<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 6, 1996
SECURITIES ACT FILE NO. 33-35442
INVESTMENT COMPANY ACT FILE NO. 811-4375
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 /x/
PRE-EFFECTIVE AMENDMENT NO. / /
POST-EFFECTIVE AMENDMENT NO. 7 /x/
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 /x/
AMENDMENT NO. 131 /x/
(CHECK APPROPRIATE BOX OR BOXES)
------------------------
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
OF MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
<TABLE>
<S> <C>
800 SCUDDERS MILL ROAD 08536
PLAINSBORO, NEW JERSEY (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (609) 282-2800
ARTHUR ZEIKEL
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
------------------------
Copies to:
<TABLE>
<S> <C>
COUNSEL FOR THE TRUST: PHILIP L. KIRSTEIN, ESQ.
BROWN & WOOD LLP FUND ASSET MANAGEMENT
ONE WORLD TRADE CENTER P.O. BOX 9011
NEW YORK, NEW YORK 10048-0557 PRINCETON, NEW JERSEY 08543-9011
ATTENTION: THOMAS R. SMITH JR., ESQ.
</TABLE>
------------------------
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE
(CHECK APPROPRIATE BOX)
/ / immediately upon filing pursuant to paragraph (b)
/x/ on November 15, 1996 pursuant to paragraph (b)
/ / 60 days after filing pursuant to paragraph (a)(1)
/ / on (date) pursuant to paragraph (a)(1)
/ / 75 days after filing pursuant to paragraph (a)(2)
/ / on (date) pursuant to paragraph (a)(2) of Rule 485.
IF APPROPRIATE, CHECK THE FOLLOWING BOX:
/ / this post-effective amendment designates a new effective
date for a previously filed post-effective amendment.
------------------------
THE REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF ITS SHARES UNDER THE
SECURITIES ACT OF 1933 PURSUANT TO RULE 24F-2 UNDER THE INVESTMENT COMPANY ACT
OF 1940. THE NOTICE REQUIRED BY SUCH RULE FOR THE REGISTRANT'S MOST RECENT
FISCAL YEAR WAS FILED ON SEPTEMBER 26, 1996.
------------------------
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED
TITLE OF SECURITIES AMOUNT OF SHARES OFFERING PRICE MAXIMUM AGGREGATE AMOUNT OF
BEING REGISTERED BEING REGISTERED PER UNIT OFFERING PRICE REGISTRATION FEE
<S> <C> <C> <C> <C>
Shares of Beneficial Interest
(par value $.10 per share).................. 1,399,286 $11.66 $329,990 $100
</TABLE>
*(1) The calculation of the maximum aggregate offering price is made pursuant to
Rule 24e-2 under the Investment Company Act of 1940.
(2) The total amount of securities redeemed or repurchased during the
Registrant's previous fiscal year was 2,704,244 shares of beneficial
interest.
(3) 1,333,259 of the shares described in (2) above have been used for reduction
pursuant to Rule 24e-2(a) or Rule 24f-2(c) under the Investment Company Act
of 1940 in previous filings during the Registrant's current fiscal year.
(4) 1,370,985 of the shares redeemed during the Registrant's previous fiscal
year are being used for the reduction of the registration fee in this
amendment to the Registration Statement.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND OF
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
N-1A ITEM NO. LOCATION
- ------------- ------------------------------
<S> <C> <C>
PART A
Item 1. Cover Page.................... Cover Page
Item 2. Synopsis...................... Fee Table
Item 3. Condensed Financial
Information................. Financial Highlights
Item 4. General Description of
Registrant.................. Investment Objectives and
Policies; Additional
Information
Item 5. Management of the Fund........ Fee Table; Management of the
Trust; Inside Back Cover Page
Item 5A. Management's Discussion of
Fund Performance............ Not Applicable
Item 6. Capital Stock and Other
Securities.................. Cover Page; Merrill Lynch
Select PricingSM System;
Additional Information
Item 7. Purchase of Securities Being
Offered..................... Cover Page; Fee Table; Merrill
Lynch Select PricingSM System;
Purchase of Shares;
Shareholder Services;
Additional Information;
Inside Back Cover Page
Item 8. Redemption or Repurchase...... Fee Table; Merrill Lynch
Select PricingSM System;
Purchase of Shares;
Redemption of Shares
Item 9. Pending Legal Proceedings..... Not Applicable
PART B
Item 10. Cover Page.................... Cover Page
Item 11. Table of Contents............. Back Cover Page
Item 12. General Information and
History..................... Additional Information
Item 13. Investment Objective and
Policies.................... Investment Objective and
Policies; Investment
Restrictions
Item 14. Management of the Fund........ Management of the Trust
Item 15. Control Persons and Principal
Holders of Securities....... Management of the Trust;
Additional Information
Item 16. Investment Advisory and Other
Services.................... Management of the Trust;
Purchase of Shares; General
Information
Item 17. Brokerage Allocation and Other
Practices................... Portfolio Transactions
Item 18. Capital Stock and Other
Securities.................. General
Information--Description of
Shares
Item 19. Purchase, Redemption and
Pricing of Securities Being
Offered..................... Purchase of Shares; Redemption
of Shares;
Determination of Net Asset
Value;
Shareholder Services
Item 20. Tax Status.................... Distributions and Taxes
Item 21. Underwriters.................. Purchase of Shares
Item 22. Calculation of Performance
Data........................ Performance Data
Item 23. Financial Statements.......... Financial Statements
PART C
</TABLE>
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
PROSPECTUS
NOVEMBER 15, 1996
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011-PHONE NO. (609) 282-2800
Merrill Lynch Pennsylvania Municipal Bond Fund (the 'Fund') is a mutual
fund seeking to provide shareholders with as high a level of income exempt from
Federal and Pennsylvania personal income taxes as is consistent with prudent
investment management. The Fund invests primarily in a portfolio of long-term,
investment grade obligations issued by or on behalf of the Commonwealth of
Pennsylvania, its political subdivisions, agencies and instrumentalities and
obligations of other qualifying issuers, such as issuers located in Puerto Rico,
the Virgin Islands, and Guam, which pay interest exempt from Federal and
Pennsylvania personal income taxes ('Pennsylvania Municipal Bonds'). Dividends
paid by the Fund are exempt from Federal and Pennsylvania personal income taxes
to the extent they are derived from Pennsylvania Municipal Bonds. The Fund may
invest in certain tax-exempt securities classified as 'private activity bonds'
that may subject certain investors in the Fund to an alternative minimum tax. At
times, the Fund may seek to hedge its portfolio through the use of futures
transactions and options. There can be no assurance that the investment
objective of the Fund will be realized. For more information on the Fund's
investment objective and policies, please see 'Investment Objective and
Policies' on page 9.
------------------------
Pursuant to the Merrill Lynch Select Pricing(Service Mark) System, the Fund
offers four classes of shares, each with a different combination of sales
charges, ongoing fees and other features. The Merrill Lynch Select
Pricing(Service Mark) System permits an investor to choose the method of
purchasing shares that the investor believes is most beneficial given the amount
of the purchase, the length of time the investor expects to hold the shares and
other relevant circumstances. See 'Merrill Lynch Select Pricing(Service Mark)
System' on page 4.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the 'Distributor'), P.O. Box 9081, Princeton, New Jersey 08543-9081 [(609)
282-2800], or from securities dealers which have entered into dealer agreements
with the Distributor, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated ('Merrill Lynch'). The minimum initial purchase is $1,000 and the
minimum subsequent purchase is $50. Merrill Lynch may charge its customers a
processing fee (presently $4.85) for confirming purchases and repurchases.
Purchases and redemptions directly through the Fund's Transfer Agent are not
subject to the processing fee. See 'Purchase of Shares' and 'Redemption of
Shares'.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
This Prospectus is a concise statement of information about the Fund that
is relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated November 15, 1996 (the 'Statement of Additional
Information'), has been filed with the Securities and Exchange Commission (the
'Commission') and is available, without charge, by calling or by writing Merrill
Lynch Multi-State Municipal Series Trust (the 'Trust') at the above-referenced
telephone number or address. The Statement of Additional Information is hereby
incorporated by reference into this Prospectus. The Fund is a separate series of
the Trust, an open-end management investment company organized as a
Massachusetts business trust.
------------------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
---------- --------------------------- ----------------- -------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price)..... 4.00%(c) None None 4.00%(c)
Sales Charge Imposed on Dividend
Reinvestments........................... None None None None
Deferred Sales Charge (as a percentage of
original purchase price or redemption
proceeds, whichever is lower)........... None(d) 4.0% during the first year, 1.0% for one None(d)
decreasing 1.0% annually year(f)
thereafter to 0.0% after
the fourth year(e)
Exchange Fee.............................. None None None None
ANNUAL FUND OPERATING EXPENSES (AS A
PERCENTAGE OF AVERAGE NET ASSETS):
Management Fees(g)........................ 0.55% 0.55% 0.55% 0.55%
Rule 12b-1 Fees(h):
Account Maintenance Fees................ None 0.25% 0.25% 0.10%
Distribution Fees....................... None 0.25% 0.35% None
(Class B shares convert to
Class D shares
automatically
after approximately ten
years,
cease being subject to
distribution fees and are
subject to lower account
maintenance fees)
Other Expenses:
Custodial Fees.......................... .01% .01% .01% .01%
Shareholder Servicing Costs(i).......... .05% .06% .06% .05%
Other................................... .15% .15% .15% .15%
----- ----- ----- -----
Total Other Expenses.................. .21% .22% .22% .21%
----- ----- ----- -----
Total Fund Operating Expenses............. .76% 1.27% 1.37% .86%
===== ===== ===== =====
</TABLE>
- ------------
<TABLE>
<S> <C>
(a) Class A shares are sold to a limited group of investors including existing Class A shareholders and certain
participants in fee-based programs. See 'Purchase of Shares--Initial Sales Charge Alternatives--Class A and
Class D Shares'--page 22 and 'Shareholder Services--Fee-Based Programs'--page 32.
(b) Class B shares convert to Class D shares automatically approximately 10 years after initial purchase. See
'Purchase of Shares--Deferred Sales Charge Alternatives--Class B and Class C Shares'--page 24.
(c) Reduced for purchases of $25,000 and over and waived for purchases of Class A shares in connection with certain
fee-based programs. Class A or Class D purchases of $1,000,000 or more may not be subject to an initial sales
charge. See 'Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class D Shares'--page 22.
(d) Class A and Class D shares are not subject to a contingent deferred sales charge ('CDSC'), except that certain
purchases of $1,000,000 or more which are not subject to an initial sales charge may instead be subject to a
CDSC of 1.0% of amounts redeemed within the first year after purchase. Such CDSC may be waived in connection
with redemptions to fund participation in certain fee-based programs. See 'Shareholder Services--Fee-Based
Programs'--page 32.
(e) The CDSC may be modified in connection with redemptions to fund participation in certain fee-based programs.
See 'Shareholder Services--Fee-Based Programs'--page 32.
(f) The CDSC may be waived in connection with redemptions to fund participation in certain fee-based programs. See
'Shareholder Services--Fee-Based Programs'--page 32.
(g) See 'Management of the Trust--Management and Advisory Arrangements'--page 19.
(h) See 'Purchase of Shares--Distribution Plans'--page 27.
(i) See 'Management of the Trust--Transfer Agency Services'--page 20.
</TABLE>
2
<PAGE>
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID FOR THE PERIOD OF:
-------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000 investment
including the maximum $40 initial sales charge (Class A and Class D
shares only) and assuming (1) the Total Fund Operating Expenses for
each class set forth on page 2, (2) a 5% annual return throughout
the periods and (3) redemption at the end of the period:
Class A......................................................... $ 47 $63 $81 $130
Class B......................................................... $ 53 $60 $70 $153
Class C......................................................... $ 24 $43 $75 $165
Class D......................................................... $ 48 $66 $86 $142
An investor would pay the following expenses on the same $1,000
investment assuming no redemption at the end of the period:
Class A......................................................... $ 47 $63 $81 $130
Class B......................................................... $ 13 $40 $70 $153
Class C......................................................... $ 14 $43 $75 $165
Class D......................................................... $ 48 $66 $86 $142
</TABLE>
- ------------
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Commission regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR ANNUAL RATE OF RETURN, AND ACTUAL EXPENSES OR ANNUAL
RATES OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE
EXAMPLE. Class B and Class C shareholders who hold their shares for an extended
period of time may pay more in Rule 12b-1 distribution fees than the economic
equivalent of the maximum front-end sales charge permitted under the Conduct
Rules of the National Association of Securities Dealers, Inc. ('NASD'). Merrill
Lynch may charge its customers a processing fee (presently $4.85) for confirming
purchases and repurchases. Purchases and redemptions directly through the Fund's
Transfer Agent are not subject to the processing fee. See 'Purchase of Shares'
and 'Redemption of Shares'.
3
<PAGE>
MERRILL LYNCH SELECT PRICING(Service Mark) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(Service Mark) System. The shares of each class may be purchased at a
price equal to the next determined net asset value per share subject to the
sales charges and ongoing fee arrangements described below. Shares of Class A
and Class D are sold to investors choosing the initial sales charge
alternatives, and shares of Class B and Class C are sold to investors choosing
the deferred sales charge alternatives. The Merrill Lynch Select Pricing(Service
Mark) System is used by more than 50 registered investment companies advised by
Merrill Lynch Asset Management, L.P. ('MLAM') or Fund Asset Management, L.P.
('FAM' or the 'Manager'), an affiliate of MLAM. Funds advised by MLAM or FAM
which utilize the Merrill Lynch Select Pricing(Service Mark) System are referred
to herein as 'MLAM-advised mutual funds'.
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
CDSCs, distribution and account maintenance fees that are imposed on Class B and
Class C shares, as well as the account maintenance fees that are imposed on the
Class D shares, are imposed directly against those classes and not against all
assets of the Fund and, accordingly, such charges will not affect the net asset
value of any other class or have any impact on investors choosing another sales
charge option. Dividends paid by the Fund for each class of shares will be
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Each class has different exchange privileges. See 'Shareholder
Services--Exchange Privilege'.
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(Service Mark)
System, followed by a more detailed description of each class and a discussion
of the factors that investors should consider in determining the method of
purchasing shares under the Merrill Lynch Select Pricing(Service Mark) System
that the investor believes is most beneficial under his particular
circumstances. More detailed information as to each class of shares is set forth
under 'Purchase of Shares'.
4
<PAGE>
<TABLE>
<CAPTION>
ACCOUNT DISTRIBUTION
CLASS SALES CHARGE(1) MAINTENANCE FEE FEE CONVERSION FEATURE
<S> <C> <C> <C> <C>
A Maximum 4.00% initial No No No
sales charge(2)(3)
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to
at a rate of 4.0% during the D shares automatically
first year, decreasing 1.0% after approximately
annually to 0.0%(4) ten years(5)
C 1.0% CDSC for one year(6) 0.25% 0.35% No
D Maximum 4.00% initial 0.10% No No
sales charge(3)
</TABLE>
- ------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs are imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See 'Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares--Eligible Class A
Investors.'
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class A
shares in connection with certain fee-based programs. Class A and Class D
share purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject to a 1.0% CDSC if redeemed within one
year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See 'Class A' and 'Class D'
below.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs may be modified. Also, Class B shares of certain other MLAM-advised
mutual funds into which exchanges may be made have an eight year conversion
period. If Class B shares of a Fund are exchanged for Class B shares of
another MLAM-advised mutual fund, the conversion period applicable to the
Class B shares acquired in the exchange will apply, and the holding period
for the shares exchanged will be tacked onto the holding period for the
shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class A shares.
Investors that currently own Class A shares of the Fund in a
shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Other eligible investors include
participants in certain fee-based programs. In addition, Class A shares
will be offered at net asset value to Merrill Lynch & Co., Inc. ('ML &
Co.') and its subsidiaries (the term 'subsidiaries', when used herein
with respect to ML & Co., includes MLAM, the Manager and certain other
entities directly or indirectly wholly-owned and controlled by ML &
Co.) and their directors and employees, and to members of the Boards of
MLAM-advised mutual funds. The maximum initial sales charge is 4.00%,
which is reduced for purchases of $25,000 and over and waived for
purchases of Class A shares in connection with certain fee-based
programs. Purchases of $1,000,000 or more may not be subject to an
initial sales charge, but if the initial sales charge is waived, such
purchases may be subject to a 1.0% CDSC if the shares are redeemed
within one year after purchase. Such CDSC may be waived in connection
with redemptions to fund participation in certain fee-based programs.
Sales charges are also reduced under a right of accumulation which
takes into account the investor's holdings of all classes of all
MLAM-advised mutual funds. See 'Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares'.
Class B: Class B shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25%, and an
ongoing distribution fee of 0.25% of the Fund's average net assets
attributable to Class B shares, as well as a CDSC if they are redeemed
within four years of
5
<PAGE>
purchase. Such CDSC may be modified in connection with redemptions to
fund participation in certain fee-based programs. Approximately ten
years after issuance, Class B shares will convert automatically into
Class D shares of the Fund, which are subject to a lower account
maintenance fee of 0.10% and no distribution fee; Class B shares of
certain other MLAM-advised mutual funds into which exchanges may be
made convert into Class D shares automatically after approximately
eight years. If Class B shares of the Fund are exchanged for Class B
shares of another MLAM-advised mutual fund, the conversion period
applicable to the Class B shares acquired in the exchange will apply,
as will the Class D account maintenance fee of the acquired fund upon
the conversion, and the holding period for the shares exchanged will be
tacked onto the holding period for the shares acquired. Automatic
conversion of Class B shares into Class D shares will occur at least
once a month on the basis of the relative net asset values of the
shares of the two classes on the conversion date, without the
imposition of any sales load, fee or other charge. Conversion of Class
B shares to Class D shares will not be deemed a purchase or sale of the
shares for Federal income tax purposes. Shares purchased through
reinvestment of dividends on Class B shares also will convert
automatically to Class D shares. The conversion period for dividend
reinvestment shares is modified as described under 'Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C
Shares--Conversion of Class B Shares to Class D Shares'.
Class C: Class C shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25% and an
ongoing distribution fee of 0.35% of the Fund's average net assets
attributable to Class C shares. Class C shares are also subject to a
CDSC of 1.0% if they are redeemed within one year of purchase. Such
CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs. Although Class C shares are subject to a
CDSC for only one year (as compared to four years for Class B shares),
Class C shares have no conversion feature and, accordingly, an investor
that purchases Class C shares will be subject to account maintenance
fees and higher distribution fees that will be imposed on Class C
shares for an indefinite period subject to annual approval by the
Trust's Board of Trustees and regulatory limitations.
Class D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.10% of the
Fund's average net assets attributable to Class D shares. Class D
shares are not subject to an ongoing distribution fee or any CDSC when
they are redeemed. Purchases of $1,000,000 or more may not be subject
to an initial sales charge, but if the initial sales charge is waived
such purchases may be subject to a CDSC of 1.0% if the shares are
redeemed within one year after purchase. Such CDSC may be waived in
connection with redemptions to fund participation in certain fee-based
programs. The schedule of initial sales charges and reductions for the
Class D shares is the same as the schedule for Class A shares, except
that there is no waiver for purchases of Class D shares in connection
with certain fee-based programs. Class D shares also will be issued
upon conversion of Class B shares as described above under 'Class B'.
See 'Purchase of Shares--Initial Sales Charge Alternatives--Class A and
Class D Shares'.
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing(Service Mark) System that the investor believes is most beneficial under
his or her particular circumstances.
Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly
6
<PAGE>
reduced initial sales charges may find the initial sales charge alternative
particularly attractive because similar sales charge reductions are not
available with respect to the CDSCs imposed in connection with purchases of
Class B or Class C shares. Investors not qualifying for reduced initial sales
charges who expect to maintain their investment for an extended period of time
also may elect to purchase Class A or Class D shares, because over time the
accumulated ongoing account maintenance and distribution fees on Class B or
Class C shares may exceed the initial sales charge and, in the case of Class D
shares, the account maintenance fee. Although some investors that previously
purchased Class A shares may no longer be eligible to purchase Class A shares of
other MLAM-advised mutual funds, those previously purchased Class A shares,
together with Class B shares holdings, will count toward a right of accumulation
which may qualify the investor for reduced initial sales charges on new initial
sales charge purchases. In addition, the ongoing Class B and Class C account
maintenance and distribution fees will cause Class B and Class C shares to have
higher expense ratios, pay lower dividends and have lower total returns than the
initial sales charge shares. The ongoing Class D account maintenance fees will
cause Class D shares to have a higher expense ratio, pay lower dividends and
have a lower total return than Class A shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the benefit
of putting all of the investor's dollars to work from the time the investment is
made. The deferred sales charge alternatives may be particularly appealing to
investors who do not qualify for a reduction in initial sales charges. Both
Class B and Class C shares are subject to ongoing account maintenance fees and
distributions fees; however, the ongoing account maintenance and distribution
fees potentially may be offset to the extent any return is realized on the
additional funds initially invested in Class B or Class C shares. In addition,
Class B shares will be converted into Class D shares of the Fund after a
conversion period of approximately ten years, and thereafter investors will be
subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all their funds invested initially and intend to
hold their shares for an extended period of time. Investors in Class B shares
should take into account whether they intend to redeem their shares within the
CDSC period and, if not, whether they intend to remain invested until the end of
the conversion period and thereby take advantage of the reduction in ongoing
fees resulting from the conversion into Class D shares. Other investors,
however, may elect to purchase Class C shares if they determine that it is
advantageous to have all their assets invested initially and they are uncertain
as to the length of time they intend to hold their assets in MLAM-advised mutual
funds. Although Class C shareholders are subject to a shorter CDSC period at a
lower rate, they are subject to higher distribution fees and forgo the Class B
conversion feature, making their investment subject to account maintenance and
distribution fees for an indefinite period of time. In addition, while both
Class B and Class C distribution fees are subject to the limitations on
asset-based sales charges imposed by the NASD, the Class B distribution fees are
further limited under a voluntary waiver of asset-based sales charges. See
'Purchase of Shares--Limitations on the Payment of Deferred Sales Charges'.
7
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with the annual audits of the financial statements of the Fund by
Deloitte & Touche LLP, independent auditors. Financial statements for the year
ended July 31, 1996 and the independent auditors' report thereon are included in
the Statement of Additional Information. The following per share data and ratios
have been derived from information provided in the Fund's audited financial
statements. Further information about the performance of the Fund is contained
in the Fund's most recent annual report to shareholders which may be obtained,
without charge, by calling or by writing the Trust at the telephone number or
address on the front cover of this Prospectus.
<TABLE>
<CAPTION>
CLASS A CLASS B
---------------------------------------------------------------- ----------------------------------------
FOR THE PERIOD
FOR THE YEAR ENDED JULY 31, AUG. 31 FOR THE YEAR ENDED JULY 31,
----------------------------------------------- 1990+ TO ----------------------------------------
1996 1995 1994 1993 1992 JULY 31, 1991 1996 1995 1994 1993
------- ------- ------- ------- ------- ------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease)
in Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning
of period.......... $ 11.07 $ 11.00 $ 11.39 $ 11.04 $ 10.27 $10.00 $ 11.07 $ 11.00 $ 11.39 $ 11.04
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Investment
income--net........ .61 .62 .60 .63 .67 .61 .55 .56 .54 .58
Realized and
unrealized
gain (loss) on
investments--net... .10 .07 (.33) .36 .77 .27 .10 .07 (.33) .36
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Total from
investment
operations......... .71 .69 .27 .99 1.44 .88 .65 .63 .21 .94
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Less dividends and
distributions:
Investment
income--net........ (.61) (.62) (.60) (.63) (.67) (.61) (.55) (.56) (.54) (.58)
Realized gain on
investments--net... -- -- (.04) (.01) -- -- -- -- (.04) (.01)
In excess of
realized gain on
investments--net... -- -- (.02) -- -- -- -- -- (.02) --
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Total dividends and
distributions...... (.61) (.62) (.66) (.64) (.67) (.61) (.55) (.56) (.60) (.59)
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Net asset value, end
of
period............. $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04 $10.27 $ 11.17 $ 11.07 $ 11.00 $ 11.39
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
TOTAL INVESTMENT
RETURN:**
Based on net asset
value
per share.......... 6.53% 6.54% 2.37% 9.30% 14.53% 9.30%# 5.98% 6.00% 1.86% 8.75%
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
RATIOS TO AVERAGE
NET ASSETS:
Expenses, net of
reimbursement...... .76% .77% .75% .69% .55% .39%* 1.27% 1.28% 1.25% 1.19%
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Expenses............ .76% .77% .75% .81% .97% 1.57%* 1.27% 1.28% 1.25% 1.32%
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Investment
income--net........ 5.41% 5.72% 5.30% 5.70% 6.33% 6.71%* 4.91% 5.21% 4.80% 5.19%
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
SUPPLEMENTAL DATA:
Net assets, end of
period
(in thousands)..... $21,626 $23,040 $28,239 $27,639 $17,144 $9,402 $120,565 $123,260 $130,418 $109,463
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
Portfolio
turnover........... 58.33% 59.17% 37.73% 9.69% 4.14% -- 58.33% 59.17% 37.73% 9.69%
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
------- ------- ------- ------- ------- ----- -------- ------- -------- --------
<CAPTION>
CLASS B CLASS C CLASS D
-------------------------- ---------------------- ----------------------
FOR THE FOR THE FOR THE
YEAR FOR THE PERIOD FOR THE PERIOD
ENDED FOR THE PERIOD YEAR OCTOBER 21, YEAR OCTOBER 21,
JULY 31, AUG. 31 ENDED 1994+ ENDED 1994+
-------- 1990+ TO JULY 31, TO JULY 31, JULY 31, TO JULY 31,
1992 JULY 31, 1991 1996 1995 1996 1995
-------- ------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease)
in Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning
of period.......... $ 10.27 $ 10.00 $11.07 $ 10.68 $11.08 $ 10.68
------- ------ -------- ----- -------- -----
Investment
income--net........ .62 .57 .54 .43 .60 .47
Realized and
unrealized
gain (loss) on
investments--net... .77 .27 .10 .39 .10 .40
------- ------ -------- ----- -------- -----
Total from
investment
operations......... 1.39 .84 .64 .82 .70 .87
------- ------ -------- ----- -------- -----
Less dividends and
distributions:
Investment
income--net........ (.62) (.57) (.54) (.43) (.60) (.47)
Realized gain on
investments--net... -- -- -- -- -- --
In excess of
realized gain on
investments--net... -- -- -- -- -- --
------- ------ -------- ----- -------- -----
Total dividends and
distributions...... (.62) (.57) (.54) (.43) (.60) (.47)
------- ------ -------- ----- -------- -----
Net asset value, end
of period......... $ 11.04 $ 10.27 $11.17 $ 11.07 $11.18 $ 11.08
------- ------ -------- ----- -------- -----
------- ------ -------- ----- -------- -----
TOTAL INVESTMENT
RETURN:**
Based on net asset
value per share... 13.94% 8.81%# 5.87% 7.83%# 6.42% 8.36%#
------- ------ -------- ----- -------- -----
------- ------ -------- ----- -------- -----
RATIOS TO AVERAGE
NET ASSETS:
Expenses, net of
reimbursement...... 1.06% .90%* 1.37% 1.38%* .86% .87%*
------- ------ -------- ----- -------- -----
------- ------ -------- ----- -------- -----
Expenses............ 1.48% 2.07%* 1.37% 1.38%* .86% .87%*
------- ------ -------- ----- -------- -----
------- ------ -------- ----- -------- -----
Investment
income--net........ 5.81% 6.21%* 4.80% 5.05%* 5.31% 5.65%*
------- ------ -------- ----- -------- -----
------- ------ -------- ----- -------- -----
</TABLE>
<TABLE>
<CAPTION>
SUPPLEMENTAL DATA:
<S> <<C> <C> <C> <C> <C> <C>
Net assets, end of
period
(in thousands)..... $65,599 $ 30,435 $4,722 $ 1,868 $3,583 $ 2,630
------- ------ -------- ----- -------- -----
------- ------ -------- ----- -------- -----
Portfolio
turnover........... 4.14% -- 58.33% 59.17% 58.33% 59.17%
------- ------ -------- ----- -------- -----
------- ------ -------- ----- -------- -----
</TABLE>
- ------------
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as
high a level of income exempt from Federal and Pennsylvania personal income
taxes as is consistent with prudent investment management. The Fund seeks to
achieve its objective by investing primarily in a portfolio of long-term
obligations issued by or on behalf of the Commonwealth of Pennsylvania, its
political subdivisions, agencies and instrumentalities and obligations of other
qualifying issuers, such as issuers located in Puerto Rico, the Virgin Islands,
and Guam, which pay interest exempt, in the opinion of bond counsel to the
issuer, from Federal and Pennsylvania personal income taxes. Obligations exempt
from Federal income taxes are referred to herein as 'Municipal Bonds' and
obligations exempt from both Federal and Pennsylvania income taxes are referred
to as 'Pennsylvania Municipal Bonds.' Unless otherwise indicated, references to
Municipal Bonds shall be deemed to include Pennsylvania Municipal Bonds. The
Fund at all times, except during temporary defensive periods, will maintain at
least 65% of its total assets invested in Pennsylvania Municipal Bonds. The
investment objective of the Fund as set forth in the first sentence of this
paragraph is a fundamental policy of the Fund and may not be changed without
shareholder approval. At times, the Fund may seek to hedge its portfolio through
the use of futures transactions to reduce volatility in the net asset value of
Fund shares.
