SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-1A
REGISTRATION STATEMENT (NO. 2-54886) UNDER THE
SECURITIES ACT OF 1933
Pre-Effective Amendment No.
Post-Effective Amendment No. 34
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 38
VANGUARD PREFERRED STOCK FUND
(Exact Name of Registrant as Specified in Charter)
P.O. Box 2600, Valley Forge, PA 19482
(Address of Principal Executive Office)
Registrant's Telephone Number (610) 669-1000
Raymond J. Klapinsky, Esquire
P.O. Box 876
Valley Forge, PA 19482
It is proposed that this filing become effective on February 21,
1997, pursuant to paragraph (b) of Rule 485.
Approximate Date of Proposed Public Offering: As soon as practicable after
this Registration Statement becomes effective.
Registrant elects to register an indefinite number of shares pursuant to
Rule 24f-2 under the Investment Company Act of 1940. Registrant filed
its Rule 24f-2 Notice for the fiscal year ended October 31, 1996 on
December 30, 1996.
<PAGE>
VANGUARD PREFERRED STOCK FUND
CROSS REFERENCE SHEET
Form N-1A Item Number Location in Prospectus
Item 1. Cover Page -- Cover Page
Item 2. Synopsis -- Not Applicable
Item 3. Condensed Financial Information -- Financial Highlights; Fund
Expenses; Yield and Total Return Disclosure
Item 4. General Description of Registrant -- Investment Objective;
Investment Policies; Investment Risks; Implementation of
Policies; Investment Limitations; General Information
Item 5. Management of the Fund -- Management of the Fund; Investment
Adviser; Trustees and Officers
Item 6. Capital Stock and Other Securities -- Opening an Account and
Purchasing Shares; The Fund's Share Price; Dividends, Capital
Gains and Distributions
Item 7. Purchase of Securities Being Offered -- Opening an Account and
Purchasing Shares
Item 8. Redemption or Repurchase -- Selling Your Shares
Item 9. Pending Legal Proceedings -- Not Applicable
Form N-1A Item Number Location in Statement of Additional Information
Item 10. Cover Page -- Cover Page
Item 11. Table of Contents -- Cover Page
Item 12. General Information and History -- Investment Objective and
Policies; General Information
Item 13. Investment Objective and Policies -- Investment Objective and
Policies; Investment Limitations
Item 14. Management of the Fund -- Management of the Fund; Investment
Management
Item 15. Control Persons and Principal Holders of Securities --
Management of the Fund; General Information
Item 16. Investment Advisory and Other Services -- Management of the
Fund; Investment Management
Item 17. Brokerage Allocation -- Not Applicable
Item 18. Capital Stock and Other Securities -- General Information;
Financial Statements
Item 19. Purchase, Redemption and Pricing of Securities Being Offered --
Purchase of Shares; Redemption of Shares
Item 20. Tax Status -- Appendix
Item 21. Underwriters -- Not Applicable
Item 22. Calculations of Yield Quotations of Money Market Fund -- Not
Applicable
Item 23. Financial Statements -- Financial Statements
<PAGE>
Vanguard
PREFERRED
STOCK FUND
P R O S P E C T U S
FEBRUARY 21, 1997
The Vanguard Group
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
Investor Information Department:
1-800-662-7447 (SHIP)
Client Services Department:
1-800-662-2739 (CREW)
Tele-Account for 24-Hour Access:
1-800-662-6273 (ON-BOARD)
Telecommunications Service for the Hearing-Impaired:
1-800-662-2738
Transfer Agent:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
<PAGE>
Vanguard
PREFERRED
STOCK FUND
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A Member of The Vanguard Group
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PROSPECTUS--February 21, 1997
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NEW ACCOUNT INFORMATION: Investor Information Department--
1-800-662-7447 (SHIP)
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SHAREHOLDER ACCOUNT SERVICES: Client Services Department--
1-800-662-2739 (CREW)
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INVESTMENT OBJECTIVE AND POLICIES
Vanguard Preferred Stock Fund (the "Fund") is an open-end
diversified investment company that seeks to provide the maximum
dividend income which qualifies for the 70% corporate dividends
received deduction under federal tax law. The Fund invests
primarily in the preferred stocks of domestic corporations. There
is no assurance that the Fund will achieve its stated objective.
Shares of the Fund are neither insured nor guaranteed by any
agency of the U.S. Government, including the FDIC.
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OPENING AN ACCOUNT
To open a regular (non-retirement) account, please complete and
return the Account Registration Form. If you need assistance in
completing this Form, please call the Investor Information
Department. To open an Individual Retirement Account (IRA), please
use a Vanguard IRA Adoption Agreement. To obtain a copy of this
form, call 1-800-662-7447, Monday through Friday, from 8:00 a.m.
to 9:00 p.m. and Saturday, from 9:00 a.m. to 4:00 p.m. (Eastern
time). The minimum initial investment is $3,000 or $1,000 for
Uniform Gifts/Transfers to Minors Act accounts. The Fund is
offered on a no-load basis (i.e., there are no sales commissions
or 12b-1 fees). However, the Fund incurs expenses for investment
advisory, management, administrative and distribution services.
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ABOUT THIS PROSPECTUS
This Prospectus is designed to set forth concisely the information
you should know about the Fund before you invest. It should be
retained for future reference. A "Statement of Additional
Information" containing additional information about the Fund has
been filed with the Securities and Exchange Commission. This
Statement is dated February 21, 1997, and has been
incorporated by reference into this Prospectus. A copy may be
obtained, without charge, by writing to the Fund or by calling the
Investor Information Department.
TABLE OF CONTENTS
Page
Fund Expenses................................. 2
Financial Highlights.......................... 2
Yield and Total Return........................ 3
FUND INFORMATION
Investment Objective.......................... 4
Investment Policies........................... 4
Investment Risks.............................. 4
Who Should Invest............................. 5
Implementation of Policies.................... 6
Investment Limitations........................ 7
Management of the Fund........................ 8
Investment Adviser............................ 9
Performance Record............................ 10
Dividends, Capital Gains and Taxes............ 10
The Share Price of the Fund................... 12
General Information........................... 13
SHAREHOLDER GUIDE
Opening an Account and Purchasing Shares...... 14
When Your Account Will Be Credited............ 17
Selling Your Shares........................... 17
Exchanging Your Shares........................ 20
Important Information About
Telephone Transactions....................... 21
Transferring Registration..................... 22
Statements and Reports........................ 22
Other Vanguard Services....................... 22
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 COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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1
<PAGE>
FUND EXPENSES
The following table illustrates all expenses and fees that you
would incur as a shareholder of the Fund. The expenses and fees
set forth in the table are for the 1996 fiscal year.
Shareholder Transaction Expenses
------------------------------------------------------------------
Sales Load Imposed on Purchases............................ None
Sales Load Imposed on Reinvested Dividends................ None
Redemption Fees........................................... None
Exchange Fees............................................. None
Annual Fund Operating Expenses
------------------------------------------------------------------
Management & Administrative Expenses..................... 0.20%
Investment Advisory Fees................................. 0.13
12b-1 Fees............................................... None
Other Expenses
Distribution Costs.............................. 0.02%
Miscellaneous Expenses.......................... 0.04
Total Other Expenses...................................... 0.06
Total Fund Operating Expenses...................... 0.39%
The purpose of this table is to assist you in understanding the
various costs and expenses that you would bear directly or
indirectly as an investor in the Fund.
The following example illustrates the expenses that you would
incur on a $1,000 investment over various periods, assuming (1) a
5% annual rate of return and (2) redemption at the end of each
period. As noted in the table above, the Fund charges no
redemption fees of any kind.
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$4 $13 $22 $49
This example should not be considered a representation of past or
future expenses or performance. Actual expenses may be higher or
lower than those shown.
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FINANCIAL HIGHLIGHTS
The following financial highlights for a share outstanding
throughout each period, insofar as they relate to each of the five
years in the period ended October 31, 1996, have been
audited by Price Waterhouse LLP, independent accountants, whose
report thereon was unqualified. This information should be read in
conjunction with the Fund's financial statements and notes thereto
which, together with the remaining portions of the Fund's
1996 Annual Report to Shareholders, are incorporated by
reference in the Statement of Additional Information and in this
Prospectus, and which appear, along with the report of Price
Waterhouse LLP, in the Fund's 1996 Annual Report to
Shareholders. For a more complete discussion of the Fund's
performance, please see the Fund's 1996 Annual Report to
Shareholders, which may be obtained without charge by writing to
the Fund or by calling our Investor Information Department at 1-
800-662-7447.
2
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year Ended October 31,
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1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
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<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning
of Year ...................... $9.61 $8.35 $ 9.99 $9.32 $9.06 $8.22 $8.62 $7.94 $8.02 $9.76
----- ----- ------ ----- ----- ----- ----- ----- ----- -----
Investment Operations
Net Investment Income ........ .69 .660 .660 .690 .749 .765 .695 .691 .765 .765
Net Realized and Unrealized
Gain (Loss) on Investments . .04 1.250 (1.460) .685 .236 .855 (.350) .514 .170 (1.730)
----- ----- ------ ----- ----- ----- ----- ----- ----- -----
Total from Investment
Operations ............... .73 1.910 (.800) 1.375 .985 1.620 .345 1.205 .935 (.965)
- ------------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment
Income ..................... (.67) (.650) (.700) (.705) (.725) (.780) (.745) (.525) (.895) (.775)
Distributions from Realized
Capital Gains .............. -- -- (.140) -- -- -- -- -- (.120) --
----- ----- ------ ----- ----- ----- ----- ----- ----- -----
Total Distributions ........ (.67) (.650) (.840) (.705) (.725) (.78 0) (.745) (.525) (1.015) (.775)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Year ... $9.67 $9.61 $8.35 $9.99 $9.32 $9.06 $8.22 $8.62 $7.94 $8.02
====================================================================================================================================
Total Return ................... 8.04% 23.79% (8.45)% 15.56% 11.34% 20.83% 4.28% 15.82% 12.37% (10.64)%
====================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Ratio of Expenses to Average
Net Assets ................... 0.39% 0.52% 0.51% 0.53% 0.58% 0.63% 0.65% 0.67% 0.66% 0.64%
Ratio of Net Investment Income
to Average Net Assets ........ 7.23% 7.43% 7.27% 6.77% 7.43% 7.96% 8.69% 9.11% 9.40% 8.60%
Portfolio Turnover Rate ........ 31% 20% 27% 45% 33% 18% 15% 42% 52% 67%
Average Commission Rate Paid ... $.0600 N/A N/A N/A N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
YIELD AND TOTAL RETURN
From time to time the Fund advertises its yield and total return.
Both yield and total return figures are based on historical
earnings and are not intended to indicate future performance. The
"total return" of the Fund refers to the average annual compounded
rates of return over one-, five- and ten-year periods or over the
life of the Fund (as stated in the advertisement) that would
equate an initial amount invested at the beginning of a stated
period to the ending redeemable value of the investment, assuming
the reinvestment of all dividend and distributions.
In accordance with industry guidelines set forth by the U.S.
Securities and Exchange Commission, the "30-day yield" of the Fund
is calculated by dividing the net investment income per share
earned during a 30-day period by the net asset value per share on
the last day of the period. Net investment income includes
interest and dividend income earned on the Fund's securities; it
is net of all expenses and all recurring and nonrecurring charges
that have been applied to all shareholder accounts. The yield
calculation assumes that the net investment income earned over 30
days is compounded monthly for six months and then annualized.
Methods used to calculate advertised yields are standardized for
all stock and bond mutual funds. However, these methods differ
from the accounting methods used by the Fund to maintain its books
and records, and so the advertised 30-day yield may not fully
reflect the income paid to an investor's account or the yield
reported in the Fund's reports to shareholders. Additionally the
Fund may compare its performance to that of the Merrill Lynch
Perpetual Preferred Index.
3
<PAGE>
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INVESTMENT OBJECTIVE
The Fund seeks to provide qualified dividend income
The Fund is an open-end diversified investment company. The
objective of the Fund is to provide the maximum dividend income
which qualifies for the corporate dividends received
deduction (currently 70%) under federal tax law by
investing primarily in the preferred stocks of domestic
corporations. There is no assurance that the Fund will achieve its
stated objective.
The investment objective of the Fund is not fundamental and so may
be changed by the Board of Trustees without shareholder approval.
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INVESTMENT POLICIES
The Fund invests in preferred stocks
Under normal circumstances, the Fund will invest more than 75% of
its total assets in cumulative preferred stocks of domestic
corporations which have been rated Baa or better by Moody's
Investor Service, Inc. or BBB or better by Standard &
Poor's Corporation. The remainder of the Fund's assets may be
invested in (i) similarly rated fixed-income securities, including
convertible preferred stocks and bonds, and money market
instruments, and (ii) preferred stocks with lower ratings. The
Fund will not sell any of the securities that it holds solely on
account of such securities having been downgraded. Except for the
qualified dividend income exclusion previously described, the Fund
is managed without regard to tax ramifications.
