LEGG MASON INCOME TRUST INC, 497, 1995-05-09

LEGG MASON INCOME TRUST INC
497, 1995-05-09

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<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Highlights 2
Fund Expenses 3
Financial Highlights 4
Performance Information 5
The Fund's Investment Objective and
Policies 6
How You Can Invest in the Fund 12
How Your Shareholder Account is Maintained 13
How You Can Redeem Your Primary Shares 13
How Net Asset Value Is Determined 14
Dividends and Other Distributions 14
Tax Treatment of Dividends and Other
Distributions 15
Shareholder Services 16
Investing through Tax-Deferred Retirement
Plans 17
The Fund's Board of Directors, Manager and
Investment Adviser 17
The Fund's Distributor 18
Description of the Corporation and its
Shares 19
</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 East Redwood Street, Baltimore, Maryland 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.
(Recycle Logo) PRINTED ON RECYCLED PAPER
LMF-025

PROSPECTUS
MAY 1, 1995
LEGG MASON
U.S.
GOVERNMENT
INTERMEDIATE-
TERM
PORTFOLIO
PRIMARY SHARES
PUTTING YOUR FUTURE FIRST
(Logo of Legg Mason appears here)
<PAGE>
THE LEGG MASON U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO -- PRIMARY
SHARES
PROSPECTUS
The Legg Mason U.S. Government Intermediate-Term Portfolio ("Fund") is
a professionally managed portfolio seeking to provide investors with high
current income consistent with prudent investment risk and liquidity
needs. The Fund is a separate portfolio of Legg Mason Income Trust, Inc.
("Corporation"), a diversified open-end management 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, invests at least 75% of the
Fund's total assets in obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, or instruments secured by
such securities. The Fund expects to maintain an average dollar-weighted
maturity of between three and ten years.
The Adviser believes that shares of the Fund may be appropriate both
for direct investment and for investment in Individual Retirement Accounts
and other qualified retirement plans.
The Primary Class of Shares ("Primary Shares") offered in this
Prospectus is available to all investors except certain institutions (see
page 4). No initial sales charge is payable on purchases, and no
redemption charge is payable on sales, of Primary Shares of the Fund. The
Fund pays management fees to its Manager, Legg Mason Fund Adviser, Inc.
("Manager"), and distribution fees with respect to Primary Shares to its
Distributor, Legg Mason Wood Walker, Incorporated ("Legg Mason"), as
described on pages 17-19 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 U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO-PRIMARY SHARES
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 Primary 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 12, and "How You Can Redeem Your Primary Shares," page 13.
FUND STARTED:
August 7, 1987
NET ASSETS:
Over $234.8 million as of February 28, 1995
INVESTMENT OBJECTIVE AND POLICIES:
The Fund's investment objective is to obtain high current income
consistent with prudent investment risk and liquidity needs. The Fund
attempts to meet this objective by investing at least 75% of the Fund's
total assets in obligations issued or guaranteed by the U.S. Government,
its agencies or instrumentalities, or instruments secured by such
securities. Of course, there can be no assurance that the Fund will
achieve its objective. The value of the debt instruments held by the Fund,
and thus the net asset value of Fund shares, generally fluctuates
inversely with movements in market interest rates. Certain investment
grade debt securities in which the Fund invests may have speculative
characteristics. The Fund's participation in hedging and option income
strategies also involves certain investment risks and transaction costs.
See "The Fund's Investment Objective and Policies," page 6.
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. See "Exchange Privilege,"
page 16.
DIVIDENDS:
Declared daily and paid monthly.
REINVESTMENT:
All dividends and other distributions are automatically reinvested in
Primary 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
12.
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 Primary Shares of 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 related to
Primary Shares for the year ended December 31, 1994, adjusted for current
expense and fee waiver levels.
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum sales charge on purchases or
reinvested dividends None
Redemption and exchange fees None
ANNUAL FUND OPERATING EXPENSES -- PRIMARY
SHARES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Management fees 0.55 %
12b-1 fees 0.50 %
Other expenses 0.14 %
Less: Reimbursement of fees (1) (0.24)%
Total operating expenses 0.95 %
</TABLE>

(1) The expense ratio for Primary Shares would have been 1.19% had the Fund's
Manager not agreed to reimburse fees. The reimbursement agreement, wherein the
Manager has agreed to continue to reimburse fees and/or assume other expenses to
the extent the expenses attributable to Primary Shares (exclusive of taxes,
interest, brokerage and extraordinary expenses) exceed during any month an
annual rate of 0.95% of average daily net assets (Primary Shares) for such
month, will remain in effect until October 31, 1995, or until net assets reach
$400 million, whichever occurs first, and unless extended will terminate on that
date.