Municipal Bonds may include several types of bonds. The Fund may also
invest in variable rate demand obligations ('VRDOs'). The interest on Municipal
Bonds may bear a fixed rate or be payable at a variable or floating rate. At
least 80% of the Municipal Bonds purchased by the Fund primarily will be what
are commonly referred to as 'investment grade' securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ('Moody's') (currently Aaa,
Aa, A and Baa), Standard & Poor's Ratings Group ('Standard & Poor's') (currently
AAA, AA, A and BBB) or Fitch Investors Service, Inc. ('Fitch') (currently AAA,
AA, A and BBB). If Municipal Bonds are unrated, such securities will possess
creditworthiness comparable, in the opinion of the Manager of the Fund, to
obligations in which the Fund may invest. Bonds rated in the fourth highest
rating category, while considered 'investment grade', have certain speculative
characteristics and are more likely to be downgraded to non-investment grade
than obligations rated in one of the top three rating categories. See Appendix
II--'Ratings of Municipal Bonds' in the Statement of Additional Information for
more information regarding ratings of debt securities. An issue of rated
Municipal Bonds may cease to be rated or its rating may be reduced below
'investment grade' subsequent to its purchase by the Fund. If an obligation is
downgraded below investment grade, the Manager will consider factors such as
price, credit risk, market conditions, financial condition of the issuer and
interest rates to determine whether to continue to hold the obligation in the
Fund's portfolio.
The Fund may invest up to 20% of its total assets in Municipal Bonds that
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch. Such
securities, sometimes referred to as 'high yield' or 'junk' bonds, are
predominantly speculative with respect to the capacity to pay interest and repay
principal in accordance with the terms of the security and generally involve a
greater volatility of price than securities in higher rating categories. The
market prices of high-yielding, lower-rated securities may fluctuate more than
higher-rated securities and may decline significantly in periods of general
economic difficulty, which may follow periods of rising interest rates. In
purchasing such securities, the Fund will rely on the Manager's judgment,
analysis and experience in evaluating the creditworthiness of the issuer of such
securities. The Manager will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and trends,
its operating history, the quality of its management and regulatory matters. See
'Investment Objective and Policies' in the Statement of Additional Information
for a more detailed discussion of the pertinent risk factors involved in
investing in 'high yield' or 'junk' bonds and Appendix II--'Ratings of Municipal
Bonds' in the Statement of Additional Information for additional information
regarding ratings of debt securities. The
9
<PAGE>
Fund does not intend to purchase debt securities that are in default or which
the Manager believes will be in default.
Certain Municipal Bonds may be entitled to the benefits of letters of
credit or similar credit enhancements issued by financial institutions. In such
instances, the Trustees and the Manager will take into account in assessing the
quality of such bonds not only the creditworthiness of the issuer of such bonds
but also the creditworthiness of the financial institution.
The Fund's investments include both VRDOs, and VRDOs in the form of
participation interests ('Participating VRDOs') in variable rate tax-exempt
obligations held by a financial institution. The VRDOs in which the Fund will
invest are tax-exempt obligations which contain a floating or variable interest
rate adjustment formula and an unconditional right of demand on the part of the
holder thereof to receive payment of the unpaid principal balance plus accrued
interest on a short notice period not to exceed seven days. Participating VRDOs
provide the Fund with a specified undivided interest (up to 100%) of the
underlying obligation and the right to demand payment of the unpaid principal
balance plus accrued interest on the Participating VRDOs from the financial
institution on a specified number of days' notice, not to exceed seven days.
There is, however, some possibility that because of default or insolvency, the
demand feature of VRDOs or Participating VRDOs may not be honored. The Fund has
been advised by its counsel that the Fund should be entitled to treat the income
received on Participating VRDOs as interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
exceeding seven days will therefore be subject to the Fund's restriction on
illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for such
determination.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Pennsylvania income taxes. However, to the extent that suitable
Pennsylvania Municipal Bonds are not available for investment by the Fund, the
Fund may purchase Municipal Bonds issued by other states, their agencies and
instrumentalities, the interest income on which is exempt, in the opinion of
bond counsel, from Federal, but not Pennsylvania, income taxes. The Fund also
may invest in securities not issued by or on behalf of a state or territory or
by an agency or instrumentality thereof, if the Fund nevertheless believes such
securities to be exempt from Federal income taxation ('Non-Municipal Tax-Exempt
Securities'). Non-Municipal Tax-Exempt Securities also may include securities
issued by other investment companies that invest in municipal bonds, to the
extent such investments are permitted by the Investment Company Act of 1940, as
amended (the '1940 Act'). Other Non-Municipal Tax-Exempt Securities could
include trust certificates or other instruments evidencing interests in one or
more long-term municipal securities.
Under normal circumstances, except when acceptable securities are
unavailable as determined by the Manager, the Fund will invest at least 65% of
its total assets in Pennsylvania Municipal Bonds. For temporary defensive
periods or to provide liquidity, the Fund has the authority to invest as much as
35% of its total assets in tax-exempt or taxable money market obligations with a
maturity of one year or less (such short-term obligations being referred to
herein as 'Temporary Investments'), except that taxable Temporary Investments
shall not exceed 20% of the Fund's net assets. The Temporary Investments, VRDOs
and Participating VRDOs in which the Fund may invest also will be in the
following rating categories at the time of purchase: MIG-1/VMIG-1 through
MIG-4/VMIG-4 for notes and VRDOs and Prime-1 through Prime-3 for commercial
paper (as
10
<PAGE>
determined by Moody's), SP-1 through SP-2 for notes and A-1 through A-3 for
VRDOs and commercial paper (as determined by Standard & Poor's), or F-1 through
F-3 for notes, VRDOs and commercial paper (as determined by Fitch) or, if
unrated, of comparable quality in the opinion of the Manager. The Fund at all
times will have at least 80% of its net assets invested in securities the
interest on which is exempt from Federal income taxation. However, interest
received on certain otherwise tax-exempt securities which are classified as
'private activity bonds' (in general, bonds that benefit non-governmental
entities) may be subject to Federal alternative minimum tax. The percentage of
the Fund's net assets invested in 'private activity bonds' will vary during the
year. See 'Distributions and Taxes'. In addition, the Fund reserves the right to
invest temporarily a greater portion of its assets in Temporary Investments for
defensive purposes, when, in the judgment of the Manager, market conditions
warrant. The investment objective of the Fund is a fundamental policy of the
Fund which may not be changed without a vote of a majority of the outstanding
shares of the Fund. The Fund's hedging strategies, which are described in more
detail under 'Financial Futures Transactions and Options', are not fundamental
policies and may be modified by the Trustees of the Trust without the approval
of the Fund's shareholders.
POTENTIAL BENEFITS
Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and Pennsylvania
personal income taxes by investing in a professionally managed portfolio of
long-term Pennsylvania Municipal Bonds. The Fund also provides liquidity because
of its redemption features and relieves the investor of the burdensome
administrative details involved in managing a portfolio of tax-exempt
securities. The benefits are at least partially offset by the expenses involved
in operating an investment company. Such expenses primarily consist of the
management fee and operational costs and, in the case of certain classes of
shares, the account maintenance and distribution costs.
SPECIAL AND RISK CONSIDERATIONS RELATING TO MUNICIPAL BONDS
The risks and special considerations involved in investments in Municipal
Bonds vary with the types of instruments being acquired. Investments in
Non-Municipal Tax-Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as derivative instruments. See 'Description of Municipal Bonds'
and 'Financial Futures Transactions and Options'.
Moreover, the Fund ordinarily will invest at least 65% of its total assets
in Pennsylvania Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of Pennsylvania Municipal Bonds than is a municipal
bond mutual fund that is not concentrated in issuers of Pennsylvania Municipal
Bonds to this degree.
Many different social, environmental and economic factors may affect the
financial condition of Pennsylvania and its political subdivisions. From time to
time Pennsylvania and certain of its political subdivisions have encountered
financial difficulties which have adversely affected their respective credit
standings. For example, the financial condition of the City of Philadelphia had
impaired its ability to borrow and resulted in its obligations generally being
downgraded by the major rating services to below investment grade. Other factors
which may negatively affect economic conditions in Pennsylvania include adverse
changes in employment rates, Federal revenue sharing or laws with respect to
tax-exempt financing. For the 1995 fiscal year, the Commonwealth of Pennsylvania
recorded a $49.8 million deficit (determined on a 'GAAP' basis). Some of the
deficit was attributable to changes in the methodology used to compute certain
liabilities. Currently,
11
<PAGE>
Pennsylvania's general obligation bonds are rated AA- by Standard & Poor's and
Fitch and A1 by Moody's. See 'Description of Municipal Bonds' in the Statement
of Additional Information and see also Appendix I to the Statement of Additional
Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction and equipping of a wide range of public
facilities (including water, sewer, gas, electricity, solid waste, health care,
transportation, education and housing facilities), refunding of outstanding
obligations and obtaining funds for general operating expenses and loans to
other public institutions and facilities. In addition, certain types of bonds
are issued by or on behalf of public authorities to finance various privately
operated facilities, including certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. For purposes of this Prospectus,
such obligations are Municipal Bonds if the interest paid thereon is excluded
from gross income for Federal income tax purposes ('exempt from Federal income
tax') and, in the case of Pennsylvania Municipal Bonds, exempt from Pennsylvania
personal income tax, even though such bonds may be IDBs or 'private activity
bonds' as discussed below.
The two principal classifications of Municipal Bonds are 'general
obligation' and 'revenue' bonds which latter category includes industrial
development bonds ('IDBs') and, for bonds issued after August 15, 1986, private
activity bonds. General obligation bonds are secured by the issuer's pledge of
its faith, credit and taxing power for the payment of principal and interest.
The taxing power of any governmental entity may be limited, however, by
provisions of its state constitution or laws, and an entity's creditworthiness
will depend on many factors, including potential erosion of the tax base due to
population declines, natural disasters, declines in the state's industrial base
or inability to attract new industries, economic limits on the ability to tax
without eroding the tax base, state legislative proposals or voter initiatives
to limit ad valorem real property taxes, and the extent to which the entity
relies on Federal or state aid, access to capital markets or other factors
beyond the state or entity's control. Accordingly, the capacity of the issuer of
a general obligation bond as to the timely payment of interest and the repayment
of principal when due is affected by the issuer's maintenance of its tax base.
Revenue bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as from the user of the
facility being financed; accordingly, the timely payment of interest and the
repayment of principal in accordance with the terms of the revenue or special
obligation bond is a function of the economic viability of such facility or such
revenue source. The Fund will not invest in revenue bonds where the entity
supplying the revenues from which the issuer is paid, including predecessors,
has a record of less than three years of continuous business operations, if such
investments, together with investments in other unseasoned issuers, would exceed
5% of the Fund's total assets. Investments involving entities with less than
three years of continuous business operations may pose somewhat greater risks
due to the lack of a substantial operating history for such entities. The
Manager believes, however, that the potential benefits of such investments
outweigh the potential risks, particularly given the Fund's limitations on such
investments.
The Fund may purchase IDBs or private activity bonds. IDBs or private
activity bonds are, in most cases, tax-exempt securities issued by states,
municipalities or public authorities and are issued to provide funds, usually
through a loan or lease arrangement, to a private entity for the purpose of
financing construction or improvement of a facility to be used by the entity.
Such bonds are secured primarily by revenues derived from loan repayments or
lease payments due from the entity which may or may not be guaranteed by a
parent company or otherwise secured. IDBs and private activity bonds are
generally not secured by a pledge of the taxing power of the issuer
12
<PAGE>
of such bonds. Therefore, an investor should be aware that repayment of such
bonds generally depends on the revenues of a private corporation and be aware of
the risks that such an investment may entail. Continued ability of a corporation
to generate sufficient revenues for the payment of principal and interest on
such bonds will be affected by many factors including the size of the
corporation, capital structure, demand for its products or services,
competition, general economic conditions, government regulation and the
corporation's dependence on revenues for the operation of the particular
facility being financed. The Fund may also invest in so-called 'moral
obligation' bonds, which are normally issued by special purpose public
authorities. If an issuer of moral obligation bonds is unable to meet its
obligations, the repayment of such bonds becomes a moral commitment, but not a
legal obligation, of the state or municipality in question.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the value
of the particular index. Interest and principal payable on the Municipal Bonds
may also be based on relative changes among particular indices. Also, the Fund
may invest in so-called 'inverse floating obligations' or 'residual interest
bonds' on which the interest rates typically decline as market rates increase
and increase as market rates decline. The Fund's return on such types of
Municipal Bonds (and Non-Municipal Tax-Exempt Securities) will be subject to
risk with respect to the value of the particular index, which may include
reduced or eliminated interest payments and losses of invested principal. Such
securities have the effect of providing a degree of investment leverage, since
they may increase or decrease in value in response to changes, as an
illustration, in market interest rates at a rate which is a multiple (typically
two) of the rate at which fixed-rate long-term tax-exempt securities increase or
decrease in response to such changes. As a result, the market values of such
securities will generally be more volatile than the market values of fixed-rate
tax-exempt securities. To seek to limit the volatility of these securities, the
Fund may purchase inverse floating obligations with shorter-term maturities or
which contain limitations on the extent to which the interest rate may vary.
Certain investments in such obligations may be illiquid. The Fund may not invest
in such illiquid obligations if such investments, together with other illiquid
investments, would exceed 15% of the Fund's total assets. The Manager believes,
however, that indexed and inverse floating obligations represent flexible
portfolio management instruments for the Fund which allow the Fund to seek
potential investment rewards, hedge other portfolio positions or vary the degree
of investment leverage relatively efficiently under different market conditions.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called 'lease
obligations') relating to such equipment, land or facilities. Although lease
obligations do not constitute general obligations of the issuer for which the
issuer's unlimited taxing power is pledged, a lease obligation is frequently
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. However, certain lease obligations contain
'non-appropriation' clauses which provide that the issuer has no obligation to
make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. Although 'non-appropriation'
lease obligations are secured by the leased property, disposition of the
property in the event of foreclosure might prove difficult. These securities
represent a type of financing that has not yet developed the depth of
marketability associated with more conventional securities. Certain investments
in lease obligations may be illiquid. The Fund may not
13
<PAGE>
invest in illiquid lease obligations if such investments, together with all
other illiquid investments, would exceed 15% of the Fund's total assets. The
Fund may, however, invest without regard to such limitation in lease obligations
which the Manager, pursuant to guidelines which have been adopted by the Board
of Trustees and subject to the supervision of the Board, determines to be
liquid. The Manager will deem lease obligations to be liquid if they are
publicly offered and have received an investment grade rating of Baa or better
by Moody's, or BBB or better by Standard & Poor's or Fitch. Unrated lease
obligations, or those rated below investment grade, will be considered liquid if
the obligations come to the market through an underwritten public offering and
at least two dealers are willing to give competitive bids. In reference to
obligations rated below investment grade, the Manager must, among other things,
also review the creditworthiness of the municipality obligated to make payment
under the lease obligation and make certain specified determinations based on
such factors as the existence of a rating or credit enhancement such as
insurance, the frequency of trades or quotes for the obligation and the
willingness of dealers to make a market in the obligation.
The value of bonds and other fixed-income obligations may fall when
interest rates rise and rise when interest rates fall. In general, bonds and
other fixed-income obligations with longer maturities will be subject to greater
volatility resulting from interest rate fluctuations than will similar
obligations with shorter maturities. Under normal conditions, it is generally
anticipated that the Fund's average weighted maturity would be in excess of ten
years.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation which may be enacted in the future may affect
the availability of Municipal Bonds for investment by the Fund.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a 'Call
Right'). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to that of
holding a Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS
The Fund may purchase or sell Municipal Bonds on a delayed delivery basis
or a when-issued basis at fixed purchase terms. These transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future. The purchase will be recorded on the date the Fund enters
into the commitment and the value of the obligation will thereafter be reflected
in the calculation of the Fund's net asset value. The value of the obligation on
the delivery date may be more or less than its purchase price. A separate
account of the Fund will be established with its custodian consisting of cash,
cash equivalents or liquid securities having a market value at all times at
least equal to the amount of the forward commitment.
14
<PAGE>
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
The Fund is authorized to purchase and sell certain exchange traded
financial futures contracts ('financial futures contracts') solely for the
purpose of hedging its investments in Municipal Bonds against declines in value
and to hedge against increases in the cost of securities it intends to purchase.
However, any transactions involving financial futures or options (including puts
and calls associated therewith) will be in accordance with the Fund's investment
policies. A financial futures contract obligates the seller of a contract to
deliver and the purchaser of a contract to take delivery of the type of
financial instrument covered by the contract, or in the case of index-based
futures contracts to make and accept a cash settlement, at a specific future
time for a specified price. A sale of financial futures contracts may provide a
hedge against a decline in the value of portfolio securities because such
depreciation may be offset, in whole or in part, by an increase in the value of
the position in the financial futures contracts. A purchase of financial futures
contracts may provide a hedge against an increase in the cost of securities
intended to be purchased, because such appreciation may be offset, in whole or
in part, by an increase in the value of the position in the futures contracts.
Distributions, if any, of net long-term capital gains from certain transactions
in futures or options are taxable at long-term capital gains rates for Federal
income tax purposes, regardless of the length of time the shareholder has owned
Fund shares. See 'Distributions and Taxes--Taxes'.
The Fund deals in financial futures contracts traded on the Chicago Board
of Trade based on The Bond Buyer Municipal Bond Index, a price-weighted measure
of the market value of 40 large, recently issued tax-exempt bonds. There can be
no assurance, however, that a liquid secondary market will exist to terminate
any particular financial futures contract at any specific time. If it is not
possible to close a financial futures position entered into by the Fund, the
Fund would continue to be required to make daily cash payments of variation
margin in the event of adverse price movements. In such a situation, if the Fund
has insufficient cash, it may have to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do so.
The inability to close financial futures positions also could have an adverse
impact on the Fund's ability to hedge effectively. 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 financial futures contract.
The Fund may purchase and sell financial futures contracts on U.S.
Government securities and write and purchase put and call options on such
futures contracts as a hedge against adverse changes in interest rates as
described more fully in the Statement of Additional Information. With respect to
U.S. Government securities, currently there are financial futures contracts
based on long-term U.S. Treasury bonds, Treasury notes, Government National
Mortgage Association ('GNMA') Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Trustees, the Fund also may engage in
other financial futures contracts transactions and options thereon, such as
financial futures contracts or options on other municipal bond indexes which may
become available if the Manager of the Fund and the Trustees of the Trust should
determine that there is normally a sufficient correlation between the prices of
such futures contracts and the Municipal Bonds in which the Fund invests to make
such hedging appropriate.
Utilization of futures transactions and options thereon involves the risk
of imperfect correlation in movements in the price of futures contracts and
movements in the price of the security which is the subject of the hedge. If the
price of the futures contract moves more or less than the price of the security
that is the subject of the hedge, the Fund will experience a gain or loss which
will not be completely offset by movements in the price of such security. There
is a risk of imperfect correlation where the securities underlying futures
contracts have different maturities, ratings or geographic mixes than the
security being hedged. In addition, the correlation may
15
<PAGE>
be affected by additions to or deletions from the index which serves as a basis
for a financial futures contract. Finally, in the case of futures contracts on
U.S. Government securities and options on such futures contracts, the
anticipated correlation of price movements between the U.S. Government
securities underlying the futures or options and Municipal Bonds may be
adversely affected by economic, political, legislative or other developments
which have a disparate impact on the respective markets for such securities.
Under regulations of the Commodity Futures Trading Commission ('CFTC'), the
futures trading activities described herein will not result in the Fund being
deemed to be a 'commodity pool', as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, the Fund may
purchase and sell futures contracts and options thereon (i) only for bona fide
hedging purposes, and (ii) for non-hedging purposes, if the aggregate initial
margins and premiums required to establish positions in such contracts and
options does not exceed 5% of the liquidation value of the Fund's portfolio
assets after taking into account unrealized profits and unrealized losses on any
such contracts and options. (However, as stated above, the Fund intends to
engage in options and futures transactions only for hedging purposes.) Margin
deposits may consist of cash or securities acceptable to the broker and the
relevant contract market.
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., high grade commercial paper and daily tender adjustable
notes) or liquid securities in a segregated account with the Fund's custodian,
so that the amount so segregated plus the amount of initial and variation margin
held in the account of its broker equals the market value of the futures
contracts, thereby ensuring that the use of such futures contract is
unleveraged. It is not anticipated that transactions in futures contracts will
have the effect of increasing portfolio turnover.
Although certain risks are involved in options and futures transactions,
the Manager believes that, because the Fund will engage in futures transactions
only for hedging purposes, the futures portfolio strategies of the Fund will not
subject the Fund to certain risks frequently associated with speculation in
futures transactions. The Fund must meet certain Federal income tax requirements
under the Internal Revenue Code of 1986, as amended (the 'Code'), in order to
qualify for the special tax treatment afforded regulated investment companies,
including a requirement that less than 30% of its gross income be derived from
the sale or other disposition of securities held for less than three months.
Additionally, the Fund is required to meet certain diversification requirements
under the Code.
The liquidity of a secondary market in a futures contract may be adversely
affected by 'daily price fluctuation limits' established by commodity exchanges
which limit the amount of fluctuation in a futures contract price during a
single trading day. Once the daily limit has been reached in the contract, no
trades may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past moved beyond the
daily limit on a number of consecutive trading days.
The successful use of transactions in futures also depends on the ability
of the Manager to forecast correctly the direction and extent of interest rate
movements within a given time frame. To the extent these rates remain stable
during the period in which a futures contract is held by the Fund or moves in a
direction opposite to that anticipated, the Fund may realize a loss on the
hedging transaction which is not fully or partially offset by an increase in the
value of portfolio securities. As a result, the Fund's total return for such
period may be less than if it had not engaged in the hedging transaction.
Furthermore, the Fund will only engage in hedging transactions from time to time
and may not necessarily be engaging in hedging transactions when movements in
interest rates occur.
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
16
<PAGE>
REPURCHASE AGREEMENTS
As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer in U.S. Government
securities or an affiliate thereof. Under such agreements, the seller agrees,
upon entering into the contract, to repurchase the security from the Fund at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. The Fund may not invest in repurchase
agreements maturing in more than seven days if such investments, together with
the Fund's other illiquid investments, exceed 15% of the Fund's total assets. In
the event of default by the seller under a repurchase agreement, the Fund may
suffer time delays and incur costs or possible losses in connection with the
disposition of the underlying securities.
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that
are described in the Statement of Additional Information. Investment
restrictions and policies which are fundamental policies may not be changed
without the approval of the holders of a majority of the Fund's outstanding
voting securities, as defined in the 1940 Act which means the lesser of (i) 67%
of the shares represented at a meeting at which more than 50% of the outstanding
shares are represented or (ii) more than 50% of the outstanding shares. Among
its fundamental policies, the Fund may not invest more than 25% of its assets,
taken at market value at the time of each investment, in the securities of
issuers in any particular industry (excluding the U.S. Government and its
agencies and instrumentalities) (For purposes of this restriction, states,
municipalities and their political subdivisions are not considered to be part of
any industry). Investment restrictions and policies that are non-fundamental
policies may be changed by the Board of Trustees without shareholder approval.
As a non-fundamental policy, the Fund may not borrow amounts in excess of 20% of
its total assets taken at market value (including the amount borrowed), and then
only from banks as a temporary measure for extraordinary or emergency purposes.
In addition, the Fund will not purchase securities while borrowings are
outstanding.
As a non-fundamental policy, the Fund will not invest in securities which
cannot be readily resold because of legal or contractual restrictions or which
cannot otherwise be marketed, redeemed or put to the issuer or a third party, if
at the time of acquisition more than 15% of its total assets would be invested
in such securities. This restriction shall not apply to securities which mature
within seven days or securities which the Board of Trustees of the Trust has
otherwise determined to be liquid pursuant to applicable law.
Under prior Pennsylvania law, in order for the Fund to qualify to pass
through to investors income exempt from Pennsylvania personal income tax, the
Fund was required to adhere to certain investment restrictions. In order to
comply with this and other Pennsylvania law requirements previously in effect,
the Fund adopted, as a fundamental policy, a requirement that it invest in
securities for income earnings rather than trading for profit, and that, in
accordance with such policy, it not vary its portfolio investments except to (i)
eliminate unsafe investments or investments not consistent with the preservation
of the capital or the tax status of the investments of the Fund; (ii) honor
redemption orders, meet anticipated redemption requirements, and negate gains
from discount purchases; (iii) reinvest the earnings from securities in like
securities; or (iv) defray normal administrative expenses. Pennsylvania has
enacted legislation which eliminated the necessity for the foregoing investment
policies. Since such policies are fundamental policies of the Fund, which can
only be changed by the affirmative vote of a majority (as defined under the
Investment Company Act) of the outstanding shares, the Fund continues to be
governed by such investment policies.
17
<PAGE>
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by the 1940 Act in the proportion
of its assets that it may invest in obligations of a single issuer. However, the
Fund's investments will be limited so as to qualify for the special treatment
afforded regulated investment companies under the Code. See 'Distributions and
Taxes--Taxes'. To qualify, among other requirements, the Trust will limit the
Fund's investments so that, at the close of each quarter of the taxable year,
(i) not more than 25% of the market value of the Fund's total assets will be
invested in the securities of a single issuer, and (ii) with respect to 50% of
the market value of its total assets, not more than 5% of the market value of
its total assets will be invested in the securities of a single issuer and the
Fund will not own more than 10% of the outstanding voting securities of a single
issuer. For purposes of this restriction, the Fund will regard each state and
each political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity as a separate issuer,
except that if the security is backed only by the assets and revenues of a
non-government entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal tax requirements. A fund
which elects to be classified as 'diversified' under the 1940 Act must satisfy
the foregoing 5% and 10% requirements with respect to 75% of its total assets.
To the extent that the Fund assumes large positions in the obligations of a
small number of issuers, the Fund's total return may fluctuate to a greater
extent than that of a diversified company as a result of changes in the
financial condition or in the market's assessment of the issuers.
Investors are referred to the Statement of Additional Information for a
complete description of the Fund's investment restrictions.
MANAGEMENT OF THE TRUST
TRUSTEES
The Trustees of the Trust consist of six individuals, five of whom are not
'interested persons' of the Trust as defined in the 1940 Act. The Trustees are
responsible for the overall supervision of the operations of the Trust and the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the 1940 Act.
The Trustees are:
ARTHUR ZEIKEL*--President of the Manager and its affiliate, MLAM; President
and Director of Princeton Services, Inc. ('Princeton Services'); Executive Vice
President of ML & Co.; and Director of the Distributor.
JAMES H. BODURTHA--Director and Executive Vice President, The China
Business Group, Inc.