No investments will be made in common stocks. In the case of
convertible securities, the conversion privilege may be exercised,
but the common stocks received will be sold. The Fund will not
ordinarily invest in non-cumulative or non-rated preferred stocks,
but reserves the right to do so should market conditions dictate
that it be in the best interests of the Fund and its shareholders.
The Fund will not purchase warrants or rights directly and will
not in any event hold rights or warrants to an extent greater than
5% of its total assets. See "Implementation of Policies" for other
investment practices of the Fund.
The Fund is responsible for voting the shares of all securities it
holds.
These policies are not fundamental and so may be changed by the
Board of Trustees without shareholder approval.
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INVESTMENT RISKS
The Fund is subject to interest rate, credit and manager risks
As a mutual fund investing primarily in perpetual preferred
stocks, the Fund is subject to interest rate risk--i.e., the
possibility that the market value of preferred stocks will vary
inversely with interest rates. When interest rates rise, the value
of preferred stocks will fall; when interest rates fall, the value
of preferred stocks will rise.
Perpetual preferred stocks are similar in many ways to corporate
fixed-income securities; they provide investors with a fixed
stream of income that is generated from corporate earnings.
However, perpetual preferred stocks, unlike corporate bonds, do
not have a stated maturity date. Because they lack a fixed
maturity date, the prices of preferred stocks are extremely
sensitive to changes in interest rates. Investors should
anticipate that the fluctuations in market value of preferred
stocks will generally exceed those of long-term government or
corporate bonds (those with maturities of 15 to 30 years).
4
<PAGE>
As an illustration of interest rate risk, the table below depicts
the effect of a one and two percentage point change in interest
rates on long-term bonds:
Percent Change in the Price of a Par Bond Yielding 5.5%
1 Percentage Point 1 Percentage Point
Increase in Decrease in
Interest Rates Interest Rates
-------------------- -------------------
-11.1% +13.1%
2 Percentage Point 2 Percentage Point
Increase in Decrease in
Interest Rates Interest Rates
------------------- -------------------
-20.5% +28.6%
This table is intended to provide you with guidelines for
determining the degree of interest rate risk you may be willing to
assume. The price changes shown should not be taken as
representative of the Fund's current or future change in share
price.
In addition to interest rate risk, the Fund is also subject to a
limited degree to credit risk--i.e., the likelihood that the
issuing corporation will be unable to make the dividend payments
due on its preferred stock. Credit risk in the Fund will be
minimized by investing chiefly in investment grade preferred
stocks, and by diversi- fying preferred stock investments among
many companies and industries.
The investment adviser manages the Fund according to the
traditional methods of "active" investment management, which
involve the buying and selling of securities based upon economic,
financial and market analysis and investment judgment.
Manager risk refers to the possibility that the Fund's investment
adviser may fail to execute the Fund's investment strategy
effectively. As a result, an investor in the Fund may lose money.
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WHO SHOULD INVEST
Investors seeking income which qualifies for the dividends
received deduction
The Fund is intended for investors who are seeking income from
their investments and who can tolerate substantial price risks in
pursuit of their income objectives. The Fund is suited to
investors who are willing to hold their investments over a long
time horizon in anticipation of the income that preferred stocks
may provide. Because the Fund invests in preferred stocks,
investors should be able to tolerate sharp, sometimes substantial
fluctuations in the value of their investment due to changes in
interest rates.
By minimizing nonqualifying investment income (i.e., realized
interest income and net realized short-term capital gains), the
Fund is especially suitable for corporations seeking to benefit
from the corporate dividends received deduction, which
is currently 70%. Because of the tax considerations involved,
the Fund may not be as suitable an investment for individuals,
who, unlike corporations, are not permitted to exclude qualified
dividends received from their taxable income.
Because of the risks associated with stock investments,
the Fund is intended to be a long-term investment vehicle
and is not designed to provide investors with a
5
<PAGE>
means of speculating on short-term stock market movements.
Investors who en-gage in excessive account activity generate
additional costs which are borne by all of the Fund's
shareholders. In order to minimize such costs, the Fund has
adopted the following policies. The Fund reserves the right to
reject any purchase request (including exchange purchases from
other Vanguard portfolios) that is reasonably deemed to be
disruptive to efficient portfolio management, either because of
the timing of the investment or previous excessive trading by the
investor. Additionally, the Fund has adopted exchange privilege
limitations as described in the section "Exchange Privilege
Limitations." Finally, the Fund reserves the right to suspend the
offering of its shares.
Given its objectives and risks, the Fund is not intended as a
complete investment program. Most investors should maintain
diversified holdings of securities with different risk
characteristics--including common stocks, bonds and money market
instruments.
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IMPLEMENTATION OF POLICIES
The Fund may invest in short-term fixed income securities
In addition to investing in preferred stocks, the Fund follows a
number of additional investment policies.
Although it normally seeks to remain substantially invested in
preferred stocks, the Fund may invest temporarily in certain
short-term fixed income securities. Such securities may be used to
invest uncommitted cash balances or to maintain liquidity to meet
shareholder redemptions. Under normal circumstances, the Fund
will invest no more than 35% of its assets in short-term fixed
income securities. However, the Fund reserves the right to invest
100% of its assets in such securities for temporary defensive
purposes. These short-term fixed income securities include:
obligations of the United States Government and its
agencies or instrumentalities; commercial paper, bank certificates
of deposit, and bankers' acceptances; and repurchase agreements
collateralized by these securities.
The Fund may lend its securities
The Fund may lend its investment securities on a short-term or a
long-term basis to qualified institutional investors for the
purpose of realizing additional income. Loans of securities by the
Fund will be collateralized by cash, letters of credit, or
securities issued or guaranteed by the U.S. Government or its
agencies. The collateral will equal at least 100% of the current
market value of the loaned securities.
The Fund may borrow money
The Fund may borrow money, subject to the limits set forth on page
8, for temporary or emergency purposes, including the meeting of
redemption requests which might otherwise require the untimely
disposition of securities.
Portfolio turnover is not expected to exceed 100%
Although it generally seeks to invest for the long term, the Fund
retains the right to sell securities irrespective of how long they
have been held. It is anticipated that the Fund's annual turnover
rate will not exceed 100%. A turnover rate of 100% would occur,
for example, if all of the securities of the Fund were replaced
within one year.
Derivative Investing
Derivatives are instruments whose values are linked to or derived
from an underlying security or index. The most common and
conventional types of derivative securities are futures and
options.
6
<PAGE>
The Fund may invest in derivative securities
The Fund may invest in futures contracts and options, but only to
a limited extent. Specifically, the Fund may enter into futures
contracts provided that not more than 5% of its assets are
required as a futures contract deposit; in addition, the Fund may
enter into futures contracts and options transactions only to the
extent that obligations under such contracts or transactions
represent not more than 20% of the Fund's assets.
Futures contracts and options may be used for several common fund
management strategies: to maintain cash reserves while simulating
full investment, to facilitate trading, to reduce transaction
costs, or to seek higher investment returns when a specific
futures contract is priced more attractively than other futures
contracts or the underlying security or index.
The Fund may use futures contracts for bona fide "hedging"
purposes. In executing a hedge, a manager sells, for example,
stock index futures to protect against a decline in the stock
market. As such, if the market drops, the value of the futures
position will rise, thereby offsetting the decline in value of the
Fund's stock holdings.
The Fund may invest in CMOs
The Fund may also invest modestly in a fairly conservative class
of collateralized mortgage obligations (CMOs) which feature a high
degree of cash flow predictability and moderate vulnerability to
mortgage prepayment risk. To reduce credit risk, Vanguard
purchases these less risky classes of collateralized mortgage
obligations issued only by agencies of the U.S. Government or
privately-issued collateralized mortgage obligations that carry
high-quality investment-grade ratings.
Futures contracts and options pose certain risks
The primary risks associated with the use of futures contracts and
options are: (i) imperfect correlation between the change in
market value of the stocks or bonds held by the Fund and the
prices of futures contracts and options; and (ii) possible lack of
a liquid secondary market for a futures contract and the resulting
inability to close a futures position prior to its maturity date.
The risk of imperfect correlation will be minimized by investing
in those contracts whose price fluctuations are expected to
resemble those of the Fund's underlying securities. The risk that
the Fund will be unable to close out a futures position will be
minimized by entering into such transactions on a national
exchange with an active and liquid secondary market.
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INVESTMENT LIMITATIONS
The Fund has adopted certain fundamental limitations
The Fund has adopted certain limitations on its investment
practices. Specifically, the Fund will not:
(a) With respect to 75% of the value of its total assets, purchase
the securities of any issuer (except obligations of the United
States Government and its instrumentalities) if, as a result,
the Fund would hold more than 10% of the outstanding voting
securities of the issuer, or more than 5% of the value of the
Fund's total assets would be invested in the securities of
such issuer;
(b) Invest more than 25% of its assets in any one industry, with
the exception of the electric and/or gas industries; and
7
<PAGE>
(c) Borrow money, except from banks (or through reverse repurchase
agreements) for temporary or emergency (not leveraging)
purposes, and then not in an amount exceeding 15% of the value
of the Fund's net assets (including the amount borrowed and
the value of any outstanding reverse repurchase agreements) at
the time the borrowing is made. Whenever borrowings exceed 5%
of the value of the Fund's net assets, the Fund will not make
any additional investments.
These investment limitations are considered at the time investment
securities are purchased. The limitations described here and in
the Statement of Additional Information may be changed only with
the approval of a majority of the Fund's shareholders.
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MANAGEMENT OF THE FUND
Vanguard administers and distributes the Fund
The Fund is a member of The Vanguard Group of Investment
Companies, a family of more than 30 investment companies with more
than 90 distinct investment portfolios and total assets in excess
of $240 billion. Through their jointly-owned subsidiary,
The Vanguard Group, Inc. ("Vanguard"), the Fund and the other
funds in the Group obtain at cost virtually all of their corporate
management, administrative, shareholder accounting and
distribution services. Vanguard also provides investment advisory
services on an at-cost basis to certain Vanguard funds. As a
result of Vanguard's unique corporate structure, the Vanguard
funds have costs substantially lower than those of most competing
mutual funds. In 1996, the average expense ratio (annual
costs including advisory fees divided by total net assets) for the
Vanguard funds amounted to approximately 0.29% compared to an
average of 1.22% for the mutual fund industry (data provided
by Lipper Analytical Services).
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Trustees. The Trustees set
broad policies for the Fund and choose its Officers. A list of the
Trustees and Officers of the Fund and a statement of their present
positions and principal occupations during the past five years can
be found in the Statement of Additional Information.
Vanguard employs a supporting staff of management and
administrative personnel needed to provide the requisite services
to the funds and also furnishes the funds with necessary office
space, furnishings and equipment. Each fund pays its share of
Vanguard's total expenses, which are allocated among the funds
under methods approved by the Board of Trustees (Directors) of
each fund. In addition, each fund bears its own direct expenses,
such as legal, auditing and custodian fees.
Vanguard also provides distribution and marketing services to the
Vanguard funds. The funds are available on a no-load basis (i.e.,
there are no sales commissions or 12b-1 fees). However, each fund
bears its share of the Group's distribution costs.
8
<PAGE>
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INVESTMENT ADVISER
Wellington Management Company, LLP manages the Fund's investments
The Fund has entered into an investment advisory agreement with
Wellington Management Company, LLP ("WMC"), 75 State
Street, Boston, MA 02109, under which WMC manages the investment
and reinvestment of the Fund's assets and continuously reviews,
supervises and administers the Fund's investment program. WMC
discharges its responsibilities subject to the control of the
Fund's Officers and Trustees.
WMC is a professional investment advisory firm which globally
provides services to investment companies, other institutions and
individuals. Among the clients of WMC are more than 10 investment
companies of The Vanguard Group. As of October 31, 1996,
WMC held investment management authority with respect to more than
$130 billion of assets. WMC and its predecessor
organizations have provided investment advisory services to
investment companies since 1933 and to investment counseling
clients since 1960.
Earl E. McEvoy, Senior Vice President of WMC, serves as portfolio
manager of the Fund, a position he has held since October 1982.
Mr. McEvoy also manages the Long-Term Corporate and High Yield
Corporate Portfolios of Vanguard Fixed Income Securities Fund, as
well as the High Yield Bond Portfolio of the Vanguard Variable
Insurance Fund and the bond component of Vanguard/Wellesley Income
Fund. Mr. McEvoy has been associated with Wellington Management
Company for 19 years. Mr. McEvoy is supported by research
and other investment services provided by the professional staff
of WMC.
