, which was
approved by the Corporation's Board of Directors. The Adviser manages the
investment and other affairs of the Fund and directs the investments of
the Fund in accordance with its investment objectives, policies and
limitations. For these services, the Manager (not the Fund) pays the
Adviser a fee, computed daily and payable monthly, at an annual rate equal
to 77% of the fee received by the Manager, or 0.50% of the Fund's average
daily net assets.
An investment committee has been responsible for the day-to-day
management of the Fund since its inception.
The Adviser also renders investment advice to eleven open-end
investment companies and one closed-end investment company, which together
had aggregate assets under management of approximately $2.5 billion as of
February 28, 1995. The Adviser also renders investment advice to private
accounts with fixed-income assets under management of approximately $10.8
billion as of that date. The address of the Adviser is 117 East Colorado
Boulevard, Pasadena, California 91105.
The Adviser has managed fixed-income portfolios continuously since its
founding in 1971, and has focused exclusively on such accounts since 1984.
In managing fixed-income portfolios, the Adviser first studies the
range of factors that influence interest rates and develops a long-term
interest rate forecast. It then allocates available funds to those sectors
of the market (for example, government, corporate, or mortgage-backed
securities), which it considers most attractive. Then it selects the
specific issues which it believes represent the best values. All three
decisions are integral parts of the Adviser's portfolio management process
and contribute to its performance record.
THE FUND'S DISTRIBUTOR
Legg Mason is the distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to pay certain expenses in connection with the
offering of shares of the Fund, including any compensation to its
investment executives, the printing and distribution of prospectuses,
statements of additional information and periodic reports used in
connection with the offering to prospective investors, after the
prospectuses, statements of additional information and reports have been
prepared, set in type and mailed to existing shareholders at the Fund's
expense, and for any supplementary sales literature and advertising costs.
Legg Mason also receives a fee from BFDS for assisting it with its
transfer agent and shareholder servicing functions. For the period
February 1, 1994 (commencement of operations) to December
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31, 1994, Legg Mason received $9,327 for performing such services in
connection with the Fund.
The Board of Directors of the Corporation has adopted a Distribution
and Shareholder Services Plan ("Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940 ("1940 Act"). The Plan provides that as
compensation for Legg Mason's ongoing services to shareholders and its
activities and expenses related to the sale and distribution of Fund
shares, Legg Mason receives from the Fund an annual distribution fee and
an annual service fee, each of which is equal to 0.25% of the Fund's
average daily net assets. The distribution and service fees are calculated
daily and paid monthly. The fees received by Legg Mason during any year
may be more or less than its cost of providing distribution and
shareholder services to the Fund.
NASD rules limit the amount of annual distribution fees that may be
charged by mutual funds and impose a ceiling on the cumulative
distribution fees received. The Fund's Plan complies with those rules.
The Chairman, President and Treasurer of the Corporation are employed
by Legg Mason.
THE FUND'S CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company ("State Street"), P.O. Box 1790,
Boston, Massachusetts 02105, serves as custodian of the Fund's assets.
Boston Financial Data Services, P.O. Box 953, Boston, Massachusetts 02103,
serves as transfer and dividend-disbursing agent, and administrator of
various shareholder services. Shareholders who request an historical
transcript of their account will be charged a fee based on the number of
years researched. The Fund reserves the right, upon 60 days' written
notice, to make other charges to investors to cover administrative costs.
Pursuant to rules adopted under Section 17(f) of the 1940 Act, the
Fund may maintain foreign securities and cash in the custody of certain
eligible foreign banks and securities depositories. Selection of these
foreign custodial institutions is made by the Board of Directors in
accordance with SEC rules. The Board of Directors will consider a number
of factors, including, but not limited to, the relationship of the
institution to State Street, the reliability and financial stability of
the institution, the ability of the institution to capably perform
custodial services for the Fund, the reputation of the institution in its
national market, the political and economic stability of the countries in
which the sub-custodians will be located and risks of potential
nationalization or expropriation of Fund assets. No assurance can be given
that the Board of Directors' appraisal of the risks in connection with
foreign custodial arrangements will always be correct or that
expropriation, nationalization, freezes, or confiscation of Fund assets
will not occur.