HERBERT I. LONDON--John M. Olin Professor of Humanities, New York
University.
ROBERT R. MARTIN--Former Chairman, Kinnard Investments, Inc.
JOSEPH L. MAY--Attorney in private practice.
ANDRE F. PEROLD--Professor, Harvard Business School.
- ------------
* Interested person, as defined in the 1940 Act, of the Trust.
18
<PAGE>
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager, which is an affiliate of MLAM and is owned and controlled by
ML&Co., a financial services holding company, acts as the manager for the Fund
and provides the Fund with management services. The Manager or MLAM acts as the
investment adviser for more than 130 registered investment companies. MLAM also
provides investment advisory services to individual and institutional accounts.
As of September 30, 1996, the Manager and MLAM had a total of approximately
$214.1 billion in investment company and other portfolio assets under
management, including accounts of certain affiliates of the Manager.
Subject to the direction of the Trustees, the Manager is responsible for
the actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager. The Manager performs certain of the
other administrative services and provides all the office space, facilities,
equipment and necessary personnel for management of the Fund.
William Michael Petty became the Portfolio Manager of the Fund in 1995 and
is responsible for the day-to-day management of the Fund's investment portfolio.
He has been a Vice President of MLAM since 1993, an Assistant Vice President of
MLAM from 1992 to 1993 and a municipal bond broker with J.J. Kenny Municipal
Bond Brokers from 1990 to 1992.
Pursuant to the management agreement between the Manager and the Trust on
behalf of the Fund (the 'Management Agreement'), the Manager is entitled to
receive from the Fund a monthly fee based upon the average daily net assets of
the Fund at the following annual rates: 0.55% of the average daily net assets
not exceeding $500 million; 0.525% of the average daily net assets exceeding
$500 million but not exceeding $1.0 billion and 0.50% of the average daily net
assets exceeding $1.0 billion. For the fiscal year ended July 31, 1996, the
total fee paid by the Fund to the Manager was $845,927 (based upon average net
assets of approximately $153.8 million).
The Management Agreement obligates the Trust on behalf of the Fund to pay
certain expenses incurred in the Fund's operations, including, among other
things, the management fee, legal and audit fees, unaffiliated Trustee's fees
and expenses, registration fees, custodian and transfer agency fees, accounting
and pricing costs, and certain of the costs of printing proxies, shareholder
reports, prospectuses and statements of additional information. Accounting
services are provided to the Fund by the Manager and the Fund reimburses the
Manager for its costs in connection with such services. The Manager may
voluntarily waive all or a portion of its management fee and may voluntarily
assume all or a portion of the Fund's expenses. For the fiscal year ended July
31, 1996, the Fund reimbursed the Manager $62,902 for accounting services. For
the fiscal year ended July 31, 1996, the ratio of total expenses, to average net
assets was .76% for Class A shares, 1.27% for Class B shares, 1.37% for Class C
shares and .86% for Class D shares.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Manager
(together, the 'Codes'). The Codes significantly restrict the personal investing
activities of all employees of the Manager and, as described below, impose
additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of the Manager include
a ban on acquiring any securities in a
19
<PAGE>
'hot' initial public offering and a prohibition from profiting on short-term
trading in securities. In addition, no employee may purchase or sell any
security which at the time is being purchased or sold (as the case may be), or
to the knowledge of the employee is being considered for purchase or sale, by
any fund advised by the Manager. Furthermore, the Codes provide for trading
'blackout periods' which prohibit trading by investment personnel of the Fund
within periods of trading by the Fund in the same (or equivalent) security (15
or 30 days depending upon the transaction).
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. (the 'Transfer Agent'), which
is a wholly-owned subsidiary of ML&Co., acts as the Trust's transfer agent
pursuant to a transfer agency, dividend disbursing agency and shareholder
servicing agency agreement (the 'Transfer Agency Agreement'). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of shareholder
accounts. Pursuant to the Transfer Agency Agreement, the Fund pays the Transfer
Agent an annual fee of $11.00 per Class A or Class D shareholder account and
$14.00 per Class B and Class C shareholder account and the Transfer Agent is
entitled to reimbursement from the Fund for out-of-pocket expenses incurred by
the Transfer Agent under the Transfer Agency Agreement. For the fiscal year
ended July 31, 1996, the Fund paid the Transfer Agent a total fee of $82,854
pursuant to the Transfer Agency Agreement for providing transfer agency
services. At September 30, 1996, the Fund had 568 Class A shareholder accounts,
3,821 Class B shareholder accounts, 177 Class C shareholder accounts and 105
Class D shareholder accounts. At this level of accounts, the annual fee paid to
the Transfer Agent would aggregate approximately $63,375, plus miscellaneous and
out-of-pocket expenses.
PURCHASE OF SHARES
The Distributor, an affiliate of the Manager, MLAM and Merrill Lynch, acts
as the Distributor of the shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000 and the minimum subsequent purchase is $50.
The Fund offers its shares in four classes at a public offering price equal
to the next determined net asset value per share plus sales charges imposed
either at the time of purchase or on a deferred basis depending upon the class
of shares selected by the investor under the Merrill Lynch Select
Pricing(Service Mark) System, as described below. The applicable offering price
for purchase orders is based upon the net asset value of the Fund next
determined after receipt of the purchase orders by the Distributor. As to
purchase orders received by securities dealers prior to the close of business on
the New York Stock Exchange (the 'NYSE') (generally, 4:00 P.M., New York time),
which includes orders received after the close of business on the previous day,
the applicable offering price will be based on the net asset value determined as
of 15 minutes after the close of business on the NYSE on that day, provided the
Distributor in turn receives the order from the securities dealer prior to 30
minutes after the close of business on the NYSE on that day. If the purchase
orders are not received by the Distributor prior to 30 minutes after the close
of business on the NYSE, such orders shall be deemed received on the next
business day. The Trust or the Distributor may suspend the continuous offering
of the Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Distributor or the Trust. Neither
the Distributor nor the dealers are permitted to withhold placing orders to
benefit themselves by a price change. Merrill Lynch may charge its
20
<PAGE>
customers a processing fee (presently $4.85) to confirm a sale of shares to
such customers. Purchases directly through the Fund's Transfer Agent are not
subject to the processing fee.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(Service Mark) System, which permits each investor to choose the method
of purchasing shares that the investor believes is most beneficial given the
amount of the purchase, the length of time the investor expects to hold the
shares and other relevant circumstances. Shares of Class A and Class D are sold
to investors choosing the initial sales charge alternatives and shares of Class
B and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the investment
thereafter being subject to a CDSC and ongoing distribution fees and higher
account maintenance fees. A discussion of the factors that investors should
consider in determining the method of purchasing shares under the Merrill Lynch
Select Pricing(Service Mark) System is set forth under 'Merrill Lynch Select
Pricing(Service Mark) System' on page 4.
Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
CDSCs, distribution and account maintenance fees that are imposed on Class B and
Class C shares, as well as the account maintenance fees that are imposed on
Class D shares, will be imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares will be
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Class B, Class C and Class D shares each have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class pursuant to which account maintenance and/or distribution fees are
paid. See 'Distribution Plans' below. Each class has different exchange
privileges. See 'Shareholder Services--Exchange Privilege'.
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in that
the sales charges applicable to each class provide for the financing of the
distribution of the shares of the Fund. The distribution-related revenues paid
with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised that
only Class A and Class D shares may be available for purchase through securities
dealers, other than Merrill Lynch, which are eligible to sell shares.
21
<PAGE>
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(Service Mark)
System.
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
<S> <C> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(2)(3)
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to D shares
at a rate of 4.0% during the automatically after approximately
first year, decreasing 1.0% ten years(5)
annually to 0.0%(4)
C 1.0% CDSC for one year(6) 0.25% 0.35% No
D Maximum 4.00% initial 0.10% No No
sales charge(3)
</TABLE>
- ------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs are imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See 'Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors.'
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class A
shares in connection with certain fee-based programs. Class A and Class D
share purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject to a 1.0% CDSC if redeemed within one
year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs may be modified. Also, Class B shares of certain other MLAM-advised
mutual funds into which exchanges may be made have an eight year conversion
period. If Class B shares of the Fund are exchanged for Class B shares of
another MLAM-advised mutual fund, the conversion period applicable to the
Class B shares acquired in the exchange will apply, and the holding period
for the shares exchanged will be tacked onto the holding period for the
shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
Investors choosing the initial sales charge alternatives who are eligible
to purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.
The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternative is the next determined net asset
value plus varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE DISCOUNT TO
AS PERCENTAGE AS PERCENTAGE* SELECTED DEALERS
OF OFFERING OF THE NET AS PERCENTAGE OF
AMOUNT OF PURCHASE PRICE AMOUNT INVESTED THE OFFERING PRICE
- --------------------------------------------------------------- ------------- --------------- ------------------
<S> <C> <C> <C>
Less than $25,000.............................................. 4.00% 4.17% 3.75%
$25,000 but less than $50,000.................................. 3.75 3.90 3.50
$50,000 but less than $100,000................................. 3.25 3.36 3.00
$100,000 but less than $250,000................................ 2.50 2.56 2.25
$250,000 but less than $1,000,000.............................. 1.50 1.52 1.25
$1,000,000 and over**.......................................... 0.00 0.00 0.00
</TABLE>
(Footnotes on next page)
22
<PAGE>
(Footnotes from previous page)
- ------------------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more and on Class A purchases in connection with certain
fee-based programs. If the sales charge is waived in connection with a
purchase of $1,000,000 or more, such purchases may be subject to a CDSC of
1.0% if the shares are redeemed within one year after purchase. Such CDSC may
be waived in connection with redemptions to fund participation in certain
fee-based programs. The charge will be assessed on an amount equal to the
lesser of the proceeds of the redemption or the cost of the shares being
redeemed.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and Class
D shares of the Fund will receive a concession equal to most of the sales
charge, they may be deemed to be underwriters under the Securities Act of 1933,
as amended. For the fiscal year ended July 31, 1996, the Fund sold 109,752 Class
A shares for aggregate net proceeds of $1,229,333. The gross sales charges for
the sale of Class A shares of the Fund for that year were $13,189, of which,
$1,089 and $12,100 were received by the Distributor and Merrill Lynch,
respectively. For the fiscal year ended July 31, 1996, the Distributor received
no CDSCs with respect to redemption within one year after purchase of Class A
shares purchased subject to a front-end sales charge waiver. For the fiscal year
ended July 31, 1996, the Fund sold 174,458 Class D shares for aggregate net
proceeds of $1,955,538. The gross sales charges for the sale of Class D shares
of the Fund for that year were $16,399, of which $1,544 and $14,855 were
received by the Distributor and Merrill Lynch, respectively. For the fiscal year
ended July 31, 1996, the Distributor received no CDSCs with respect to
redemption within one year after purchase of Class D shares purchased subject to
a front-end sales charge waiver.
Eligible Class A Investors. Class A shares are offered to a limited group
of investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Class A shares are available at net asset value to
corporate warranty insurance reserve fund programs provided that the program has
$3 million or more initially invested in MLAM-advised mutual funds. Also
eligible to purchase Class A shares at net asset value are participants in
certain investment programs including TMA(Service Mark) Managed Trusts to which
Merrill Lynch Trust Company provides discretionary trustee services and
purchases made in connection with certain fee-based programs. In addition, Class
A shares are offered at net asset value to ML & Co. and its subsidiaries and
their directors and employees and to members of the Boards of MLAM-advised
investment companies, including the Trust. Certain persons who acquired shares
of certain MLAM-advised closed-end funds in their initial offerings who wish to
reinvest the net proceeds from a sale of their closed-end fund shares of common
stock in shares of the Fund also may purchase Class A shares of the Fund if
certain conditions set forth in the Statement of Additional Information are met.
In addition, Class A shares of the Fund and certain other MLAM-advised mutual
funds are offered at net asset value to shareholders of Merrill Lynch Senior
Floating Rate Fund, Inc. and, if certain conditions set forth in the Statement
of Additional Information are met, to shareholders of Merrill Lynch Municipal
Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund, Inc. who
wish to reinvest the net proceeds from a sale of certain of their shares of
common stock pursuant to a tender offer conducted by such funds in shares of the
Fund and certain other MLAM-advised mutual funds.
Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges also
may be reduced under a Right of Accumulation and a Letter of Intention. Class A
shares are offered at net asset value to certain eligible Class A investors as
set forth above under 'Eligible Class A Investors'. See 'Shareholder
Services--Fee-Based Programs'. Class A and Class D shares are offered at net
23
<PAGE>
asset value to Employee Access Accounts(Service Mark) available through
qualified employers which provide employer-sponsored retirement and savings
plans that are eligible to purchase such shares at net asset value. Class A and
Class D shares are offered at net asset value to shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. who wish to reinvest in shares of the Fund the net proceeds from a sale of
certain of their shares of common stock, pursuant to tender offers conducted by
those funds.
Class D shares are offered at net asset value, without a sales charge, to
an investor who has a business relationship with a Merrill Lynch Financial
Consultant, if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Additional information concerning these reduced initial sales charges is
set forth in the Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four year CDSC,
while Class C shares are subject only to a one year 1.0% CDSC. On the other
hand, approximately ten years after Class B shares are issued, such Class B
shares, together with shares issued upon dividend reinvestment with respect to
those shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See 'Conversion of Class B
Shares to Class D Shares' below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets and Class B and Class C shares
are subject to distribution fees of 0.25% and 0.35%, respectively, of net assets
as discussed below under 'Distribution Plans'. The proceeds from the ongoing
account maintenance fees are used to compensate Merrill Lynch for providing
continuing account maintenance activities.
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See 'Distribution
Plans' below.
Proceeds from the CDSCs and the distribution fee are paid to the
Distributor and are used in whole or in part by the Distributor to defray the
expenses of dealers (including Merrill Lynch) related to providing distribution-
related services to the Fund in connection with the sale of the Class B and
Class C shares, such as the payment of compensation to financial consultants for
selling Class B and Class C shares from the dealer's own funds. The combination
of the CDSC and the ongoing distribution fee facilitates the ability of the Fund
to sell the Class B and Class C shares without a sales charge being deducted at
the time of purchase. Approximately ten years after issuance, Class B shares
will convert automatically into Class D shares of the Fund, which are subject to
a lower account maintenance fee and no distribution fee; Class B shares of
certain other MLAM-advised mutual funds into which exchanges may be made convert
into Class D shares automatically after approximately eight years. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares acquired in
the exchange will apply, and the holding period for the shares exchanged will be
tacked onto the holding period for the shares acquired.
24
<PAGE>
Imposition of the CDSC and the distribution fee on Class B and Class C
shares is limited by the NASD asset-based sales charge rule. See 'Limitations on
the Payment of Deferred Sales Charges' below. Class B shareholders of the Fund
exercising the exchange privilege described under 'Shareholder
Services--Exchange Privilege' will continue to be subject to the Fund's CDSC
schedule, if such schedule is higher than the CDSC schedule relating to the
Class B shares acquired as a result of the exchange.
Contingent Deferred Sales Charges--Class B Shares. Class B shares which
are redeemed within four years of purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no CDSC will
be imposed on increases in net asset value above the initial purchase price. In
addition, no CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B
CDSC AS A
PERCENTAGE OF
DOLLAR AMOUNT
YEAR SINCE PURCHASE SUBJECT TO
PAYMENT MADE CHARGE
- -------------------------------------------------------------------------------------------------- -------------
<S> <C>
0-1............................................................................................... 4.0%
1-2............................................................................................... 3.0%
2-3............................................................................................... 2.0%
3-4............................................................................................... 1.0%
4 and thereafter.................................................................................. None
</TABLE>
For the fiscal year ended July 31, 1996, the Distributor received CDSCs of
$195,896 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch.
In determining whether a CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
applicable rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over four years or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the four-year period. The charge will not be applied to dollar amounts
representing an increase in the net asset value since the time of purchase. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
To provide an example, assume an investor purchased 100 Class B shares at
$10 per share (at a cost of $1,000) and in the third year after purchase, the
net asset value per share is $12 and, during such time, the investor has
acquired 10 additional shares upon dividend reinvestment. If at such time the
investor makes his first redemption of 50 shares (proceeds of $600), 10 shares
will not be subject to a CDSC because of dividend reinvestment. With respect to
the remaining 40 shares, the CDSC is applied only to the original cost of $10
per share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 2.0% (the
applicable rates in the third year after purchase).
The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Code) of a shareholder. Additional information
concerning the waiver of the Class B CDSC is set forth in the Statement of
Additional Information. The terms of the CDSC may be modified in connection with
redemptions to fund participation in certain fee-based programs. See
'Shareholder Services--Fee-Based Programs'.
25
<PAGE>
Contingent Deferred Sales Charges--Class C Shares. Class C shares which
are redeemed within one year of purchase may be subject to a 1.0% CDSC charged
as a percentage of the dollar amount subject thereto. The charge will be
assessed on an amount equal to the lesser of the proceeds of redemption or the
cost of the shares being redeemed. Accordingly, no Class C CDSC will be imposed
on increases in net asset value above the initial purchase price. In addition,
no Class C CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions. For the fiscal year ended July 31,
1996, the Distributor received CDSCs of $2,273 with respect to redemptions of
Class C shares, all of which were paid to Merrill Lynch. No Class C CDSC will be
assessed in connection with redemptions to fund participation in certain
fee-based programs. See 'Shareholder Services--Fee-Based Programs'.
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over one year or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the one-year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of shares
from a shareholder's account to another account will be assumed to be made in
the same order as a redemption.
Conversion of Class B Shares to Class D Shares. After approximately ten
years (the 'Conversion Period'), Class B shares also will be converted
automatically into Class D shares of the Fund. Class D shares are subject to an
ongoing account maintenance fee of 0.10% of net assets but are not subject to
the distribution fee that is borne by Class B shares. Automatic conversion of
Class B shares into Class D shares will occur at least once each month (on the
'Conversion Date') on the basis of the relative net asset values of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class D
shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert approximately
ten years after initial purchase. If, during the Conversion Period, a
shareholder exchanges Class B shares with an eight-year Conversion Period for
Class B shares with a ten-year Conversion Period, or vice versa, the Conversion
Period applicable to the Class B shares acquired in the exchange will apply, and
the holding period for the shares exchanged will be tacked onto the holding
period for the shares acquired.
The Conversion Period may be modified for certain fee-based programs. See
'Shareholder Services--Fee-Based Programs'.
26
<PAGE>
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the Investment Company Act (each, a
'Distribution Plan') with respect to the account maintenance and/or distribution
fees paid by the Fund to the Distributor with respect to such classes. The Class
B and Class C Distribution Plans provide for the payment of account maintenance
fees and distribution fees, and the Class D Distribution Plan provides for the
payment of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to compensate
the Distributor and Merrill Lynch (pursuant to a sub-agreement) in connection
with account maintenance activities.
The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rate of 0.25% and
0.35%, respectively, of the average daily net assets of the Fund attributable to
the shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) for providing shareholder and
distribution services, and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling Class B and Class
C shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C shares
through dealers without the assessment of an initial sales charge and at the
same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
For the fiscal year ended July 31, 1996, the Fund paid the Distributor
$621,816 pursuant to the Class B Distribution Plan (based on average net assets
subject to such Class B Distribution Plan of approximately $124.4 million), all
of which was paid to Merrill Lynch for providing account maintenance and
distribution-related activities and services in connection with Class B shares.
For the fiscal year ended July 31, 1996, the Fund paid the Distributor $21,538
pursuant to the Class C Distribution Plan (based on average net assets subject
to such Class C Distribution Plan of approximately $3.6 million), all of which
was paid to Merrill Lynch for providing account maintenance and
distribution-related activities and services in connection with Class C shares.
For the fiscal year ended July 31, 1996, the Fund paid the Distributor $3,286
pursuant to the Class D Distribution Plan (based on average net assets subject
to such Class D Distribution Plan of approximately $3.3 million), all of which
was paid to Merrill Lynch for providing account maintenance activities in
connection with Class D shares. At September 30, 1996, the net assets of the
Fund subject to the Class B Distribution Plan aggregated approximately $119.2
million. At this asset level, the annual fee payable pursuant to such Class B
Distribution Plan would aggregate approximately $595,834. At September 30, 1996,
the net assets of the Fund subject to the Class C Distribution Plan aggregated
approximately $5.0 million. At this asset level, the annual fee payable pursuant
to such Class C Distribution Plan would aggregate approximately $29,722. At
September 30, 1996, the net assets of the Fund subject to the Class D
Distribution Plan aggregated approximately $3.8 million. At this asset level,
the annual fee payable pursuant to such Class D Distribution Plan would
aggregate approximately $3,841.
Payments under the Distribution Plan are based on a percentage of average
daily net assets attributable to the shares regardless of the amount of expenses
incurred and, accordingly, distribution-related revenues from the
27
<PAGE>
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Trustees for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information is presented annually as of December 31 of each year on
a 'fully allocated accrual' basis and quarterly on a 'direct expense and
revenue/cash' basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses, corporate
overhead and interest expense. On the direct expense and revenue/cash basis,
revenues consist of the account maintenance fees, distribution fees and CDSCs
and the expenses consist of financial consultant compensation.
As of December 31, 1995, the fully allocated accrual expenses incurred by
the Distributor and Merrill Lynch since the commencement of operations of Class
B shares exceeded fully allocated accrual revenues by approximately $2,111,000
(1.64% of Class B net assets at that date). As of July 31, 1996, direct cash
revenues for the period since the commencement of operations of Class B shares
exceeded direct cash expenses by $1,051,706 (0.87% of Class B net assets at that
date). Similar fully allocated accrual data for Class C shares is not presented
because such revenues and expenses for the period from October 21, 1994
(commencement of operations) to December 31, 1995, are de minimis. As of July
31, 1996, direct cash revenues for the period since the commencement of
operations of Class C shares exceeded direct cash expenses by $9,995 (0.21% of
Class C net assets at that date).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee and
the CDSC borne by the Class B and the Class C shares, but not the account
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges) plus (2) interest on the unpaid balance for the respective class,
computed separately at the prime rate plus 1% (the unpaid balance being the
maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the 'voluntary maximum') in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares and
any CDSCs will be paid to the Fund rather than to the Distributor; however, the
Fund will continue to make payments of the account maintenance fee. In certain
circumstances the amount payable pursuant to the voluntary maximum may exceed
the amount payable under the NASD formula. In such circumstances payments in
excess of the amount payable under the NASD formula will not be made.
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Trustees of the Trust will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Trustees will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the
28
<PAGE>
account maintenance fees, the distribution fees and/or the CDSCs received with
respect to one class will not be used to subsidize the sale of shares of another
class. Payments of the distribution fee on Class B shares will terminate upon
conversion of those Class B shares into Class D shares as set forth under
'Deferred Sales Charge Alternatives--Class B and Class C Shares--Conversion of
Class B Shares to Class D Shares'.
REDEMPTION OF SHARES
The Trust is required to redeem for cash all shares of the Fund upon
receipt of a written request in proper form. The redemption price is the net
asset value per share next determined after the initial receipt of proper notice
of redemption. Except for any CDSC which may be applicable, there will be no
charge for redemption if the redemption request is sent directly to the Transfer
Agent. Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption. The value of shares at the
time of redemption may be more or less than the shareholder's cost, depending on
the market value of the securities held by the Fund at such time.
REDEMPTION
A shareholder wishing to redeem shares may do so without charge by
tendering the shares directly to the Transfer Agent, Merrill Lynch Financial
Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289.
Redemption requests delivered other than by mail should be delivered to Merrill
Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484. Proper notice of redemption in the case of shares deposited
with the Transfer Agent may be accomplished by a written letter requesting
redemption. Proper notice of redemption in the case of shares for which
certificates have been issued may be accomplished by a written letter as noted
above accompanied by certificates for the shares to be redeemed. Redemption
requests should not be sent to the Trust. The notice in either event requires
the signature(s) of all persons in whose name(s) the shares are registered,
signed exactly as such name(s) appear(s) on the Transfer Agent's register. The
signature(s) on the redemption request must be guaranteed by an 'eligible
guarantor institution' as such is defined in Rule 17Ad-15 under the Securities
Exchange Act of 1934, as amended, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications.
Notarized signatures are not sufficient. In certain instances, the Transfer
Agent may require additional documents such as, but not limited to, trust
instruments, death certificates, appointments as executor or administrator, or
certificates of corporate authority. For shareholders redeeming directly with
the Transfer Agent, payments will be mailed within seven days of receipt of a
proper notice of redemption.
At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal funds or certified
check drawn on a United States bank). The Trust may delay or cause to be delayed
the mailing of a redemption check until such time as it has assured itself that
good payment has been collected for the purchase of such Fund shares, which will
not exceed 10 days.
REPURCHASE
The Trust also will repurchase Fund shares through a shareholder's listed
securities dealer. The Trust normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after receipt of the order by the dealer, provided that the
request for repurchase is received by the dealer prior to the close of business
on the NYSE (generally, 4:00 P.M., New York time) on the day received, and such
request is received by the Trust from such dealer not later than 30 minutes
after the close of business on the NYSE on the same day. Dealers have the
responsibility of submitting such repurchase requests
29
<PAGE>
to the Fund not later than 30 minutes after the close of business on the NYSE,
in order to obtain that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Trust (other than any applicable
CDSC). Securities firms which do not have selected dealer agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Trust. Merrill Lynch may charge its
customers a processing fee (presently $4.85) to confirm a repurchase of shares
of such customers. Repurchases directly through the Fund's Transfer Agent are
not subject to the processing fee. The Trust reserves the right to reject any
order for repurchase, which right of rejection might adversely affect
shareholders seeking redemption through the repurchase procedure. However, a
shareholder whose order for repurchase is rejected by the Trust may redeem Fund
shares as set forth above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
privilege to reinstate their accounts by purchasing Class A or Class D shares,
as the case may be, of the Fund at net asset value without a sales charge up to
the dollar amount redeemed. The reinstatement privilege may be exercised by
sending a notice of exercise along with a check for the amount to be reinstated
to the Transfer Agent within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
Financial Consultant within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. The reinstatement will be
made at the net asset value per share next determined after the notice of
reinstatement is received and cannot exceed the amount of the redemption
proceeds.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services and investment plans
designed to facilitate investment in shares of the Fund. Full details as to each
of such services, copies of the various plans described below and instructions
as to how to participate in the various services or plans, or to change options
with respect thereto can be obtained from the Trust by calling the telephone
number on the cover page hereof or from the Distributor or Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements at least quarterly from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income dividends
and long-term capital gains distributions. The statements will also show any
other activity in the account since the preceding statement. Shareholders will
receive separate confirmations for each purchase or sale transaction other than
automatic investment purchases and the reinvestment of ordinary income dividends
and long-term capital gains distributions. A shareholder may make additions to
his or her Investment Account at any time by mailing a check directly to the
Transfer Agent. Shareholders may also maintain their accounts through Merrill
Lynch. Upon the transfer of shares out of a Merrill Lynch brokerage account, an
Investment Account in the transferring shareholder's name will be opened
automatically at the Transfer Agent. Shareholders considering transferring their
Class A or Class D shares from Merrill Lynch to another brokerage firm or
financial institution should be aware that, if the firm to which the Class A or
Class D shares are to be transferred will not take delivery of shares of the
Fund, a shareholder either must redeem the Class A or Class D shares (paying any
applicable CDSC) so
30
<PAGE>
that the cash proceeds can be transferred to the account at the new firm or such
shareholder must continue to maintain an Investment Account at the Transfer
Agent for those Class A or Class D shares. Shareholders interested in
transferring their Class B or Class C shares from Merrill Lynch and who do not
wish to have an Investment Account maintained for such shares at the Transfer
Agent may request their new brokerage firm to maintain such shares in an account
registered in the name of the brokerage firm for the benefit of the shareholder
at the Transfer Agent.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund each have an exchange
privilege with certain other MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated at any time in
accordance with the rules of the Commission.