The Fund pays WMC an advisory fee at the end of each fiscal
quarter, calculated by applying a quarterly rate, based on the
following annual percentage rates, to the Fund's average month-end
net assets for the quarter:
Net Assets Rate
--------------------------------- -----
First $200 million .150%
Next $200 million .100%
Assets in excess of $400 million .075%
During the fiscal year which ended on October 31, 1996, the
total advisory fees paid by the Fund to WMC represented an annual
effective rate of .13 of 1% of the Fund's total average net
assets. This fee was paid under a previous fee schedule that
provided for a higher rate of fees.
The investment advisory agreement with WMC authorizes the adviser
to select brokers or dealers to execute purchases and sales of the
Fund's portfolio securities, and directs the adviser to use its
best efforts to obtain the best available price and most favorable
execution with respect to all transactions. The full range and
quality of brokerage services available are considered in making
these determinations.
The Fund has authorized WMC to pay higher commissions in recognition
of brokerage services felt necessary for the achievement of better
execution, provided the adviser believes this to be in the best
interest of the Fund. Although the Fund does not market its shares
through intermediary brokers or dealers, the Fund may
9
<PAGE>
place orders with qualified broker-dealers who recommend the Fund
to clients if the Officers of the Fund believe that the quality of
the transaction and the commission are comparable to what they
would be with other qualified brokerage firms.
The Fund's Board of Trustees may, without the approval of
shareholders, provide for: (a) the employment of a new investment
adviser pursuant to the terms of a new advisory agreement, either
as a replacement for an existing adviser or as an additional
adviser; (b) a change in the terms of an advisory agreement; and
(c) the continued employment of an existing adviser on the same
advisory contract terms where a contract has been assigned because
of a change in control of the adviser. Any such change will only
be made upon not less than 30 days' prior written notice to
shareholders of the Fund which shall include substantially the
information concerning the adviser that would have normally been
included in a proxy statement.
- ----------------------------------------------------------------------------
PERFORMANCE RECORD
The table below provides investment results for the Fund for
several periods over the Fund's lifetime. The results represent
the Fund's "total return" investment performance, which assumes
the reinvestment of all capital gains and income dividends for the
indicated periods. Also included is comparative information on the
unmanaged Merrill Lynch Perpetual Preferred Index, a measure of
the investment performance of preferred stocks. The table does not
make any allowance for federal, state or local income taxes, which
shareholders must pay on a current basis.
The results shown should not be considered a representation of the
total return from an investment made in the Fund today. This
information is provided to help investors better understand the
Fund and may not provide a basis for comparison with other
investments or mutual funds which use a different method to
calculate performance.
Average Annual Return for Vanguard Preferred Stock Fund
------------------------------------------------------------------
Merrill Lynch
Fiscal Years Vanguard Preferred Perpetual Preferred
Ended 10/31/96 Stock Fund Index**
-------------- ------------------- -------------------
1 Year + 8.0% +7.4%
3 Years + 7.0 +6.4
5 Years + 9.5 +8.6
10 Years + 8.7 +8.2
Lifetime* +10.0 +9.5
*December 3, 1975, to October 31, 1996.
**Standard & Poor's Preferred Stock Index through March 1989;
Merrill Lynch Perpetual Preferred Index thereafter.
- ----------------------------------------------------------------------------
DIVIDENDS, CAPITAL GAINS AND TAXES
The Fund pays quarterly dividends
The Fund expects to pay dividends quarterly from ordinary income.
Net capital gains distributions, if any, will be made annually.
In addition, in order to satisfy certain distribution
requirements of the Tax Reform Act of 1986, the Fund
may declare special year-end dividend and capital gains
10
<PAGE>
distributions during December. Such distributions, if received by
shareholders by January 31, are deemed to have been paid by the
Fund and received by shareholders on December 31 of the prior
year.
Dividend and capital gains distributions may be automatically
reinvested or received in cash. See "Choosing a Distribution
Option" for a description of these methods.
The Fund intends to continue to qualify for taxation as a
"regulated investment company" under the Internal Revenue Code so
that it will not be subject to federal income tax to the extent
its income is distributed to shareholders. Dividends paid by the
Fund from net investment income, whether received in cash or
reinvested in additional shares, will be taxable to shareholders
as ordinary income.
Dividends will qualify for the dividends received deduction
For corporate investors, if the Fund qualifies for taxation as a
regulated investment company and satisfies certain requirements, a
portion of the dividends paid by the Fund will be eligible,
whether received in cash or reinvested in additional shares, for
the corporate dividends received deduction, which is
currently 70%. After such a deduction, the qualifying portion
of the Fund's dividends would be subject to a maximum federal tax
rate of 10.2%, in contrast to the current maximum federal
corporate tax rate
of 34%.
In keeping with the policies and objectives of the Fund, the Fund
will seek to maximize dividend income which qualifies for the
corporate dividends received deduction. In fiscal year
1996, all of the Fund's dividend distributions qualified
for the dividends received deduction.
In order to qualify for the corporate dividends received
deduction, corporate shareholders must satisfy certain holding
period requirements for the Fund's shares. Specifically, the
deduction is only permitted when the Fund's shares have been held
for more than 45 days. The holding period requirements apply to
each block of Fund shares acquired, including each block of shares
received in payment of the Fund's quarterly dividends. Corporate
investors are advised to consult with their tax advisers on their
eligibility for the dividends received deduction.
Distributions paid by the Fund from long-term capital gains,
whether received in cash or reinvested in additional shares, are
taxable to shareholders, as long-term capital gains, regardless of
the length of time the shareholder has owned the shares. Capital
gains distributions result when the Fund realizes net capital
gains on sales of portfolio securities. For the Fund, realized
capital gains are not expected to be a significant or predictable
part of investment return.
Keep in mind that if you purchase shares shortly before the record
date of a dividend or capital gains distribution, you will pay the
full price for the shares and then receive some portion of the
price back as a taxable dividend or capital gains distribution.
The Fund notifies shareholders annually as to the tax status of
distributions paid by the Fund. Except for qualification for the
corporate dividends received deduction, the Fund is managed
without regard to tax ramifications.
11
<PAGE>
A capital gain or loss may be realized upon exchange or redemption
A sale of shares of the Fund is a taxable event and may result in
a capital gain or loss. A capital gain or loss may be realized
from an ordinary redemption of shares or an exchange of shares
between two mutual funds (or two portfolios of a mutual fund).
Dividend distributions, capital gains distributions, and capital
gains or losses from redemptions and exchanges may be subject to
state and local taxes.
The Fund is required to withhold 31% of taxable dividends, capital
gains distributions, and redemptions paid to shareholders who have
not complied with IRS taxpayer identification regulations. You may
avoid this withholding requirement by certifying on your Account
Registration Form your proper Social Security or Employer
Identification number and by certifying that you are not subject
to backup withholding.
The Fund is organized as a Pennsylvania business trust and, in the
opinion of counsel, is not liable for any income or franchise tax
in the Commonwealth of Pennsylvania. The Fund will be subject to
Pennsylvania county personal property tax in the county which is
the site of its principal office. Shareholders who are residents
of Pennsylvania will be exempt from county personal property
taxes, except for shareholders who are residents of the City and
School District of Pittsburgh.
The tax discussion set forth above is included for general
information only. Prospective investors should consult their own
tax advisers concerning the tax consequences of an investment in
the Fund.
- ----------------------------------------------------------------------------
THE SHARE PRICE OF THE FUND
The Fund's share price or "net asset value" per share is
determined by dividing the total assets of the Fund, less all
liabilities, by the total number of shares outstanding. Net asset
value is determined as of the regular close of the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on each day the
exchange is open for trading. The Fund's net asset value includes
interest on fixed-income securities which is accrued daily.
Portfolio securities which are traded over-the-counter and
on a stock exchange will be valued according to the broadest and
most representative market, and it is expected that for bonds and
other fixed-income securities (including preferred stocks) this
market will ordinarily be the over-the-counter market. Valuation
of such securities will be at the currently quoted bid price. When
stock exchange valuations are used, the valuation will also be the
latest quoted bid price on the day of valuation.
Securities may be valued on the basis of prices provided by a
pricing service when such prices are believed to better reflect
the fair market value of such securities. The prices provided by a
pricing service may be determined without regard to bid or last
sale prices of each security but take into account institutional
size trading in similar groups of securities and developments
related to specific securities. Short-term instruments (those with
remaining maturities of 60 days or less) may be valued
12
<PAGE>
at cost, plus or minus any amortized discount or premium, which
approximates market. Other assets and securities for which market
quotations are not readily available or which are restricted as to
sale and other assets are valued by such methods as the Board of
Trustees deems in good faith to reflect fair value.
The Fund's share price can be found daily in the mutual fund
listings of most major newspapers under the heading of Vanguard
Group.
- ----------------------------------------------------------------------------
GENERAL INFORMATION
The Fund is a Pennsylvania business trust and is authorized to
issue an unlimited number of shares of beneficial interest,
without par value. Annual meetings of shareholders will not be
held except as required by the Investment Company Act of 1940 and
other applicable law. An annual meeting will be held to vote on
the removal of a Trustee or Trustees of the Fund if requested in
writing by the holders of not less than 10% of the outstanding
shares of the Fund.
The shares of the Fund are fully paid and non-assessable; have no
preference as to conversion, exchange, dividends, retirement or
other features; and have no pre-emptive rights. The shares of the
Fund have non-cumulative voting rights, meaning that the holders
of more than 50% of the shares voting for the election of Trustees
can elect 100% of the Trustees if they so choose.
All securities and cash are held by State Street Bank and Trust
Company, Boston, MA. CoreStates Bank, N.A., holds daily cash
balances that are used by the Fund to invest in repurchase
agreements or securities acquired in these transactions. The
Vanguard Group, Inc., Valley Forge, PA, serves as the Fund's
Transfer and Dividend Disbursing Agent. Price Waterhouse LLP,
serves as independent accountants for the Fund and will audit its
financial statements annually. The Fund is not involved in any
litigation.
- ----------------------------------------------------------------------------
13
<PAGE>
SHAREHOLDER GUIDE
OPENING AN ACCOUNT AND PURCHASING SHARES
You may open a regular (non-retirement) account, either by mail or
wire. Simply complete and return an Account Registration Form and
any required legal documentation, indicating the amount you wish
to invest. Your purchase must be equal to or greater than the
$3,000 minimum initial investment requirement ($1,000 for Uniform
Gifts/Transfers to Minors Act accounts). You must open a new
Individual Retirement Account by mail (IRAs may not be opened by
wire) using a Vanguard IRA Adoption Agreement. Your purchase must
be equal to or greater than the $1,000 minimum initial investment
requirement, but no more than $2,000 if you are making a regular
IRA contribution. Rollover contributions are generally limited to
the amount withdrawn within the past 60 days from an IRA or other
qualified Retirement Plan. If you need assistance with the forms
or have any questions about this Fund, please call our Investor
Information Department at 1-800-662-7447. Note: For other types of
account registrations (e.g., corporations, associations,
other organizations, trusts or powers of attorney), please call us
to determine which additional forms you may need.
The Fund's shares are purchased at the next-determined net asset
value after your investment has been received. The Fund is offered
on a no-load basis (i.e., there are no sales commissions or 12b-1
fees).
Purchase Restrictions
1) Because of the risks associated with stock investments, the
Fund is intended to be a long-term investment vehicle and is
not designed to provide investors with a means of speculating
on short-term stock market movements. Consequently, the
Fund reserves the right to reject any specific purchase (and
exchange purchase) request. The Fund also reserves the right to
suspend the offering of shares for a period of time.
2) Vanguard will not accept third-party checks to purchase shares
of the Fund. Please be sure your purchase check is made payable
to The Vanguard Group.
Additional Investments
Subsequent investments to regular accounts may be made by mail
($100 minimum), wire ($1,000 minimum), exchange from another
Vanguard Fund account, or Vanguard Fund Express. Subsequent
investments to Individual Retirement Accounts may be made by mail
($100 minimum) or exchange from another Vanguard Fund account. In
some instances, contributions may be made by wire or Vanguard Fund
Express. Please call us for more information on these options.
------------------------------------------------------------------
14
<PAGE>
Purchasing by Mail Complete and sign the
enclosed Account Registration Form
NEW ACCOUNT
Please include the amount of your initial investment on the
registration form, make your check payable to The Vanguard Group-
38, and mail to:
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
For express or registered mail, send to:
Vanguard Financial Center
455 Devon Park Drive
Wayne, PA 19087
ADDITIONAL INVESTMENTS TO EXISTING ACCOUNTS
Additional investments should include the Invest-by-Mail
remittance form attached to your Fund confirmation statements.
Please make your check payable to The Vanguard Group-38, write
your account number on your check and, using the return envelope
provided, mail to the address indicated on the Invest-by-Mail
Form.