Because the Fund pays a 12b-1 fee with respect to Primary Shares, long-term
shareholders in Primary Shares 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 17.
EXAMPLE OF EFFECT OF FUND EXPENSES
The following example illustrates the expenses that you would pay on a
$1,000 investment in Primary Shares 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>
$ 10 $30 $53 $117
</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 PROJECTED OR ACTUAL PERFORMANCE OF
PRIMARY SHARES. 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 actual expenses attributable to Primary Shares 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 Primary Shares incur variable
expenses, such as transfer agency costs.
3

<PAGE>
FINANCIAL HIGHLIGHTS
Effective December 1, 1994, the Fund commenced the sale of a second
class of shares, known as Navigator Shares. Navigator Shares are currently
offered for sale only to institutional clients of the Fairfield Group, Inc.
("Fairfield") for investment of their own funds and funds for which they
act in a fiduciary capacity, to clients of Legg Mason Trust Company ("Trust
Company") for which Trust Company exercises discretionary investment
management responsibility, to qualified retirement plans managed on a
discretionary basis and having net assets of at least $200 million, and to
The Legg Mason Profit Sharing Plan and Trust. Navigator Shares pay no 12b-1
distribution fees and may pay lower transfer agency fees. The information
for Primary Shares reflects the 12b-1 fees paid by that Class.
The financial highlights for the period August 7, 1987 (commencement of
operations) to December 31, 1987 and for the years ended December 31, 1988
through 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 year ended 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>
AUGUST 7,
PRIMARY CLASS TO
NAVIGATOR CLASS FOR THE YEARS ENDED DECEMBER 31, DECEMBER 31,
1994(1) 1994 1993 1992 1991 1990 1989 1988 1987
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period $9.72 $10.43 $10.70 $10.77 $10.29 $10.20 $ 9.79 $9.92 $10.00
Net investment income 0.05(3) 0.51(2) 0.53(2) 0.60(2) 0.72(2) 0.78(2) 0.80(2) 0.74(2) 0.30(2)
Net realized and
unrealized gain
(loss) on
investments -- (0.71) 0.17 0.05 0.70 0.09 0.41 (0.12) (0.08)
Total from investment
operations 0.05 (0.20) 0.70 0.65 1.42 0.87 1.21 0.62 0.22
Distributions to
shareholders:
Net investment
income (0.05) (0.51) (0.53) (0.60) (0.72) (0.78) (0.80) (0.74) (0.30)
Net realized gain
on investments -- -- (0.39) (0.12) (0.22) -- -- (0.01) --
In excess of net
realized gain on
investments -- -- (0.05) -- -- -- -- -- --
Net asset value, end
of period $9.72 $ 9.72 $10.43 $10.70 $10.77 $10.29 $10.20 $9.79 $ 9.92
Total return 0.50%** (1.93)% 6.6% 6.3% 14.4% 9.1% 12.8% 6.4% 2.2%**
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net
assets:
Expenses 0.4%(3) 0.9%(2)(4) 0.9%(2)(4) 0.9%(2)(4) 0.8%(2)(4) 0.6%(2)(4) 0.8%(2)(4) 1.0%(2)(4) 1.0%(2)(4)
(double dagger) (double dagger)
Net investment
income 6.4%(3) 5.1%(2) 4.8%(2) 5.5%(2) 6.7%(2) 7.7%(2) 7.9%(2) 7.4%(2) 7.4%(2)
(double dagger)
Portfolio turnover
rate 315.7% 315.7% 490.2% 512.6% 642.8% 67.0% 57.3% 132.5% 66.3%
Net assets, end of
period (in
thousands) $4,024 $231,255 $299,529 $307,320 $211,627 $74,423 $43,051 $27,087 $16,617
</TABLE>
* Commencement of operations.
** Not annualized.
(double
dagger) Annualized.
(1) For the period December 1, 1994 (commencement of sale of Navigator
Shares) to December 31, 1994.
(2) Net of fees waived and reimbursements made by the manager for expenses
in excess of voluntary expense limitations as follows: 1.0% until
September 10, 1989; 0.5% until March 31, 1990; 0.6% until December 31,
1990; 0.75% until April 30, 1991; 0.8% until December 31, 1991; 0.85%
until August 31, 1992; and 0.95% until October 31, 1995.