Under the Merrill Lynch Select Pricing(Service Mark) System, Class A
shareholders may exchange Class A shares of the Fund for Class A shares of a
second MLAM-advised mutual fund if the shareholder holds any Class A shares of
the second fund in his or her account in which the exchange is made at the time
of the exchange or is otherwise eligible to purchase Class A shares of the
second fund. If the Class A shareholder wants to exchange Class A shares for
shares of a second MLAM-advised mutual fund, and the shareholder does not hold
Class A shares of the second fund in his account at the time of the exchange and
is not otherwise eligible to acquire Class A shares of the second fund, the
shareholder will receive Class D shares of the second fund as a result of the
exchange. Class D shares also may be exchanged for Class A shares of a second
MLAM-advised mutual fund at any time as long as, at the time of the exchange,
the shareholder holds Class A shares of the second fund in the account in which
the exchange is made or is otherwise eligible to purchase Class A shares of the
second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the Class A or Class D shares being exchanged and the sales charge payable at
the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the
same class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC are exchangeable on the
basis of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is 'tacked' to the holding period for the newly acquired shares of the
other Fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares are
held in a money market fund, however, will not count toward satisfaction of the
holding period requirement for reduction of any CDSC imposed on such shares, if
any, and, with respect to Class B shares, toward satisfaction of the Conversion
Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's
31
<PAGE>
CDSC schedule if such schedule is higher than the CDSC schedule relating to the
Class B shares of the MLAM-advised mutual fund from which the exchange has been
made.
Exercise of the exchange privilege is treated as a sale for Federal income
tax purposes. For further information, see 'Shareholder Services--Exchange
Privilege' in the Statement of Additional Information.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
All dividends and capital gains distributions are reinvested automatically
in full and fractional shares of the Fund, without a sales charge, at the net
asset value per share at the close of business on the monthly payment date for
such dividends and distributions. A shareholder may at any time, by written
notification or by telephone (1-800-MER-FUND) to the Transfer Agent, elect to
have subsequent dividends or both dividends and capital gains distributions paid
in cash, rather than reinvested, in which event payment will be mailed monthly.
Cash payments can also be directly deposited to the shareholder's bank account.
No CDSC will be imposed upon redemption of shares issued as a result of the
automatic reinvestment of dividends or capital gains distributions.
SYSTEMATIC WITHDRAWAL PLANS
A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his or her Investment Account through automatic payment by check
or through automatic payment by direct deposit to his or her bank account on
either a monthly or quarterly basis. Alternatively, a Class A or Class D
shareholder whose shares are held within a CMA(Registered) or CBA(Registered)
account may elect to have shares redeemed on a monthly, bimonthly, quarterly,
semiannual or annual basis through the CMA(Registered) or CBA(Registered)
Systematic Redemption Program, subject to certain conditions.
AUTOMATIC INVESTMENT PLANS
Regular additions of Class A, Class B, Class C or Class D shares may be
made to an investor's Investment Account by pre-arranged charges of $50 or more
to his or her regular bank account. Alternatively, investors who maintain
CMA(Registered) or CBA(Registered) accounts may arrange to have periodic
investments made in the Fund in their CMA(Registered) or CBA(Registered) account
or in certain related accounts in amounts of $100 or more through the
CMA(Registered) or CBA(Registered) Automated Investment Program.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives
for securities transactions (each referred to in this paragraph as a 'Program'),
may permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of shares
held therein or the automatic exchange thereof to another class at net asset
value, which may be shares of a money market fund. In addition, upon termination
of participation in a Program, shares that have been held for less than
specified periods within such Program may be subject to a fee based upon the
current value of such shares. These Programs also generally prohibit such shares
from being transferred to another account at Merrill Lynch, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance fees)
in order for the investment not to be subject to Program
32
<PAGE>
fees. Additional information regarding a specific Program (including charges and
limitations on transferability applicable to shares that may be held in such
Program) is available in such Program's client agreement and from Merrill Lynch
Investor Services at (800) MER-FUND (637-3863).
PORTFOLIO TRANSACTIONS
The Trust has no obligation to deal with any dealer or group of dealers in
the execution of transactions in portfolio securities of the Fund. Municipal
Bonds and other securities in which the Fund invests are traded primarily in the
over-the-counter market. Where possible, the Trust deals directly with the
dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Trust to obtain the best net results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread), the size, type and difficulty of the transactions
involved, the firm's general execution and operations facilities, and the firm's
risk in positioning the securities involved and the provision of supplemental
investment research by the firm. While reasonably competitive spreads or
commissions are sought, the Fund will not necessarily be paying the lowest
spread or commission available. The sale of shares of the Fund may be taken into
consideration as a factor in the selection of brokers and dealers to execute
portfolio transactions for the Fund. The portfolio securities of the Fund
generally are traded on a net basis and normally do not involve either brokerage
commissions or transfer taxes. The cost of portfolio securities transactions of
the Fund primarily consists of dealer or underwriter spreads. Under the 1940
Act, persons affiliated with the Trust, including Merrill Lynch, are prohibited
from dealing with the Trust as a principal in the purchase and sale of
securities unless such trading is permitted by an exemptive order issued by the
Commission. The Trust has obtained an exemptive order permitting it to engage in
certain principal transactions with Merrill Lynch involving high quality
short-term municipal bonds subject to certain conditions. In addition, the Trust
may not purchase securities, including Municipal Bonds, for the Fund during the
existence of any underwriting syndicate of which Merrill Lynch is a member
except pursuant to procedures approved by the Trustees of the Trust which comply
with rules adopted by the Commission. The Trust has applied for an exemptive
order permitting it to, among other things, (i) purchase high quality tax-exempt
securities from Merrill Lynch when Merrill Lynch is a member of an underwriting
syndicate and (ii) purchase tax-exempt securities from and sell tax-exempt
securities to Merrill Lynch in secondary market transactions. An affiliated
person of the Trust may serve as its broker in over-the-counter transactions
conducted for the Fund on an agency basis only.
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The net investment income of the Fund is declared as dividends daily prior
to the determination of the net asset value which is calculated 15 minutes after
the close of business on the NYSE (generally, 4:00 P.M., New York time) on that
day. The net investment income of the Fund for dividend purposes consists of
interest earned on portfolio securities, less expenses, in each case computed
since the most recent determination of the net asset value. Expenses of the
Fund, including the management fees and the account maintenance and distribution
fees, are accrued daily. Dividends of net investment income are declared daily
and reinvested monthly in the form of additional full and fractional shares of
the Fund at net asset value as of the close of business on the payment date
unless the shareholder elects to receive such dividends in cash. Shares will
accrue dividends as long as they are issued and outstanding. Shares are issued
and outstanding from the settlement date of a purchase order to the day prior to
the settlement date of a redemption order.
33
<PAGE>
All net realized long- or short-term capital gains, if any, are declared
and distributed to the Fund's shareholders at least annually. Capital gains
distributions will be reinvested automatically in shares unless the shareholder
elects to receive such distributions in cash.
The per share dividends and distributions on each Class of shares will be
reduced as a result of any account maintenance, distribution and transfer agency
fees applicable to that class. See 'Additional Information-- Determination of
Net Asset Value'.
See 'Shareholder Services' for information as to how to elect either
dividend reinvestment or cash payments. Portions of dividends and distributions
which are taxable to shareholders as described below are subject to income tax
whether they are reinvested in shares of the Fund or received in cash.
TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ('RICs') under the Code. If it
so qualifies, the Fund (but not its shareholders) will not be subject to Federal
income tax to the extent that it distributes its net investment income and net
realized capital gains. The Trust intends to cause the Fund to distribute
substantially all of such income. So long as the Fund qualifies as a regulated
investment company under the Code, it will not be subject to any Pennsylvania
income tax.
To the extent that the dividends distributed to the Fund's Class A, Class
B, Class C and Class D shareholders (together, the 'shareholders') are derived
from interest income exempt from Federal income tax under Code Section 103(a)
and are properly designated as 'exempt-interest dividends' by the Trust, they
will be excludable from a shareholder's gross income for Federal income tax
purposes. Exempt-interest dividends are included, however, in determining the
portion, if any, of a person's social security benefits and railroad retirement
benefits subject to Federal income taxes. The portion of exempt-interest
dividends paid from interest received by the Fund from Pennsylvania Municipal
Bonds also will be exempt from Pennsylvania personal income taxes. However,
distributions attributable to capital gains derived by the Fund as well as
distributions derived from income from investments other than Pennsylvania
Municipal Bonds will be taxable for Pennsylvania personal income tax purposes.
In the case of residents of the City of Philadelphia, distributions which are
derived from interest received by the Fund from Pennsylvania Municipal Bonds or
which are designated as capital gain dividends for Federal income tax purposes
will be exempt from the Philadelphia School District investment income tax.
Shareholders subject to income taxation by states other than Pennsylvania will
realize a lower after-tax rate of return than Pennsylvania shareholders since
the dividends distributed by the Fund generally will not be exempt, to any
significant degree, from income taxation by such other states. The Trust will
inform shareholders annually as to the portion of the distributions which
constitutes exempt-interest dividends and the portion which is exempt from
Pennsylvania personal income taxes. Interest on indebtedness incurred or
continued to purchase or carry Fund shares is not deductible for Federal income
tax purposes to the extent attributable to exempt-interest dividends. Persons
who may be 'substantial users' (or 'related persons' of substantial users) of
facilities financed by industrial development bonds or private activity bonds
held by the Fund should consult their tax advisors before purchasing Fund
shares.
At present, it is unclear whether an investment in the Fund by a corporate
shareholder will qualify as an exempt asset for purposes of apportionment of the
Pennsylvania capital stock/foreign franchise tax. To the extent exempt-interest
dividends are excluded from taxable income for Federal corporate income tax
purposes (determined before net operating loss carryovers and special
deductions), they will not be subject to the Pennsylvania corporate net income
tax.
34
<PAGE>
Shares of the Fund will be exempt from Pennsylvania county personal
property taxes to the extent the Fund's portfolio securities consist of
Pennsylvania Municipal Bonds on the annual assessment date.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short-term capital gains over
net long-term capital losses ('ordinary income dividends') such distributions
are considered ordinary income for Federal income tax purposes. Distributions,
if any, from an excess of net long-term capital gains over net short-term
capital losses derived from the sale of securities or from certain transactions
in futures or options ('capital gain dividends') are taxable as long-term
capital gains for Federal income tax purposes, regardless of the length of time
the shareholder has owned Fund shares. Distributions by the Fund, whether from
exempt-interest income, ordinary income or capital gains, will not be eligible
for the dividends received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income for Federal income tax purposes rather than capital gain. This
rule may increase the amount of ordinary income dividends received by
shareholders. Distributions in excess of the Fund's earnings and profits will
first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Any loss upon the sale
or exchange of Fund shares held for six months or less will be disallowed to the
extent of any exempt-interest dividends received by the shareholder. In
addition, any such loss that is not disallowed under the rule stated above will
be treated as long-term capital loss to the extent of any capital gain dividends
received by the shareholder. If the Fund pays a dividend in January which was
declared in the previous October, November or December to shareholders of record
on a specified date in one of such months, then such dividend will be treated
for tax purposes as being paid by the Fund and received by its shareholders on
December 31 of the year in which such dividend was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies to
certain interest received on certain 'private activity bonds' issued after
August 7, 1986. Private activity bonds are bonds which, although tax-exempt, are
used for purposes other than those generally performed by governmental units and
which benefit non-governmental entities (e.g., bonds used for industrial
development or housing purposes). Income received on such bonds is classified as
an item of 'tax preference', which could subject certain investors in such
bonds, including shareholders of the Fund, to an alternative minimum tax. The
Fund will purchase such 'private activity bonds' and the Trust will report to
shareholders within 60 days after the Fund's taxable year-end the portion of its
dividends declared during the year which constitutes an item of tax preference
for alternative minimum tax purposes. The Code further provides that
corporations are subject to an alternative minimum tax based, in part, on
certain differences between taxable income as adjusted for other tax preferences
and 'adjusted current earnings,' which more closely reflect a corporation's
economic income. Because an exempt-interest dividend paid by the Fund will be
included in adjusted current earnings, a corporate shareholder may be required
to pay alternative minimum tax on exempt-interest dividends paid by the Fund.
No gain or loss will be recognized for Federal income tax purposes by Class
B shareholders on the conversion of their Class B shares into Class D shares. A
shareholder's basis in the Class D shares acquired will be the same as such
shareholder's basis in the Class B shares converted, and the holding period of
the acquired Class D shares will include the holding period for the converted
Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange for Federal income tax purposes will be reduced (or the gain increased)
to the extent any sales charge paid to the Fund on the exchanged shares reduces
any sales charge such
35
<PAGE>
shareholder would have owed upon purchase of the new shares in the absence of
the exchange privilege. Instead, such sales charge will be treated as an amount
paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed for Federal income tax purposes if other Fund shares are acquired
(whether through the automatic reinvestment of dividends or otherwise) within a
61-day period beginning 30 days before and ending 30 days after the date that
the shares are disposed of. In such a case, the basis of the shares acquired
will be adjusted to reflect the disallowed loss.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ('backup withholding'). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Pennsylvania income tax laws
presently in effect. For the complete provisions, reference should be made to
the pertinent Code sections, the Treasury regulations promulgated thereunder and
the applicable Pennsylvania income tax laws. The Code and the Treasury
regulations, as well as the Pennsylvania tax laws, are subject to change by
legislative, judicial or administrative action either prospectively or
retroactively.
Shareholders are urged to consult their tax advisors regarding the
availability of any exemption from state or local taxes and with specific
questions as to Federal, foreign, state or local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return,
yield and tax-equivalent yield for various specified time periods in
advertisements or information furnished to present or prospective shareholders.
Average annual total return, yield and tax-equivalent yield are computed
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including any CDSC that would be applicable to a
complete redemption of the investment at the end of the specified period such as
in the case of Class B and Class C shares and the maximum sales charge in the
case of Class A and Class D shares. Dividends paid by the Fund with respect to
all shares, to the extent any dividends are paid, will be calculated in the same
manner at the same time on the same day and will be in the same amount, except
that account maintenance fees and distribution charges and any incremental
transfer agency costs relating to each class of shares will be borne exclusively
by that class. The Fund will include performance data for all classes of shares
of the Fund in any advertisement or information including performance data of
the Fund.
36
<PAGE>
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return calculated
will not be average annual rates, but rather, actual annual, annualized or
aggregate rates of return and (2) the maximum applicable sales charges will not
be included with respect to annual or annualized rates of return calculations.
Aside from the impact on the performance data calculations of including or
excluding the maximum applicable sales charges, actual annual or annualized
total return data generally will be lower than average annual total return data
since the average annual rates of return reflect compounding; aggregate total
return data generally will be higher than average annual total return data since
the aggregate rates of return reflect compounding over a longer period of time.
In advertisements distributed to investors whose purchases are subject to
reduced sales loads in the case of Class A shares or waiver of the CDSC in the
case of Class B shares or to reduced sales charges in the case of Class A or
Class D shares, the performance data may take into account the reduced, and not
the maximum, sales charge or may not take into account the CDSC and therefore
may reflect greater total return since, due to the reduced sales charges or
waiver of the contingent deferred sales charge, a lower amount of expenses is
deducted. See 'Purchase of Shares.' The Fund's total return may be expressed
either as a percentage or as a dollar amount in order to illustrate such total
return on a hypothetical $1,000 investment in the Fund at the beginning of each
specified period.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average daily number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per share
on the last day of the period. Tax-equivalent yield quotations will be computed
by dividing (a) the part of the Fund's yield that is tax-exempt by (b) one minus
a stated tax rate and (c) adding the result to that part, if any, of the Fund's
yield that is not tax-exempt. The yield for the 30-day period ended July 31,
1996 was 4.90% for Class A shares, 4.60% for Class B shares, 4.50% for Class C
shares and 4.81% for Class D shares and the tax-equivalent yield for the same
period (based on a Federal income tax rate of 28%) was 6.81% for Class A shares,
6.39% for Class B shares, 6.25% for Class C shares and 6.68% for Class D shares.
Total return, yield and tax-equivalent yield figures are based on the
Fund's historical performance and are not intended to indicate future
performance. The Fund's total return, yield and tax-equivalent yield will vary
depending on market conditions, the securities comprising the Fund's portfolio,
the Fund's operating expenses and the amount of realized and unrealized net
capital gains or losses during the period. The value of an investment in the
Fund will fluctuate and an investor's shares, when redeemed, may be worth more
or less than their original cost.
On occasion, the Fund may compare its performance to performance data
published by Lipper Analytical Services, Inc., Morningstar Publications, Inc.
('Morningstar') and CDA Investment Technology, Inc. or to data contained in
publications such as Money Magazine, U.S. News & World Report, Business Week,
Forbes Magazine and Fortune Magazine. From time to time, the Fund may include
the Fund's Morningstar risk-adjusted performance ratings in advertisements or
supplemental sales literature. As with other performance data, performance
comparisons should not be considered indicative of the Fund's relative
performance for any future period.
37
<PAGE>
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
once daily 15 minutes after the close of business on the NYSE (generally, 4:00
P.M., New York time), on each day during which the NYSE is open for trading. The
net asset value per share is computed by dividing the sum of the value of the
securities held by the Fund plus any cash or other assets minus all liabilities
by the total number of shares outstanding at such time, rounded to the nearest
cent. Expenses, including the fees payable to the Manager and the Distributor,
are accrued daily.
The per share net asset value of Class A shares will generally be higher
than the per share net asset value of shares of the other classes, reflecting
the daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to Class B and Class C shares and
the daily expense accruals of the account maintenance fees applicable with
respect to Class D shares; moreover, the per share net asset value of Class D
shares generally will be higher than the per share net asset value of Class B
and Class C shares, reflecting the daily expense accruals of the distribution
fees, higher account maintenance fees and higher transfer agency fees applicable
with respect to Class B and Class C shares. It is expected, however, that the
per share net asset value of the classes will tend to converge (although not
necessarily meet) immediately after the payment of dividends or distributions
which will differ by approximately the amount of the expense accrual
differentials between the classes.
ORGANIZATION OF THE TRUST
The Trust is an unincorporated business trust organized on August 2, 1985
under the laws of Massachusetts. On October 1, 1987, the Trust changed its name
from 'Merrill Lynch Multi-State Tax Exempt Series Trust' to 'Merrill Lynch
Multi-State Municipal Bond Series Trust' and on December 22, 1987 the Trust
changed its name to 'Merrill Lynch Multi-State Municipal Series Trust'. The
Trust is an open-end management investment company comprised of separate series
('Series'), each of which is a separate portfolio offering shares to selected
groups of purchasers. Each of the Series is to be managed independently in order
to provide to shareholders who are residents of the state to which such Series
relates as high a level of income exempt from Federal and, in certain cases,
state and local income taxes as is consistent with prudent investment
management. The Trustees are authorized to create an unlimited number of Series
and, with respect to each Series, to issue an unlimited number of full and
fractional shares of beneficial interest of $.10 par value of different classes.
Shareholder approval is not required for the authorization of additional Series
or classes of a Series of the Trust. At the date of this Prospectus, the shares
of the Fund are divided into Class A, Class B, Class C and Class D shares. Class
A, Class B, Class C and Class D shares represent interests in the same assets of
the Fund and are identical in all respects except that Class B, Class C and
Class D shares bear certain expenses related to the account maintenance
associated with such shares, and Class B and Class C shares bear certain
expenses related to the distribution of such shares. Each class has exclusive
voting rights with respect to matters relating to account maintenance and
distribution expenditures as applicable. See 'Purchase of Shares'. The Trustees
of the Trust may classify and reclassify the shares of any Series into
additional classes at a future date.
Shareholders are entitled to one vote for each full share and to fractional
votes for fractional shares held in the election of Trustees (to the extent
hereinafter provided) and on other matters submitted to the vote of
shareholders. There normally will be no meeting of shareholders for the purpose
of electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. Shareholders may,
38
<PAGE>
in accordance with the terms of the Declaration of Trust, cause a meeting of
shareholders to be held for the purpose of voting on the removal of Trustees.
Also, the Trust will be required to call a special meeting of shareholders of a
Series in accordance with the requirements of the 1940 Act to seek approval of
new management and advisory arrangements, of a material increase in distribution
fees or of a change in the fundamental policies, objectives or restrictions of a
Series. Except as set forth above, the Trustees shall continue to hold office
and appoint successor Trustees. Each issued and outstanding share is entitled to
participate equally in dividends and distributions declared by the respective
Series and in net assets of such Series upon liquidation or dissolution
remaining after satisfaction of outstanding liabilities except that, as noted
above, Class B, Class C and Class D shares bear certain additional expenses. The
obligations and liabilities of a particular Series are restricted to the assets
of that Series and do not extend to the assets of the Trust generally. The
shares of each Series, when issued, will be fully-paid and non-assessable by the
Trust.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
copies of each report and communication for all of the shareholder's related
accounts the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, FL 32232-5289
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
please call your Merrill Lynch Financial Consultant or Merrill Lynch Financial
Data Services, Inc. at 800-637-3863.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Trust at the address or
telephone number set forth on the cover page of this Prospectus.
------------------------
The Declaration of Trust establishing the Trust, dated August 2, 1985, a
copy of which together with all amendments thereto (the 'Declaration'), is on
file in the office of the Secretary of the Commonwealth of Massachusetts,
provides that the name 'Merrill Lynch Multi-State Municipal Series Trust' refers
to the Trustees under the Declaration collectively as Trustees, but not as
individuals or personally; and no Trustee, shareholder, officer, employee or
agent of the Trust shall be held to any personal liability, nor shall resort be
had to their private property for the satisfaction of any obligation or claim of
the Trust but the 'Trust Property' only shall be liable.
39
<PAGE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART 1)
- --------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C shares / / Class
D shares
of Merrill Lynch Pennsylvania Municipal Bond Fund and establish an Investment
Account as described in the Prospectus. In the event that I am not eligible to
purchase Class A shares, I understand that Class D shares will be purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $.......payable to Merrill Lynch Financial Data
Services, Inc., as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next
to be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the Right of Accumulation as outlined in the Statement of
Additional Information: (Please list all funds. Use a separate sheet of
paper if necessary.)
<TABLE>
<S> <C>
1. ...................................................... 4. ......................................................
2. ...................................................... 5. ......................................................
3. ...................................................... 6. ......................................................
(PLEASE PRINT)
</TABLE>
<TABLE>
<S> <C> <C>
Name.................................................................................................................
First Name Initial Last Name
Name of Co-Owner (if any)............................................................................................
First Name Initial Last Name
Address......................................................................... Date......................, 19....
.....................................................................................................................
(Zip Code)
Occupation................................................ Name and Address of Employer.............................
..........................................................
..........................................................
.......................................................... ..........................................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owners, a joint tenancy with right of survivorship will be presumed unless otherwise specified.)
</TABLE>
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
<TABLE>
<S> <C>
Ordinary Income Dividends Long-Term Capital Gains
SELECT / / Reinvest SELECT / / Reinvest
ONE: / / Cash ONE: / / Cash
</TABLE>
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: / / Check
or / / Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch Pennsylvania Municipal Bond Fund Authorization
Form.
Specify type of account (check one): / / checking / / savings
Name on your Account ...........................................................
Bank Name ......................................................................
Bank Number ......................... Account Number .........................
Bank Address ...................................................................
I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE WRITTEN
NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Signature of Depositor .........................................................
Signature of Depositor ......................... Date ........................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED 'VOID' OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
40
<PAGE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART 1) --
(CONTINUED)
- --------------------------------------------------------------------------------
3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security Number or Taxpayer Identification Number and (2) that
I am not subject to backup withholding (as discussed in the Prospectus under
'Distributions and Taxes--Taxes') either because I have not been notified that I
am subject thereto as a result of a failure to report all interest or dividends,
or the Internal Revenue Service ('IRS') has notified me that I am no longer
subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDERREPORTING AND IF
YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS CERTIFICATION TO
OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
<TABLE>
<S> <C>
...................................... .......................................
Signature of Owner Signature of Co-Owner (if any)
</TABLE>
- --------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION).
.................. , 19 ......
Date of Initial Purchase
Dear Sir/Madam:
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch Pennsylvania Municipal Bond Fund or any other investment company with an
initial sales charge or deferred sales charge for which the Merrill Lynch Funds
Distributor, Inc. acts as distributor over the next 13-month period which will
equal or exceed:
/ / $25,000 / / $50,000 / / $100,000 / / $250,000 / / $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch Pennsylvania
Municipal Bond Fund Prospectus.
I agree to the terms and conditions of this Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Pennsylvania Municipal Bond Fund held as security.
<TABLE>
<S> <C>
By: ................................... .......................................
Signature of Owner Signature of Co-Owner
(If registered in joint names, both
must sign)
</TABLE>
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
<TABLE>
<S> <C>
(1) Name .............................. (2) Name ..............................
Account Number ........................ Account Number ........................
</TABLE>
- --------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp
This form, when completed, should be mailed to:
Merrill Lynch Pennsylvania Municipal Bond Fund
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
We hereby authorize Merrill Lynch Funds Distributor, Inc. to act as our agent in
connection with transactions under this authorization form and agree to notify
the Distributor of any purchases or sales made under a Letter of Intention,
Automatic Investment Plan or Systematic Withdrawal Plan. We guarantee the
shareholder's signature.
...............................................................................
Dealer Name and Address
By:.............................................................................
Authorized Signature of Dealer
<TABLE>
<S> <C>
/ / / / / / / / / / / / / / .......................................
Branch Code F/C No. F/C Last Name
/ / / / / / / / / / / / / /
Dealer's Customer Account No.
</TABLE>
41
<PAGE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART 2)
- --------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR AUTOMATIC
INVESTMENT PLANS ONLY.
- --------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION Social Security No.
(Please Print) or Taxpayer Identification Number
Name of Owner ................................................................
First Name Initial Last Name
Name of Co-Owner (if any) ....................................................
First Name Initial Last Name
Account Number ................................................................
(if existing account)
Address .......................................................................
(Zip Code)
- --------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION).
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for quarterly,
of / / Class A or / / Class D shares in Merrill Lynch Pennsylvania Municipal
Bond Fund at cost or current offering price. Withdrawals to be made either
(check one) / / Monthly on the 24th day of each month, or / / Quarterly on the
24th day of March, June, September and December. If the 24th falls on a weekend
or holiday, the next succeeding business day will be utilized. Begin systematic
withdrawal on ________ or as soon as possible thereafter.
(month)
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE):
/ / $_________ or / /_________% of the current value of / / Class A or
/ / Class D shares in the account.
SPECIFY WITHDRAWAL METHOD: / / check or / / direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a) I hereby authorize payment by check
/ / as indicated in Item 1.
/ / to the order of .......................................................
Mail to (check one)
/ / the address indicated in Item 1.
/ / Name (please print) ...................................................
Address .......................................................................
.......................................................................
Signature of Owner ....................... Date .......................
Signature of Co-Owner (if any) ..........................................
(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO MY BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Specify type of account (check one): / / checking / / savings
Name on your Account ..........................................................
Bank Name .....................................................................
Bank Number ......................... Account Number ........................
Bank Address ..................................................................
........................................
Signature of Depositor ........................ Date ........................
Signature of Depositor ........................................................
(If joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED 'VOID' OR
A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS APPLICATION.
42
<PAGE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART 2) --
(CONTINUED)
- --------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ('ACH') debit on my checking account as described below
each month to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C shares / / Class D shares
of Merrill Lynch Pennsylvania Municipal Bond Fund subject to the terms set forth
below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.
MERRILL LYNCH FINANCIAL DATA SERVICES, INC.
You are hereby authorized to draw an ACH debit each month on my bank account for
investment in Merrill Lynch Pennsylvania Municipal Bond Fund, as indicated
below:
Amount of each ACH debit $ ................................................
Account No. ...............................................................
Please date and invest ACH debits on the 20th of each month
beginning ___________________________________ or as soon thereafter as possible.
(Month)
I agree that you are drawing these ACH debits voluntarily at my request and
that you shall not be liable for any loss arising from any delay in preparing or
failure to prepare any such debit. If I change banks or desire to terminate or
suspend this program, I agree to notify you promptly in writing. I hereby
authorize you to take any action to correct erroneous ACH debits of my bank
account or purchases of Fund shares including liquidating shares of the Fund and
crediting my bank account. I further agree that if a check or debit is not
honored upon presentation, Merrill Lynch Financial Data Services, Inc. is
authorized to discontinue immediately the Automatic Investment Plan and to
liquidate sufficient shares held in my account to offset the purchase made with
the dishonored debit.
