<PAGE> 1
GRADISON - MCDONALD
GOVERNMENT INCOME FUND
LETTER TO SHAREHOLDERS
August 12, 1996
Dear Shareholder:
As 1995 came to a close the investment community as a whole felt that the
Federal Reserve Board had successfully "cooled off" a vigorous U.S. economy thus
preventing inflation from reappearing. This belief was manifested by the decline
of interest rates in the open market by approximately 2 full percentage points
(8% to 6% for the 30 year U.S. Treasury Bond). We did not wholeheartedly endorse
that view for many reasons, but primarily because we felt the market had gone
too far too fast and thus we were maintaining a "neutral" attitude regarding
further interest rate reductions. We obviously were not "neutral" enough because
we did experience a negative total return for the first 6 months of 1996, namely
- -1.03%. The Lehman Brothers Government Bond Index experienced a -1.79% return
during the same period. Your fund's average annual compounded return from
inception was 8.27%, at net asset value. See performance results.
The most recent economic numbers appear to be indicative of a very vigorous
economy, which may cause inflation fears to increase again. Once again, we do
not embrace this belief as pessimistically as many do. Initially, we must
remember that the G-7 nations are committed to a "stronger" U.S. dollar which
will erode our export capability. Also, there are enormous amounts of "cheap"
labor around the world and the exportation of U.S. jobs will continue to weaken
domestic labor's demands. Thirdly, many investment gurus are anticipating a weak
stock market and if that should happen, consumer confidence will wane, perhaps
very rapidly. Based on current circumstances, we intend to maintain a neutral
strategy, focusing on intermediate bonds and anticipating neither significantly
higher or lower interest rates.
As in the past, the Government Income Fund team appreciates your continued
patronage.
Sincerely,
Gradison-McDonald Government Income Fund
/s/ Michael J. Link
- -------------------------------
Michael J. Link
Executive Vice President and Portfolio Manager
[GRAPHIC]
<PAGE> 2
AVERAGE ANNUAL TOTAL RETURN PERIODS ENDED JUNE 30, 1996
<TABLE>
<CAPTION>
SINCE INCEPTION
9/16/87 5 YEARS 1 YEAR
<S> <C> <C> <C>
@ Maximum Offer Price (2% Sales Charge) 8.01% 6.61% 2.38%
@ Net Asset Value (No Sales Charge)* 8.27% 7.04% 4.45%
</TABLE>
*Certain qualifying group retirement Fund purchases are made without a sales
charge, as are all purchases representing reinvestment of dividends. See pages 6
and 9 of the Prospectus. This performance data does not reflect the deduction of
the sales charge which would reduce the performance illustrated to the figure of
the line above it.
The performance quoted above represents past performance. The investment return
and value of an investment in the Fund will fluctuate so that an investor's
shares, when redeemed, may be worth more or less than the original cost. Total
return includes changes in share value and reinvestment of all distributions.
See accompanying notes to financial statements.