(3) Net of fees waived and reimbursements made by the manager for expenses
in excess of voluntary limitation as follows: 0.45% until October 31,
1995.
(4) Includes distribution fee of 0.5%
4

<PAGE>
PERFORMANCE INFORMATION
From time to time the Fund may quote the total return of each class of
shares 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 reflect past performance and are not
intended to indicate future performance. Average annual returns tend to smooth
out variations in the fund's return, so they differ from actual year-by-year
results.
Total returns of Primary Shares as of December 31, 1994 were as follows:
<TABLE>
<CAPTION>
CUMULATIVE AVERAGE ANNUAL
TOTAL RETURN TOTAL RETURN
<S> <C> <C>
One Year -1.93 % -1.93%
Five Years +38.59 +6.75
Life of Fund (dagger) +70.08 +7.43
</TABLE>

(dagger) Fund's inception -- August 7, 1987.
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. Returns would have been lower if the Manager had not
waived/reimbursed certain fees and expenses during the fiscal years 1987 through
1994. As of the date of this Prospectus, Navigator Shares have no material
performance record.
The Fund also may 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>
THE FUND'S INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide investors with high
current income consistent with prudent investment risk and liquidity
needs. The investment objective 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 objective will be achieved.
At least 75% of the Fund's total assets are, under normal
circumstances, invested in U.S. government securities or instruments
secured by such securities, including repurchase agreements. The Fund
expects to maintain an average dollar-weighted maturity of between three
and ten years. U.S. government securities include: 1) U.S. Treasury
obligations, which differ only in their interest rates, maturities and
times of issuance: U.S. Treasury bills (maturity of one year or less),
U.S. Treasury notes (maturity of one to ten years) and U.S. Treasury bonds
(generally maturities of greater than ten years); and 2) obligations
issued or guaranteed by U.S. government agencies and instrumentalities
which are supported by any of the following: a) the full faith and credit
of the U.S. Government (such as certificates of the Government National
Mortgage Association, "GNMA", b) the right of the issuer to borrow an
amount limited to a specific line of credit from the U.S. Government (such
as obligations of the Federal Home Loan Banks), c) discretionary authority
of the U.S. Treasury to lend to the government agency or instrumentality
(such as the Federal National Mortgage Association), or d) only the credit
of the instrumentality (such as the Student Loan Marketing Association).
In the case of obligations not backed by the full faith and credit of the
Untied States, the Fund must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate
repayment and may not be able to assert a claim against the United States
itself in the event the agency or instrumentality does not meet its
commitments. The U.S. Government does not guarantee the market value of
the Fund's investments or the market value or yield of the Fund's shares,
which will fluctuate with changes in market interest rates. Investments in
mortgage-related securities issued by governmental or government-related
entities, as described on the next page, will be included in the 75%
limitation.
The balance of the Fund, up to 25% of its total assets, normally is
invested in cash, commercial paper and investment grade debt securities
rated within one of the four highest grades assigned by Standard & Poor's
Ratings Group ("S&P") (AAA, AA, A or BBB), Moody's Investors Service, Inc.
("Moody's") (Aaa, Aa, A or Baa), securities comparably rated by another
nationally recognized statistical rating organization, or unrated
securities judged by the Adviser to be of comparable quality. Debt
securities rated Baa are deemed by Moody's to have speculative
characteristics; changes in economic conditions or other circumstances are
more likely to lead to a weakened capacity for the issuers of such
securities to make principal and interest payments than is the case for
high-grade debt securities. A further description of Moody's and S&P's
ratings is included in the Appendix to the Statement of Additional
Information.
The market value of the interest-bearing debt securities held by the
Fund, and therefore the net asset value of Fund shares, is affected by
changes in market interest rates. There is normally an inverse
relationship between the market value of securities sensitive to
prevailing interest rates and actual changes in interest rates; i.e., a
decline in interest rates produces an increase in market value, while an
increase in rates produces a decrease in market value. Moreover, the
longer the remaining maturity of a security, the greater is the effect of
interest rate changes on the market value of such a security. In addition,
changes in the ability of an issuer to make payments of interest and
principal and in the market's perception of an issuer's creditworthiness
also affect the market value of the debt securities of that issuer.