All written requests should be mailed to one of the addresses
indicated for new accounts. Do not send registered or express mail
to the post office box address.
------------------------------------------------------------------
Purchasing By Wire Money should be wired to:
CORESTATES BANK, N.A.
ABA 031000011
CORESTATES NO. 0101 9897
ATTN VANGUARD
Before Wiring Please contact Client Services (1-800-662-2739)
VANGUARD PREFERRED STOCK FUND
ACCOUNT NUMBER
ACCOUNT REGISTRATION
To assure proper receipt, please be sure your bank includes the
name of the Fund selected, the account number Vanguard has
assigned to you and the eight-digit CoreStates number. If you are
opening a new account, please complete the Account Registration
Form and mail it to the "New Account" address above after
completing your wire arrangement. Note: Federal Funds wire
purchase orders will be accepted only when the Fund and Custodian
Bank are open for business.
------------------------------------------------------------------
Purchasing By Exchange (from a Vanguard account)
You may open an account or purchase additional shares by making an
exchange from an existing Vanguard Fund account. However, the Fund
reserves the right to refuse any exchange purchase request. Call
our Client Services Department at 1-800-662-2739. The new account
will have the same registration as the existing account.
------------------------------------------------------------------
Purchasing By Fund Express
Special Purchase and Automatic Investment
The Fund Express Special Purchase option lets you move money from
your bank account to your Vanguard account at your request. Or if
you choose the Automatic Investment option, money will be moved from
your bank account to your Vanguard account on the schedule (monthly,
bimonthly [every other month], quarterly, semiannually or
annually) you select. To establish these Fund Express options,
please
15
<PAGE>
provide the appropriate information on the Account Registration
Form. We will send you a confirmation of your Fund Express
service; please wait two weeks before using the service.
- ----------------------------------------------------------------------------
CHOOSING A DISTRIBUTION OPTION
You must select one of three distribution options:
1. Automatic Reinvestment Option--Both dividends and capital gains
distributions will be reinvested in additional Fund shares.
This option will be selected for you automatically unless you
specify one of the other options.
2. Cash Dividend Option--Your dividends will be paid in cash and
your capital gains will be reinvested in additional Fund
shares.
3. All Cash Option--Both dividend and capital gains distributions
will be paid in cash.
You may change your option by calling our Client Services
Department (1-800-662-2739).
In addition, an option to invest your cash dividends and/or
capital gains distributions in another Vanguard Fund account is
available. Please call our Client Services Department (1-800-662-
2739) for information. You may also elect Vanguard Dividend
Express which allows you to transfer your cash dividends and/or
capital gains distributions automatically to your bank account.
Please see "Other Vanguard Services" for more information.
- ----------------------------------------------------------------------------
TAX CAUTION
Investors should ask about the timing of capital gains and
dividend distributions before investing
Under Federal tax laws, the Fund is required to distribute net
capital gains and dividend income to Fund shareholders. These
distributions are made to all shareholders who own Fund shares as
of the distribution's record date, regardless of how long the
shares have been owned. Purchasing shares just prior to the record
date could have a significant impact on your tax liability for the
year. For example, if you purchase shares immediately prior to the
record date of a sizable capital gain or income dividend
distribution, you will be assessed taxes on the amount of the
capital gain and/or dividend distribution later paid even though
you owned the Fund shares for just a short period of time. (Taxes
are due on the distributions even if the dividend or gain is
reinvested in additional Fund shares.) While the total value of
your investment will be the same after the distribution--the
amount of the distribution will offset the drop in the net asset
value of the shares--you should be aware of the tax implications
the timing of your purchase may have.
Prospective investors should, therefore, inquire about potential
distributions before investing. The Fund's annual capital gains
distribution normally occurs in December, while income dividends
are generally paid quarterly in March, June, September and
December. For additional information on distributions and taxes,
see the section titled "Dividends, Capital Gains, and Taxes."
- ----------------------------------------------------------------------------
16
<PAGE>
IMPORTANT ACCOUNT INFORMATION
Establishing Optional Services
The easiest way to establish optional Vanguard services on your
account is to select the options you desire when you complete your
Account Registration Form. If you wish to add shareholder options
later, you may need to provide Vanguard with additional
information and a signature guarantee. Please call our Client
Services Department (1-800-662-2739) for further assistance.
Signature Guarantees
For our mutual protection, we may require a signature guarantee on
certain written transaction requests. A signature guarantee
verifies the authenticity of your signature and may be obtained
from banks, brokers and any other guarantors that Vanguard deems
acceptable. A signature guarantee cannot be provided by a notary
public.
Certificates
Share certificates will be issued upon request. If a certificate
is lost, you may incur an expense to replace it.
Broker/Dealer Purchases
If you purchase shares in Vanguard Funds through a registered
broker-dealer or investment adviser, the broker-dealer or adviser
may charge a service fee.
Cancelling Trades
The Fund will not cancel any trade (e.g., a purchase, exchange or
redemption) believed to be authentic, received in writing or by
telephone, once the trade request has been received.
Electronic Prospectus Delivery
You may receive a prospectus for the Fund or any of the
Vanguard Funds in an electronic format. Please call
1-800-231-7870 for additional information or see "Other Vanguard
Services--Computer Access." If you elect to do so, you may
also receive a paper copy of the prospectus by calling
1-800-662-7447.
- ----------------------------------------------------------------------------
WHEN YOUR ACCOUNT WILL BE CREDITED
The trade date is the date on which your account is credited. If
your purchase is made by check, Federal Funds wire, or exchange,
and is received by the close of the New York Stock Exchange
(generally 4:00 p.m. Eastern time), your trade date is the day of
receipt. If your purchase is received after the close of the
Exchange, your trade date is the next business day. Your shares
are purchased at the net asset value determined on your trade
date.
In order to prevent lengthy processing delays caused by the
clearing of foreign checks, Vanguard will only accept a foreign
check which has been drawn in U.S. dollars and has been issued by
a foreign bank with a U.S. correspondent bank. The name of the
U.S. correspondent bank must be printed on the face of the foreign
check.
- ----------------------------------------------------------------------------
SELLING YOUR SHARES
You may withdraw any portion of the funds in your account by
redeeming shares at any time. You generally may initiate a
redemption request by writing or by telephoning. Your redemption
proceeds are normally mailed within two business days after the
receipt of the request in Good Order.
------------------------------------------------------------------
17
<PAGE>
Selling By Mail
Requests should be mailed to Vanguard Financial Center, Vanguard
Preferred Stock Fund, P.O. Box 1120, Valley Forge, PA 19482. (For
express or registered mail, send your request to Vanguard
Financial Center, Vanguard Preferred Stock Fund, 455 Devon Park
Drive, Wayne, PA 19087.)
The redemption price of shares will be the Fund's net asset value
next determined after Vanguard has received all required documents
in Good Order.
Definition of Good Order
Good Order means that the request includes the following:
1. The account number and Fund name.
2. The amount of the transaction (specified in dollars or shares).
3. Signatures of all owners exactly as they are registered on the
account.
4. Any required signature guarantees.
5. Other supporting legal documentation that might be required in
the case of estates, corporations, trusts, and certain other
accounts.
6. Any certificates that you hold for the account.
If you have questions about this definition as it pertains to your
request, please call our Client Services Department at
1-800-662-2739.
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Selling By Telephone
To sell shares by telephone, you or your pre-authorized
representative may call our Client Services Department at 1-800-
662-2739. The proceeds will be sent to you by mail or by wire. In
addition to the details below, please see "Important Information
About Telephone Transactions."
By Mail: Telephone mail redemption is automatically established on
your account unless you indicate otherwise on your Account
Registration Form. You may redeem any amount by calling Vanguard.
The proceeds will be paid to the registered shareholders. Please
Note: As a protection against fraud, your telephone mail
redemption privilege will be suspended for 15 calendar days
following any expedited address change to your account. An
expedited address change is one that is made by telephone,
by Vanguard Online, or, in writing, without the signatures
of all account owners.
By Wire: Telephone wire redemption must be specifically elected
for your account. The best time to elect telephone wire redemption
is at the time you complete your Account Registration Form. If you
do not presently have telephone wire redemption and wish to
establish it, please contact our Client Services Department.
With the wire redemption option, you may withdraw a minimum of
$1,000 and have the amount wired directly to your bank account.
Wire redemptions less than $5,000 are subject to a $5 charge
deducted by Vanguard. There is no Vanguard charge for wire
redemptions of $5,000 or more. However, your bank may assess a
separate fee to accept incoming wires.
A request to change the bank associated with your wire redemption
option must be received in writing, signed by each registered
shareholder, and accompanied by a
18
<PAGE>
voided check or preprinted deposit slip. A signature guarantee is
required if your bank registration is not identical to your
Vanguard Fund account registration.
------------------------------------------------------------------
Selling By Fund Express
Automatic Withdrawal & Special Redemption
If you select the Fund Express Automatic Withdrawal option, money
will be automatically moved from your Vanguard Fund account to
your bank account according to the schedule you have selected. The
Special Redemption option lets you move money from your Vanguard
account to your bank account on an "as needed" basis. To establish
these Fund Express options, please provide the appropriate
information on the Account Registration Form. We will send you a
confirmation of your Fund Express service; please wait two
weeks before using the service.
------------------------------------------------------------------
Selling By Exchange
You may sell shares of the Fund by making an exchange to another
Vanguard Fund account. Please see "Exchanging Your Shares" for
details.
------------------------------------------------------------------
Important Redemption Information
Shares purchased by check or Fund Express may be redeemed at any
time. However, your redemption proceeds will not be paid until
payment for the purchase is collected, which may take up to ten
calendar days.
------------------------------------------------------------------
Delivery of Redemption Proceeds
Redemption requests received by telephone prior to the close of
regular trading on the New York Stock Exchange (generally 4:00
p.m. Eastern time) are processed on the day of receipt and the
redemption proceeds are normally sent on the following business
day.
Redemption requests received by telephone after the close of the
Exchange are processed on the business day following receipt and
the proceeds are normally sent on the second business day
following receipt.
Redemption proceeds must be sent to you within seven days of
receipt of your request in Good Order, except as described
above in "Important Redemption Information."
If you experience difficulty in making a telephone redemption
during periods of drastic economic or market changes, your
redemption request may be made by regular or express mail. It will
be implemented at the net asset value next determined after your
request has been received by Vanguard in Good Order. The Fund
reserves the right to revise or terminate the telephone redemption
privilege at any time.
The Fund may suspend the redemption right or postpone payment at
times when the New York Stock Exchange is closed or under any
emergency circumstances as determined by the United States
Securities and Exchange Commission.
If the Board of Trustees determines that it would be detrimental
to the best interests of the Fund's remaining shareholders to make
payment in cash, the Fund may pay redemption proceeds in whole or
in part by a distribution in kind of readily marketable
securities.
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19
<PAGE>
Vanguard's Average Cost Statement
If you make a redemption from a qualifying account, Vanguard will
send you an Average Cost Statement which provides you with the
cost and tax basis of the shares you redeemed. Please see
"Statements and Reports" for additional information.
------------------------------------------------------------------
Low Balance Fee and Minimum Account Balance Requirement
Due to the relatively high cost of maintaining smaller accounts,
the Fund will automatically deduct a $10 annual fee from non-
retirement accounts with balances falling below $2,500 ($500 for
Uniform Gifts/Transfers to Minors Act accounts). This fee
deduction will occur mid-year, beginning in 1996. The fee
generally will be waived for investors whose aggregate Vanguard
assets exceed $50,000.
In addition, the Fund reserves the right to liquidate any non-
retirement account that is below the minimum initial investment
amount of $3,000. If at any time your total investment does not
have a value of at least $3,000, you may be notified that your
account is below the Fund's minimum account balance requirement.
You would then be allowed 60 days to make an additional investment
before the account is liquidated. Proceeds would be promptly paid
to the registered shareholder.
Vanguard will not liquidate your account if it has fallen below
$3,000 solely as a result of declining markets (i.e., a decline in
a Fund's net asset value).
- ----------------------------------------------------------------------------
EXCHANGING YOUR SHARES
Should your investment goals change, you may exchange shares of
Vanguard Preferred Stock Fund for those of other available
Vanguard Funds.
Exchanging By Telephone
Call Client Services (1-800-662-2739)
When exchanging shares by telephone, please have ready your Fund
name, account number, Social Security or Employer Identification
number listed on the account and the exact name and address in
which the account is registered. Only the registered shareholder
may complete such an exchange. Requests for telephone exchanges
received prior to the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) are processed at the
close of business that same day. Requests received after the close
of the Exchange are processed the next business day. Telephone
exchanges are not accepted into or from non-retirement
investments in Vanguard Balanced Index Fund, Vanguard Index
Trust, Vanguard Quantitative Portfolios, Vanguard REIT Index
Portfolio and Vanguard International Equity Fund. If you
experience difficulty in making a telephone exchange, your
exchange request may be made by regular or express mail, and it
will be implemented at the closing net asset value on the date
received by Vanguard provided the request is received in Good
Order.