2
<PAGE> 3
FINANCIAL HIGHLIGHTS (For a share outstanding throughout each period)
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED DECEMBER 31,
ENDED
JUNE 30, 1996 1995 1994 1993 1992 1991
<S> <C> <C> <C> <C> <C> <C>
Net asset value at beginning of period $13.214 $12.018 $13.373 $13.327 $13.553 $12.933
------- ------- ------- ------- ------- -------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income .387 .786 .755 .749 .856 .947
Net realized and unrealized gain (loss)
on investments (.526) 1.232 (1.244) .239 (.050) .785
------- ------- ------- ------- ------- -------
Total income (loss) from investment operations (.139) 2.018 (.489) .988 .806 1.732
------- ------- ------- ------- ------- -------
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income (.384) (.787) (.779) (.738) (.859) (.946)
Dividends in excess of net investment income - - (.013) - -
Distributions from realized capital gains - - (.053) (.204) (.173) (.166)
Distributions from paid-in capital - (.035) (.021) - - -
------- ------- ------- ------- ------- -------
Total distributions to shareholders (.384) (.822) (.866) (.942) (1.032) (1.112)
------- ------- ------- ------- ------- -------
Net asset value at end of year $12.691 $13.214 $12.018 $13.373 $13.327 $13.553
======= ======= ======= ======= ======= =======
Total return (1) (1.03%)(2) 17.20% (3.69%) 7.52% 6.29% 14.08%
======= ======= ======= ======= ======= =======
RATIOS/SUPPLEMENTAL DATA:
Net assets at end of period (in millions) $171.3 $185.4 $184.0 $266.0 $210.9 $151.8
Ratio of expenses to average net assets .88%(3) .92% .90% .90% .94% .99%
Ratio of net investment income to
average net assets 6.04%(3) 6.19% 6.03% 5.48% 6.39% 7.33%
Portfolio turnover rate 3.51% 15.84% 20.91% 133.88% 83.36% 108.08%
</TABLE>
On October 4, 1991, McDonald & Company Securities, Inc. became investment
adviser of the Fund as a result of a merger with Gradison & Company
Incorporated.
(1) Total return is based upon an initial investment purchased without a sales
charge.
(2) Total return for the six months ended June 30, 1996 represents the actual
return over that period and has not been annualized.
(3) Annualized.
See accompanying notes to financial statements.
3
<PAGE> 4
PORTFOLIO OF INVESTMENTS JUNE 30, 1996 (Unaudited)
<TABLE>
<CAPTION>
PAR COUPON
AMOUNT MORTGAGE-BACKED SECURITIES - 61.27% RATE MATURITY VALUE
<S> <C> <C> <C> <C>
$13,420,140 Government National Mortgage Association 6.50% 11/15/08-5/15/11 $13,038,505
736,033 Government National Mortgage Association 6.55 11/15/13 707,742
20,929,999 Government National Mortgage Association 7.00 4/15/23-9/15/23 20,073,177
22,256,069 Government National Mortgage Association 7.50 4/15/23-3/15/24 21,936,138
22,446,183 Government National Mortgage Association 8.00 7/15/02-7/15/26 22,777,164
3,774,621 Government National Mortgage Association 8.25 6/15/35 3,807,059
8,739,676 Government National Mortgage Association 8.50 4/15/21-11/15/22 8,985,479
2,633,873 Government National Mortgage Association 8.75 4/15/22 2,705,893
2,237,737 Government National Mortgage Association 9.00 1/15/20-8/15/21 2,341,932
3,523,335 Government National Mortgage Association 9.50 10/15/02-6/15/21 3,754,485
3,404,326 Government National Mortgage Association 10.00 5/15/12-6/15/21 3,709,652
-----------
TOTAL MORTGAGE-BACKED SECURITIES
(COST $106,524,442) 103,837,226
-----------
U.S. TREASURY OBLIGATIONS - 38.55%
10,000,000 U.S. Treasury Note 5.75 8/15/03 9,512,500
5,000,000 U.S. Treasury Bond 5.88 11/15/05 4,706,250
20,000,000 U.S. Treasury Note 6.25 2/15/03 19,650,000
10,000,000 U.S. Treasury Note 6.38 1/15/00 9,996,875
10,000,000 U.S. Treasury Bond 7.63 2/15/07 10,368,750
10,000,000 U.S. Treasury Bond 8.75 11/15/08 11,090,625
----------
TOTAL U.S. TREASURY OBLIGATIONS
(COST $68,005,469) 65,325,000
----------
FACE INTEREST
AMOUNT REPURCHASE AGREEMENT - 0.18% RATE (1)
300,000 Fuji Securities, dated 6/28/96, collateral: 5.42 7/1/96 300,000
-------
U.S. Treasury Notes, 6.125% due 9/30/00
with a market value of $308,023
(repurchase proceeds: $300,134)
(COST $300,000)
TOTAL INVESTMENTS, AT VALUE (NOTE 1)
(COST $174,829,911) - 100% $169,462,226
------------
</TABLE>
(1) For Repurchase agreements, the rate shown reflects the actual rate of return
to the Fund.