Certain of the mortgage-backed and other securities in which the Fund
can invest pay interest at variable or floating rates. Variable rate
instruments reset at specified intervals, while floating rate instruments
reset whenever there is a change in a specified index rate. The more
closely these changes reflect current market rates, the more likely the
instrument will trade at a price close to its par value.
6

<PAGE>
Some instruments do not directly track the underlying index, but reset
based on formulas that can produce an effect similar to leverage; others
may provide for interest payments that vary inversely with market rates;
these instruments are regarded as "derivatives," and may vary
significantly in market price when interest rates change.
The Fund has adopted certain fundamental investment limitations that,
like its investment objective, may not be changed without the approval of
the Fund's shareholders. A full description of these investment
limitations is included in the Statement of Additional Information.
Corporate Debt Securities
Among the debt securities in which the Fund may invest are those
issued by corporations. In selecting corporate debt securities for the
Fund, the Adviser reviews and monitors the creditworthiness of each issuer
and issue. Interest rate trends and specific developments which the
Adviser believes may affect individual issuers are also analyzed.
Mortgage-Related Securities
The Fund normally may invest up to 50% of its total assets in
mortgage-related securities, including those issued by the governmental or
government-related entities referred to above. 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 governmental 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. No more than 25% of
the Fund's total assets normally are invested in mortgage-related
securities issued by non-governmental entities.
Interests in pools of mortgage-related securities differ from other
forms of debt securities which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified
call dates. In contrast, 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.
The Adviser expects that governmental or private entities may create
new types of mortgage-related securities in response to changes in the
market or changes in government regulation of such securities. As new
types of mortgage-related securities are developed and offered to
investors, the Adviser will, consistent with the investment objective and
policies of the Fund, consider making investments in such new types of
securities.
As prepayment rates of individual pools of mortgage loans vary widely,
it is not possible to predict accurately the average life of a particular
mortgage-related security. Although both government and privately-issued
mortgage-related securities are issued with stated maturities of up to
forty years, unscheduled or early payments of principal and interest on
the underlying mortgages may shorten considerably the securities'
effective maturities. On the other hand, a decrease in the rate of
prepayments may extend the effective maturities of mortgage-related
securities, increasing their sensitivity to changes in market interest
rates. Such a decrease in prepayments may result from an increase in
market interest rates, among other causes. The volume of prepayments of
principal on a pool of mortgages underlying a particular mortgage-related
security will influence the yield of that security, and the principal
returned to the Fund may be reinvested in instruments whose yield may be
higher or lower than that which might have been obtained had such
prepayments not occurred. When interest rates are declining, such
prepayments usually increase, with the result that reinvestment 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
7

<PAGE>
rates. An increase in mortgage prepayments could cause the Fund to incur a
loss on a mortgage-related security that was purchased at a premium. In
determining the Fund's average maturity, the Adviser must apply certain
assumptions and projections about the maturity and prepayments of
mortgage-related securities; actual prepayment rates may differ.
Government Mortgage-Related Securities
GNMA is the principal federal government guarantor of mortgage-related
securities. GNMA is a wholly owned U.S. government corporation within the
Department of Housing and Urban Development. GNMA pass-through securities
are considered to have a very low risk of default in that (i) the
underlying mortgage loan portfolio is comprised entirely of
government-backed loans and (ii) the timely payment of both principal and
interest on the securities is guaranteed by the full faith and credit of
the U.S. Government -- regardless of whether they have been collected.
GNMA pass-through securities are, however, subject to the same market risk
as comparable debt securities. Therefore, the effective maturity and
market value of the Fund's GNMA securities can be expected to fluctuate in
response to changes in interest rate levels.
Residential mortgage loans are also pooled by the Federal Home Loan
Mortgage Corporation ("FHLMC"). FHLMC is a corporate instrumentality of
the U.S. Government that was created by Congress in 1970 for the purposes
of increasing the availability of mortgage credit for residential housing.
FHLMC issues mortgage participation certificates ("PCs") which represent
interests in mortgages from FHLMC's national portfolio. The mortgage loans
in FHLMC's portfolio are not government backed; rather, the loans are
either uninsured with loan-to-value ratios of 80% or less, or privately
insured if the loan-to-value ratio exceeds 80%. FHLMC, not the U.S.
Government, guarantees the timely payment of interest and ultimate
collection of principal on FHLMC PCs.
The Federal National Mortgage Association ("FNMA") is a
government-sponsored corporation owned entirely by private stockholders.