<TABLE>
<S> <C>
...................................... .......................................
Date Signature of Depositor
.......................................
Signature of Depositor
(If joint account, both must sign)
</TABLE>
AUTHORIZATION TO HONOR ACH DEBITS
DRAWN BY MERRILL LYNCH FINANCIAL DATA
SERVICES, INC.
To ....................................................................... Bank
(Investor's Bank)
Bank Address ..................................................................
City ............ State ............ Zip Code ...............................
As a convenience to me, I hereby request and authorize you to pay and charge to
my account ACH debits drawn on my account by and payable to Merrill Lynch
Financial Data Services, Inc. I agree that your rights in respect to each such
debit shall be the same as if it were a check drawn on you and signed personally
by me. This authority is to remain in effect until revoked personally by me in
writing. Until you receive such notice, you shall be fully protected in honoring
any such debit. I further agree that if any such debit be dishonored, whether
with or without cause and whether intentionally or inadvertently, you shall be
under no liability.
<TABLE>
<S> <C>
...................................... .......................................
Date Signature of Depositor
...................................... .......................................
Bank Account Number Signature of Depositor
(If joint account, both must sign)
</TABLE>
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED
'VOID' SHOULD ACCOMPANY THIS APPLICATION.
43
<PAGE>
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
State Street Bank and Trust Company
P.O. Box 351
Boston, Massachusetts 02101
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400
COUNSEL
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE
MADE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table...................................... 2
Merrill Lynch Select Pricing(Service Mark)
System....................................... 4
Financial Highlights........................... 8
Investment Objective and Policies.............. 9
Potential Benefits........................... 11
Special and Risk Considerations Relating to
Municipal Bonds............................ 11
Description of Municipal Bonds............... 12
Call Rights.................................. 14
When-Issued Securities and Delayed Delivery
Transactions............................... 14
Financial Futures Transactions and Options... 15
Repurchase Agreements........................ 17
Investment Restrictions...................... 17
Management of the Trust........................ 18
Trustees..................................... 18
Management and Advisory Arrangements......... 19
Code of Ethics............................... 19
Transfer Agency Services..................... 20
Purchase of Shares............................. 20
Initial Sales Charge Alternatives--
Class A and Class D Shares................. 22
Deferred Sales Charge Alternatives--
Class B and Class C Shares................. 24
Distribution Plans........................... 27
Limitations on the Payment of Deferred Sales
Charges.................................... 28
Redemption of Shares........................... 29
Redemption................................... 29
Repurchase................................... 29
Reinstatement Privilege--
Class A and Class D Shares................. 30
Shareholder Services........................... 30
Investment Account........................... 30
Exchange Privilege........................... 31
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 32
Systematic Withdrawal Plans.................. 32
Automatic Investment Plans................... 32
Fee-Based Programs........................... 32
Portfolio Transactions......................... 33
Distributions and Taxes........................ 33
Distributions................................ 33
Taxes........................................ 34
Performance Data............................... 36
Additional Information......................... 38
Determination of Net Asset Value............. 38
Organization of the Trust.................... 38
Shareholder Reports.......................... 39
Shareholder Inquiries........................ 39
Authorization Form............................. 40
</TABLE>
Code #11197-1196
Merrill Lynch
Pennsylvania Municipal Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
(Art)
PROSPECTUS
November 15, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 o PHONE NO. (609) 282-2800
------------------------
Merrill Lynch Pennsylvania Municipal Bond Fund (the 'Fund') is a series of
Merrill Lynch Multi-State Municipal Series Trust (the 'Trust'), an open-end
management investment company organized as a Massachusetts business trust. The
investment objective of the Fund is to provide shareholders with as high a level
of income exempt from Federal and Pennsylvania personal income taxes as is
consistent with prudent investment management. The Fund invests primarily in a
portfolio of long-term investment grade obligations issued by or on behalf of
the Commonwealth of Pennsylvania, its political subdivisions, agencies and
instrumentalities and obligations of other qualifying issuers, such as issuers
located in Puerto Rico, the Virgin Islands, and Guam, which pay interest exempt
from Federal and Pennsylvania personal income taxes. There can be no assurance
that the investment objective of the Fund will be realized.
Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes is
most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.
------------------------
This Statement of Additional Information of the Fund is not a prospectus
and should be read in conjunction with the prospectus of the Fund, dated
November 15, 1996 (the 'Prospectus'), which has been filed with the Securities
and Exchange Commission (the 'Commission') and can be obtained, without charge,
by calling or by writing the Fund at the above telephone number or address. This
Statement of Additional Information has been incorporated by reference into the
Prospectus. Capitalized terms used but not defined herein have the same meanings
as in the Prospectus.
------------------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is November 15, 1996.
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as
high a level of income exempt from Federal and Pennsylvania personal income
taxes as is consistent with prudent investment management. The Fund seeks to
achieve its objective by investing primarily in a portfolio of long-term
obligations issued by or on behalf of the Commonwealth of Pennsylvania, its
political subdivisions, agencies and instrumentalities and obligations of other
qualifying issuers, such as issuers located in Puerto Rico, the Virgin Islands
and Guam, which pay interest exempt, in the opinion of bond counsel to the
issuer, from Federal and Pennsylvania income taxes. Obligations exempt from
Federal income taxes are referred to herein as 'Municipal Bonds' and obligations
exempt from both Federal and Pennsylvania income taxes are referred to as
'Pennsylvania Municipal Bonds'. Unless otherwise indicated, references to
Municipal Bonds shall be deemed to include Pennsylvania Municipal Bonds. The
Fund anticipates that at all times, except during temporary defensive periods,
it will maintain at least 65% of its total assets invested in Pennsylvania
Municipal Bonds. At times, the Fund will seek to hedge its portfolio through the
use of futures transactions to reduce volatility in the net asset value of Fund
shares. Reference is made to 'Investment Objective and Policies' in the
Prospectus for a discussion of the investment objective and policies of the
Fund.
Municipal Bonds may include general obligation bonds of the State and its
political subdivisions, revenue bonds of utility systems, highways, bridges,
port and airport facilities, colleges, hospitals, housing facilities, etc., and
industrial development bonds ('IDBs') or private activity bonds. The interest on
such obligations may bear a fixed rate or be payable at a variable or floating
rate. The Municipal Bonds purchased by the Fund will be what are commonly
referred to as 'investment grade' securities, which are obligations rated at the
time of purchase within the four highest quality ratings as determined by either
Moody's Investors Service, Inc. ('Moody's') (currently Aaa, Aa, A and Baa),
Standard & Poor's Ratings Group ('Standard & Poor's') (currently AAA, AA, A and
BBB), or Fitch Investors Service, Inc. ('Fitch') (currently AAA, AA, A and BBB).
If unrated, such securities must possess creditworthiness comparable, in the
opinion of the manager of the Fund, Fund Asset Management, L.P. (the 'Manager'),
to other obligations in which the Fund may invest.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Pennsylvania income taxes. However, to the extent that suitable
Pennsylvania Municipal Bonds are not available for investment by the Fund, the
Fund may purchase Municipal Bonds issued by other states, their agencies and
instrumentalities, the interest income on which is exempt, in the opinion of
bond counsel, from Federal, but not Pennsylvania, income taxes. The Fund also
may invest in securities not issued by or on behalf of a state or territory or
by an agency or instrumentality thereof, if the Fund nevertheless believes such
securities to be exempt from Federal income taxation ('Non-Municipal Tax-Exempt
Securities'). Non-Municipal Tax-Exempt Securities may include securities issued
by other investment companies that invest in municipal bonds, to the extent
permitted by applicable law. Other Non-Municipal Tax-Exempt Securities could
include trust certificates or other instruments evidencing interests in one or
more long-term municipal securities.
Except when acceptable securities are unavailable as determined by the
Manager, the Fund will under normal circumstances invest at least 65% of its
total assets in Pennsylvania Municipal Bonds. For temporary periods or to
provide liquidity, the Fund has the authority to invest as much as 35% of its
assets in tax-exempt or taxable money market obligations with a maturity of one
year or less (such short-term obligations being referred to herein as 'Temporary
Investments'), except that taxable Temporary Investments, together with such
other instruments as are not exempt from Pennsylvania taxation, shall not exceed
20% of the Fund's net assets. The Fund at all times will have at least 80% of
its net assets invested in securities exempt from Federal taxation.
2
<PAGE>
However, interest received on certain otherwise tax-exempt securities which are
classified as 'private activity bonds' (in general, bonds that benefit
non-governmental entities) may be subject to an alternative minimum tax. The
Fund may purchase such private activity bonds. See 'Distributions and Taxes'. In
addition, the Fund reserves the right to invest temporarily a greater portion of
its assets in Temporary Investments for defensive purposes, when, in the
judgment of the Manager, market conditions warrant. The investment objective of
the Fund and the policies set forth in this paragraph are fundamental policies
of the Fund which may not be changed without a vote of a majority of the
outstanding shares of the Fund. The Fund's hedging strategies are not
fundamental policies and may be modified by the Trustees of the Trust without
the approval of the Fund's shareholders.
Municipal Bonds may at times be purchased or sold on a delayed delivery
basis or a when-issued basis. These transactions arise when securities are
purchased or sold by the Fund with payment and delivery taking place in the
future, often a month or more after the purchase. The payment obligation and the
interest rate are each fixed at the time the buyer enters into the commitment.
The Fund will make only commitments to purchase such securities with the
intention of actually acquiring the securities, but the Fund may sell these
securities prior to the settlement date if it is deemed advisable. Purchasing
Municipal Bonds on a when-issued basis involves the risk that the yields
available in the market when the delivery takes place may actually be higher
than those obtained in the transaction itself; if yields so increase, the value
of the when-issued obligations generally will decrease. The Fund will maintain a
separate account at its custodian bank consisting of cash, cash equivalents or
high grade, liquid Municipal Bonds or Temporary Investments (valued on a daily
basis) equal at all times to the amount of the when-issued commitment.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
Also, the Fund may invest in so-called 'inverse floating obligations' or
'residual interest bonds' on which the interest rates typically decline as
market rates increase and increase as market rates decline. For example, to the
extent the Fund invests in these types of Municipal Bonds, the Fund's return on
such Municipal Bonds will be subject to risk with respect to the value of the
particular index, which may include reduced or eliminated interest payments and
losses of invested principal. Such securities have the effect of providing a
degree of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate
which is a multiple (typically two) of the rate at which fixed-rate long-term
tax exempt securities increase or decrease in response to such changes. As a
result, the market values of such securities will generally be more volatile
than the market values of fixed-rate tax exempt securities. To seek to limit the
volatility of these securities, the Fund may purchase inverse floating
obligations with shorter term maturities or which contain limitations on the
extent to which the interest rate may vary. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets. The Manager believes, however, that
indexed and inverse floating obligations represent flexible portfolio management
instruments for the Fund which allow the Fund to seek potential investment
rewards, hedge other portfolio positions or vary the degree of investment
leverage relatively efficiently under different market conditions.
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a 'Call
Right'). A holder of a Call Right may exercise such right to require a
3
<PAGE>
mandatory tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect to holding
both the Call Right and the related Municipal Bond is identical to holding a
Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets.
The Fund may invest up to 20% of its total assets in Municipal Bonds which
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or
which, in the Manager's judgment, possess similar credit characteristics ('high
yield securities'). See Appendix II--'Ratings of Municipal Bonds' for additional
information regarding ratings of debt securities. The Manager considers the
ratings assigned by Standard & Poor's, Moody's or Fitch as one of several
factors in its independent credit analysis of issuers.
High yield securities are considered by Standard & Poor's, Moody's and
Fitch to have varying degrees of speculative characteristics. Consequently,
although high yield securities can be expected to provide higher yields, such
securities may be subject to greater market price fluctuations and risk of loss
of principal than lower yielding, higher rated debt securities. Investments in
high yield securities will be made only when, in the judgment of the Manager,
such securities provide attractive total return potential relative to the risk
of such securities, as compared to higher quality debt securities. The Fund will
not invest in debt securities in the lowest rating categories (those rated CC or
lower by Standard & Poor's or Fitch or Ca or lower by Moody's) unless the
Manager believes that the financial condition of the issuer or the protection
afforded the particular securities is stronger than would otherwise be indicated
by such low ratings.
Issuers or obligors of high yield securities may be highly leveraged and
may not have available to them more traditional methods of financing. Therefore,
the risks associated with acquiring the securities of such issuers generally are
greater than is the case with higher rated securities. For example, during an
economic downturn or a sustained period of rising interest rates, issuers or
obligors of high yield securities may be more likely to experience financial
stress, especially if such issuers or obligors are highly leveraged. During
periods of economic recession, such issuers may not have sufficient revenues to
meet their interest payment obligations. The issuer's ability to service its
debt obligations also may be adversely affected by specific issuer developments,
or the issuer's inability to meet specific projected business forecasts, or the
unavailability of additional financing. The risk of loss due to default by the
issuer is significantly greater for the holders of high yield securities because
such securities may be unsecured and may be subordinated to other creditors of
the issuer.
High yield securities frequently have call or redemption features that
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends to
shareholders.
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. Because not all
dealers maintain markets in all high yield securities, there is no established
secondary market for many of these securities, and the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. To the extent that a secondary trading market for high
yield securities does exist, it generally is not as liquid as the secondary
market for higher rated securities. Reduced secondary market liquidity may have
an adverse impact on market price and the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific
4
<PAGE>
economic event such as a deterioration in the creditworthiness of the issuer.
Reduced secondary market liquidity for certain securities also may make it more
difficult for the Fund to obtain accurate market quotations for purposes of
valuing the Fund's portfolio. Market quotations generally are available on many
high yield securities only from a limited number of dealers and may not
necessarily represent firm bids of such dealers or prices for actual sales.
It is expected that a significant portion of the high yield securities
acquired by the Fund will be purchased upon issuance, which may involve special
risks because the securities so acquired are new issues. In such instances the
Fund may be a substantial purchaser of the issue and therefore have the
opportunity to participate in structuring the terms of the offering. Although
this may enable the Fund to seek to protect itself against certain of such
risks, the considerations discussed herein would nevertheless remain applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent that it is required to seek recovery upon a default on a portfolio
holding or participate in the restructuring of the obligation.
DESCRIPTION OF MUNICIPAL BONDS AND TEMPORARY INVESTMENTS
Set forth below is a description of the Municipal Bonds and Temporary
Investments in which the Fund may invest. A more complete discussion concerning
futures and options transactions is set forth under 'Investment Objective and
Policies' in the Prospectus. Information with respect to ratings assigned to
tax-exempt obligations which the Fund may purchase is set forth in Appendix II
to this Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refunding of outstanding obligations and obtaining funds for general operating
expenses and loans to other public institutions and facilities. In addition,
certain types of bonds are issued by or on behalf of public authorities to
finance various privately operated facilities. Such obligations are included
within the term Municipal Bonds if the interest paid thereon is, in the opinion
of bond counsel, excluded from gross income for Federal income tax purposes and,
in the case of Pennsylvania Municipal Bonds, exempt from Pennsylvania personal
income taxes. Other types of IDBs or private activity bonds, the proceeds of
which are used for the construction, equipment or improvement of privately
operated industrial or commercial facilities, may constitute Municipal Bonds,
although the current Federal tax laws place substantial limitations on the size
of such issues.
The two principal classifications of Municipal Bonds are 'general
obligation' and 'revenue' bonds which latter category includes IDBs and, for
bonds issued after August 15, 1986, private activity bonds. General obligation
bonds are secured by the issuer's pledge of faith, credit and taxing power for
the payment of principal and interest. Revenue bonds are payable only from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special or limited tax or other specific revenue
source such as from the user of the facility being financed. IDBs and in the
case of bonds issued after August 15, 1986, private activity bonds are in most
cases revenue bonds and generally do not constitute the pledge of the credit or
taxing
5
<PAGE>
power of the issuer of such bonds. Generally, the payment of the principal of
and interest on such bonds depends solely on the ability of the user of the
facility financed by the bonds to meet its financial obligations and the pledge,
if any, of real and personal property so financed as security for such payment,
unless a line of credit, bond insurance or other security is furnished. The Fund
also may invest in 'moral obligation' bonds, which are normally issued by
special purpose public authorities. If an issuer of moral obligation bonds is
unable to meet its obligations, repayment of such bonds becomes a moral
commitment, but not a legal obligation, of the state or municipality in
question.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called 'lease
obligations') relating to such equipment, land or facilities. Although lease
obligations do not constitute general obligations of the issuer for which the
issuer's unlimited taxing power is pledged, a lease obligation is frequently
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. Certain investments in lease obligations may be
illiquid. The Fund may not invest in illiquid lease obligations if such
investments, together with all other illiquid investments, would exceed 15% of
the Fund's total assets. The Fund may, however, invest without regard to such
limitation in lease obligations which the Manager, pursuant to guidelines which
have been adopted by the Board of Trustees and subject to the supervision of the
Board, determines to be liquid. The Manager will deem lease obligations to be
liquid if they are publicly offered and have received an investment grade rating
of Baa or better by Moody's, or BBB or better by Standard & Poor's or Fitch.
Unrated lease obligations, or those rated below investment grade, will be
considered liquid if the obligations come to the market through an underwritten
public offering and at least two dealers are willing to give competitive bids.
In reference to the latter, the Manager must, among other things, also review
the creditworthiness of the municipality obligated to make payment under the
lease obligation and make certain specified determinations based on such factors
as the existence of a rating or credit enhancement such as insurance, the
frequency of trades or quotes for the obligation and the willingness of dealers
to make a market in the obligation.
Yields on Municipal Bonds are dependent on a variety of factors, including
the general condition of the money market and of the municipal bond market, the
size of a particular offering, the financial condition of the issuer, the
general conditions of the Municipal Bond market, the maturity of the obligation,
and the rating of the issue. The ability of the Fund to achieve its investment
objective is also dependent on the continuing ability of the issuers of the
bonds in which the Fund invests to meet their obligations for the payment of
interest and principal when due. There are variations in the risks involved in
holding Municipal Bonds, both within a particular classification and between
classifications, depending on numerous factors. Furthermore, the rights of
owners of Municipal Bonds and the obligations of the issuer of such Municipal
Bonds may be subject to applicable bankruptcy, insolvency and similar laws and
court decisions affecting the rights of creditors generally and to general
equitable principles, which may limit the enforcement of certain remedies.
DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject
to the limitations set forth under 'Investment Objective and Policies'. The
tax-exempt money market securities may include municipal notes, municipal
commercial paper, municipal bonds with a remaining maturity of less than one
year, variable rate demand notes and participations therein. Municipal notes
include tax anticipation notes, bond anticipation notes and grant anticipation
notes. Anticipation notes are sold as interim financing in anticipation of tax
collection,
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bond sales, government grants or revenue receipts. Municipal commercial paper
refers to short-term unsecured promissory notes generally issued to finance
short-term credit needs. The taxable money market securities in which the Fund
may invest as Temporary Investments consist of U.S. Government securities, U.S.
Government agency securities, domestic bank or savings institution certificates
of deposit and bankers' acceptances, short-term corporate debt securities such
as commercial paper, and repurchase agreements. These Temporary Investments must
have a stated maturity not in excess of one year from the date of purchase.
Variable rate demand obligations ('VRDOs') are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period not to exceed seven days. There is, however, the possibility that
because of default or insolvency the demand feature of VRDOs and Participating
VRDOs, described below, may not be honored. The interest rates are adjustable at
intervals (ranging from daily to up to one year) to some prevailing market rate
for similar investments, such adjustment formula being calculated to maintain
the market value of the VRDO at approximately the par value of the VRDOs on the
adjustment date. The adjustments typically are based upon the Public Securities
Association Index or some other appropriate interest rate adjustment index. The
Fund may invest in all types of tax-exempt instruments currently outstanding or
to be issued in the future which satisfy the short-term maturity and quality
standards of the Fund.
The Fund also may invest in VRDOs in the form of participation interests
('Participating VRDOs') in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank. Participating VRDOs provide
the Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the Participating VRDOs from the financial institution upon
a specified number of days' notice, not to exceed seven days. In addition, a
Participating VRDO is backed by an irrevocable letter of credit of guaranty of
the financial institution. The Fund would have an undivided interest in the
underlying obligation and thus participate on the same basis as the financial
institution in such obligation except that the financial institution typically
retains fees out of the interest paid on the obligation for servicing the
obligation, providing the letter of credit and issuing the repurchase
commitment. The Fund has been advised by its counsel that the Fund should be
entitled to treat the income received on Participating VRDOs as interest from
tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
exceeding seven days will therefore be subject to the Fund's restriction on
illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for such
determination.
The Trust has established the following standards with respect to money
market securities in which the Fund invests. Commercial paper investments at the
time of purchase must be rated A-1 through A-3 by Standard & Poor's, Prime-1
through Prime-3 by Moody's, or F-1 through F-3 by Fitch or, if not rated, the
commercial paper must be issued by companies having an outstanding debt issue
rated at least A by Standard & Poor's, Fitch or Moody's. Investments in
corporate bonds and debentures (which must have maturities at the date of
purchase of one year or less) must be rated at the time of purchase at least A
by Standard & Poor's, Moody's or Fitch. Notes and VRDOs at the time of purchase
must be rated SP-1/A-1 through SP-2/A-3 by Standard & Poor's, MIG-1/VMIG-1
through MIG-4/VMIG-4 by Moody's or F-1 through F-3 by Fitch. Temporary
Investments, if
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not rated, must be of comparable quality to securities rated in the above rating
categories, in the opinion of the Manager. The Fund may not invest in any
security issued by a commercial bank or a savings institution unless the bank or
institution is organized and operating in the United States, has total assets of
at least one billion dollars and is a member of the Federal Deposit Insurance
Corporation ('FDIC'), except that up to 10% of total assets may be invested in
certificates of deposit of small institutions if such certificates are fully
insured by the FDIC.
REPURCHASE AGREEMENTS
The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the Federal
Reserve System or a primary dealer in U.S. Government securities or an affiliate
thereof. Under such agreements, the seller agrees, upon entering into the
contract, to repurchase the security from the Fund at a mutually agreed upon
time and price, thereby determining the yield during the term of the agreement.
This results in a fixed rate of return insulated from market fluctuations during
such period. In repurchase agreements, the prices at which the trades are
conducted do not reflect accrued interest on the underlying obligations. Such
agreements usually cover short periods, such as under one week. Repurchase
agreements may be construed to be collateralized loans by the purchaser to the
seller secured by the securities transferred to the purchaser. In the case of a
repurchase agreement, the Fund will require the seller to provide additional
collateral if the market value of the securities falls below the repurchase
price at any time during the term of the repurchase agreement. In the event of
default by the seller under a repurchase agreement construed to be a
collateralized loan, the underlying securities are not owned by the Fund but
only constitute collateral for the seller's obligation to pay the repurchase
price. Therefore, the Fund may suffer time delays and incur costs or possible
losses in connection with the disposition of the collateral. In the event of a
default under such a repurchase agreement, instead of the contractual fixed rate
of return, the rate of return to the Fund will depend on intervening
fluctuations of the market value of such security and the accrued interest on
the security. In such event, the Fund would have rights against the seller for
breach of contract with respect to any losses arising from market fluctuations
following the failure of the seller to perform. The Fund may not invest in
repurchase agreements maturing in more than seven days if such investments,
together with other illiquid securities, would exceed 15% of the Fund's total
assets.
In general, for Federal and Pennsylvania income tax purposes, repurchase
agreements are treated as collateralized loans secured by the securities 'sold.'
Therefore, amounts earned under such agreements will not be considered
tax-exempt interest.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to the discussion concerning futures transactions under
'Investment Objective and Policies' in the Prospectus. Set forth below is
additional information concerning these transactions.
As described in the Prospectus, the Fund may purchase and sell exchange
traded financial futures contracts ('financial futures contracts') to hedge its
portfolio of Municipal Bonds against declines in the value of such securities
and to hedge against increases in the cost of securities the Fund intends to
purchase. However, any transactions involving financial futures or options (and
puts and calls associated therewith) will be in accordance with the Fund's
investment policies and limitations. To hedge its portfolio, the Fund may take
an investment position in a futures contract which will move in the opposite
direction from the portfolio position being hedged. While the Fund's use of
hedging strategies is intended to moderate capital changes in portfolio holdings
and
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thereby reduce the volatility of the net asset value of Fund shares, the Fund
anticipates that its net asset value will fluctuate. Set forth below is
information concerning futures transactions.
Description of Futures Contracts. A futures contract is an agreement
between two parties to buy and sell a security, or in the case of an index-based
futures contract, to make and accept a cash settlement for a set price on a
future date. A majority of transactions in futures contracts, however, do not
result in the actual delivery of the underlying instrument or cash settlement,
but are settled through liquidation, i.e., by entering into an offsetting
transaction. Futures contracts have been designed by boards of trade which have
been designated 'contracts markets' by the Commodity Futures Trading Commission
('CFTC').
The purchase or sale of a futures contract differs from the purchase or
sale of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount must be
deposited with the broker. This amount is known as 'initial margin' and
represents a 'good faith' deposit assuring the performance of both the purchaser
and seller under the futures contract. Subsequent payments to and from the
broker, called 'variation margin', are required to be made on a daily basis as
the price of the futures contract fluctuates making the long and short positions
in the futures contract more or less valuable, a process known as 'mark to the
market.' At any time prior to the settlement date of the futures contract, the
position may be closed out by taking an opposite position which will operate to
terminate the position in the futures contract. A final determination of
variation margin is then made, additional cash is required to be paid to or
released by the broker and the purchase realizes a loss or gain. In addition, a
nominal commission is paid on each completed sale transaction.
The Fund deals in financial futures contracts based on a long-term
municipal bond index developed by the Chicago Board of Trade ('CBT') and The
Bond Buyer (the 'Municipal Bond Index'). The Municipal Bond Index is comprised
of 40 tax-exempt municipal revenue and general obligations bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or
Standard & Poor's and must have a remaining maturity of 19 years or more. Twice
a month new issues satisfying the eligibility requirements are added to, and an
equal number of old issues are deleted from, the Municipal Bond Index. The value
of the Municipal Bond Index is computed daily according to a formula based on
the price of each bond in the Municipal Bond Index, as evaluated by six
dealer-to-dealer brokers.
The Municipal Bond Index futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a non-profit organization managed by the
exchange membership which also is responsible for handling daily accounting of
deposits or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to U.S. Government
securities, currently there are financial futures contracts based on long-term
U.S. Treasury bonds, Treasury notes, Government National Mortgage Association
('GNMA') Certificates and three-month U.S. Treasury bills. The Fund may purchase
and write call and put options on futures contracts on U.S. Government
securities in connection with its hedging strategies.
Subject to policies adopted by the Trustees, the Fund also may engage in
other futures contracts transactions such as futures contracts on other
municipal bond indices which may become available if the Manager and the
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<PAGE>
Trustees should determine that there is normally a sufficient correlation
between the prices of such futures contracts and the Municipal Bonds in which
the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as a
result of the shortening of maturities. The sale of futures contracts provides
an alternative means of hedging against declines in the value of its investments
in Municipal Bonds. As such values decline, the value of the Fund's positions in
the futures contracts will tend to increase, thus offsetting all or a portion of
the depreciation in the market value of the Fund's Municipal Bond investments
which are being hedged. While the Fund will incur commission expenses in selling
and closing out futures positions, commissions on futures transactions are lower
than transaction costs incurred in the purchase and sale of Municipal Bonds. In
addition, the ability of the Fund to trade in the standardized contracts
available in the futures markets may offer a more effective defensive position
than a program to reduce the average maturity of the portfolio securities due to
the unique and varied credit and technical characteristics of the municipal debt
instruments available to the Fund. Employing futures as a hedge also may permit
the Fund to assume a defensive posture without reducing the yield on its
investments beyond any amounts required to engage in futures trading.