See accompanying notes to financial statements.
4
<PAGE> 5
STATEMENT OF ASSETS AND LIABILITIES (Unaudited)
<TABLE>
<CAPTION>
JUNE 30, 1996
<S> <C>
ASSETS
Investments in securities, at value (Note 1) (Cost $174,829,911) $169,462,226
Cash 32,966
Interest receivable 2,085,152
Receivable for Fund shares sold 73,055
Prepaid expenses and other assets 47,863
------------
TOTAL ASSETS 171,701,262
------------
LIABILITIES
Payable for Fund shares redeemed 259,785
Accrued investment advisory fee (Note 2) 65,261
Other accrued expenses payable to adviser (Note 2) 42,047
Other accrued expenses and liabilities 13,876
------------
TOTAL LIABILITIES 380,969
------------
NET ASSETS $171,320,293
============
Net assets consist of:
Aggregate paid-in capital $182,165,141
Distributions in excess of net investment income (Note 1) (154,928)
Accumulated net realized loss (5,322,235)
Net unrealized depreciation of investments (5,367,685)
------------
Net Assets $171,320,293
============
Shares of capital stock outstanding
(no par value - unlimited number of shares authorized ) 13,498,946
============
Net asset value and redemption price per share (Note 1) $ 12.69
============
Maximum offering price per share (Note 1) $ 12.95
============
</TABLE>
See accompanying notes to financial statements.
5
<PAGE> 6
STATEMENT OF OPERATIONS (Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1996
<S> <C> <C>
INTEREST INCOME $ 6,150,886
EXPENSES:
Investment advisory fee (Note 2) $ 444,011
Distribution (Note 2) 221,535
Personnel costs (Note 2) 32,597
Data Processing fee (Note 2) 23,109
Professional fees 21,299
Trustees' fees (Note 2) 11,395
Custodian fees 10,246
Registration fees 10,179
Other 9,240
-----------
TOTAL EXPENSES 783,611
----------
NET INVESTMENT INCOME 5,367,275
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized loss on investments (97,386)
Net realized gain on written call options closed and expired 172,656
Net change in unrealized depreciation of investments (7,471,116)
-----------
NET REALIZED AND UNREALIZED LOSS ON INVESTMENTS (7,395,846)
----------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS ($2,028,571)
==========
</TABLE>
See accompanying notes to financial statements.
6
<PAGE> 7
STATEMENTS OF CHANGES IN NET ASSETS (Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS YEAR
ENDED ENDED
JUNE 30, 1996 DECEMBER 31,1995
<S> <C> <C>
FROM OPERATIONS:
Net investment income $ 5,367,275 $ 11,374,446
Net realized gain (loss) on investments 75,270 (3,220,413)
Net change in unrealized appreciation (depreciation) of investments (7,471,116) 21,179,573
------------- ------------
Net increase (decrease) in net assets resulting from operations (2,028,571) 29,333,606
------------- ------------
FROM DISTRIBUTIONS TO SHAREHOLDERS:
Net investment income (5,313,687) (11,374,395)
Paid-in capital (Note 1) -- (495,716)
------------- ------------
Decrease in net assets from distributions to shareholders (5,313,687) (11,870,111)
------------- ------------
FROM FUND SHARE TRANSACTIONS:
Proceeds from shares sold 16,030,475 32,626,195
Net asset value of shares issued as distributions 4,453,476 9,872,425
Payments for fund shares redeemed (27,254,923) (58,557,288)
------------- ------------
Net decrease in net assets from Fund share transactions (6,770,972) (16,058,668)
------------- ------------
Total increase (decrease) in net assets (14,113,230) 1,404,827
NET ASSETS:
Beginning of period 185,433,523 184,028,696
------------- ------------
End of period (including distributions in excess of net investment
income of $154,928 and $208,516, respectively) (Note 1) $ 171,320,293 $185,433,523
============= ============
NUMBER OF FUND SHARES:
Sold 1,237,950 2,562,741
Issued as distributions to shareholders 346,031 774,962
Redeemed (2,117,885) (4,618,139)
------------- ------------
Net decrease in shares outstanding (533,904) (1,280,436)
Outstanding at beginning of period 14,032,850 15,313,286
------------- ------------
Outstanding at end of period 13,498,946 14,032,850
============= ============
</TABLE>
See Accompanying notes to financial statements.