------------------------------------------------------------------
Exchanging By Mail
Please be sure to include on your exchange request the name and
account number of your current Fund, the name of the Fund you wish
to exchange into, the amount you wish to exchange, and the
signatures of all registered account holders. Send your request to
Vanguard Financial Center, Vanguard Preferred Stock Fund, P.O. Box
1120, Valley Forge, PA 19482. (For express or registered mail,
send your request to Vanguard Financial Center, Vanguard Preferred
Stock Fund, 455 Devon Park Drive, Wayne, PA 19087.)
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20
<PAGE>
Important Exchange Information
Before you make an exchange, you should consider the following:
* Please read the Fund's prospectus before making an exchange. For
a copy and for answers to any questions you may have, call our
Investor Information Department (1-800-662-7447).
* An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on the
transaction.
* Exchanges are accepted only if the registrations and the
taxpayer identification numbers of the two accounts are
identical.
* The shares to be exchanged must be on deposit and not held in
certificate form.
* New accounts are not currently accepted in Vanguard/Windsor
Fund.
* The redemption price of shares redeemed by exchange is the net
asset value next determined after Vanguard has received any
required documents in Good Order.
Every effort will be made to maintain the exchange privilege.
However, the Fund reserves the right to revise or terminate its
provisions, limit the amount of or reject any exchange, as deemed
necessary, at any time.
- ----------------------------------------------------------------------------
EXCHANGE PRIVILEGE LIMITATIONS
The Fund's exchange privilege is not intended to afford
shareholders a way to speculate on short-term movements in the
market. Accordingly, in order to prevent excessive use of the
exchange privilege that may potentially disrupt the management of
the Fund and increase transaction costs, the Fund has established
a policy of limiting excessive exchange activity.
Exchange activity generally will not be deemed excessive if
limited to two substantive exchange redemptions (at least 30 days
apart) from the Fund during any twelve month period.
Notwithstanding these limitations, the Fund reserves the right to
reject any purchase request (including exchange purchases from
other Vanguard portfolios) that is reasonably deemed to be
disruptive to efficient portfolio management.
- ----------------------------------------------------------------------------
IMPORTANT INFORMATION ABOUT TELEPHONE TRANSACTIONS
The ability to initiate redemptions (except wire redemptions) and
exchanges by telephone is automatically established on your
account unless you request in writing that telephone transactions
on your account not be permitted. The ability to initiate wire
redemptions by telephone will be established on your account only
if you specifically elect this option in writing.
To protect your account from losses resulting from unauthorized or
fraudulent telephone instructions, Vanguard adheres to the
following security procedures:
1. Security Check. To request a transaction by telephone, the
caller must know (i) the name of the Portfolio; (ii) the 10-
digit account number; (iii) the exact name and address used in
the registration; and (iv) the Social Security or employer
identification number listed on the account.
21
<PAGE>
2. Payment Policy. The proceeds of any telephone redemption by
mail will be made payable to the registered shareowner and
mailed to the address of record, only. In the case of a
telephone redemption by wire, the wire transfer will be made
only in accordance with the shareowner's prior written
instructions.
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by telephone,
provided that reasonable security procedures have been followed.
Vanguard believes that the security procedures described above are
reasonable, and that if such procedures are followed, you will
bear the risk of any losses resulting from unauthorized or
fraudulent telephone transactions on your account.
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TRANSFERRING REGISTRATION
You may transfer the registration of any of your Fund shares to
another person by completing a transfer form and sending it to:
Vanguard Financial Center, P.O. Box 1110, Valley Forge, PA 19482.
The request must be in Good Order. Before mailing your request,
please call our Client Services Department (1-800-662-2739) for
full instructions.
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STATEMENTS AND REPORTS
Vanguard will send you a confirmation statement each time you
initiate a transaction in your account (except for checkwriting
redemptions from Vanguard money market accounts). You will also
receive a comprehensive account statement at the end of each
calendar quarter. The fourth-quarter statement will be a year-end
statement, listing all transaction activity for the entire
calendar year.
Vanguard's Average Cost Statement provides you with the average
cost of shares redeemed from your account during the calendar
year, using the average cost single category method. This
service is available for most taxable accounts opened since
January 1, 1986. In general, investors who redeemed shares from a
qualifying Vanguard account may expect to receive their Average
Cost Statement along with their Fund Summary Statement. Please
call our Client Services Department (1-800-662-2739) for
information.
Financial reports on the Fund will be mailed to you semi-annually,
according to the Fund's fiscal year-end.
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OTHER VANGUARD SERVICES
For more information about any of these services, please call our
Investor Information Department at 1-800-662-7447.
Vanguard Direct Deposit Service
With Vanguard's Direct Deposit Service, most U.S. Government
checks (including Social Security and military pension checks) and
private payroll checks may be automatically deposited into your
Vanguard Fund account. Separate brochures and forms are available
for direct deposit of U.S. Government and private payroll checks.
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Vanguard Automatic Exchange Service
Vanguard's Automatic Exchange Service allows you to move money
automatically among your Vanguard Fund accounts. For instance, the
service can be used to "dollar cost average" from a money market
portfolio into a stock or bond fund or to contribute to an IRA or
other retirement plan. Please contact our Client Services
Department at 1-800-662-2739 for additional information.
Vanguard Fund Express
Vanguard's Fund Express allows you to transfer money between your
Fund account and your account at a bank, savings and loan
association, or a credit union that is a member of the Automated
Clearing House (ACH) system. You may elect this service on the
Account Registration Form or call our Investor Information
Department (1-800-662-7447) for a Fund Express application.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition, some
services of Fund Express cannot be used with specific Vanguard
Funds. For more information, please refer to the Vanguard Fund
Express brochure.
Vanguard Dividend Express
Vanguard's Dividend Express allows you to transfer your dividends
and/or capital gains distributions automatically from your Fund
account, one business day after the Fund's payable date, to your
account at a bank, savings and loan association, or a credit union
that is a member of the Automated Clearing House (ACH) system. You
may elect this service on the Account Registration Form or call
our Investor Information Department (1-800-662-7447) for a
Vanguard Dividend Express application.
Vanguard Tele-Account
Vanguard's Tele-Account is a convenient, automated service that
provides share price, price change and yield quotations on
Vanguard Funds through any Touch-Tone[TM] telephone. This service
also lets you obtain information about your account balance, your
last transaction, and your most recent dividend or capital gains
payment. In addition, you may perform investment exchanges of
Vanguard Fund shares and redemptions by check using Tele-
Account. To contact Vanguard's Tele-Account service, dial
1-800-ON-BOARD (1-800-662-6273). A brochure offering detailed
operating instructions is available from our Investor Information
Department (1-800-662-7447).
Computer Access
Vanguard Online Keyword: vanguard
Vanguard Online allows you to obtain information via your personal
computer on Fund share price, yield, and total return. Vanguard
Online is offered through America Online (AOL). To establish an
AOL account, call 1-800-238-6336.
Vanguard on the World Wide Web http://www.vanguard.com
Vanguard sponsors an education-oriented website offering news and
information about Vanguard Funds and services, as well as
interactive, easy-to-use investment planning tools.
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PART B
VANGUARD PREFERRED STOCK FUND
STATEMENT OF ADDITIONAL INFORMATION February 21, 1997
This Statement is not a prospectus, but should be read in conjunction
with the Fund's current Prospectus (dated February 21, 1997). To
obtain the Prospectus please call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS Page
----------------- ----
Investment Objective and Policies........................ 1
Yield and Total Return................................... 5
Purchase of Shares....................................... 5
Redemption of Shares..................................... 5
Investment Limitations................................... 6
Management of the Fund................................... 8
Investment Advisory Services............................. 11
Portfolio Transactions................................... 11
General Information...................................... 12
Financial Statements..................................... 13
Performance Measures..................................... 13
Appendix -- Description of Preferred Stock Ratings....... 14
INVESTMENT OBJECTIVE AND POLICIES
The following policies supplement the Fund's investment objective and
policies set forth in the Prospectus.
Repurchase Agreements
The Fund may invest in repurchase agreements with commercial banks,
brokers or dealers either for defensive purposes due to market conditions or
to generate income from its excess cash balances. A repurchase agreement is
an agreement under which the Fund acquires a money market instrument
(generally a security issued by the U.S. Government or an agency thereof, a
banker's acceptance or a certificate of deposit) from a commercial bank,
broker or dealer, subject to resale to the seller at an agreed upon price
and date (normally, the next business day). A repurchase agreement may be
considered a loan collateralized by securities. The resale price reflects an
agreed upon interest rate effective for the period the instrument is held by
the Fund and is unrelated to the interest rate on the underlying instrument.
In these transactions, the securities acquired by the Fund (including
accrued interest earned thereon) must have a total value in excess of the
value of the repurchase agreement and are held by a custodian bank until
repurchased. In addition, the Fund's Board of Trustees will monitor the
Fund's repurchase agreement transactions generally and will establish
guidelines and standards for review by the investment adviser of the
creditworthiness of any bank, broker or dealer party to a repurchase
agreement with the Fund. No more than an aggregate of 15% of the Fund's
assets, at the time of investment, will be invested in repurchase agreements
having maturities longer than seven days and securities subject to legal or
contractual restrictions on resale or for which there are no readily
available market quotations. See "Illiquid Securities" on page 2.
The use of repurchase agreements involves certain risks. For example,
if the other party to the agreement defaults on its obligation to repurchase
the underlying security at a time when the value of the security has
declined, the Fund may incur a loss upon disposition of the security. If the
other party to the agreement becomes insolvent and subject to liquidation or
reorganization under the Bankruptcy Code or other laws, a court may
determine that the underlying security is collateral for a loan by the Fund
not within the control of the Fund and therefore the realization by the Fund
on such collateral may be automatically stayed. Finally, it is possible that
the Fund may not be able to substantiate its interest in the underlying
security and may be deemed an unsecured creditor of the other party to the
agreement. While the Fund's management acknowledges these risks, it is
expected that they can be controlled through careful monitoring procedures.
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Illiquid Securities
The Fund may not invest more than 15% of its net assets in illiquid
securities. Illiquid securities are securities that may not be
sold or disposed of in the ordinary course of business within seven business
days at approximately the value at which they are being carried on a Fund's
books. An illiquid security includes repurchase agreements which have a
maturity of longer than seven days, securities which are illiquid by virtue
of the absence of a readily available market, and demand instruments with a
demand notice exceeding seven days. Illiquid securities may include
securities that are not registered under the Securities Act of 1933 (the
"1933 Act"), however, unregistered securities that can be sold to "qualified
institutional buyers" in accordance with Rule 144A under the 1933 Act will
not be considered illiquid so long as it is determined by the Fund's
adviser that an adequate trading market exists for the security.
Futures Contracts and Options
The Fund may enter into futures contracts, options, and options on
futures contracts for the purpose of remaining fully invested and reducing
transaction costs. Futures contracts provide for the future sale by
one party and purchase by another party of a specified amount of a specific
security at a specified future time and at a specified price. Futures
contracts which are standardized as to maturity date and underlying
financial instrument are traded on national futures exchanges. Futures
exchanges and trading are regulated under the Commodity Exchange Act by the
Commodity Futures Trading Commission ("CFTC"), a U.S. Government Agency.
Assets committed to futures contracts will be segregated at the Fund's
custodian bank to the extent required by law.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold" or "selling"
a contract previously "purchased") in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is
bought or sold.
Futures traders are required to make a good faith margin deposit in
cash or government securities with a broker or custodian to initiate and
maintain open positions in futures contracts. A margin deposit is intended
to assure completion of the contract (delivery or acceptance of the
underlying security) if it is not terminated prior to the specified delivery
date. Minimal initial margin requirements are established by the futures
exchange and may be changed. Brokers may establish deposit requirements
which are higher than the exchange minimums. Futures contracts are
customarily purchased and sold that may range upward from less than 5% of
the value of the contract being traded.
The Fund may invest in futures contracts and options
Although it has no present intention to do so, the Fund may utilize
equity futures contracts and options to a limited extent. Specifically, the
Fund may enter into futures contracts provided that not more than 5% of its
assets are required as a futures contract deposit; in addition, the Fund may
enter into futures contracts and options transactions only to the extent
that obligations under such contracts or transactions represent not more
than 20% of the Fund's assets.
Futures contracts and options may be used for several reasons: to
maintain cash reserves while simulating full investment, to facilitate
trading, to reduce transactions costs, or to seek higher investment returns
when a futures contract is priced more attractively than the underlying
equity security or index. Although futures contracts and options may
be used as leveraged instruments, the Fund will not use futures contracts or
options transactions to leverage its assets.