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
futures contracts as a hedge against any increase in the cost of such Municipal
Bonds resulting from a decrease in interest rates or otherwise, that may occur
before such purchases can be effected. Subject to the degree of correlation
between the Municipal Bonds and the futures contracts, subsequent increases in
the cost of Municipal Bonds should be reflected in the value of the futures held
by the Fund. As such purchases are made, an equivalent amount of futures
contracts will be closed out. Due to changing market conditions and interest
rate forecasts, however, a futures position may be terminated without a
corresponding purchase of portfolio securities.
Call Options on Futures Contracts. The Fund also may purchase and sell
exchange traded call and put options on financial futures contracts on U.S.
Government securities. The purchase of a call option on a futures contract is
analogous to the purchase of a call option on an individual security. Depending
on the pricing of the option compared to either the futures contract on which it
is based, or on the price of the underlying debt securities, it may or may not
be less risky than ownership of the futures contract or underlying debt
securities. Like the purchase of a futures contract, the Fund will purchase a
call option on a futures contract to hedge against a market advance when the
Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in the
Fund's portfolio holdings.
Put Options on Futures Contracts. The purchase of options on a futures
contract is analogous to the purchase of protective put options on portfolio
securities. The Fund will purchase put options on futures contracts to hedge the
Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial
hedge against increasing prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is higher
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<PAGE>
than the exercise price, the Fund will retain the full amount of the option
premium which provides a partial hedge against any increase in the price of
Municipal Bonds which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit
initial and variation margin pursuant to requirements similar to those
applicable to futures contracts. Premiums received from the writing of an option
will be included in initial margin. The writing of an option on a futures
contract involves risks similar to those relating to futures contracts.
The Trust has received an order from the Commission exempting it from the
provisions of Section 17(f) and Section 18(f) of the Investment Company Act of
1940, as amended (the '1940 Act') in connection with its strategy of investing
in futures contracts. Section 17(f) relates to the custody of securities and
other assets of an investment company and may be deemed to prohibit certain
arrangements between the Trust and commodities brokers with respect to initial
and variation margin. Section 18(f) of the 1940 Act prohibits an open-end
investment company such as the Trust from issuing a 'senior security' other than
a borrowing from a bank. The staff of the Commission has in the past indicated
that a futures contract may be a 'senior security' under the 1940 Act.
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed 5%
of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. (However, the Fund intends to engage in options and futures
transactions only for hedging purposes.) Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
When the Fund purchases futures contracts or a call option with respect
thereto or writes a put option on a futures contract, an amount of cash, cash
equivalents or liquid securities will be deposited in a segregated account with
the Fund's custodian so that the amount so segregated, plus the amount of
initial and variation margin held in the account of its broker, equals the
market value of the futures contract, thereby ensuring that the use of such
futures is unleveraged.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
The particular municipal bonds comprising the index underlying the
Municipal Bond Index financial futures contract may vary from the Municipal
Bonds held by the Fund. As a result, the Fund's ability to hedge effectively all
or a portion of the value of its Municipal Bonds through the use of such
financial futures contracts will depend in part on the degree to which price
movements in the index underlying the financial futures contract correlate
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<PAGE>
with the price movements of the Municipal Bonds held by the Fund. The
correlation may be affected by disparities in the average maturity, ratings,
geographical mix or structure of the Fund's investments as compared to those
comprising the Municipal Bond Index, and general economic or political factors.
In addition, the correlation between movements in the value of the Municipal
Bond Index may be subject to change over time as additions to and deletions from
the Municipal Bond Index alter its structure. The correlation between futures
contracts on U.S. Government securities and the Municipal Bonds held by the Fund
may be adversely affected by similar factors and the risk of imperfect
correlation between movements in the prices of such futures contracts and the
prices of the Municipal Bonds held by the Fund may be greater.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability to
close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The Fund will
enter into a futures position only if, in the judgment of the Manager, there
appears to be an actively traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund or such rates move in a direction opposite to that
anticipated, the Fund may realize a loss on the hedging transaction which is not
fully or partially offset by an increase in the value of portfolio securities.
As a result, the Fund's total return for such period may be less than if it had
not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. Because the Fund will engage in the
purchase and sale of futures contracts solely for hedging purposes, however, any
losses incurred in connection therewith should, if the hedging strategy is
successful, be offset in whole or in part by increases in the value of
securities held by the Fund or decreases in the price of securities the Fund
intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of an
option on a futures contract also entails the risk that changes in the value of
the underlying futures contract will not be reflected fully in the value of the
option purchased.
Municipal Bond Index futures contracts were approved for trading in 1986.
Trading in such futures contracts may tend to be less liquid than that in other
futures contracts. The trading of futures contracts also is subject to certain
market risks, such as inadequate trading activity, which could at times make it
difficult or impossible to liquidate existing positions.
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INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental
restrictions and policies relating to the investment of its assets and its
activities. The fundamental policies set forth below may not be changed without
the approval of the holders of a majority of the Fund's outstanding voting
securities (which for this purpose and under the 1940 Act means the lesser of
(i) 67% of the Fund's shares present at a meeting, at which more than 50% of the
outstanding shares of the Fund are represented or (ii) more than 50% of the
Fund's outstanding shares). The Fund may not:
1. Invest more than 25% of its assets, taken at market value at the
time of each investment, in the securities of issuers in any particular
industry (excluding the U.S. Government and its agencies and
instrumentalities). For purposes of this restriction, states,
municipalities and their political subdivisions are not considered part of
any industry.
2. Make investments for the purpose of exercising control or
management.
3. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers' acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (i) the Fund may Borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (ii) the Fund may to the extent permitted
by applicable law, borrow up to an additional 5% of its total assets for
temporary purposes, (iii) the Fund may obtain such short-term credit as may
be necessary for the clearance of purchases and sales of portfolio
securities and (iv) the Fund may purchase securities on margin to the
extent permitted by applicable law. The Fund may not pledge its assets
other than to secure such borrowings or, to the extent permitted by the
Fund's investment policies as set forth in its Prospectus and Statement of
Additional Information, as they may be amended from time to time, in
connection with hedging transactions, short sales, when-issued and forward
commitment transactions and similar investment strategies.
7. Underwrite securities of other issuers, except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the 'Securities Act'), in selling portfolio securities.
8. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
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Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Make short sales of securities or maintain a short position, except
to the extent permitted by applicable law. The Fund currently does not
intend to engage in short sales, except short sales 'against the box'.
c. Invest in securities which cannot be readily resold because of
legal or contractual restrictions or which cannot otherwise be marketed,
redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its total assets would be invested in such
securities. This restriction shall not apply to securities which mature
within seven days or securities which the Board of Trustees of the Fund has
otherwise determined to be liquid pursuant to applicable law.
d. Invest in warrants if, at the time of acquisition, its investments
in warrants, valued at the lower of cost or market value, would exceed 5%
of the Fund's net assets; included within such limitation, but not to
exceed 2% of the Fund's net assets, are warrants which are not listed on
the New York Stock Exchange (the 'NYSE') or American Stock Exchange or a
major foreign exchange. For purposes of this restriction, warrants acquired
by the Fund in units or attached to securities may be deemed to be without
value.
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, if more
than 5% of the Fund's total assets would be invested in such securities.
This restriction shall not apply to mortgage-backed securities,
asset-backed securities or obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
f. Purchase or retain the securities of any issuer, if those
individual officers and Trustees of the Fund, the officers and general
partner of the Manager, the directors of such general partner or the
officers and directors of any subsidiary thereof each owning beneficially
more than one-half of one percent of the securities of such issuer own in
the aggregate more than 5% of the securities of such issuer.
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time.
i. Notwithstanding fundamental investment restriction (6) above,
borrow amounts in excess of 20% of its total assets taken at market value
(including the amount borrowed), and then only from banks as a temporary
measure for extraordinary or emergency purposes. In addition, the Fund will
not purchase securities while borrowings are outstanding.
In addition, to comply with Federal income tax requirements for
qualification as a 'regulated investment company', the Fund's investments will
be limited in a manner such that, at the close of each quarter of each fiscal
year, (a) no more than 25% of the Fund's total assets are invested in the
securities of a single issuer, and (b) with regard to at least 50% of the Fund's
total assets, no more than 5% of its total assets are invested in the securities
of a single issuer. For purposes of this restriction, the Fund will regard each
state and each political subdivision, agency or instrumentality of such state
and each multi-state agency of which such state is a member and each public
authority which issues securities on behalf of a private entity as a separate
issuer, except that if
14
<PAGE>
the security is backed only by the assets and revenues of a non-government
entity then the entity with the ultimate responsibility for the payment of
interest and principal may be regarded as the sole issuer. These tax-related
limitations may be changed by the Trustees of the Trust to the extent necessary
to comply with changes to the Federal tax requirements.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ('Merrill Lynch') with the Trust, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates except
for brokerage transactions permitted under the 1940 Act involving only usual and
customary commissions or transactions pursuant to an exemptive order under the
1940 Act. Included among such restricted transactions will be purchases from or
sales to Merrill Lynch of securities in transactions in which it acts as
principal. See 'Portfolio Transactions'. An exemptive order has been obtained
which permits the Trust to effect principal transactions with Merrill Lynch in
high quality, short-term, tax-exempt securities subject to conditions set forth
in such order.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and the portfolio
manager of the Trust, including their ages and their principal occupations for
at least the last five years, is set forth below. Unless otherwise noted, the
address of each Trustee and executive officer is P.O. Box 9011, Princeton, New
Jersey 08543-9011.
ARTHUR ZEIKEL (64)--President and Trustee(1)(2)--President of the Manager
(which term, as used herein, includes the Manager's corporate predecessors)
since 1977; President of Merrill Lynch Asset Management, L.P. ('MLAM,' which
term, as used herein, includes MLAM's corporate predecessors) since 1977;
President and Director of Princeton Services, Inc. ('Princeton Services') since
1993; Executive Vice President of Merrill Lynch & Co., Inc. ('ML & Co.') since
1990; Director of Merrill Lynch Funds Distributor, Inc. ('MLFD' or the
'Distributor') since 1977.
JAMES H. BODURTHA (52)--Trustee(2)--36 Popponesset Road, Cotuit,
Massachusetts 02635. Director and Executive Vice President, The China Business
Group, Inc. since 1996; Chairman and Chief Executive Officer, China Enterprise
Management Corporation from 1993 to 1996; Chairman, Berkshire Corporation since
1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
HERBERT I. LONDON (57)--Trustee(2)--113-115 University Place, New York, New
York 10003. John M. Olin Professor of Humanities, New York University since 1993
and Professor thereof since 1980; Dean, Gallatin Division of New York University
from 1978 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson Institute
from 1984 to 1985; Trustee, Hudson Institute since 1980; Director, Damon
Corporation since 1991; Overseer, Center for Naval Analyses from 1983 to 1993;
Limited Partner, Hypertech L.P. since 1996.
ROBERT R. MARTIN (69)--Trustee(2)--513 Grand Hill, St. Paul, Minnesota
55102. Chairman and Chief Executive Officer, Kinnard Investments, Inc. from 1990
to 1993; Executive Vice President, Dain Bosworth from 1974 to 1989; Director,
Carnegie Capital Management from 1977 to 1985 and Chairman thereof in 1979;
Director, Securities Industry Association from 1981 to 1982 and Public
Securities Association from 1979 to 1980; Chairman of the Board, WTC Industries,
Inc. in 1994; Trustee, Northland College since 1992.
JOSEPH L. MAY (67)--Trustee(2)--424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation
15
<PAGE>
from 1954 to 1983; Vice President, Wayne-Gossard Corporation from 1972 to 1983;
Chairman, The May Corporation (personal holding company) from 1972 to 1983;
Director, Signal Apparel Co. from 1972 to 1989.
ANDRE F. PEROLD (44)--Trustee(2)--Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and Associate
Professor from 1983 to 1989; Trustee, The Common Fund, since 1989; Director,
Quantec Limited since 1991.
TERRY K. GLENN (56)--Executive Vice President(1)(2)--Executive Vice
President of the Manager and MLAM since 1983; Executive Vice President and
Director of Princeton Services since 1993; President of MLFD since 1986 and
Director thereof since 1991; President of Princeton Adminstrators, L.P. since
1988.
VINCENT R. GIORDANO (52)--Vice President(1)(2)--Portfolio Manager of the
Manager and MLAM since 1977 and Senior Vice President of the Manager and MLAM
since 1984; Vice President of MLAM from 1980 to 1984; Senior Vice President of
Princeton Services since 1993.
KENNETH A. JACOB (45)--Vice President(1)(2)--Vice President of the Manager
and MLAM since 1984.
WILLIAM MICHAEL PETTY (34)--Portfolio Manager(1)(2)--Vice President of MLAM
since 1993; Assistant Vice President of MLAM from 1992 to 1993; municipal bond
broker with J.J. Kenny Municipal Bond Brokers from 1990 to 1992.
DONALD C. BURKE (36)--Vice President(1)(2)--Vice President and Director of
Taxation of MLAM since 1990; employee at Deloitte & Touche LLP from 1982 to
1990.
GERALD M. RICHARD (47)--Treasurer(1)(2)--Senior Vice President and
Treasurer of the Manager and MLAM since 1984; Senior Vice President and
Treasurer of Princeton Services since 1993; Treasurer of MLFD since 1984 and
Vice President thereof since 1981.
JERRY WEISS (38)--Secretary(1)(2)--Vice President of MLAM since 1990;
Attorney in private practice from 1982 to 1990.
- ------------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director or officer of certain other
investment companies for which the Manager or MLAM acts as investment
adviser or manager.
At October 31, 1996, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 1% of the outstanding shares of common
stock of ML & Co. and owned an aggregate of less than 1% of the outstanding
shares of the Fund.
COMPENSATION OF TRUSTEES
The Trust pays each Trustee not affiliated with the Manager (each a
'non-affiliated Trustee') a fee of $10,000 per year plus $1,000 per meeting
attended, together with such Trustee's actual out-of-pocket expenses relating to
attendance at meetings. The Trust also compensates members of its Audit and
Nominating Committee (the 'Committee'), which consists of all the non-affiliated
Trustees, a fee of $2,000 per year plus $500 per meeting attended. The Trust
reimburses each non-affiliated Trustee for his out-of-pocket expenses relating
to attendance at Board and Committee meetings. The fees and expenses of the
Trustees are allocated to the respective series of the Trust on the basis of
asset size. For the fiscal year ended July 31, 1996, fees and expenses paid to
non-affiliated Trustees which were allocated to the Fund aggregated $7,603.
The following table sets forth for the fiscal year ended July 31, 1996,
compensation paid by the Fund to the non-affiliated Trustees and for the
calendar year ended December 31, 1995, the aggregate compensation paid by
16
<PAGE>
all registered investment companies (including the Fund) advised by the Manager
and its affiliate, MLAM ('FAM/MLAM Advised Funds') to the non-affiliated
Trustees:
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PENSION OR FROM FUND AND
RETIREMENT OTHER
BENEFITS FAM/MLAM
ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF FUND'S PAID TO
NAME OF TRUSTEE FROM FUND EXPENSES TRUSTEE(1)
- ------------------------------------------------------------------- ------------ -------------- -------------
<S> <C> <C> <C>
James H. Bodurtha.................................................. $1,444 None $ 157,500*
Herbert I. London.................................................. $1,444 None $ 157,500
Robert R. Martin................................................... $1,444 None $ 157,500
Joseph L. May...................................................... $1,444 None $ 157,500
Andre F. Perold.................................................... $1,444 None $ 157,500
</TABLE>
- ------------
(1) The Trustees serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Bodurtha (22 registered investment companies consisting of 46 portfolios);
Mr. London (22 registered investment companies consisting of 46
portfolios); Mr. Martin (22 registered investment companies consisting of
46 portfolios); Mr. May (22 registered investment companies consisting of
46 portfolios); and Mr. Perold (22 registered investment companies
consisting of 46 portfolios).
* $157,500 represents the amount Mr. Bodurtha would have received if he had
been a Trustee for the entire calendar year ended December 31, 1995. Mr.
Bodurtha was elected to the Trust's Board of Trustees effective June 23,
1995.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to 'Management of the Trust--Management and Advisory
Arrangements' in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or its
affiliates. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If the Manager or its affiliates purchase or sell
securities for the Fund or other funds for which they act as manager or for
their advisory clients arise for consideration at or about the same time,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Manager or its
affiliates during the same period may increase the demand for securities being
purchased or the supply of securities being sold, there may be an adverse effect
on price.
Pursuant to a management agreement between the Trust on behalf of the Fund
and the Manager (the 'Management Agreement'), the Manager receives for its
services to the Fund monthly compensation based upon the average daily net
assets of the Fund at the following annual rates: 0.55% of the average daily net
assets not exceeding $500 million; 0.525% of the average daily net assets
exceeding $500 million but not exceeding $1.0 billion and 0.50% of the average
daily net assets exceeding $1.0 billion. For the fiscal years ended July 31,
1994, 1995, and 1996 the total advisory fees paid by the Fund to the Manager
were $852,481, $827,537, and $845,927, respectively.
The Management Agreement obligates the Manager to provide investment
advisory services and to pay all compensation of and furnish office space for
officers and employees of the Trust connected with investment and economic
research, trading and investment management of the Trust, as well as the
compensation of all Trustees of the Trust who are affiliated persons of ML & Co.
or any of its affiliates. The Fund pays all other expenses
17
<PAGE>
incurred in its operation and, a portion of the Trust's general administrative
expenses will be allocated on the basis of the asset size of the respective
series of the Trust ('Series'). Expenses that will be borne directly by the
Series include, among other things, redemption expenses, expenses of portfolio
transactions, expenses of registering the shares under Federal and state
securities laws, pricing costs (including the daily calculation of net asset
value), expenses of printing shareholder reports, prospectuses and statements of
additional information (except to the extent paid by the Distributor as
described below), fees for legal and auditing services, Commission fees,
interest, certain taxes, and other expenses attributable to a particular Series.
Expenses which will be allocated on the basis of asset size of the respective
Series include fees and expenses of unaffiliated Trustees, state franchise
taxes, costs of printing proxies and other expenses related to shareholder
meetings, and other expenses properly payable by the Trust. The organizational
expenses of the Trust were paid by the Trust, and if additional Series are added
to the Trust, the organizational expenses are allocated among the Series
(including the Fund) in a manner deemed equitable by the Trustees. Depending
upon the nature of a lawsuit, litigation costs may be assessed to the specific
Series to which the lawsuit relates or allocated on the basis of the asset size
of the respective Series. The Trustees have determined that this is an
appropriate method of allocation of expenses. Accounting services are provided
to the Fund by the Manager and the Fund reimburses the Manager for its costs in
connection with such services. For the fiscal years ended July 31, 1994, 1995
and 1996, the Fund reimbursed the Manager $58,164, $40,065, and $62,902,
respectively, for such services. As required by the Fund's distribution
agreements, the Distributor will pay the promotional expenses of the Fund
incurred in connection with the offering of shares of the Fund. Certain expenses
in connection with the account maintenance and distribution of Class B shares
will be financed by the Fund pursuant to the Distribution Plan in compliance
with Rule 12b-1 under the 1940 Act. See 'Purchase of Shares--Distribution
Plans'.
The Manager is a limited partnership, the partners of which are ML & Co.
and Princeton Services. ML & Co. and Princeton Services are 'controlling
persons' of the Manager as defined under the 1940 Act because of their ownership
of its voting securities or their power to exercise a controlling influence over
its management or policies.
Duration and Termination. Unless earlier terminated as described herein,
the Management Agreement will remain in effect from year to year if approved
annually (a) by the Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees who are not parties to
such contract or interested persons (as defined in the 1940 Act) of any such
party. Such contracts are not assignable and may be terminated without penalty
on 60 days' written notice at the option of either party thereto or by vote of
the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to 'Purchase of Shares' in the Prospectus for certain
information as to the purchase of Fund shares.
The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives, and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class A,
Class B, Class C and Class D share of the Fund represents identical interests in
the investment portfolio of the Fund and has the same rights, except that Class
B, Class C and Class D shares bear the expenses of the ongoing account
maintenance fees, and Class B and Class C shares bear the expenses of the
ongoing distribution fees and the additional incremental transfer agency costs
resulting from the deferred sales charge arrangements. Class B, Class C and
Class D shares each have exclusive voting rights with respect to the Rule 12b-1
distribution plan adopted with respect to such
18
<PAGE>
class pursuant to which account maintenance and/or distribution fees are paid.
Each class has different exchange privileges. See 'Shareholder
Services--Exchange Privilege'.
The Merrill Lynch Select PricingSM System is used by more than 50
registered investment companies advised by MLAM or its affiliate, the Manager.
Funds advised by MLAM or the Manager which utilize the Merrill Lynch Select
PricingSM System are referred to herein as 'MLAM-advised mutual funds'.
The Fund has entered into four separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the 'Distribution Agreements'). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the offering
of each class of shares of the Fund. After the prospectuses, statements of
additional information and periodic reports have been prepared, set in type and
mailed to shareholders, the Distributor pays for the printing and distribution
of copies thereof used in connection with the offering to dealers and
prospective investors. The Distributor also pays for other supplementary sales
literature and advertising costs. The Distribution Agreements are subject to the
same renewal requirements and termination provisions as the Management Agreement
described above.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
The gross sales charges for the sale of Class A shares for the fiscal year
ended July 31, 1994 were $93,697, of which the Distributor received $8,083 and
Merrill Lynch received $85,614. The gross sales charges for the sale of Class A
shares for the fiscal year ended July 31, 1995 were $16,482, of which the
Distributor received $1,289 and Merrill Lynch received $15,193. The gross sales
charges for the sale of Class A shares for the fiscal year ended July 31, 1996
were $13,189, of which the Distributor received $1,089 and Merrill Lynch
received $12,100. The gross sales charges for the sale of Class D shares for the
period October 21, 1994 (commencement of operations) to July 31, 1995 were
$26,959, of which the Distributor received $773 and Merrill Lynch received
$26,186. The gross sales charges for the sale of Class D shares for the fiscal
year ended July 31, 1996 were $16,399, of which the Distributor received $1,544
and Merrill Lynch received $14,855. For the fiscal years ended July 31, 1994,
1995 and 1996, the Distributor received no CDSCs with respect to redemption
within one year after purchase of Class A shares purchased subject to a
front-end sales charge waiver. For the period October 21, 1994 (commencement of
operations) to July 31, 1995 and for the fiscal year ended July 31, 1996, the
Distributor received no CDSCs with respect to redemption within one year after
purchase of Class D shares purchased subject to a front-end sales charge waiver.
The term 'purchase', as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his spouse and their children under the
age of 21 years purchasing shares for his or their own account and to single
purchases by a trustee or other fiduciary purchasing shares for a single trust
estate or single fiduciary account although more than one beneficiary is
involved. The term 'purchase' also includes purchases by any 'company', as that
term is defined in the 1940 Act, but does not include purchases by any such
company which has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or broker-
dealer or clients of an investment adviser.
Closed-End Investment Option. Class A shares of the Fund and other
MLAM-advised mutual funds ('Eligible Class A shares') are offered at net asset
value to shareholders of certain closed-end funds advised by
19
<PAGE>
the Manager or MLAM who purchased such closed-end fund shares prior to October
21, 1994 and wish to reinvest the net proceeds of a sale of their closed-end
fund shares of common stock in Eligible Class A shares, if the conditions set
forth below are satisfied. Alternatively, closed-end fund shareholders who
purchased such shares on or after October 21, 1994 and wish to reinvest the net
proceeds from a sale of their closed-end fund shares are offered Class A shares
(if eligible to buy Class A shares) or Class D shares of the Fund and other
MLAM-advised mutual funds ('Eligible Class D Shares'), if the following
conditions are met. First, the sale of closed-end fund shares must be made
through Merrill Lynch, and the net proceeds therefrom must be immediately
reinvested in Eligible Class A or Class D shares. Second, the closed-end fund
shares must either have been acquired in the initial public offering or be
shares representing dividends from shares of common stock acquired in such
offering. Third, the closed-end fund shares must have been continuously
maintained in a Merrill Lynch securities account. Fourth, there must be a
minimum purchase of $250 to be eligible for the investment option.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. will receive Class D shares of the Fund, except that shareholders already
owning Class A shares of the Fund will be eligible to purchase additional Class
A shares pursuant to this option, if such additional Class A shares will be held
in the same account as the existing Class A shares and the other requirements
pertaining to the reinvestment privilege are met. In order to exercise this
investment option, a shareholder of one of the above-referenced continuously
offered closed-end funds (an 'eligible fund') must sell his or her shares of
common stock of the eligible fund (the 'eligible shares') back to the eligible
fund in connection with a tender offer conducted by the eligible fund and
reinvest the proceeds immediately in the designated class of shares of the Fund.
This investment option is available only with respect to eligible shares as to
which no Early Withdrawal Charge or CDSC (each as defined in the eligible fund's
prospectus) is applicable. Purchase orders from eligible fund shareholders
wishing to exercise this investment option will be accepted only on the day that
the related tender offer terminates and will be effected at the net asset value
of the designated class of the Fund on such day.
REDUCED INITIAL SALES CHARGES
Right of Accumulation. Reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value or
cost, whichever is higher, of the purchaser's combined holdings of all classes
of shares of the Fund and of other MLAM-advised mutual funds. For any such right
of accumulation to be made available, the Distributor must be provided at the
time of purchase, by the purchaser or the purchaser's securities dealer, with
sufficient information to permit confirmation of qualification. Acceptance of
the purchase order is subject to such confirmation. The right of accumulation
may be amended or terminated at any time. Shares held in the name of a nominee
or custodian under pension, profit-sharing, or other employee benefit plans may
not be combined with other shares to qualify for the right of accumulation.
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds made within a 13-month period starting with the
first purchase pursuant to a Letter of Intention in the form provided in the
Prospectus. The Letter of Intention is available only to investors whose
accounts are maintained at the Fund's transfer agent. The Letter
20
<PAGE>
of Intention is not available to employee benefit plans for which Merrill Lynch
provides plan participant recordkeeping services. The Letter of Intention is not
a binding obligation to purchase any amount of Class A or Class D shares;
however, its execution will result in the purchaser paying a lower sales charge
at the appropriate quantity purchase level. A purchase not originally made
pursuant to a Letter of Intention may be included under a subsequent Letter of
Intention executed within 90 days of such purchase if the Distributor is
informed in writing of this intent within such 90-day period. The value of Class
A and Class D shares of the Fund and of other MLAM-advised mutual funds
presently held, at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intention, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in the
Letter of Intention (minimum of $25,000), the investor will be notified and must
pay, within 20 days of the expiration of such Letter, the difference between the
sales charge on the Class A or Class D shares purchased at the reduced rate and
the sales charge applicable to the shares actually purchased through the Letter.
Class A or Class D shares equal to five percent of the intended amount will be
held in escrow during the 13-month period (while remaining registered in the
name of the purchaser) for this purpose. The first purchase under the Letter of
Intention must be at least five percent of the dollar amount of such Letter. If
a purchase during the term of such Letter would otherwise be subject to a
further reduced sales charge based on the right of accumulation, the purchaser
will be entitled on that purchase and subsequent purchases to that further
reduced percentage sales charge but there will be no retroactive reduction of
the sales charges on any previous purchase. The value of any shares redeemed or
otherwise disposed of by the purchaser prior to termination or completion of the
Letter of Intention will be deducted from the total purchases made under such
Letter. An exchange from a MLAM-advised money market fund into the Fund that
creates a sales charge will count toward completing a new or existing Letter of
Intention from the Fund.
Employee Access Accounts(SM). Class A or Class D shares are offered at
net asset value to Employee Access Accounts available through qualified
employers that provide employer-sponsored retirement or savings plans that are
eligible to purchase such shares at net asset value. The initial minimum for
such accounts is $500, except that the initial minimum for shares purchased for
such accounts pursuant to the Automatic Investment Program is $50.
TMA(SM) Managed Trusts. Class A shares are offered at net asset value to
TMASM Managed Trusts to which Merrill Lynch Trust Company provides discretionary
trustee services at net asset value.