DESCRIPTION OF THE CORPORATION AND ITS SHARES
The Corporation is a diversified open-end investment company which was
incorporated in Maryland on April 28, 1987. The Articles of Incorporation
of the Corporation permit the Board of Directors to create additional
series (or portfolios), each of which issues a separate class of shares.
There are currently four portfolios of the Corporation, including the
Fund. While additional series may be created in the future, there is no
intention at this time to form any particular additional series.
The Corporation has authorized one billion shares of common stock, par
value $.001 per share. Shareholders of each portfolio of the Corporation
are entitled to one vote per share and fractional votes for fractional
shares held. However, shareholders of the Fund vote separately on certain
matters affecting it. For example, a change in investment policy for the
Fund would be voted upon only by its shareholders. Voting rights are not
cumulative. All shares of the Corporation are fully paid and
non-assessable and have no preemptive or conversion rights.
Shareholders' meetings will not be held except where the 1940 Act
requires a shareholder vote on certain matters (including the election of
directors, approval of an advisory contract and approval of a plan of
distribution pursuant to Rule 12b-1). The Corporation will call a special
meeting of the shareholders at the request of 10% or more of the shares
entitled to vote; shareholders wishing to call such a meeting should
submit a written request to the Fund at 111 South Calvert Street,
Baltimore, Maryland 21202, stating the purpose of the proposed meeting and
the matters to be acted upon.
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APPENDIX A
The Fund may use the following hedging instruments:
OPTIONS ON SECURITIES AND FOREIGN CURRENCIES -- A call option is a
short-term contract pursuant to which the purchaser of the option, in
return for a premium, has the right to buy the security or currency
underlying the option at a specified price at any time during the term of
the option. The writer of the call option, who receives the premium, has
the obligation, upon exercise of the option during the option term, to
deliver the underlying security or currency against payment of the
exercise price. A put option is a similar contract that gives its
purchaser, in return for a premium, the right to sell the underlying
security or currency at a specified price during the option term. The
writer of the put option, who receives the premium, has the obligation,
upon exercise of the option during the option term, to buy the underlying
security or currency at the exercise price.
OPTION ON A SECURITIES INDEX -- An option on a securities index is
similar to an option on a security or foreign currency, except that
settlement of an index option is effected with a cash payment based on the
value of the index and does not involve the delivery of the securities
included in the index. Thus, upon settlement of an index option, the
purchaser will realize, and the writer will pay, an amount based on the
difference between the exercise price of the option and the closing price
of the index.
INTEREST RATE AND FOREIGN CURRENCY FUTURES CONTRACTS -- Interest rate
and foreign currency futures contracts are bilateral agreements pursuant
to which one party agrees to make, and the other party agrees to accept,
delivery of a specified type of debt security or currency at a specified
future time and at a specified price. Although such futures contracts by
their terms call for actual delivery or acceptance of debt securities or
currency, in most cases the contracts are closed out before the settlement
date without the making or taking of delivery. An index futures contract
is similar to any other futures contract except that settlement of an
index futures contract is effected with a cash payment based on the value
of the index and does not involve the delivery of the securities included
in the index.
OPTIONS ON FUTURES CONTRACTS -- Options on futures contracts are
similar to options on securities or currency, except that an option on a
futures contract gives the purchaser the right, in return for the premium,
to assume a position in a futures contract (a long position if the option
is a call and a short position if the option is a put), rather than to
purchase or sell a security or currency, at a specified price at any time
during the option term. Upon exercise of the option, the delivery of the
futures position to the holder of the option will be accompanied by
delivery of the accumulated balance that represents the amount by which
the market price of the futures contract exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the option on
the future. The writer of an option, upon exercise, will assume a short
position in the case of a call and a long position in the case of a put.