It is subject to general regulation by the Secretary of Housing and Urban
Development. FNMA purchases residential mortgages from a list of approved
seller/servicers, which include savings and loan associations, savings
banks, commercial banks, credit unions and mortgage bankers. Pass-through
certificates ("FNMA certificates") issued by FNMA are guaranteed as to
timely payment of principal and interest by FNMA, not the U.S. Government.
Privately Issued Mortgage-Related Securities
Mortgage-related securities offered by private issuers include
pass-through securities comprised of pools of conventional residential
mortgage loans; mortgage-backed bonds which are considered to be
obligations of the institution issuing the bonds and are collateralized by
mortgage loans; and bonds and collateralized mortgage obligations ("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. Each
class of obligations is scheduled to receive periodic interest payments
according to the coupon rate on the obligations. However, all monthly
principal payments and any repayments from the collateral pool are paid
first to the "Class 1" bondholders. The principal payments are such that
the Class 1 obligations are scheduled to be completely repaid no later
than, for example, five years after the offering date. Thereafter, all
payments of principal are allocated to the next most senior class of bonds
until that class of bonds has been fully repaid. Although full payoff of
each class of bonds 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 non-governmental issuers
generally offer a higher rate of interest than government and government-
related securities because there are no direct or indirect government
guarantees of payments in the former 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
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<PAGE>
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.
Since the inception of the mortgage-related pass-through security in
1970, the market for these securities has expanded considerably. The size
of the primary issuance market and active participation in the secondary
market by securities dealers and many types of investors make government
and government-related pass-through pools highly liquid. Private
conventional pools of mortgages (pooled by commercial banks, savings and
loan institutions and others with no relationship to government and
government-related entities) have also achieved broad market acceptance,
and consequently an active secondary market has emerged. However, the
market for conventional pools is smaller and less liquid than the market
for the government and government-related mortgage pools.
The Fund may purchase some mortgage-related securities through private
placements. In such cases, the securities may be considered illiquid and,
if so, will be subject to the Fund's investment limitation that no more
than 10% of its net assets will be invested in illiquid securities.
Asset-Backed Securities
Asset-backed securities are securities that represented direct or
indirect participations in, or are secured by and payable from, assets
such as motor vehicle installment sales contracts, installment loan
contracts, leases of various types of real and personal property and
receivables from revolving credit (credit card) agreements. Such assets
are securitized through the use of trusts and special purpose
corporations. The value of such securities partly depends on loan
repayments by individuals, which may be adversely affected during general
downturns in the economy. 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 is the case for
mortgage-backed securities.
Zero Coupon Bonds
Zero coupon bonds are debt obligations which make no fixed interest
payments but instead are issued at a significant discount from face value.
Like other debt securities, the price can also reflect a premium or
discount to the original issue discount reflecting the market's judgment
as to the issuer's creditworthiness, the interest rate or other similar
factors. The discount approximates the total amount of interest the bonds
will accrue and compound over the period until maturity or the first
interest payment date at a rate of interest reflecting the market rate of
the security at the time of issuance. Because zero coupon bonds do not
require the periodic payment of interest, their prices can be very
volatile when market interest rates change.
The original issue discount on zero coupon bonds must be included in
the Fund's income ratably as it accrues. Accordingly, to continue to
qualify for tax treatment as a regulated investment company and to avoid a
certain excise tax, the Fund may be required to distribute as a dividend
an amount that is greater than the total amount of cash it actually
receives. See "Additional Tax Information" in the Statement of Additional
Information. These distributions must be made from the Fund's cash assets
or, if necessary, from the proceeds of sales of portfolio securities. Such
sales could occur at a time which would be disadvantageous to the Fund and
when the Fund would not otherwise choose to dispose of the assets.
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
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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 objective.
The Fund does not intend to exercise conversion rights for any convertible
security it owns and does not intend to hold any security which has been
subject to conversion.
Foreign Securities
The Fund may invest in U.S. dollar-denominated debt securities issued
by foreign companies and governments. The foreign government securities in
which the Fund invests generally consist of obligations supported by
national, state or provincial governments or similar political
subdivisions. The Fund also may invest in debt securities of foreign
"quasi-government agencies," which are issued by entities owned by a
national, state or equivalent government or are obligations of a political
unit that is not backed by the national government's full faith and credit
and general taxing powers.