For example, in order to remain fully invested in stocks, while
maintaining liquidity to meet potential shareholder redemptions, the Fund
may invest a portion of its assets in a stock index futures contract.
Because futures contracts only require a small initial margin deposit, the
Fund would then be able to maintain a cash reserve to meet potential
redemptions, while at the same time remaining fully invested. Also, because
the transaction costs of futures contracts and options may be lower
than the costs of investing in stocks directly, it is expected that the use
of futures contracts and options may reduce the Fund's total
transaction costs.
Futures contracts and options pose certain risks
The primary risks associated with the use of futures contracts and
options are: (i) imperfect correlation between the change in market value of
the stocks held by the Fund and the prices of futures and options; and (ii)
possible lack of a liquid secondary market for a futures contract and the
resulting inability to close a futures position prior to its maturity date.
The risk of imperfect correlation will be minimized by investing only in
those contracts whose price fluctuations are
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expected to resemble those of the Fund's underlying securities. The risk
that the Fund will be unable to close out a futures position will be
minimized by entering into such transactions on a national exchange with an
active and liquid secondary market.
After a futures contract position is opened, the value of the contract
is marked to the market daily. If the futures contract price changes
to the extent that the margin on deposit does not satisfy margin
requirements, payment of additional "variation" margin will be required.
Conversely, change in the contract value may reduce the required margin,
resulting in a repayment of excess margin to the contract holder. Variation
margin payments are made to and from the futures broker for as long as the
contract remains open. The Fund expects to earn interest income on its
margin deposits.
Traders in futures contracts may be broadly classified as either
"hedgers" or "speculators." Hedgers use the futures markets primarily to
offset unfavorable changes in the value of securities otherwise held for
investment purposes or expected to be acquired by them. Speculators are less
inclined to own the securities underlying the futures contracts which they
trade, and use futures contracts with the expectation of realizing profits
from fluctuations in the value of the underlying securities. The Fund
intends to use futures contracts only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions. The Fund
will only sell futures contracts to protect securities it owns against price
declines or purchase contracts to protect against an increase in the price
of securities it intends to purchase. As evidence of this hedging interest,
the Fund expects that approximately 75% of its futures contract purchases
will be "completed;" that is, equivalent amounts of related securities will
have been purchased or are being purchased by the Fund upon sale of open
futures contracts.
Although techniques other than the sale and purchase of futures
contracts could be used to control the Fund's exposure to market
fluctuations, the use of futures contracts may be a more effective means of
hedging this exposure. While the Fund will incur commission expenses in both
opening and closing out futures positions, these costs are lower than
transaction costs incurred in the purchase and sale of the underlying
securities.
Restrictions on the Use of Futures Contracts
The Fund will not enter into futures contract transactions to the
extent that, immediately thereafter, the sum of its initial margin deposits
on open contracts exceeds 5% of the market value of the Fund's total assets.
In addition, the Fund will not enter into futures contracts to the extent
that its outstanding obligations to purchase securities under these
contracts would exceed 20% of the Fund's total assets.
Risk Factors in Futures Transactions
Positions in futures contracts may be closed out only on an Exchange
which provides a secondary market for such futures. However, there can be no
assurance that a liquid secondary market will exist for any particular
futures contract at any specific time. Thus, it may not be possible to close
a futures position. In the event of adverse price movements, the Fund would
continue to be required to make daily cash payments to maintain its required
margin. In such situations, if the Fund has insufficient cash, it may have
to sell portfolio securities to meet daily margin requirements at a time
when it may be disadvantageous to do so. In addition, the Fund may be
required to make delivery of the instruments underlying interest rate
futures contracts it holds. The inability to close options and futures
positions also could have an adverse impact on the Fund's ability to
effectively hedge. It is also possible that the Fund could both lose money
on futures contracts and also experience a decline in value of its portfolio
securities. There is also the risk of loss by the Fund of margin deposits in
the event of bankruptcy of a broker with whom the Fund has an open position
in a futures contract or related option. Additionally, investments in
futures contracts and options involve the risk that the investment advisers
will incorrectly predict stock market and interest rate trends.
The Fund will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary
market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a
relatively small price movement in a futures contract may result in
immediate and substantial loss (as well as gain) to the investor. For example,
if at the time of purchase, 10% of the value of the futures contract is
deposited as margin, a subsequent 10% decrease in the value of the futures
contract would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then closed out. A
15% decrease would result in a loss equal to 150% of the original margin
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deposit if the contract were closed out. Thus, a purchase or sale of a
futures contract may result in losses in excess of the amount invested in
the contract. However, because the futures strategies of the Fund are
engaged in only for hedging purposes, the Adviser does not believe that the
Fund is subject to the risks of loss frequently associated with futures
transactions. The Fund would presumably have sustained comparable losses if,
instead of the futures contract, it had invested in the underlying financial
instrument and sold it after the decline.
Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures
contracts have different maturities than the portfolio securities being
hedged. It is also possible that the Fund could both lose money on futures
contracts and also experience a decline in value of its portfolio
securities. There is also the risk of loss by the Fund of margin deposits in
the event of bankruptcy of a broker with whom the Fund has an open position
in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit.
The daily limit governs only price movement during a particular trading day
and therefore does not limit potential losses, because the limit may prevent
the liquidation of unfavorable positions. Futures contract prices have
occasionally moved to the daily limit for several consecutive trading days
with little or no trading, thereby preventing prompt liquidation of future
positions and subjecting some futures traders to substantial losses.
Federal Tax Treatment of Futures Contracts
The Fund is required for Federal income tax purposes to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts held as of the end of the year as well as those actually realized
during the year. In most cases, any gain or loss recognized with respect to
a futures contract is considered to be 60% long-term capital gain or loss
and 40% short-term capital gain or loss, without regard to the holding
period of the contract. Furthermore, sales of futures contracts which are
intended to hedge against a change in the value of securities held by the
Fund may affect the holding period of such securities and, consequently, the
nature of the gain or loss on such securities upon disposition. The Fund may
be required to defer the recognition of losses on futures contracts to the
extent of any unrecognized gains on related positions held by the Fund.
In order for the Fund to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross
income for a taxable year must be derived from qualifying income; i.e.,
dividends, interest, income derived from loans of securities, and gains from
the sale of securities or foreign currencies, or other income derived with
respect to its business of investing in such securities or currencies. In
addition, gains realized on the sale or other disposition of securities held
for less than three months must be limited to less than 30% of the Fund's
annual gross income. It is anticipated that any net gain realized from the
closing out of futures contracts will be considered gain from the sale of
securities and therefore be qualifying income for purposes of the 90%
requirement. In order to avoid realizing excessive gains on securities held
less than three months, the Fund may be required to defer the closing out of
futures contracts beyond the time when it would otherwise be advantageous to
do so. It is anticipated that unrealized gains on futures contracts, which
have been open for less than three months as of the end of the Fund's fiscal
year and which are recognized for tax purposes, will not be considered gains
on securities held less than three months for the purpose of the 30% test.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including
unrealized gains at the end of the Fund's fiscal year) on futures
transactions. Such distributions will be combined with distributions of
capital gains realized on the Fund's other investments and shareholders will
be advised on the nature of the payments.
Lending of Securities
The Fund may lend its portfolio securities on a short-term or a long-
term basis to qualified institutional investors who need to borrow
securities in order to complete certain transactions, such as covering short
sales, avoiding failures to deliver securities or completing arbitrage
operations. By lending its portfolio securities, the Fund attempts to
increase its income through the receipt of interest on the loan. Any gain or
loss in the market price of the securities loaned that might occur during the
term of the loan would be for the account of the Fund. The Fund may lend its
portfolio securities to qualified brokers, dealers, banks or other financial
institutions, so long as the terms and the structure of such loans are not
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inconsistent with the Investment Company Act of 1940, or the Rules and
Regulations or interpretations of the Securities and Exchange Commission
(the "Commission") thereunder, which currently require that (a) the borrower
pledge and maintain with the Fund collateral consisting of cash, an
irrevocable letter of credit, or securities issued or guaranteed by the
United States Government having a value at all times not less than 100% of
the value of the securities loaned, (b) the borrower add to such collateral
whenever the price of the securities loaned rises (i.e., the borrower "marks
to the market" on a daily basis), (c) the loan be made subject to
termination by the Fund at any time, and (d) the Fund receive reasonable
interest on the loan (which may include the Fund's investing any cash
collateral in interest bearing short-term investments), any distributions on
the loaned securities and any increase in their market value. The Fund will
accept only cash as collateral for its loaned securities and will not lend
portfolio securities if, as a result, the aggregate of such loans exceeds
10% of the value of the Fund's total assets. Loan arrangements made by the
Fund will comply with all other applicable regulatory requirements,
including the rules of the New York Stock Exchange, which rules presently
require the borrower, after notice, to redeliver the securities within the
normal settlement time of three business days. All relevant facts and
circumstances, including the credit worthiness of the broker, dealer or
institution, will be considered in making decisions with respect to the
lending of securities, subject to review by the Fund's Board of Trustees.
Since income derived from lending portfolio securities is not qualifying
income for the purpose of the 70% intercorporate dividends received
deduction under Federal tax laws, the Fund will limit such activity in
accordance with its objective of maximizing dividend income which qualifies
for the dividends deduction.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's Trustees (Directors).
YIELD AND TOTAL RETURN
The yield of the Fund for the 30-day period ended October 31,
1996 was +7.21%.
The average annual total return of the Fund for the one-, five- and
ten-year periods ending October 31, 1996 was +8.04%, +9.52%
and +8.73%, respectively. Total return is computed by finding the
average compounded rates of return over the one-, five- and ten-year periods
set forth above that would equate an initial amount invested at the
beginning of the periods to the ending redeemable value of the investment.
PURCHASE OF SHARES
The purchase price of shares of the Fund is the net asset value next
determined after the order is received. The net asset value is calculated as
of the close of the New York Stock Exchange on each day the Exchange is open
for business. An order received prior to the close of the Exchange will be
executed at the price computed on the date of receipt; and an order received
after the close of the Exchange will be executed at the price computed on
the next day the Exchange is open.
The Fund reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment
of management such rejection is in the best interest of the Fund, and (iii)
to reduce or waive the minimum investment for or any other restrictions on
initial and subsequent investments for certain fiduciary accounts such as
employee benefit plans or under circumstances where certain economies can be
achieved in sales of the Fund's shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange is closed, or
trading on the Exchange is restricted as determined by the Securities and
Exchange Commission (the "Commission"), (ii) during any period when an
emergency exists as defined by the rules of the Commission as a result of
which it is not reasonably practicable for the Fund to dispose of securities
owned by it, or fairly to determine the value of its assets, and (iii) for
such other periods as the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during
any 90-day period to the lesser of $250,000 or 1% of the net assets of the
Fund at the beginning of such period. Such commitment is irrevocable without
the prior approval of the Commission. Redemptions in excess of the above
limits may be paid, in whole or in part, in investment securities or in
cash, as the Trustees may deem advisable; however, payment will be made wholly
in cash unless the Trustees believe that economic or market conditions
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exist which would make such a practice detrimental to the best interests of
the Fund. If redemptions are paid in investment securities, such securities
will be valued as set forth in the Prospectus under "The Fund's Share Price"
and a redeeming shareholder would normally incur brokerage expenses if he
converted these securities to cash.
No charge is made by the Fund for redemptions, except for wire
withdrawals in amounts less than $5,000 which are subject to a $5.00 charge
which will be deducted from the payment issued to you. Any redemption may be
more or less than the shareholder's cost depending on the market value of
the Fund's portfolio securities.
Signature Guarantees -- To protect your account, the Fund and Vanguard
from fraud, signature guarantees are required for certain redemptions.
Signature guarantees enable the Fund to verify the identity of the person
who has authorized a redemption from your account. Signature guarantees are
required in connection with: (1) all redemptions, regardless of the
amount involved, when the proceeds are to be paid to someone other than the
registered owner(s) and/or registered address; and (2) share transfer
requests. These requirements are not applicable to redemptions in Vanguard's
prototype retirement plans except in connection with: (1) distributions made
when the proceeds are to be paid to someone other than the plan participant;
(2) certain authorizations to effect exchanges by telephone; and (3) when
proceeds are to be wired. These requirements may be waived by the Fund in
certain instances.
Signature guarantees may be obtained from a bank, broker or any other
guarantor institution that Vanguard deems acceptable. Notaries public are
not acceptable guarantors.
The signature guarantees must appear either: (1) on the written request
for redemption; (2) on a separate instrument for assignment ("stock power")
which should specify the total number of shares to be redeemed; or (3) on
all stock certificates tendered for redemption and, if shares held by the
Fund are also being redeemed, on the letter or stock power.