7
<PAGE> 8
NOTES TO FINANCIAL STATEMENTS JUNE 30, 1996 (UNAUDITED)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Gradison Custodian Trust (the "Trust") is registered under the Investment
Company Act of 1940, as amended, as a diversified, open-end management
investment company. The Trust was created under Ohio law by a Declaration of
Trust dated June 3, 1987; it commenced investment operations and the public
offering of its shares on September 16, 1987. There is currently one series, the
Gradison-McDonald Government Income Fund (The "Fund"). The following is a
summary of the Trust's significant accounting policies:
SECURITIES VALUATION - Portfolio securities for which over-the counter market
quotations are readily available are valued at the latest bid price. Debt
securities maturing within 60 days are valued at amortized cost, which
approximates market value. Portfolio securities for which market quotations are
not readily available are valued at their fair value as determined in good faith
by the Board of Trustees.
Repurchase agreements, which are collateralized by U.S. Government obligations,
are valued at cost which, together with accrued interest, approximates market.
Collateral for repurchase agreements is held in safekeeping in the customer-only
account of the Fund's custodian. At the time the Fund enters into a repurchase
agreement, the seller agrees that the value of the underlying security,
including accrued interest, will be equal to or exceed the face amount of the
repurchase agreement. In the event of a bankruptcy or other default of the
seller of a repurchase agreement, the Fund could experience both delays in
liquidating the underlying security and losses. These losses would not exceed an
amount equal to the difference between the liquidating value of the underlying
security and the face amount of the repurchase agreement and accrued interest.
To minimize the possibility of loss, the Fund enters into repurchase agreements
only with selected domestic banks and securities dealers which the Fund's
investment adviser believes present minimal credit risk. Refer to the Fund's
Portfolio of Investments for the face amount of repurchase agreements and
repurchase proceeds as of June 30, 1996.
OPTION ACCOUNTING PRINCIPLES - When the Fund writes a call option, an amount
equal to the premium received by the Fund is recorded as an asset and as an
equivalent liability. The amount of the liability is subsequently
marked-to-market to reflect the current market value of the written option. The
current market value of a traded option is the last ask price on the principal
exchange on which such option is traded. If the option expires on its stipulated
expiration date or if the Fund enters into a closing purchase transaction, the
Fund will realize a gain or loss without regard to any unrealized gain or loss
on the underlying security and liability related to such option will be
extinguished.
The risk in writing a call option on a security which the Fund owns is that the
Fund limits the profit potential from an increase in the market price of the
security. The Fund may also be subject to the additional risk of not being able
to enter into a closing transaction if a liquid secondary market does not exist.
The Fund also writes over-the-counter options where the Fund's ability to
successfully extinguish its obligation is dependent upon the credit standing of
the other party.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME - Securities transactions are
accounted for on the trade date (the date the order to buy or sell is executed).
Interest income is accrued as earned. Gains and losses on sales of investments
are calculated on the identified cost basis for financial reporting and tax
purposes.
SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY BASIS - When the Fund
purchases securities on a when-issued or delayed delivery basis, the transaction
may be entered into a month or more before delivery and payment are made. Such
securities are subject to market fluctuation during this period. In the event
that the seller fails to deliver the securities, the Fund could experience a
loss to the extent of any appreciation, or a gain to the extent of any
depreciation, in the price of the securities.
The Fund will maintain, in a segregated account with its custodian, cash or U.S.
Government securities having an aggregate value at least equal to the amount of
such purchase commitments. At June 30, 1996, the Fund had not committed to the
purchase or any when-issued or delayed delivery securities.