Investment in foreign securities presents certain risks, including
those resulting from adverse political and economic developments, reduced
availability of public information concerning issuers and the fact that
foreign issuers generally are not subject to uniform accounting, auditing
and financial reporting standards or to other regulatory practices and
requirements comparable to those applicable to domestic issuers. Moreover,
securities of many foreign issuers may be less liquid and their prices
more volatile than those of comparable domestic issuers. Some foreign
securities are subject to foreign taxes and withholding. Because the
foreign securities in which the Fund invests are U.S. dollar-denominated,
there is no risk of currency fluctuation.
Repurchase Agreements
A repurchase agreement is an agreement under which the Fund acquires
U.S. government obligations 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 right 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 the Adviser believes
present minimal risk of default during the term of the agreement based on
guidelines established by the Corporation's Board of Directors. The Fund
will not enter into repurchase agreements of more than seven days'
duration if more than 10% of its total assets would be invested in such
agreements and other illiquid investments.
When-Issued Securities
The Fund may enter into commitments to purchase U.S. government
securities or other securities on a when-issued basis. The Fund may
purchase when-issued securities because such securities are often the more
efficiently priced and have the best liquidity in the bond market. As with
the purchase of all securities, when the Fund purchases securities on a
when-issued basis, it assumes the risks of ownership, including the risk
of price fluctuation, at the time of purchase, not at the time of receipt.
However, the Fund does not have to pay for the obligations until they are
delivered to the Fund, which is normally 7 to 15 days later, but could be
considerably longer in the case of some mortgage-backed securities. To
meet that payment obligation, the Fund will set aside cash or liquid high-
quality debt securities equal to the payment that will be due. Depending
on market conditions, the Fund's when-issued purchases could cause its net
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<PAGE>
asset value to be more volatile, because they will increase the amount by
which the Fund's total assets, including the value of the when-issued
securities held by the Fund, exceed its net assets. The Fund does not
expect that its commitment to purchase when-issued securities will at any
time exceed, in the aggregate, 20% of its total assets.
Futures and Option Transactions
In an effort to protect against the effect of adverse changes in
interest rates, the Fund may purchase and sell interest rate futures
contracts and may purchase put options on interest rate futures contracts
and debt securities (practices known at "hedging"). A futures contract is
an agreement by the Fund to buy or sell securities at a specified date and
price. The purchase of a put option on a futures contract allows the Fund,
at its option, to enter into a particular futures contract or sell
securities at any time up to the option's expiration date.
The Fund may purchase put options on interest rate futures contracts
or sell interest rate futures contracts (that is, enter into a futures
contract to sell the underlying security) to attempt to reduce the risk of
fluctuations in its share value. The Fund may purchase an interest rate
futures contract (that is, enter into a futures contract to purchase the
underlying security) to attempt to establish more definitely the return on
securities the Fund intends to purchase. The Fund may not use these
instruments for speculation or leverage.
The Fund may seek to enhance its income or hedge the portfolio by
writing (selling) covered call options (i.e., the Fund will own the
underlying instrument while the call is outstanding) and covered put
options (i.e., the Fund will have cash, U.S. government securities or
other high-grade, liquid debt instruments in a segregated account in an
amount not less than the exercise price while the put is outstanding).
The Fund may write call options on securities in its portfolio in an
attempt to realize, through the premium the Fund receives, a greater
current return than would be realized on the securities alone. The Fund
may write put options in an attempt to realize enhanced income when it is
willing to purchase the underlying instrument for its portfolio at the
exercise price. The Fund may also purchase call options for the purpose of
acquiring the underlying instruments for its portfolio. At times, the net
cost of acquiring instruments in this manner (the exercise price of the
call option plus the premium paid) may be less than the cost of acquiring
the instruments directly.
The success of the Fund's hedging activities in reducing risks depends
on many factors, the most significant of which is the Adviser's ability to
predict market interest rate changes correctly. Generally speaking,
selling futures contracts, purchasing put options and writing call options
are strategies designed to protect against falling security prices, and
can limit potential gains if prices rise. Purchasing futures contracts,
purchasing call options and writing put options are strategies whose
return tend to rise and fall together with security prices, and can cause
losses if prices fall. If security prices remain unchanged over time,
option writing strategies tend to be profitable, while option buying
strategies tend to decline in value. However, there may not be perfect
correlation between movements in the price of an option or futures
contract and movements in the price of the underlying security.