INVESTMENT LIMITATIONS
The Fund is subject to the following limitations which may not be
changed without the approval of at least a majority of the outstanding
voting securities of the Fund. The Fund will not:
(1) Borrow money, except that the Fund may borrow from banks (or
through reverse repurchase agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of redemption requests which
might otherwise require the untimely disposition of securities, in an amount
not exceeding 15% of the value of the Fund's net assets (including the
amount borrowed and the value of any outstanding reverse repurchase
agreements) at the time the borrowing is made. Whenever borrowings exceed 5%
of the value of the Fund's net assets, the Fund will not make any additional
investments;
(2) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States government
and its instrumentalities) if, as a result, the Fund would hold more than
10% of the outstanding voting securities of the issuer, or more than 5% of
the value of the Fund's total assets would be invested in the securities of
such issuer;
(3) Invest in companies for the purpose of exercising control;
(4) Invest in securities of other investment companies, except as they
may be acquired as a part of a merger, consolidation or acquisition of
assets or otherwise to the extent permitted by Section 12 of the 1940 Act.
The Fund will invest only in investment companies which have investment
objectives and investment policies consistent with those of the Fund;
(5) Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in disposing of
portfolio securities;
(6) Purchase or otherwise acquire any security (including the Fund's
investment in The Vanguard Group, Inc.) if, as a result, more than 15% of
its net assets would be invested in securities that are illiquid;
(7) Purchase or sell real estate although it may purchase and sell
securities of companies which deal in real estate or interests therein;
(8) Purchase or sell commodities or commodity contracts, except that
the Fund may invest in stock futures contracts, stock options and options on
stock futures contracts to the extent that not more than 5% of its assets
are required as
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deposit to secure obligations under such contracts and not more than 20% of
the Funds assets are invested in futures contracts and options at any time;
(9) Write, or invest in, put, call, straddle, or spread option
contracts (except as described above in investment limitation No. 8) or
invest in interests in oil, gas, or other mineral exploration or development
programs;
(10) Purchase securities on margin or sell any securities short (except
as described above in investment limitation No. 8);
(11) Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements) which are either publicly
distributed or customarily purchased by institutional investors, and (ii) as
provided under "Lending of Securities" (page 4); and
(12) The Fund, with the exception of the electric and/or gas industries
in which it may invest a majority of its assets, will not concentrate its
investments in any other particular industry, by investing more than 25% of
the value of its total assets taken at market value in securities of issuers
all of which conduct their principal business activities in the same
industry.
These limitations are considered at the time investment securities are
purchased. Notwithstanding these limitations the Fund may own all or any
portion of the securities of, or make loans to, or contribute to the costs
or other financial requirements of any company which will be wholly owned by
the Fund and one or more other investment companies and is primarily engaged
in the business of providing, at-cost, management, administrative or related
services to the Fund and other investment companies. See "The Vanguard
Group" on page 9.
Although not fundamental policies subject to shareholder vote, as long
as the Fund's shares are registered for sale in certain states, it will not
(1) Invest more than 5% of the value of the total assets of the Fund at
the time of investment in the securities of any issuers which have records
of less than three years' continuous operation, including the operation of
any predecessor, but this limitation does not apply to securities issued or
guaranteed as to interest and principal by the United States Government or
its agencies or instrumentalities; or
(2) Purchase or retain any security of an issuer if an officer
or director of the Fund, or its investment adviser owns beneficially more
than 1/2% of the shares or securities of such issuer and all such directors
and officers owning more than 1/2% of such shares or securities together own
more than 5% of such shares or securities.
B-7
<PAGE>
MANAGEMENT OF THE FUND
Officers and Trustees
The Fund's Officers, under the supervision of the Board of Trustees,
manage the day-to-day operations of the Fund. The Trustees set broad
policies for the Fund and choose its Officers. Following is a list of the
Trustees and Officers of the Fund and a brief statement of their present
positions and principal occupations during the past 5 years. As of January
31, 1997, the Trustees and Officers of the Fund owned less than 1% of
the Fund's outstanding shares. The mailing address of the Trustees and
Officers of the Fund is Post Office Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman and Trustee *
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group; Director of The Mead
Corporation, General Accident Insurance and Chris-Craft
Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive Officer and Trustee *
President, Chief Executive Officer and Director of The Vanguard
Group, Inc., and of each of the investment companies in The Vanguard
Group.
ROBERT E. CAWTHORN, Trustee
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.;
Director of Sun Company, Inc. and Westinghouse Electric
Corporation.
BARBARA BARNES HAUPTFUHRER, Trustee
Director of The Great Atlantic and Pacific Tea Company, ALCO
Standard, Corp., Raytheon Company, Knight-Ridder, Inc., and
Massachusetts Mutual Life Insurance Co; and Trustee Emerita of
Wellesley College.
BRUCE K. MACLAURY, Trustee
President Emeritus of The Brookings Institution; Director of
American Express Bank, Ltd., The St. Paul Companies, Inc. and
National Steel Corporation.
BURTON G. MALKIEL, Trustee
Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corporation, Baker Fentress & Co., The Jeffrey Co., and Southern New
England Communications Company.
ALFRED M. RANKIN, Jr., Trustee
Chairman, Pres. and Chief Executive Officer of NACCO Industries,
Inc.; Director of The BFGoodrich Company and The Standard
Products Company.
JOHN C. SAWHILL, Trustee
President and Chief Executive Officer, The Nature Conservancy;
formerly, Director and Senior Partner, McKinsey & Co. and,
President, New York University; Director of Pacific Gas and
Electric Company, Proctor & Gamble Company and NACCO
Industries.
JAMES O. WELCH, Jr., Trustee
Retired Chairman of Nabisco Brands, Inc., retired Vice Chairman and
Director of RJR Nabisco; Director of TECO Energy, Inc. and
Kmart Corporation.
J. LAWRENCE WILSON, Trustee
Chairman and Chief Executive Officer of Rohm & Haas Company; Director
of Cummins Engine Company; and Trustee of Vanderbilt University.
RAYMOND J. KLAPINSKY, Secretary *
Senior Vice President and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer *
Treasurer of The Vanguard Group, Inc. and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, Controller *
Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
-------------------
*Officers of the Fund are "interested persons" as defined in the
Investment Company Act of 1940.
B-8
<PAGE>
The Vanguard Group
Vanguard Preferred Stock Fund is a member of The Vanguard Group of
Investment Companies. Through their jointly-owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other Funds in the Group obtain
at-cost virtually all of their corporate management, administrative and
distribution services. Vanguard also provides investment advisory services
on an at-cost basis to a number of the Vanguard Funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment.
Each Fund pays its share of Vanguard's total expenses which are allocated
among the Funds under methods approved by the Board of Trustees (Directors)
of each Fund. In addition, each Fund bears its own direct expenses, such as
legal, auditing and custodian fees.
The Vanguard Group adheres to a Code of Ethics established pursuant to
Rule 17j-1 under the Investment Company Act of 1940. The Code is
designed to prevent unlawful practices in connection with the purchase or
sale of securities by persons associated with Vanguard. Under Vanguard's
Code of Ethics certain Officers and employees of Vanguard who are
considered access persons are permitted to engage in personal securities
transactions. However, such transactions are subject to procedures and
guidelines substantially similar to those recommended by the mutual fund
industry and approved by the U.S. Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds has invested are adjusted from time to time
in order to maintain the proportionate relationship between each Fund's
relative net assets and its contribution to Vanguard's capital. The Funds'
Service Agreement provides as follows: (1) each Vanguard Fund may invest a
maximum of .40% of its current net assets in Vanguard, and (2) there are no
restrictions on the maximum aggregate cash investment that the Vanguard
Funds may make in Vanguard. At October 31, 1996, the Fund had
contributed capital of $27,000 to Vanguard, representing 0.1%
of Vanguard's capitalization.
Management
Corporate management and administrative services include: (1) executive
staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During
the fiscal year ended October 31, 1996, the Fund's share of
Vanguard's actual net costs of operation relating to management and
administrative services (including transfer agency) totaled approximately
$585,000.
Distribution
Vanguard provides all distribution and marketing activities for the
Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as Sales Agent for shares of
the Funds, in connection with any sales made directly to investors in the
states of Florida, Missouri, New York, Ohio, Texas and such other states as
it may be required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Directors
and Officers of Vanguard determine the amount to be spent annually on
distribution activities, the manner and amount to be spent on each Fund, and
whether to organize new investment companies.
One half of the distribution expenses of a marketing and promotional
nature is allocated among the Funds based upon their relative net assets.
The remaining one half of these expenses is allocated among the Funds based
upon each Fund's sales for the preceding 24 months relative to the total
sales of the Funds as a Group, provided, however, that no Fund's aggregate
quarterly rate of contribution for distribution expenses of a marketing and
promotional nature shall exceed 125% of the average distribution expense
rate for the Group, and that no Fund shall incur annual distribution
expenses in excess of .20 of 1% of its average month-end net assets.
During the fiscal year ended October 31, 1996, the Fund paid
approximately $65,000 of the Group's distribution and marketing
expenses, which represented an effective annual rate of .02 of 1% of
the Fund's average net assets.
B-9
<PAGE>
Investment Advisory Services
Vanguard provides investment advisory services to Vanguard Money Market
Reserves, Vanguard Treasury Fund, Vanguard Bond Index Fund, Vanguard
Index Trust, Vanguard Admiral Funds, Vanguard Balanced Index Fund, Vanguard
International Equity Index Fund, Vanguard Institutional Index Fund, Vanguard
Tax-Managed Fund, Aggressive Growth Portfolio of Vanguard Horizon Fund,
Vanguard REIT Index Portfolio, the Total International Portfolio of the
STAR Fund, Vanguard Municipal Bond Fund; several Portfolios of Vanguard
Fixed Income Securities Fund, several Portfolios of Vanguard Variable
Insurance Fund, Vanguard California Tax-Free Fund, Vanguard Florida Insured
Tax-Free Fund, Vanguard New Jersey Tax-Free Fund, Vanguard Ohio Tax-Free
Fund, Vanguard New York Insured Tax-Free Fund, Vanguard Pennsylvania Tax-
Free Fund, a portion of Vanguard/Windsor II, a portion of Vanguard/Morgan
Growth Fund as well as several indexed separate accounts. These services are
provided on an at-cost basis from a money management staff employed directly
by Vanguard. The compensation and other expenses of this staff are paid by
the Funds utilizing these services.
Remuneration of Trustees and Officers
The Fund pays each Trustee who is not also an Officer an annual fee
plus travel and other expenses incurred in attending Board meetings. The
Fund's Officers and employees are paid by Vanguard which, in turn, is
reimbursed by the Fund, and each other Fund in the Group, for its
proportionate share of Officers' and employees' salaries and retirement
benefits. The Fund's proportionate share of remuneration paid by Vanguard
(and reimbursed by the Fund) during the 1996 fiscal year to all
Officers of the Fund, as a group, was approximately $8,867.
Upon retirement, Trustees who are not Officers are paid an annual fee
based upon the number of years of service on the Board. The fee is equal to
$1,000 for each year of service on the Board up to a maximum of fifteen
years. Under its retirement plan, Vanguard contributes annually an amount
equal to 10% of each eligible Officer's annual compensation plus 5.7% of
that part of the eligible Officer's compensation during the year, if
any, that exceeds the Social Security Taxable Wage Base then in effect.
Under its thrift plan, all eligible Officers are permitted to make pre-tax
contributions in an amount equal to 4% of total compensation which are
matched by Vanguard on a 100% basis. The Fund's proportionate share of
retirement contributions made by Vanguard under its retirement and thrift
plans on behalf of all eligible Officers of the Fund, as a group, during the
1996 fiscal year was approximately $150.
The following table provides detailed information with respect to the
amounts paid or accrued for the Trustees, and the Officers of the Fund, for
the fiscal year ended October 31, 1996.
VANGUARD PREFERRED STOCK FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
Aggregate Pension or Estimated Total Compensation
Compensation Retirement Annual Benefits From All Vanguard
From Fund Benefits Accrued Upon Retirement Funds Paid to
As Part of Trustees (2)
Names of Trustees Fund Expenses
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John C. Bogle (1) -- -- -- --
John J. Brennan (1) -- -- -- --
Barbara Barnes Hauptfuhrer $107 $17 $15,000 $65,000
Robert E. Cawthorn $107 $14 $13,000 $65,000
Bruce K. MacLaury $116 $16 $12,000 $60,000
Burton G. Malkiel $107 $11 $15,000 $65,000
Alfred M. Rankin, Jr. $107 $ 9 $15,000 $65,000
John C. Sawhill $107 $10 $15,000 $65,000
James O. Welch, Jr. $107 $13 $15,000 $65,000
J. Lawrence Wilson $107 $ 9 $15,000 $65,000
- ----------------------------------------------------------------------------------------------------
(1) As "Interested Trustees," Messrs. Bogle and Brennan receive no compensation for their service.