8
<PAGE> 9
NOTES TO FINANCIAL STATEMENTS JUNE 30, 1996 (UNAUDITED)
TAXES - It is the Fund's policy to comply with the provisions of the Internal
Revenue Code available to regulated investment companies. As provided therein,
in any fiscal year in which the Fund so qualifies, and distributes at least 90%
of its taxable net income, the Fund will be relieved of federal income tax on
the income distributed. Accordingly, no provision for income taxes has been
made.
In order to avoid imposition of the excise tax applicable to regulated
investment companies, it is also the Fund's intention to declare as dividends in
each calendar year, at least 98% of its net investment income (earned during the
calendar year) and 98% of its net realized capital gains, if any (earned during
the twelve months ended October 31), plus undistributed amounts from prior
years.
The tax basis of investments is substantially equal to the cost as shown on the
Statement of Assets and Liabilities.
For both financial reporting and tax purposes, gross unrealized appreciation and
gross unrealized depreciation of securities at June 30, 1996 was $940,464 and
$6,308,149, respectively.
As of December 31, 1995, the Fund had a capital loss carryforward for Federal
income tax purposes of approximately $5,350,000 which may be utilized to offset
future net realized capital gains.
FUND SHARE VALUATION - The net asset value per share is computed by dividing the
net asset value of the Fund (total assets less total liabilities) by the number
of shares outstanding. The maximum offering price per share is equal to the net
asset value per share plus 2.04% of net asset value (or 2% of the offering
price). The offering price per share is reduced on sales of $100,000 or more.
The redemption price per share is equal to the net asset value per share.
DISTRIBUTION TO SHAREHOLDERS - Dividends arising from net investment income are
declared daily and paid monthly. Distributions of net realized short-term
capital gains, if any, are declared and paid monthly on all shares of record on
established record dates. Net realized long-term capital gains, if any, are
distributed at least annually. During the year ended December 31, 1995, the Fund
made distributions to shareholders of $495,716 from paid-in capital.
NOTE 2 - TRANSACTIONS WITH AFFILIATES
The Fund's investments are managed, subject to the general supervision and
control of the Fund's Board of Trustees, by the Gradison Division of McDonald &
Company Securities, Inc. (Gradison), a registered investment adviser and
securities dealer, pursuant to the terms of an Investment Advisory Agreement
(the Agreement). Under the terms of the Agreement, the Fund pays Gradison a fee
computed and accrued daily and paid monthly based upon the Fund's daily net
assets at the annual rate of .50%.
Under the terms of the Agreement, the Fund reimburses Gradison for the cost of
furnishing personnel to perform shareholder and certain other services for the
Fund. The Agreement also provides that Gradison bear the costs of salaries and
related expenses of executive officers of the Fund who are necessary for the
management and operations of the Fund. In addition, Gradison bears the costs of
preparing, printing and mailing sales literature and other advertising
materials, and compensates the Fund's trustees who are affiliated with Gradison.
All expenses not specifically assumed by Gradison are borne by the Fund.
Under the terms of a Data Processing Agreement between the Trust and Gradison,
the Fund pays Gradison a monthly fee at an annual rate of $8.25 per shareholder
non-zero balance account for data processing services to the Fund.
In accordance with the terms of a Distribution Service Plan adopted under Rule
12b-1 of the Investment Company Act of 1940, the Fund pays Gradison a
distribution service fee at an annual rate of .25% of average daily net assets.
9
<PAGE> 10
NOTES TO FINANCIAL STATEMENTS JUNE 30, 1996 (UNAUDITED)
During the period ended June 30, 1996, Gradison received sales charges
aggregating $72,343 on sales of shares of the Fund.
The officers of the Trust are also officers of McDonald & Company Securities,
Inc.
Each trustee of the Trust who is not affiliated with Gradison receives fees from
the Trust for services as a trustee. The amounts of such fees for each trustee
are as follows: (a) an annual fee of $3,500 payable in quarterly installments
for service during each fiscal quarter and (b) $500 for each Board of Trustees
or committee meeting attended.