The Fund could also be exposed to risks if it could not close out its
futures or options positions because of an illiquid secondary market. The
Adviser attempts to minimize the possible negative effects of these
factors through careful selection and monitoring of the Fund's futures and
options positions. The Adviser is of the opinion that the Fund's
investments in futures transactions will not have a material adverse
effect on the Fund's liquidity or ability to honor redemptions.
The purchase and sale of options and futures contracts involve risks
different from those involved with direct investments in securities, and
also require different skills by the Adviser in managing the Fund's
portfolio. While utilization of options, futures contracts and similar
instruments may be advantageous to the Fund, if the Adviser is not
successful in employing such instruments in managing the Fund's
investments or in predicting interest rate changes, the Fund's performance
will be worse than if the Fund had not made such investments. In addition,
the Fund will pay commissions and other costs in connection with such
investments, which may increase the Fund's expenses and reduce its yield.
A more complete
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discussion of the possible risks involved in transactions in options and
futures contracts is contained in the Statement of Additional Information.
The Fund's current policy is to limit options and futures transactions to
those described above.
The Fund will not enter into any futures contracts or related options
if the sum of the initial margin deposits on futures contracts and related
options and premiums paid for related options the Fund has purchased would
exceed 5% of the Fund's total assets. The Fund will not purchase futures
contracts or related options if, as a result, more than 33 1/3% of the
Fund's total assets would be so invested.
Portfolio Turnover
For the year ended December 31, 1994, the Fund's portfolio turnover
rate was 315.7% and the Fund anticipates that in the future its portfolio
turnover rate may exceed 300%. The portfolio turnover rate is computed by
dividing the lesser of purchases or sales of securities for the period by
the average value of portfolio securities for that period. Short-term
securities are excluded from the calculation. A portfolio turnover rate in
excess of 100% will involve 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 will affect
the tax treatment of distributions paid to shareholders because
distributions of net short-term capital gains are taxable as ordinary
income.
HOW YOU CAN INVEST IN THE FUND
You may purchase Primary 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 Primary Shares 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 Internal Revenue Code of 1986, as amended ("Code").
For purchases of shares through payroll deduction plans, the Fund's Future
First Systematic Investment Plan 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. You should always furnish your shareholder
account number when making additional purchases of Fund shares.
There are three ways you can invest in Primary Shares of the Fund:
1. THROUGH YOUR LEGG MASON OR AFFILIATED INVESTMENT EXECUTIVE
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 from
your investment executive in person, by telephone or by mail.
2. THROUGH THE FUTURE FIRST SYSTEMATIC INVESTMENT PLAN
You may also buy shares 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
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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. In addition, it may be
possible for dividends from certain unit investment trusts to be invested
automatically in shares. Persons interested in establishing such automatic
investment programs should contact the Fund through any Legg Mason or
affiliated investment executive.
Primary 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 Primary 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 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 14. 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.
HOW YOUR SHAREHOLDER ACCOUNT IS MAINTAINED
When you initially purchase shares, a shareholder account is
automatically established for you. Any shares that you purchase or receive
as a 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. 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 PRIMARY SHARES
There are two ways you can redeem your Primary 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 U.S. Government Intermediate-Term 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 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
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<PAGE>
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 may
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 Primary 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 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 share is determined daily, as of the close of the
Exchange, on every day that the Exchange is open, by subtracting the
liabilities attributable to Primary Shares from the total assets
attributable to such shares and dividing the result by the number of
Primary 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.
DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund declares dividends to holders of Primary Shares out of its
investment company taxable income attributable to those shares, which
consists of net investment income and net short-term capital gain.
Dividends from net investment income are declared daily 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
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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) 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 capital gain
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 Primary Shares on the payment
dates. Other shareholders may elect to:
1. Receive both dividends and capital gain distributions in Primary
Shares;
2. Receive dividends in cash and capital gain distributions in Primary
Shares;
3. Receive dividends in Primary Shares and capital gain distributions
in cash; or
4. Receive both dividends and capital gain distributions in cash.
In certain cases, you may reinvest your dividends and capital gain
distributions in Primary 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 capital gain distributions
will be credited to your account in Primary 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 capital
gain 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
U.S. Government Intermediate-Term 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 capital gain distributions paid to
shareholders as of that date.
TAX TREATMENT OF DIVIDENDS AND OTHER DISTRIBUTIONS
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 Primary 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 Primary 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 capital gain 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.