(2) The amounts reported in this column reflect the total compensation paid to each Trustee for
their service as Director or Trustee of 34 Vanguard Funds (33 in the case of Mr. Malkiel; 27 in the
case of Mr. MacLaury).
</TABLE>
B-10
<PAGE>
INVESTMENT ADVISORY SERVICES
The Fund employs Wellington Management Company, LLP (the
"Adviser") under an investment advisory agreement dated August 1, 1996 to
manage the investment and reinvestment of the assets of the Fund and to
continuously review, supervise and administer the Fund's investment program.
The Adviser discharges its responsibilities subject to the control of the
Officers and Trustees of the Fund.
The Fund pays the Adviser an advisory fee at the end of each fiscal
quarter, calculated by applying a quarterly rate, based on the following
annual percentage rates, to the Fund's average month-end net assets for the
quarter:
Net Assets Rate
---------- ----
First $200 million ...................... .150%
Next $200 million ....................... .100%
Assets in excess of $400 million ........ .075%
During the fiscal years ended October 31, 1994, 1995 and
1996, the Fund paid advisory fees of $817,000, $706,669, and
$394,000, respectively. In 1994, 1995 and through July 31, 1996, fees were
paid under an advisory agreement that provided for a higher rate of
fees.
The present agreement continues until July 31, 1998 and is renewable
thereafter, for successive one-year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Trustees, including
the affirmative votes of a majority of the Trustees who are not parties to
the contract or "interested persons" (as defined in the Investment Company
Act of 1940) of any such party, cast in person at a meeting called for the
purpose of considering such approval.
The Fund's Board of Trustees may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of
a new advisory agreement, either as a replacement for an existing adviser or
as an additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same advisory
contract terms where a contract has been assigned because of a change in
control of the adviser.
Any such change will only be made upon not less than 30 days' prior
written notice to shareholders, which shall include the information
concerning the adviser that would have normally been included in a proxy
statement.
Description of the Adviser
Wellington Management Company, 75 State Street, Boston, MA 02109, is a
Massachusetts limited liability partnership, of which the following
persons are managing partners: Robert W. Doran, Duncan M. McFarland and John
R. Ryan.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the Adviser (with the
approval of the Fund's Board of Trustees) to select the brokers or dealers
that will execute the purchases and sales of portfolio securities for the
Fund and directs the Adviser to use its best efforts to obtain the best
available price and most favorable execution as to all transactions for the
Fund. The Adviser has undertaken to execute each investment transaction at a
price and commission which provides the most favorable total cost or
proceeds reasonably obtainable under the circumstances.
In placing portfolio transactions, the Adviser will use its best
judgment to choose the broker most capable of providing the brokerage
services necessary to obtain best available price and most favorable
execution. The full range and quality of brokerage services available will
be considered in making these determinations. In those instances where it is
reasonably determined that more than one broker can offer the brokerage
services needed to obtain the best available price and most favorable
execution, consideration may be given to those brokers which supply
investment research and statistical information and provide other services
in addition to execution services to the Fund and/or the Adviser. The
Adviser considers such information useful in the performance of its
obligations under the agreement but is unable to determine the amount by
which such services may reduce its expenses.
The investment advisory agreement also incorporates the
concepts of Section 28(e) of the Securities Exchange Act of 1934 by
providing that, subject to the approval of the Fund's Board of
Trustees, the Adviser may cause the Fund to pay a
B-11
<PAGE>
broker-dealer which furnishes brokerage and research services a higher
commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of the Adviser to the Fund and the other Funds in the
Group.
Currently, it is the Fund's policy that the Adviser may at times pay
higher commissions in recognition of brokerage services felt necessary for
the achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be in the best interest of the Fund. Some
brokers or dealers who may receive such higher commissions in recognition of
brokerage services related to execution of securities transactions are also
providers of research information to the Adviser and/or the Fund. However,
the Adviser has informed the Fund that it will not pay higher commission
rates specifically for the purpose of obtaining research services.
Since the Fund does not market its shares through intermediary brokers
or dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such
firms. However, the Fund may place portfolio orders with qualified broker-
dealers who recommend the Fund to other clients, or who act as agent in the
purchase of the Fund's shares for their clients, and may, when a number of
brokers and dealers can provide comparable best price and execution on a
particular transaction, consider the sale of Fund shares by a broker or
dealer in selecting among qualified broker-dealers.
During the fiscal years ended October 31, 1994, 1995 and
1996 the Fund paid $6,726, $509 and $7,554 in
brokerage commissions, respectively.
Some securities considered for investment by the Fund may also be
appropriate for other Funds and/or clients served by the Adviser. If
purchase or sale of securities consistent with the investment policies of
the Fund and one or more of these other Funds or clients served by the
Adviser are considered at or about the same time, transactions in such
securities will be allocated among the several Funds and clients in a manner
deemed equitable by the Adviser.
GENERAL INFORMATION
Description of Shares and Voting Rights
The Fund was originally organized as a Maryland corporation in 1975. On
November 12, 1984 the Fund was reorganized into a Pennsylvania business
trust which was created solely for that purpose. The Declaration of Trust
permits the Trustees to issue an unlimited number of shares of beneficial
interest, without par value.
The shares of the Fund are fully paid and non-assessable, except as set
forth under "Shareholder and Trustee Liability," and have no preference as
to conversion, exchange, dividends, retirement or other features. The shares
have no pre-emptive rights. The shares have non-cumulative voting rights,
which means that the holders of more than 50% of the shares voting for the
election of Trustees can elect 100% of the Trustees if they choose to do so.
A shareholder is entitled to one vote for each full share held (and a
fractional vote for each fractional share held), then standing in his name
on the books of the Fund. On any matter submitted to a vote of shareholders,
all shares of the Fund then issued and outstanding and entitled to vote,
irrespective of the class, shall be voted in the aggregate and not by class:
except (i) when required by the Investment Company Act of 1940, shares shall
be voted by individual class; and (ii) when the matter does not affect any
interest of a particular class, then only shareholders of the affected class
or classes shall be entitled to vote thereon.
The Fund will continue without limitation of time, provided however
that:
1) Subject to the majority vote of the holders of shares of the Fund
outstanding, the Trustees may sell or convert the assets of the Fund
to another investment company in exchange for shares of such
investment company, and distribute such shares, ratably among the
shareholders of the Fund; and
2) Subject to the majority vote of shares of the Fund outstanding, the
Trustees may sell and convert into money the assets of the Fund and
distribute such assets ratably among the shareholders of the Fund.
Upon completion of the distribution of the remaining proceeds or the
remaining assets of the Fund as provided in paragraphs 1) and 2) above, the
Fund shall terminate and the Trustees shall be discharged of any and all
further liabilities and duties hereunder and the right, title and interest
of all parties shall be cancelled and discharged.
B-12
<PAGE>
Shareholder and Trustee Liability
Under Pennsylvania law, shareholders of a trust may, under certain
circumstances, be held personally liable as partners for the obligations of
the Trust. Therefore, the Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Fund and
requires that notice of such disclaimer be given in each agreement,
obligation, or instrument entered into or executed by the Fund or the
Trustees. The Declaration of Trust provides for indemnification out of the
Fund property of any shareholder held personally liable for the obligations
of the Fund. The Declaration of Trust also provides that the Fund shall,
upon request, assume the defense of any claim made against any shareholder
for any act or obligation of the Fund and satisfy any judgment thereon.
Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund itself
would be unable to meet its obligations. The Trustees and officers of the
Fund believe that, in view of the above, the risk of personal liability to
shareholders is remote.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he
would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties involved in the
conduct of his office.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended October 31,
1996, including the financial highlights for each of the five fiscal
years in the period ended October 31, 1996, appearing in the Vanguard
Preferred Stock Fund 1996 Annual Report to Shareholders, and the
report thereon of Price Waterhouse LLP, independent accountants, also
appearing therein, are incorporated by reference in this Statement of
Additional Information. The Fund's 1996 Annual Report to Shareholders
is enclosed with this Statement of Additional Information. For a more
complete discussion of the Fund's performance, please see the Fund's
1996 Annual Report to Shareholders, which may be obtained without
charge.
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc.
or any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of The Vanguard Group, including
Vanguard Preferred Stock Fund, may, from time to time, use one or more of
the following unmanaged indices for comparative performance purposes.
Standard and Poor's 500 Composite Stock Price Index--is a well diversified
list of 500 companies representing the U.S. Stock Market.
Wilshire 5000 Equity Index--consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
Wilshire 4500 Equity Index--consists of all stocks in the Wilshire 5000
except for the 500 stocks in the Standard and Poor's 500 Index.
Morgan Stanley Capital International EAFE Index--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed
on the stock exchanges of countries in Europe, Australia and the Far
East.
Goldman Sachs 100 Convertible Bond Index--currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization.
The index is priced monthly.
Salomon Brothers GNMA Index--includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government
National Mortgage Association.
Salomon Brothers High-Grade Corporate Bond Index--consists of publicly
issued, non-convertible corporate bonds rated AA or AAA. It is a value-
weighted, total return index, including approximately 800 issues with
maturities of 12 years or greater.
B-13
<PAGE>
Lehman Brothers Aggregate Bond Index--is a market weighted index that
contains over 4,000 individually priced U.S. Treasury, agency,
corporate, and mortgage pass-through securities corporate rated BBB- or
better. The Index has a market value of over $4 trillion.
Lehman Brothers Mutual Fund Short (1-5) Government/Corporate Index--is a
market weighted index that contains over 1,500 individually priced U.S.
Treasury, agency, and corporate investment grade bonds rated BBB- or
better with maturities between 1 and 5 years. The index has a market
value of over $1.3 trillion.
Lehman Brothers Mutual Fund Intermediate (5-10) Government/Corporate Index--
is a market weighted index that contains over 1,500 individually priced
U.S. Treasury, agency, and corporate securities rated BBB- or better
with maturities between 5 and 10 years. The index has a market value of
over $600 billion.
Lehman Brothers Mutual Fund Long (10+) Government/Corporate Index--is a
market weighted index that contains over 1,900 individually priced U.S.
Treasury, agency, and corporate securities rated BBB- or better with
maturities greater than 10 years. The index has a market value of over
$900 billion.
Lehman Long-Term Treasury Bond Index--is composed of all bonds
covered by the Shearson Lehman Hutton Treasury Bond Index with
maturities of 10 years or greater.
Merrill Lynch Corporate & Government Bond Index--consists of over
4,500 U.S. Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index--all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a
maturity longer than 1 year and with more than $25 million outstanding.
This index includes over 1,000 issues.
Lehman Brothers Long-Term Corporate Bond Index--is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-
rate, nonconvertible U.S. debt issues rated at least Baa, with at least
$50 million principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal (20 year) Bond Index--is a yield index on current
coupon high grade general obligation municipal bonds.
Standard & Poor's Preferred Index--is a yield index based upon the average
yield of four high grade, noncallable preferred stock issues.
NASDAQ Industrial Index--is composed of more than 3,000 industrial issues.
It is a value-weighted index calculated on price change only and does
not include income.
Composite Index--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
Composite Index--65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
Composite Index--65% Lehman Long-Term Corporate AA or Better Bond Index and
a 35% weighting in a blended equity composite (75% Standard & Poor's /
BARRA Value Index and 25% Standard & Poor's Utilities Index).
Lehman Long-Term Corporate AA or Better Bond Index--consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-
denominated, SEC-registered corporate debt rated AA or AAA.
APPENDIX -- DESCRIPTION OF PREFERRED STOCK RATINGS
Excerpts from Moody's Investor Service, Inc. description of its
four highest preferred stock ratings: aaa -- 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 --
considered a high-grade preferred stock. This rating indicates that there is
reasonable assurance that earnings and asset protection will remain
relatively well maintained in the foreseeable future; a -- considered to be
an upper-medium grade preferred stock. While risks are judged to be somewhat
greater than in the aaa and aa classifications, earning and asset protection
are, nevertheless, expected to be maintained at adequate levels; baa --
considered to be lower-medium grade, neither highly protected nor poorly
secured. Earnings and asset protection appear adequate at present but may be
questionable over any great length of time.
B-14
<PAGE>
Excerpts from Standard & Poor's Corporation description of its four
highest preferred stock ratings:
Quality ratings are expressed by symbols like those rating bonds. They
are independent of Standard & Poor's bond ratings, however, in the sense
that they are not necessarily graduated downward from the rankings accorded
the issuing company's debt. They represent a considered judgment of the
relative security of dividends, and -- what is thereby implied -- the
prospective yield stability of the stock. The four highest ratings are AAA
- -- Prime; AA -- High Grade; A -- Sound; BBB -- Medium Grade.
B-15
<PAGE>