An option on a bond index futures contract is similar to any other option
on a futures contract except that the purchaser has the right, in return
for the premium, to assume a position in a bond index futures contract at
a specified price at any time during the option term.
FORWARD CURRENCY CONTRACTS -- A forward currency contract involves an
obligation to purchase or sell a specific currency at a specified future
date, which may be any fixed number of days from the contract date agreed
upon by the parties, at a price set at the time the contract is entered
into.
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APPENDIX B
RATINGS OF SECURITIES
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") CORPORATE BOND
RATINGS:
AAA -- Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally
referred to as "gilt edge". Interest payments are protected by a large or
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
AA -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make the long-term risks appear
somewhat larger than the Aaa securities.
A -- Bonds which are rated A possess many favorable investment
attributes and are to be considered upper-medium-grade obligations.
Factors giving security to principal and interest are considered adequate,
but elements may be present which suggest a susceptibility to impairment
some time in the future.
BAA -- Bonds which are rated Baa are considered medium-grade
obligations, (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have speculative
characteristics as well.
BA -- Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered well-assured. Often the
protection of interest and principal payments may be very moderate, and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time
may be small.
CAA -- Bonds which are rated Caa are of poor standing and may be in
default or there may be present elements of danger with respect to
principal or interest.
CA -- Bonds which are rated Ca represent obligations which are
speculative in a high degree and are often in default or have other marked
shortcomings.
C -- Bonds which are rated C are the lowest rated class of bonds and
can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP ("S&P") CORPORATE BOND RATINGS:
AAA -- This is the highest rating assigned by Standard & Poor's to an
obligation. Capacity to pay interest and repay principal is extremely
strong.
AA -- Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the higher rated issues only in small
degree.
A -- Bonds rated A have a strong capacity to pay interest and repay
principal, although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher categories.
BBB -- Bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for bonds in this category than for bonds in
higher rated categories.
BB, B, CCC, CC -- Bonds rated BB, B, CCC and CC are regarded, on
balance, as predominately speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms
of the obligation. BB indicates the lowest degree of speculation and CC
the highest degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by large
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uncertainties or major risk exposures to adverse conditions.
C -- Bonds on which no interest is being paid are rated C.
D -- Bonds rated D are in payment default and payment of interest and/or
repayment of principal is in arrears.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS:
AAA -- An issue which is rated "aaa" is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least
risk of dividend impairment within the universe of preferred stocks.
AA -- An issue which is rated "aa" is considered a high-grade
preferred stock. This rating indicates that there is a reasonable
assurance that earnings and asset protection will remain relatively
well-maintained in the foreseeable future.
A -- An issue which is rated "a" is considered to be an
upper-medium-grade preferred stock. While risks are judged to be somewhat
greater than in the "aaa" and "aa" classification, earnings and asset
protection are, nevertheless, expected to be maintained at adequate
levels.
BAA -- An issue which is rated "baa" is considered to be a
medium-grade preferred stock, neither highly protected nor poorly secured.
Earnings and asset protection appear adequate at present but may be
questionable over any great length of time.
BA -- An issue which is rated "ba" is considered to have speculative
elements and its future cannot be considered well assured. Earnings and
asset protection may be very moderate and not well safeguarded during
adverse periods. Uncertainty of position characterizes preferred stocks in
this class.
B -- An issue which is rated "b" generally lacks the characteristics
of a desirable investment. Assurance of divided payments and maintenance
of other terms of the issue over any long period of time may be small.
CAA -- An issue which is rated "caa" is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate
the future status of payments.
CA -- An issue which is rated "ca" is speculative in a high degree and
is likely to be in arrears on dividends with little likelihood of eventual
payments.
C -- This is the lowest rated class of pre-
ferred or preference stock. Issues so rated can be regarded as having
extremely poor prospects of
ever attaining any real investment standing.
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