Purchase Privileges of Certain Persons. Trustees of the Trust, members of
the Boards of other MLAM-advised investment companies, ML & Co. and its
subsidiaries (the term 'subsidiaries', when used herein with respect to ML &
Co., includes MLAM, the Manager and certain other entities directly or
indirectly wholly-owned and controlled by ML & Co.) and their directors and
employees, and any trust, pension, profit-sharing or other benefit plan for such
persons, may purchase Class A shares of the Fund at net asset value.
Class D shares of the Fund are offered at net asset value, without sales
charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the financial consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, the investor also must establish that such redemption had
been made within 60 days prior to the investment in the Fund, and the proceeds
from the redemption had been maintained in the interim in cash or a money market
fund.
21
<PAGE>
Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ('notice'), if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares of
such other fund were subject to a sales charge either at the time of purchase or
on a deferred basis; and second, such purchase of Class D shares must be made
within 90 days after such notice.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Merrill Lynch
financial consultant and who has invested in a mutual fund for which Merrill
Lynch has not served as a selected dealer if the following conditions are
satisfied: first, the investor must advise Merrill Lynch that it will purchase
Class D shares of the Fund with proceeds from the redemption of shares of such
other mutual fund and that such shares have been outstanding for a period of no
less than six months; and second, such purchase of Class D shares must be made
within 60 days after the redemption and the proceeds from the redemption must be
maintained in the interim in cash or a money market fund.
Acquisition of Certain Investment Companies. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation with
a personal holding company or a public or private investment company. The value
of the assets or company acquired in a tax-free transaction may be adjusted in
appropriate cases to reduce possible adverse tax consequences to the Fund which
might result from an acquisition of assets having net unrealized appreciation
which is disproportionately higher at the time of acquisition than the realized
or unrealized appreciation of the Fund. The issuance of Class D shares for
consideration other than cash is limited to bona fide reorganizations, statutory
mergers or other acquisitions of portfolio securities which (i) meet the
investment objectives and policies of the Fund; (ii) are acquired for investment
and not for resale (subject to the understanding that the disposition of the
Fund's portfolio securities shall at all times remain within its control); and
(iii) are liquid securities, the value of which is readily ascertainable, which
are not restricted as to transfer either by law or liquidity of market (except
that the Fund may acquire through such transactions restricted or illiquid
securities to the extent the Fund does not exceed the applicable limits on
acquisition of such securities set forth under 'Investment Objective and
Policies' herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
in obtaining such investments.
DISTRIBUTION PLANS
Reference is made to 'Purchase of Shares--Distribution Plans' in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
1940 Act (each a 'Distribution Plan') with respect to the account maintenance
and/or distribution fees paid by the Fund to the Distributor with respect to
such classes.
Payments of account maintenance fees and/or distribution fees are subject
to the provisions of Rule 12b-1 under the 1940 Act. Among other things, each
Distribution Plan provides that the Distributor shall provide and the Trustees
shall review quarterly reports of the disbursement of the account maintenance
fees and/or distribution fees paid to the Distributor. In their consideration of
each Distribution Plan, the Trustees must consider all factors they deem
relevant, including information as to the benefits of the Distribution Plan to
the Fund and its related class of shareholders. Each Distribution Plan further
provides that, so long as the Distribution
22
<PAGE>
Plan remains in effect, the selection and nomination of Trustees who are not
'interested persons' of the Trust, as defined in the 1940 Act (the 'Independent
Trustees'), shall be committed to the discretion of the Independent Trustees
then in office. In approving each Distribution Plan in accordance with Rule
12b-1, the Independent Trustees concluded that there is reasonable likelihood
that each Distribution Plan will benefit the Fund and its related class of
shareholders. Each Distribution Plan can be terminated at any time, without
penalty, by the vote of a majority of the Independent Trustees or by the vote of
the holders of a majority of the outstanding related class of voting securities
of the Fund. A Distribution Plan cannot be amended to increase materially the
amount to be spent by the Fund without the approval by the related class of
shareholders, and all material amendments are required to be approved by the
vote of Trustees, including a majority of the Independent Trustees who have no
direct or indirect financial interest in such Distribution Plan, cast in person
at a meeting called for that purpose. Rule 12b-1 further requires that the Trust
preserve copies of such Distribution Plan and any report made pursuant to such
plan for a period of not less than six years from the date of such Distribution
Plan or such report, the first two years in an easily accessible place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the National
Association of Securities Dealers, Inc. ('NASD') imposes a limitation on certain
asset-based sales charges such as the distribution fee and the contingent
deferred sales charge ('CDSC') borne by the Class B and Class C shares but not
the account maintenance fee. The maximum sales charge rule is applied separately
to each class. As applicable to the Fund, the maximum sales charge rule limits
the aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the 'voluntary maximum') in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payment
in excess of the amount payable under the NASD formula will not be made.
23
<PAGE>
The following table sets forth comparative information as of July 31, 1996
with respect to the Class B and Class C shares of the Fund indicating the
maximum allowable payments that can be made under the NASD maximum sales charge
rule and, with respect to the Class B shares, the Distributor's voluntary
maximum.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF JULY 31, 1996
----------------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
ALLOWABLE DISTRIBUTION
ALLOWABLE INTEREST AMOUNTS FEE AT
ELIGIBLE AGGREGATE ON MAXIMUM PREVIOUSLY AGGREGATE CURRENT
GROSS SALES UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
-------- --------- ---------- ------- -------------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B SHARES FOR THE PERIOD AUGUST 31,
1990 (COMMENCEMENT OF OPERATIONS) TO
JULY 31, 1996:
Under NASD Rule as Adopted.............. $151,196 $ 9,450 $2,836 $12,286 $2,214 $10,072 $ 301
Under Distributor's Voluntary Waiver.... $151,196 $ 9,450 $ 756 $10,206 $2,214 $ 7,992 $ 301
CLASS C SHARES FOR THE PERIOD OCTOBER
21, 1994 (COMMENCEMENT OF OPERATIONS) TO
JULY 31, 1996:
Under NASD Rule as Adopted.............. $ 4,820 $ 301 $ 25 $ 326 $ 18 $ 308 $ 17
</TABLE>
- ------------
(1) Purchase price of all eligible Class B or Class C shares sold during the
periods indicated other than shares acquired through dividend reinvestment
and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0%, as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals.
(4) Provided to illustrate the extent to which the current level of distribution
fee payments (not including any CDSC payments) is amortizing the unpaid
balance. No assurance can be given that payments of the distribution fee
will reach either the voluntary maximum or the NASD maximum.
REDEMPTION OF SHARES
Reference is made to 'Redemption of Shares' in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended only for any period during which trading on the NYSE
is restricted as determined by the Commission or the NYSE is closed (other than
customary weekend and holiday closings), for any period during which an
emergency exists as defined by the Commission as a result of which disposal of
portfolio securities or determination of the net asset value of the Fund is not
reasonably practicable, and for such other periods as the Commission may by
order permit for the protection of shareholders of the Fund.
DEFERRED SALES CHARGES--CLASS B AND CLASS C SHARES
As discussed in the Prospectus under 'Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares,' while Class B shares redeemed
within four years of purchase are subject to a CDSC under most circumstances,
the charge is waived on redemptions of Class B shares following the death or
disability of a Class B shareholder. Redemptions for which the waiver applies
are any partial or complete redemption following the death or disability (as
defined in the Internal Revenue Code of 1986, as amended (the 'Code')) of a
Class B shareholder (including one who owns the Class B shares as joint tenant
with his or her spouse), provided the
24
<PAGE>
redemption is requested within one year of the death or initial determination of
disability. For the fiscal years ended July 31, 1994, 1995, and 1996, the
Distributor received CDSCs of $204,747, $302,369, and $195,896, respectively,
with respect to redemptions of Class B shares, all of which were paid to Merrill
Lynch. For the period October 21, 1994 (commencement of operations) to July 31,
1995, and for the fiscal year ended July 31, 1996, the Distributor received
CDSCs of $621 and $2,273, respectively, with respect to redemptions of Class C
shares, all of which were paid to Merrill Lynch.
PORTFOLIO TRANSACTIONS
Reference is made to 'Investment Objective and Policies--Other Investment
Policies and Practices' in the Prospectus.
Under the 1940 Act, persons affiliated with the Trust are prohibited from
dealing with the Fund as a principal in the purchase and sale of securities
unless such trading is permitted by an exemptive order issued by the Commission.
Since over-the-counter transactions are usually principal transactions,
affiliated persons of the Trust, including Merrill Lynch, may not serve as
dealer in connection with transactions with the Fund. The Trust has obtained an
exemptive order permitting it to engage in certain principal transactions with
Merrill Lynch involving high quality short-term municipal bonds subject to
certain conditions. For the fiscal year ended July 31, 1994, the Fund engaged in
one transaction pursuant to such order for an aggregate market value of
$602,352. For the fiscal year ended July 31, 1995, the Fund engaged in no
transactions pursuant to such order. For the fiscal year ended July 31, 1996,
the Fund engaged in one transaction pursuant to such order for an aggregate
market value of $200,000. The Trust has applied for an exemptive order
permitting it to, among other things, (i) purchase high quality tax-exempt
securities from Merrill Lynch when Merrill Lynch is a member of an underwriting
syndicate and (ii) purchase tax-exempt securities from and sell tax-exempt
securities to Merrill Lynch in secondary market transactions. Affiliated persons
of the Trust may serve as broker for the Fund in over-the-counter transactions
conducted on an agency basis. Certain court decisions have raised questions as
to the extent to which investment companies should seek exemptions under the
1940 Act in order to seek to recapture underwriting and dealer spreads from
affiliated entities. The Trustees have considered all factors deemed relevant,
and have made a determination not to seek such recapture at this time. The
Trustees will reconsider this matter from time to time.
As a non-fundamental restriction, the Trust will prohibit the purchase or
retention by the Fund of the securities of any issuer if the officers and
Trustees of the Trust, the officers and general partner of the Manager, the
directors of such general partner or the officers and directors of any
subsidiary thereof each owning beneficially more than 1/2 of 1% of the
securities of such issuer own in the aggregate more than 5% of the securities of
such issuer. In addition, under the 1940 Act, the Fund may not purchase
securities from any underwriting syndicate of which Merrill Lynch is a member
except pursuant to an exemptive order or rules adopted by the Commission. Rule
10f-3 under the 1940 Act sets forth conditions under which the Fund may purchase
municipal bonds in such transactions. The rule sets forth requirements relating
to, among other things, the terms of an issue of municipal bonds purchased by
the Fund, the amount of municipal bonds which may be purchased in any one issue
and the assets of the Fund which may be invested in a particular issue.
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who provide
supplemental investment research (such as information concerning tax-exempt
securities, economic data and market forecasts) to the Manager may receive
orders for transactions by the Fund. Information so received will be in addition
to and not in lieu of the services required to be performed by the Manager under
its Management Agreement and the expenses of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information.
25
<PAGE>
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the Conduct Rules of the NASD and policies established by the Trustees of the
Trust the Manager may consider sales of shares of the Fund as a factor in the
selection of brokers or dealers to execute portfolio transactions for the Fund.
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Manager. While it is not possible to predict turnover rates
with any certainty, at present it is anticipated that the Fund's annual
portfolio turnover rate, under normal circumstances after the Fund's portfolio
is invested in accordance with its investment objective, will be less than 100%.
(The portfolio turnover rate is calculated by dividing the lesser of purchases
or sales of portfolio securities for the particular fiscal year by the monthly
average of the value of the portfolio securities owned by the Fund during the
particular fiscal year. For purposes of determining this rate, all securities
whose maturities at the time of acquisition are one year or less are excluded.)
The portfolio turnover Rates for the fiscal years ended July 31, 1995 and 1996,
were 59.17% and 58.33%, respectively.
Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the U.S. national securities exchanges from executing
exchange transactions for their affiliates and institutional accounts which they
manage unless the member (i) has obtained prior express authorization from the
account to effect such transactions, (ii) at least annually furnishes the
account with a statement setting forth the aggregate compensation received by
the member in effecting such transactions, and (iii) complies with any rules the
Commission has prescribed with respect to the requirements of clauses (i) and
(ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
once daily, Monday through Friday, as of 15 minutes after the close of business
on the NYSE (generally, 4:00 P.M., New York time) on each day during which the
NYSE is open for trading. The NYSE is not open on New Year's Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day. Net asset value per share is computed by dividing the sum of
the value of the securities held by the Fund plus any cash or other assets minus
all liabilities by the total number of shares outstanding at such time, rounded
to the nearest cent. Expenses, including the fees payable to the Manager and the
Distributor, are accrued daily. The per share net asset value of Class B, Class
C, and Class D shares generally will be lower than the per share net asset value
of Class A shares, reflecting the daily expense accruals of the account
maintenance, distribution and higher transfer agency fees applicable with
respect to Class B and Class C shares and the daily expense accruals of the
account maintenance fees applicable with respect to Class D shares. In addition,
the per share net asset value of Class B and Class C shares generally will be
lower than the per share net asset value of Class D shares, reflecting the daily
expense accruals of the distribution fees, higher account maintenance fees and
higher transfer agency fees applicable with respect to Class B and Class C
shares of the Fund. It is expected, however, that the per share net asset value
of the four classes eventually will tend to converge (although not necessarily
meet) immediately after the payment of dividends, which will differ by
approximately the amount of the expense accrual differentials between the
classes.
The Municipal Bonds and other portfolio securities in which the Fund
invests are traded primarily in over-the-counter municipal bond and money
markets and are valued at the last available bid price in the over-the-
26
<PAGE>
counter market or on the basis of yield equivalents as obtained from one or more
dealers that make markets in the securities. One bond is the 'yield equivalent'
of another bond when, taking into account market price, maturity, coupon rate,
credit rating and ultimate return of principal, both bonds will theoretically
produce an equivalent return to the bondholder. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their settlement
prices as of the close of such exchanges. Short-term investments with a
remaining maturity of 60 days or less are valued on an amortized cost basis,
which approximates market value. Securities and assets for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust, which may
utilize a matrix system for valuations. The procedures of the pricing service
and its valuations are reviewed by the officers of the Trust under the general
supervision of the Trustees.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services described below which are
designed to facilitate investment in shares of the Fund. Full details as to each
of such services and copies of the various plans described below can be obtained
from the Trust, the Distributor or Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income dividends
and long-term capital gain distributions. The statements will also show any
other activity in the account since the preceding statement. Shareholders also
will receive separate transaction confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gains distributions. A
shareholder may make additions to his or her Investment Account at any time by
mailing a check directly to the Transfer Agent.
Share certificates are issued only for full shares and only upon the
specific request of a shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be aware
that, if the firm to which the Class A or Class D shares are to be transferred
will not take delivery of shares of the Fund, a shareholder either must redeem
the Class A or Class D shares (paying any applicable CDSC) so that the cash
proceeds can be transferred to the account at the new firm or such shareholder
must continue to maintain an Investment Account at the Transfer Agent for those
Class A or Class D shares. Shareholders interested in transferring their Class B
or Class C shares from Merrill Lynch and who do not wish to have an Investment
Account maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the Transfer Agent. If
the new brokerage firm is willing to accommodate the shareholder in this manner,
the shareholder must request that he or she be issued certificates for his or
her shares, and then must turn the certificates over to the new firm for
re-registration as described in the preceding sentence.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if an eligible Class A investor as described in the
Prospectus) or Class B, Class C or Class D shares at the applicable public
offering price either through the shareholder's securities dealer, or by mail
directly to the
27
<PAGE>
Transfer Agent, acting as agent for such securities dealers. Voluntary
accumulation also can be made through a service known as the Automatic
Investment Plan whereby the Fund is authorized through pre-authorized checks or
automated clearing house debits of $50 or more to charge the regular bank
account of the shareholder on a regular basis to provide systematic additions to
the Investment Account of such shareholder. Alternatively, investors who
maintain CMA(Registered) or CBA(Registered) accounts may arrange to have
periodic investments made in the Fund in their CMA(Registered) or
CBA(Registered) account or in certain related accounts in amounts of $100 or
more through the CMA(Registered) or CBA(Registered) Automated Investment
Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
automatically reinvested in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund as of the close of business
on the monthly payment date for such dividends and distributions. Shareholders
may elect in writing to receive either their income dividends or capital gains
distributions, or both, in cash, in which event payment will be mailed on or
about the payment date.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or capital gains distributions reinvested in shares of the Fund or vice
versa and, commencing ten days after the receipt by the Transfer Agent of such
notice, such instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS--CLASS A AND CLASS D SHARES
A Class A or Class D shareholder may elect to make systematic withdrawals
from an Investment Account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
Class A or Class D shares of the Fund having a value, based on cost or the
current offering price, of $5,000 or more, and monthly withdrawals are available
for shareholders with Class A or Class D shares with such a value of $10,000 or
more.
At the time of each withdrawal payment, sufficient Class A or Class D
shares are redeemed from those on deposit in the shareholder's account to
provide the withdrawal payment specified by the shareholder. The shareholder may
specify either a dollar amount or a percentage of the value of his Class A or
Class D shares. Redemptions will be made at net asset value as determined 15
minutes after the close of business on the NYSE (generally, 4:00 P.M., New York
time) on the 24th day of each month or the 24th day of the last month of each
quarter, whichever is applicable. If the NYSE is not open for business on such
date, the Class A or Class D shares will be redeemed at the close of business on
the following business day. The check for the withdrawal payment will be mailed,
or the direct deposit for the withdrawal payment will be made, on the next
business day following redemption. When a shareholder is making systematic
withdrawals, dividends and distributions on all Class A or Class D shares in the
Investment Account are reinvested automatically in the Fund's Class A or Class D
shares, respectively. A shareholder's Systematic Withdrawal Plan may be
terminated at any time, without charge or penalty, by the shareholder, the
Trust, the Transfer Agent or the Distributor. Withdrawal payments should not be
considered as dividends, yield or income. Each withdrawal is a taxable event. If
periodic withdrawals continuously exceed reinvested dividends, the shareholder's
original investment may be reduced correspondingly. Purchases of additional
Class A or Class D shares concurrent with withdrawals are ordinarily
disadvantageous to the shareholder because of sales charges and tax liabilities.
The Trust will not knowingly accept purchase orders for Class A or Class D
shares of the Fund from investors who maintain a Systematic Withdrawal Plan
unless such purchase is equal to at least one year's scheduled withdrawals or
$1,200, whichever
28
<PAGE>
is greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
Alternatively, a Class A or Class D shareholder whose shares are held
within a CMA(Registered) or CBA(Registered) account may elect to have shares
redeemed on a monthly, bimonthly, quarterly, semiannual or annual basis through
the CMA(Registered) or CBA(Registered) Systematic Redemption Program. The
minimum fixed dollar amount redeemable is $25. The proceeds of systematic
redemptions will be posted to the shareholder's account three business days
after the date the shares are redeemed. Monthly systematic redemptions will be
made at net asset value on the first Monday of each month, bimonthly systematic
redemptions will be made at net asset value on the first Monday of every other
month, and quarterly, semiannual or annual redemptions are made at net asset
value on the first Monday of months selected at the shareholder's option. If the
first Monday of the month is a holiday, the redemption will be processed at net
asset value on the next business day. The Systematic Redemption Program is not
available if Fund shares are being purchased within the account pursuant to the
Automatic Investment Program. For more information on the CMA(Registered) or
CBA(Registered) Systematic Redemption Program, eligible shareholders should
contact their Financial Consultant.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds. Under the Merrill Lynch Select
Pricing(Service Mark) System, Class A shareholders may exchange Class A shares
of the Fund for Class A shares of a second MLAM-advised mutual fund if the
shareholder holds any Class A shares of the second fund in his account in which
the exchange is made at the time of the exchange or is otherwise eligible to
purchase Class A shares of the second fund. If the Class A shareholder wants to
exchange Class A shares for shares of a second MLAM-advised mutual fund, and the
shareholder does not hold Class A shares of the second fund in his account at
the time of the exchange and is not otherwise eligible to acquire Class A shares
of the second fund, the shareholder will receive Class D shares of the second
fund as a result of the exchange. Class D shares also may be exchanged for Class
A shares of a second MLAM-advised mutual fund at any time as long as, at the
time of the exchange, the shareholder holds Class A shares of the second fund in
the account in which the exchange is made or is otherwise eligible to purchase
Class A shares of the second fund. Class B, Class C and Class D shares are
exchangeable with shares of the same class of other MLAM-advised mutual funds.
For purposes of computing the CDSC that may be payable upon a disposition of the
shares acquired in the exchange, the holding period for the previously owned
shares of the Fund is 'tacked' to the holding period for the newly acquired
shares of the other Fund as more fully described below. Class A, Class B, Class
C and Class D shares are also exchangeable for shares of certain MLAM-advised
money market funds as follows: Class A shares may be exchanged for shares of
Merrill Lynch Ready Assets Trust, Merrill Lynch Retirement Reserves Money Fund
(available only for exchanges within certain retirement plans), Merrill Lynch
U.S.A. Government Reserves and Merrill Lynch U.S. Treasury Money Fund; Class B,
Class C and Class D shares may be exchanged for shares of Merrill Lynch
Government Fund, Merrill Lynch Institutional Fund, Merrill Lynch Institutional
Tax-Exempt Fund and Merrill Lynch Treasury Fund. Shares with a net asset value
of at least $100 are required to qualify for the exchange privilege, and any
shares utilized in an exchange must have been held by the shareholder for 15
days. It is contemplated that the exchange privilege may be applicable to other
new mutual funds whose shares may be distributed by the Distributor.
Exchanges of Class A or Class D shares outstanding ('outstanding Class A or
Class D shares') for Class A or Class D shares of another MLAM-advised mutual
fund ('new Class A or Class D shares') are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount equal
to the difference, if any, between the sales charge previously paid on the
outstanding Class A or Class D shares and the sales charge payable at the time
of the exchange on the new Class A or Class D shares. With respect to
29
<PAGE>
outstanding Class A or Class D shares as to which previous exchanges have taken
place, the 'sales charge previously paid' shall include the aggregate of the
sales charges paid with respect to such Class A or Class D shares in the initial
purchase and any subsequent exchange. Class A or Class D shares issued pursuant
to dividend reinvestment are sold on a no-load basis in each of the funds
offering Class A or Class D shares. For purposes of the exchange privilege,
Class A and Class D shares acquired through dividend reinvestment shall be
deemed to have been sold with a sales charge equal to the sales charge
previously paid on the Class A or Class D shares on which the dividend was paid.
Based on this formula, Class A and Class D shares generally may be exchanged
into the Class A or Class D shares of the other funds or into shares of certain
money market funds without a sales charge.
In addition, each of the funds with Class B and Class C shares outstanding
('outstanding Class B or Class C shares') offers to exchange its outstanding
Class B or Class C shares for Class B or Class C shares, respectively, of other
MLAM-advised mutual funds ('new Class B or Class C shares') on the basis of
relative net asset value per Class B or Class C share, without the payment of
any contingent deferred sales load that might otherwise be due on redemption of
the outstanding shares. Class B shareholders of the Fund exercising the exchange
privilege will continue to be subject to the Fund's CDSC schedule if such
schedule is higher than the deferred sales charge schedule relating to the new
Class B shares acquired through use of the exchange privilege. In addition,
Class B shares of the Fund acquired through use of the exchange privilege will
be subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the Fund from which the exchange has
been made. For purposes of computing the sales load that may be payable on a
disposition of the new Class B or Class C shares, the holding period for the
outstanding Class B or Class C shares is 'tacked' to the holding period of the
new Class B or Class C shares. For example, an investor may exchange Class B
shares of the Fund for those of Merrill Lynch Special Value Fund, Inc. ('Special
Value Fund') after having held the Fund's Class B shares for two and a half
years. The 2% CDSC that generally would apply to a redemption would not apply to
the exchange. Three years later the investor may decide to redeem the Class B
shares of Special Value Fund and receive cash. There will be no CDSC due on this
redemption, since by 'tacking' the two and a half year holding period of the
Fund's Class B shares to the three year holding period for the Special Value
Fund Class B shares, the investor will be deemed to have held the new Class B
shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of certain
money market funds advised by the Manager or its affiliates, but the period of
time that Class B or Class C shares are held in a money market fund will not
count towards satisfaction of the holding period requirement for purposes of
reducing the CDSC or, with respect to Class B shares, towards satisfaction of
the conversion period. However, shares of a money market fund which were
acquired as a result of an exchange for Class B or Class C shares of the Fund
may, in turn, be exchanged back into Class B or Class C shares, respectively, of
any fund offering such shares, in which event the holding period for Class B or
Class C shares of the newly-acquired fund will be aggregated with previous
holding periods for purposes of reducing the CDSC. Thus, for example, an
investor may exchange Class B shares of the Fund for shares of Merrill Lynch
Institutional Fund ('Institutional Fund') after having held the Class B shares
for two and a half years and three years later decide to redeem the shares of
Institutional Fund for each. At the time of this redemption, the 2% CDSC that
would have been due had the Class B shares of the Fund been redeemed for cash
rather than exchanged for shares of Institutional Fund will be payable. If,
instead of such redemption the shareholder exchanged such shares for Class B
shares of a fund which the shareholder continued to hold for an additional two
and a half years, any subsequent redemption would not incur a CDSC.
Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.
To exercise the exchange privilege, a shareholder should contact his or her
Merrill Lynch Financial Consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other
30
<PAGE>
funds described above with shares for which certificates have not been issued,
may exercise the exchange privilege by wire through their securities dealers.
The Fund reserves the right to require a properly completed Exchange
Application. This exchange privilege may be modified or terminated at any time
in accordance with the rules of the Commission. The Fund reserves the right to
limit the number of times an investor may exercise the exchange privilege.
Certain funds may suspend the continuous offering of their shares to the general
public at any time and may thereafter resume such offering from time to time.
The exchange privilege is available only to U.S. shareholders in states where
the exchange legally may be made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ('RICs') under the Internal
Revenue Code of 1986, as amended (the 'Code'). If it so qualifies, the Fund (but
not its shareholders) will not be subject to Federal income tax to the extent
that it distributes its net investment income and net realized capital gains.
The Trust intends to cause the Fund to distribute substantially all of such
income. So long as the Fund qualifies as RIC under the Code, it will not be
subject to any Pennsylvania income tax.
As discussed in the Fund's Prospectus, the Trust has established other
series in addition to the Fund (together with the Fund, the 'Series'). Each
Series of the Trust is treated as a separate corporation for Federal income tax
purposes. Each Series therefore is considered to be a separate entity in
determining its treatment under the rules for RICs described in the Prospectus.
Losses in one Series do not offset gains in another Series, and the requirements
(other than certain organizational requirements) for qualifying for RIC status
are determined for each Series at the Series level rather than at the Trust
level.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year-end, plus certain undistributed
amounts from previous years. The required distributions, however, are based only
on the taxable income of a RIC. The excise tax, therefore, generally will not
apply to the tax-exempt income of a RIC, such as the Fund, that pays exempt-
interest dividends.
The Trust intends to qualify the Fund to pay 'exempt-interest dividends' as
defined in Section 852(b)(5) of the Code. Under such section if, at the close of
each quarter of the Fund's taxable year, at least 50% of the value of its total
assets consists of obligations exempt from Federal income tax ('tax-exempt
obligations') under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be qualified
to pay exempt-interest dividends to its Class A, Class B, Class C and Class D
shareholders (together, the 'shareholders'). Exempt-interest dividends are
dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Trust as
exempt-interest dividends in a written notice mailed to the Fund's shareholders
within 60 days after the close of the Fund's taxable year. For this purpose, the
Fund will allocate interest from tax-exempt obligations (as well as ordinary
income, capital gains and tax preference items, discussed below) among the Class
A, Class B, Class C and Class D shareholders according to a method (which it
believes is consistent with the Commission rule permitting the issuance and sale
of multiple classes of shares) that is based on the gross income allocable to
Class A, Class B, Class C and Class D shareholders during the taxable year or
such other method as the Internal Revenue Service may prescribe. To the extent
that the dividends distributed to the Fund's shareholders are derived from
interest income exempt from Federal income tax under Code Section 103(a) and are
properly designated as exempt-interest dividends, they will be excludable from
a shareholder's gross income for Federal income tax purposes. Exempt-interest
dividends are included, however, in determining the portion, if any, of a
person's social security benefits
31
<PAGE>
and railroad retirement benefits subject to Federal income taxes. Interest on
indebtedness incurred or continued to purchase or carry shares of a RIC paying
exempt-interest dividends, such as the Fund, will not be deductible by the
investor for Federal income tax purposes to the extent attributable to
exempt-interest dividends. Shareholders are advised to consult their tax
advisers with respect to whether exempt-interest dividends retain the exclusion
under Code Section 103(a) if a shareholder would be treated as a 'substantial
user' or 'related person' under Code Section 147(a) with respect to property
financed with the proceeds of an issue of 'industrial development bonds' or
'private activity bonds', if any, held by the Fund.