NOTE 3 - SUMMARY OF SECURITIES TRANSACTIONS
For the period ended June 30, 1996, purchases and proceeds from the sale of
securities, excluding short-term securities, amounted to $14,104,080 and
$6,082,575, respectively. Transactions in written options on U.S. Treasury Notes
and Bonds were as follows:
<TABLE>
<CAPTION>
NO. OF CONTRACTS PREMIUM
---------------- -------
<S> <C> <C>
Outstanding at December 31, 1995 0 $ 0
Written 2,500 177,344
Closed (1,500) (113,281)
Expired (1,000) (64,063)
------- ---------
Outstanding at June 30, 1996 0 $ 0
======= =========
-----------------------------------------------------------------------
</TABLE>
NOTE 4 - SHORT TERM BORROWINGS
The Fund had available a Line of Credit Promissory Note (the "Note") from Star
Bank (the "Bank"), the Fund's custodian, whereby borrowings may not exceed
$2,400,000 (in accordance with the Note), or 10% of total assets (in accordance
with the Fund's investment restrictions).
Information regarding borrowings on the Note by the Fund during the period ended
June 30, 1996 is as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1996
------------------------------
<S> <C>
Balance outstanding at June 30, 1996 $ 0
========
Maximum amount outstanding during the period $420,000
========
Average amount outstanding during the period $ 11,083
========
Weighted average interest during the period 6.13%
========
Interest expense on borrowings during the period $ 334
========
- ---------------------------------------------------------------------------------------------
</TABLE>
The average amount outstanding during the period was calculated by aggregating
borrowings at the end of each day and dividing by the total number of days in
the period. The weighted average interest rate during the period was calculated
by dividing the interest on borrowings during the period by the average amount
of borrowings outstanding during the period.
10
<PAGE> 11
GRADISON-MC DONALD FAMILY OF FUNDS
Increasingly, MUTUAL FUNDS are the preferred vehicle for starting and building
an investment program. And today, Gradison-McDonald is a preferred name in
mutual funds for a GROWING number of investors.
OHIO TAX-FREE INCOME FUND
An income fund which seeks to provide income exempt from regular Federal income
tax and Ohio state personal income tax.*
ESTABLISHED VALUE FUND
A common stock fund that seeks long-term capital growth by investing in
companies that are included in the Standard & Poor's 500 Index and other large
companies.
GROWTH & INCOME FUND
A common stock fund that seeks long-term capital growth, current income and
growth of income.
OPPORTUNITY VALUE FUND
A common stock fund that seeks long-term capital growth by investing in
companies that are generally smaller in size than those included in the Standard
& Poor's 500 Index.
INTERNATIONAL FUND
A common stock fund that seeks capital growth by investing in common stocks of
non-United States companies.
MONEY MARKET FUNDS
Gradison-McDonald offers a full range of taxable and tax-free money market
funds.
Prospectuses are available upon request by calling (800) 869-5999 and should be
read carefully before you invest. An investment in the money market funds is
neither insured nor guaranteed by the U.S. Government and there can be no
assurance that they will be able to maintain a stable $1.00 share price. The
return and principal value of an investment in other funds will fluctuate so
that an investor's shares, when redeemed, may be worth more or less than the
original cost. The returns of all funds will fluctuate.
* Investment income may be subject to the federal alternative minimum tax.
Capital gains, if any, are taxable.
11
<PAGE> 12
GOVERNMENT
INCOME FUND
Gradison-McDonald
SEMIANNUAL REPORT
June 30, 1996
A Fund Investing In
U.S. Government Securities
Gradison-McDonald
This material is intended for distribution to shareholders of Gradison-McDonald
Government Income Fund. It may be distributed to other persons only if it is
preceded or accompanied by a current prospectus of the Gradison-McDonald
Government Income fund.
McDonald & Company Securities, Inc -- Distributor