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 another Legg Mason fund
generally will have similiar tax consequences. If Fund shares are
purchased within 30 days before or after redeeming other Fund shares
(regardless of class) 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 capital gain 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
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capital gain distribution could cause the investor to incur tax
liabilities and should not be made solely for the purpose of receiving the
dividend or capital gain distribution.
The foregoing is only a summary of some of the important federal 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 and local income
taxes on distributions from the Fund, depending on the laws of your home
state and locality, though the 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 U.S.
Government Intermediate-Term 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 Primary
Shares of the Fund for Primary 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.
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.
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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 High Yield Portfolio
A mutual fund primarily seeking a high level of current income and
secondarily, capital appreciation, by investing principally in
lower-rated, fixed-income 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 the section "How You Can Redeem Your Primary
Shares," page 13. 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 of the funds is insured or guaranteed by the
U.S. Government.
INVESTING THROUGH TAX-DEFERRED RETIREMENT PLANS
An investment in shares of the Fund may be appropriate for IRAs, Keogh
Plans, SEPs and other qualified retirement plans. Investors who are
considering establishing such a plan may wish to consult their attorneys
or other tax advisers with respect to individual tax questions. Your Legg
Mason or affiliated investment executive can make available to you forms
of plans. The option of investing in these plans through regular payroll
deductions may be arranged with Legg Mason and your employer. Additional
information with respect to these plans is available upon request from any
Legg Mason or affiliated investment executive.
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
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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 0.55% of the Fund's average daily net assets. The Fund's
Manager has agreed that until October 31, 1995 or when the Fund reaches
net assets (Primary Shares) of $400 million, whichever occurs first, it
will continue to reimburse fees and/or assume other expenses to the extent
the Fund's expenses (exclusive of taxes, interest, brokerage and
extraordinary expenses) exceed during any month an annual rate of 0.95% of
the Fund's average daily net assets (Primary Shares) for such month. After
reimbursement by the Manager of certain expenses, the Fund's total
operating expenses for the year ended December 31, 1994 were 0.90% of
average daily net assets. Reimbursement by the Manager reduces Fund
expenses and increases its yield and total return.
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 $3.8 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 objective, 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 40% of the fee received by the Manager, or 0.22% 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 $2.3 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
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servicing functions. For the year ended December 31, 1994, Legg Mason
received $57,597 for performing such services in connection with this
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 investors in Primary
Shares and its activities and expenses related to the sale and
distribution of Primary Shares, the Fund pays Legg Mason, from the assets
attributable to Primary Shares, an annual distribution fee and an annual
service fee, each of which is equal to 0.25% of the average daily net
assets attributable to Primary Shares. The distribution fee and the
service fee are computed daily and paid monthly. The fees received by Legg
Mason during any year may be more or less than its costs of providing
distribution and shareholder services for Primary Shares.
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.
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. The Fund currently offers two Classes of Shares --
Class A (known as "Primary Shares") and Navigator Shares. Each Class
represents interests in the same pool of assets of the Fund. A separate
vote is taken by a Class of Shares of the Fund if a matter affects just
that Class of Shares. Each Class of Shares may bear differing
Class-specific expenses. Salespersons and others entitled to receive
compensation for selling or servicing Fund shares may receive more with
respect to one Class than another.
The initial and subsequent investment minimums for Navigator Shares
are $50,000 and $100, respectively. Investments in Navigator Shares may be
made through investment executives of Fairfield Group, Inc., Horsham,
Pennsylvania, or Legg Mason.
The Fund pays no Rule 12b-1 fee with respect to Navigator Shares. The
per share net asset value of Navigator Shares, and dividends and
distributions (if any) paid to Navigator shareholders, are generally
expected to be higher than those of Primary Shares of the Fund, because of
the lower expenses attributable to Navigator Shares. Navigator Shares of
the Fund may be exchanged for the corresponding class of shares of certain
other Legg Mason Funds. Investments by exchange into the other Legg Mason
Funds are made at the per share net asset value, determined on the same
business day as redemption of the Navigator Shares the investors wish to
redeem.
The Board of Directors of the Fund does not anticipate that there will
be any conflicts among the interests of the holders of the different
Classes of Fund Shares. On an ongoing basis, the Board will consider
whether any such conflict exists and, if so, take appropriate action.
Shareholders of the Fund are entitled to one vote per share and
fractional votes for fractional shares held. Voting rights are not
cumulative. All shares of the Fund are fully paid and nonassessable and
have no preemptive or conversion rights.
Shareholder 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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