The portion of the Fund's exempt-interest dividends paid from interest
received by the Fund from Pennsylvania Municipal Bonds also will be exempt from
Pennsylvania personal income tax. However, distributions attributable to capital
gains derived by the Fund as well as distributions derived from income from
investments other than Pennsylvania Municipal Bonds will be taxable for purposes
of the Pennsylvania personal income tax. In the case of residents of the City of
Philadelphia, distributions which are derived from interest received by the Fund
from Pennsylvania Municipal Bonds or which are designated as capital gain
dividends for Federal income tax purposes will be exempt from the Philadelphia
School District investment income tax. Shares of the Fund will be exempt from
Pennsylvania county personal property taxes to the extent the Fund's portfolio
securities consist of Pennsylvania Municipal Bonds on the annual assessment
date. Shareholders subject to income taxation by states other than Pennsylvania
will realize a lower after tax rate of return than Pennsylvania shareholders
since the dividends distributed by the Fund generally will not be exempt, to any
significant degree, from income taxation by such other states. The Trust will
inform shareholders annually regarding the portion of the Fund's distributions
which constitutes exempt-interest dividends and the portion which is exempt from
Pennsylvania personal income taxes. The Fund will allocate amounts exempt from
Pennsylvania personal income taxes among Class A, Class B, Class C and Class D
shareholders based on a method similar to that described above for Federal
income tax purposes.
At present, it is unclear whether an investment in the Fund by a corporate
shareholder will qualify as an exempt asset for purposes of apportionment of the
Pennsylvania capital stock/franchise tax. To the extent exempt-interest
dividends are excluded from taxable income for Federal corporate income tax
purposes (determined before net operating loss carryovers and special
deductions), they will not be subject to the Pennsylvania corporate net income
tax. An investment in or distributions from investment income and capital gains
of the Fund, including exempt-interest dividends, may be subject to state taxes
in states other than Pennsylvania (and, possibly, in Pennsylvania) and to local
taxes imposed by municipalities in states other than Pennsylvania (and,
possibly, municipalities in Pennsylvania). Accordingly, investors in the Fund,
including, in particular, corporate investors which may be subject to the
Pennsylvania capital stock/franchise tax, should consult their tax advisers with
respect to the application of such taxes to an investment in the Fund, to the
receipt of Fund dividends and to their Pennsylvania tax situation in general.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short-term capital gains over
net long-term capital losses ('ordinary income dividends'), such distributions
are considered ordinary income for Federal income tax purposes. Distributions,
if any, from an excess of net long-term capital gains over net short-term
capital losses derived from the sale of securities or from certain transactions
in futures or options ('capital gain dividends') are taxable as long-term
capital gains for Federal income tax purposes, regardless of the length of time
the shareholder has owned Fund shares. Distributions by the Fund, whether from
exempt-interest income, ordinary income or capital gains, will not be eligible
for the dividends received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income for Federal tax purposes rather than capital gain. This rule may
increase the amount of ordinary income dividends received by shareholders.
Distributions in excess of the
32
<PAGE>
Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of Fund shares held for six
months or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain dividend received by the shareholder. If the Fund
pays a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies to
interest received on certain 'private activity bonds' issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
'tax preference', which could subject certain investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such 'private activity bonds' and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitutes an item of tax preference for
alternative minimum tax purposes. The Code further provides that corporations
are subject to an alternative minimum tax based, in part, on certain differences
between taxable income as adjusted for other tax preferences and the
corporation's 'adjusted current earnings,' which more closely reflect a
corporation's economic income. Because an exempt-interest dividend paid by the
Fund will be included in adjusted current earnings, a corporate shareholder may
be required to pay alternative minimum tax on exempt-interest dividends paid by
the Fund.
The Fund may invest in high yield securities as described in the
Prospectus. Furthermore, the Fund may also invest in instruments the return on
which includes nontraditional features such as indexed principal or interest
payments ('nontraditional instruments'). These instruments may be subject to
special tax rules under which the Fund may be required to accrue and distribute
income before amounts due under the obligations are paid. In addition, it is
possible that all or a portion of the interest payments on such high yield
securities and/or nontraditional instruments could be recharacterized as taxable
ordinary income.
No gain or loss will be recognized for Federal income tax purposes by Class
B shareholders on the conversion of their Class B shares into Class D shares. A
shareholder's basis in the Class D shares acquired will be the same as such
shareholder's basis in the Class B shares converted, and the holding period of
the acquired Class D shares will include the holding period for the converted
Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange for Federal income tax purposes will be reduced (or the gain increased)
to the extent any sales charge paid to the Fund on the exchanged shares reduces
any sales charge such shareholder would have owed upon purchase of the new
shares in the absence of the exchange privilege. Instead, such sales charge will
be treated as an amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed for Federal income tax purposes if other Fund shares are acquired
(whether through the automatic reinvestment of dividends or otherwise) within a
61-day period beginning 30 days before and ending 30 days after the date that
the shares are disposed of. In such a case, the basis of the shares acquired
will be adjusted to reflect the disallowed loss.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% U.S. withholding tax under existing
provisions of the Code applicable to foreign individuals and
33
<PAGE>
entities unless a reduced rate of withholding or a withholding exemption is
provided under applicable treaty law. Nonresident shareholders are urged to
consult their own tax advisers concerning the applicability of the U.S.
withholding tax.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ('backup withholding'). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
ENVIRONMENTAL TAX
The Code previously imposed a deductible tax (the 'Environmental Tax') on a
corporation's modified alternative minimum taxable income (computed without
regard to the alternative tax net operating loss deduction and the deduction for
the Environmental Tax) at a rate of $12 per $10,000 (0.12%) of alternative
minimum taxable income in excess of $2,000,000. The Environmental Tax has
expired for tax years beginning after December 31, 1995, but may be reinstated
in the future. The Environmental Tax was imposed even if the corporation was not
required to pay an alternative minimum tax because the corporation's regular
income tax liability exceeded its minimum tax liability. The Code provides,
however, that a RIC, such as the Fund, would not be subject to the Environmental
Tax. However, exempt-interest dividends paid by the Fund that create alternative
minimum taxable income for corporate shareholders (as described above) could
subject corporate shareholders of the Fund to the Environmental Tax.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ('financial
futures contracts'). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is available
to the Fund or an exception applies, such options and financial futures
contracts that are 'Section 1256 contracts' will be 'marked to market' for
Federal income tax purposes at the end of each taxable year, i.e., each such
option or financial futures contract will be treated as sold for its market
value on the last day of the taxable year and any gain or loss attributable to
Section 1256 contracts will be 60% long-term and 40% short-term capital gain or
loss. Application of these rules to Section 1256 contracts held by the Fund may
alter the timing and character of distributions to shareholders. The
mark-to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest rates with respect to its investments.
Code Section 1092, which applies to certain 'straddles', may affect the
taxation of the Fund's sales of securities and transactions in financial futures
contracts and related options. Under Section 1092, the Fund may be required to
postpone recognition for tax purposes of losses incurred in certain sales of
securities and certain closing transactions in financial futures contracts or
the related options.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other disposition
of securities held for less than three months. Accordingly, the Fund may be
restricted in effecting closing transactions within three months after entering
into an option or financial futures contract.
34
<PAGE>
PENNSYLVANIA TAXATION
Under present Pennsylvania law, the Fund, as presently configured, is not
subject to Pennsylvania income taxes or Pennsylvania county personal property
taxes.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and applicable Pennsylvania income
tax laws presently in effect. For the complete provisions, reference should be
made to the pertinent Code sections, the Treasury regulations promulgated
thereunder and the applicable Pennsylvania tax laws. The Code and the Treasury
regulations, as well as the Pennsylvania income tax laws, are subject to change
by legislative, judicial or administrative action either prospectively or
retroactively.
Shareholders are urged to consult their own tax advisors regarding the
availability of any exemptions from state or local taxes (other than those
imposed by Pennsylvania) and with specific questions as to Federal, foreign,
state or local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield and tax-equivalent yield in
advertisements or information furnished to present or prospective shareholders.
From time to time, the Fund may include the Fund's Morningstar risk-adjusted
performance ratings in advertisements or supplemental sales literature. Total
return, yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return, yield and tax-equivalent yield are determined
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of the Class A and
Class D shares and the CDSC that would be applicable to a complete redemption of
the investment at the end of the specified period in the case of the Class B and
Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time.
35
<PAGE>
Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for the
periods indicated.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
------------------------------------ ------------------------------------
REDEEMABLE VALUE REDEEMABLE VALUE
OF A OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
A PERCENTAGE $1,000 A PERCENTAGE $1,000
BASED ON A INVESTMENT BASED ON A INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END OF
PERIOD $1,000 INVESTMENT OF THE PERIOD $1,000 INVESTMENT THE PERIOD
- ------------------------------ ----------------- ---------------- ----------------- ----------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
One year ended July 31, 1996.. 2.27% $ 1,022.70 1.98% $ 1,019.80
Five years ended July 31, 1996 6.91% $ 1,396.30 7.24% $ 1,418.00
Inception (August 31, 1990) to
July 31, 1996............... 7.41% $ 1,526.20 7.60% $ 1,542.90
Inception (October 21, 1994)
to July 31, 1996............
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Year ended July 31, 1996...... 6.53% $ 1,065.30 5.98% $ 1,059.80
Year ended July 31, 1995...... 6.54% $ 1,065.40 6.00% $ 1,060.00
Year ended July 31, 1994...... 2.37% $ 1,023.70 1.86% $ 1,018.60
Year ended July 31, 1993...... 9.30% $ 1,093.00 8.75% $ 1,087.50
Year ended July 31, 1992...... 14.53% $ 1,145.30 13.94% $ 1,139.40
Inception (August 31, 1990) to
July 31, 1991............... 9.30% $ 1,093.00 8.81% $ 1,088.10
Inception (October 21, 1994)
to July 31, 1995............
<CAPTION>
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Inception (August 31, 1990) to
July 31, 1996............... 52.62% $ 1,526.20 54.29% $ 1,542.90
Inception (October 21, 1994)
to July 31, 1996............
<CAPTION>
YIELD
<S> <C> <C> <C> <C>
30 days ended July 31, 1996... 4.90% 4.60%
<CAPTION>
TAX EQUIVALENT YIELD*
<S> <C> <C> <C> <C>
30 days ended July 31, 1996... 6.81% 6.39%
<CAPTION>
CLASS C SHARES CLASS D SHARES
--------------------------------------- ------------------------------------
REDEEMABLE VALUE REDEEMABLE VALUE
OF A OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
A PERCENTAGE $1,000 A PERCENTAGE $1,000
BASED ON A INVESTMENT BASED ON A INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
PERIOD $1,000 INVESTMENT OF THE PERIOD $1,000 INVESTMENT OF THE PERIOD
- ------------------------------ ----------------- ------------------ ----------------- ----------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
One year ended July 31, 1996.. $ 4.87% $ 1,048.70 2.17% $ 1,021.70
Five years ended July 31, 1996
Inception (August 31, 1990) to
July 31, 1996...............
Inception (October 21, 1994)
to July 31, 1996............ 7.74% $ 1,141.70 5.89% $ 1,107.00
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Year ended July 31, 1996...... 5.87% $ 1,058.70 6.42% $ 1,064.20
Year ended July 31, 1995......
Year ended July 31, 1994......
Year ended July 31, 1993......
Year ended July 31, 1992
Inception (August 31, 1990) to
July 31, 1991...............
Inception (October 21, 1994)
to July 31, 1995............ 7.83% $ 1,078.30 8.36% $ 1,083.60
<CAPTION>
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Inception (August 31, 1990) to
Inception (October 21, 1994)
to July 31, 1996............ 14.17% $ 1,141.70 10.70% $ 1,107.00
<CAPTION>
YIELD
<S> <C> <C> <C> <C>
30 days ended July 31, 1996... 4.50% 4.81%
<CAPTION>
TAX EQUIVALENT YIELD*
<S> <C> <C> <C> <C>
30 days ended July 31, 1996... 6.25% 6.68%
</TABLE>
- ------------
* Based on a Federal income tax rate of 28%.
36
<PAGE>
In order to reflect the reduced sales charges in the case of Class A or
Class D shares or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under 'Purchase of Shares'
and 'Redemption of Shares', respectively, the total return data quoted by the
Fund in advertisements directed to such investors may take into account the
reduced, and not the maximum, sales charge or may take into account the
contingent deferred sales charge and therefore may reflect greater total return
since, due to the reduced sales charge or the waiver of sales charges, a lower
amount of expenses is deducted.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust provides that the Trust shall be comprised of
separate Series each of which will consist of a separate portfolio which will
issue separate shares. The Trust is presently comprised of the Fund, Merrill
Lynch Arizona Municipal Bond Fund, Merrill Lynch Arkansas Municipal Bond Fund,
Merrill Lynch Colorado Municipal Bond Fund, Merrill Lynch Connecticut Municipal
Bond Fund, Merrill Lynch Florida Municipal Bond Fund, Merrill Lynch Maryland
Municipal Bond Fund, Merrill Lynch Massachusetts Municipal Bond Fund, Merrill
Lynch Michigan Municipal Bond Fund, Merrill Lynch Minnesota Municipal Bond Fund,
Merrill Lynch New Mexico Municipal Bond Fund, Merrill Lynch New Jersey Municipal
Bond Fund, Merrill Lynch New York Municipal Bond Fund, Merrill Lynch North
Carolina Municipal Bond Fund, Merrill Lynch Ohio Municipal Bond Fund, Merrill
Lynch Oregon Municipal Bond Fund and Merrill Lynch Texas Municipal Bond Fund.
The Trustees are authorized to create an unlimited number of Series and, with
respect to each Series, to issue an unlimited number of full and fractional
shares of beneficial interest, par value of $.10 per share, of different classes
and to divide or combine the shares into a greater or lesser number of shares
without thereby changing the proportionate beneficial interests in the Series.
Shareholder approval is not necessary for the authorization of additional Series
or classes of a Series of the Trust. At the date of this Statement of Additional
Information, the shares of the Fund are divided into Class A, Class B, Class C
and Class D shares. Class A, Class B, Class C and Class D shares represent
interests in the same assets of the Fund and are identical in all respects
except that the Class B, Class C and Class D shares bear certain expenses
related to the account maintenance and/or distribution of such shares and have
exclusive voting rights with respect to matters relating to such account
maintenance and/or distribution expenditures. The Board of Trustees of the Trust
may classify and reclassify the shares of any Series into additional classes at
a future date.
All shares of the Trust have equal voting rights, except that only shares
of the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B, Class C and Class D shares have exclusive
voting rights with respect to matters relating to the account maintenance and/or
distribution expenses being borne solely by such class. Each issued and
outstanding share is entitled to one vote and to participate equally in
dividends and distributions declared by the Fund and in the net assets of such
Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities, except that, as noted above, expenses related to the
account maintenance and/or distribution of the Class B, Class C and Class D
shares are borne solely by such class. There normally will be no meetings of
shareholders for the purposes of electing Trustees unless and until such time as
less than a majority of the Trustees holding office have been elected by
shareholders, at which time the Trustees then in office will call a
shareholders' meeting for the election of Trustees. Shareholders may, in
accordance with the terms of the Declaration of Trust, cause a meeting of
shareholders to be held for the purpose of voting on the removal of Trustees.
Also, the Trust will be required to call a special meeting of shareholders in
accordance with the requirements of the 1940 Act to seek approval of new
management and
37
<PAGE>
advisory arrangements, of a material increase in distribution fees, or of a
change in the fundamental policies, objectives or restrictions of a Series.
The obligations and liabilities of a particular Series are restricted to
the assets of that Series and do not extend to the assets of the Trust
generally. The shares of each Series, when issued, will be fully paid and
nonassessable, have no preference, preemptive, conversion, exchange or similar
rights, and are freely transferable. Holders of shares of any Series are
entitled to redeem their shares as set forth elsewhere herein and in the
Prospectus. Shares do not have cumulative voting rights and the holders of more
than 50% of the shares of the Trust voting for the election of Trustees can
elect all of the Trustees if they choose to do so and in such event the holders
of the remaining shares would not be able to elect any Trustees. No amendments
may be made to the Declaration of Trust without the affirmative vote of a
majority of the outstanding shares of the Trust.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares of the Fund for $100,000. Such shares were acquired for investment and
can only be disposed of by redemption. The organizational expenses of the Fund
(estimated at approximately $81,100) were paid by the Fund and are being
amortized over a period not exceeding five years. The proceeds realized by the
Manager upon the redemption of any of the shares initially purchased by it will
be reduced by the proportionate amount of unamortized organizational expenses
which the number of shares redeemed bears to the number of shares initially
purchased. Such organizational expenses include certain of the initial
organizational expenses of the Trust which have been allocated to the Fund by
the Trustees. If additional Series are added to the Trust, the organizational
expenses will be allocated among the Series in a manner deemed equitable by the
Trustees.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A, Class
B, Class C and Class D shares of the Fund based on the value of the Fund's net
assets and number of shares outstanding on July 31, 1996 is calculated as set
forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
----------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Net Assets............................................ $21,625,751 $120,565,055 $4,721,914 $3,583,282
----------- ------------ ---------- ----------
----------- ------------ ---------- ----------
Number of Shares Outstanding.......................... 1,935,599 10,791,465 422,593 320,418
----------- ------------ ---------- ----------
----------- ------------ ---------- ----------
Net Asset Value Per Share (net assets divided by
number of shares outstanding)....................... $ 11.17 $ 11.17 $ 11.17 $ 11.18
Sales Charge (for Class A and Class D shares: 4.00% of
offering price; 4.17% of net asset value per
share)*............................................. .47 ** ** .47
----------- ------------ ---------- ----------
Offering Price........................................ $ 11.64 $ 11.17 $ 11.17 $ 11.65
----------- ------------ ---------- ----------
----------- ------------ ---------- ----------
</TABLE>
- ------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C shares are not subject to an initial sales charge but may
be subject to a CDSC on redemption of shares. See 'Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C Shares' in
the Prospectus and 'Redemption of Shares--Deferred Sales Charges--Class B and
Class C Shares' herein.
38
<PAGE>
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Fund. The independent
auditors are responsible for auditing the annual financial statements of the
Fund.
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 351, Boston, Massachusetts
02101, acts as the custodian of the Fund's assets. The custodian is responsible
for safeguarding and controlling the Fund's cash and securities, handling the
delivery of securities and collecting interest on the Fund's investments.
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Trust's transfer agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
'Management of the Trust-- Transfer Agency Services' in the Prospectus.
LEGAL COUNSEL
Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on July 31 of each year. The Trust sends
to shareholders of the Fund at least semi-annually reports showing the Fund's
portfolio and other information. An annual report, containing financial
statements audited by independent auditors, is sent to shareholders each year.
After the end of each year shareholders will receive Federal income tax
information regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
The Declaration of Trust establishing the Trust dated August 2, 1985, a
copy of which, together with all amendments thereto (the 'Declaration') is on
file in the office of the Secretary of the Commonwealth of Massachusetts,
provides that the name 'Merrill Lynch Multi-State Municipal Series Trust' refers
to the Trustees under the Declaration collectively as Trustees, but not as
individuals or personally; and no Trustee, shareholder, officer, employee or
agent of the Trust shall be held to any personal liability; nor shall resort be
had to their private property for the satisfaction of any obligation or claim of
the Trust but the 'Trust Property' only shall be liable.
To the knowledge of the Trust, no person or entity owned beneficially 5% or
more of the Fund's shares on November 1, 1996.
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APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN PENNSYLVANIA
The following information is a brief summary of factors affecting the
economy of the Commonwealth and does not purport to be a complete description of
such factors. Other factors will affect issuers. The summary is based primarily
upon one or more publicly available offering statements relating to debt
offerings of Commonwealth issuers; however, it has not been updated nor will it
be updated during the year. The Trust has not independently verified the
information.
Many factors affect the financial condition of the Commonwealth of
Pennsylvania (also referred to as the 'Commonwealth') and its political
subdivisions, such as social, environmental and economic conditions, many of
which are not within the control of such entities. Pennsylvania and certain of
its counties, cities and school districts and public bodies (most notably the
City of Philadelphia) have from time to time in the past encountered financial
difficulties which have adversely affected their respective credit standings.
Such difficulties could affect outstanding obligations of such entities,
including obligations held by the Fund. Further, the Washington-based Center on
Budget and Policy Priorities issued a report in the spring of 1996 stating that
recent and proposed state tax cuts, combined with structural problems in the
state's revenue system, will lead to a $600 million annual deficit within five
years. Governor Ridge's administration has challenged that report.
The General Fund, the Commonwealth's largest fund, receives all tax
revenues, non-tax revenues and Federal grants and entitlements that are not
specified by law to be deposited elsewhere. The majority of the Commonwealth's
operating and administrative expenses are payable from the General Fund. Debt
service on all bonded indebtedness of the Commonwealth, except that issued for
highway purposes or for the benefit of other special revenue funds, is payable
from the General Fund.
For the five year period fiscal 1991 through fiscal 1995, total revenues
and other sources rose at a 9.1% average annual rate while expenditures and
other uses grew by 7.4% annually. Over two-thirds of the increase in total
revenues and other sources during this period occurred during fiscal 1992 when a
$2.7 billion tax increase was enacted to address a fiscal 1991 budget deficit
and to fund increased expenditures for fiscal 1992. For the four year period
from fiscal 1992 through fiscal 1995, total revenues and other sources increased
at an annual average of 3.3%, less than one-half the rate of increase for the
five year period beginning with fiscal 1991. This slower rate of growth was due,
in part, to tax reductions and other tax law revisions that restrained the
growth of tax receipts for the fiscal years 1993, 1994 and 1995.
Expenditures and other uses followed a pattern similar to that for
revenues, although with smaller growth rates, during the fiscal years 1991
through 1995. Program areas having the largest increase in costs for the fiscal
years 1991 through 1995 were for protection of persons and property, due to an
expansion of state prisons, and for public health and welfare, due to rising
caseloads, program utilization and increased prices. Recent efforts to restrain
the rapid expansion of public health and welfare program costs have resulted in
expenditure increases at or below the total rate of increase for total
expenditures in each fiscal year.
Fiscal 1995 was the fourth consecutive fiscal year the Commonwealth
reported an increase in the fiscal year-end unappropriated balance. The fiscal
1995 unappropriated surplus (prior to reserves for transfer to the Tax
Stabilization Reserve Fund) was $540 million, an increase of $204.2 million over
the fiscal 1994 unappropriated surplus (prior to transfers). Commonwealth
revenues were $459.4 million (2.9%) above the estimate of revenues used at the
time the budget was enacted. The higher than estimated revenues from tax sources
were due to faster economic growth in the national and state economy than had
been projected when the budget was adopted.
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Expenditures from Commonwealth revenues (excluding pooled financing
expenditures), including $65.5 million of supplemental appropriations enacted at
the close of the 1995 fiscal year, totaled $15,674 million, representing an
increase of 5% over spending during fiscal 1994.
For GAAP purposes, the General Fund recorded a $49.8 million deficit for
fiscal 1995, leading to a decline in the fund balance to $688.3 million at June
30, 1995. The two items which predominately contributed to the decline in the
fund balance were (i) the use of a more comprehensive procedure to compute the
liabilities for certain public welfare programs, leading to an increase for the
year-end accruals, and (ii) a change in the methodology used to calculate the
year-end accrual for corporate tax payables which increased the tax refund
liability by $72 million for the 1995 fiscal year when compared to the previous
fiscal year.
The fiscal 1996 unappropriated surplus (prior to transfer to the Tax
Stabilization Reserve Fund) was $183.8 million, $65.5 million above estimate.
Net expenditures and encumbrances from Commonwealth revenues, including $113
million of supplemental appropriations (but excluding pooled financing
expenditures) totalled $16,162.9 million. Expenditures exceeded available
revenues and lapses by $253.2 million. The difference was funded from a planned
partial drawdown of the $437 million fiscal year adjusted beginning
unappropriated surplus.
Commonwealth revenues (prior to tax refunds) for fiscal 1996 increased by
$113.9 million over the prior year to $16,338.5 million (representing a growth
rate of .7%). Tax rate reductions and other tax law changes substantially
reduced the amount and rate of revenue growth for the fiscal year. It is
estimated the tax changes enacted for the fiscal year reduced Commonwealth
revenues by $283.4 million. The most significant tax changes enacted for the
fiscal year were (i) acceleration of the reduction of the corporate net income
tax rate to 9.99 percent; (ii) double weighing of the sales factor of the
corporate net income apportionment calculation; (iii) an increase in the maximum
annual allowance for a net operating loss deduction from .5 million to $1
million; (iv) an increase in the basic exemption amount for the capital stock
and franchise tax; (v) the repeal of the tax on annuities; and (vi) the
elimination of inheritance tax on transfers of certain property to surviving
spouses.
The enacted fiscal 1997 budget provides for expenditures from Commonwealth
revenues of $16,375.8 million, an increase of .6% over appropriated amounts from
Commonwealth revenues for fiscal 1996. The fiscal 1997 budget is based on
anticipated Commonwealth revenues (before refunds) of $16,744.5 million, an
increase over actual fiscal 1996 revenues of 2.5%. The revenue estimate includes
provision for a $15 million tax credit program enacted with the fiscal 1997
budget for businesses creating new jobs. Staggered corporation tax years will
cause fiscal 1997 revenues to continue to be affected by the business tax
reductions enacted during the two prior completed fiscal years. Those
reductions, together with the new jobs creation tax credit, cause revenue growth
comparisons between fiscal 1996 and 1997 to be understated. When these tax
changes are taken into account, revenues in the fiscal 1997 budget are
anticipated to increase at the rate of 3%. The fiscal 1997 revenue estimate is
based on a forecast of the national economy for real gross domestic product to
slow to a growth rate of 2% for 1996 and below 1.5 percent for 1997. This is
based on the assumption that the Federal Reserve Board does not cut interest
rates and that foreign economic growth is weak. The consequence of this economic
scenario is a U.S. economy with very low growth, slow gains in consumer
spending, declining inflation rates, but increasing unemployment.
Increased authorized spending for fiscal 1997 is driven largely by
increased costs of the corrections and probation and payroll programs. The
fiscal 1997 budget contains an appropriation increase in excess of $110 million
for these programs. The fiscal 1997 budget also contains some departmental
restructurings.
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Providing funding for certain program increases required reductions and
savings in other programs funded from the General Fund. A major reform of the
current welfare system was enacted in May, 1996 to encourage recipients toward
self-sufficiency through work requirements, to provide temporary support for
families showing personal responsibility and to maintain safeguards for those
who cannot help themselves.
The fiscal 1997 budget anticipates receiving $60 million of proceeds from
the securitization of $151.7 million of loans held by the Sunny Day Fund. This
fund was created to finance large-scale economic development loans to attract
significant employment opportunities to the Commonwealth. Its funding was
generally obtained from General Fund appropriations. The fund has been abolished
and its loans have been transferred to the Pennsylvania Industrial Development
Fund, which will issue bonds secured by its loan reserves (including the Sunny
Day Fund). These bond proceeds will be used to refund outstanding debt of the
Commonwealth. The effect of this transaction on the fiscal 1997 budget is to
reduce the amount of debt service needed to be appropriated from the General
Fund by at least $60 million.
The fiscal 1997 budget is based on the presumption that federally enacted
reforms to Medicaid will raise the federal reimbursement percentage for those
costs to 57% from an approximate 53% rate for fiscal 1996. The higher
reimbursement rate (expected to be effective in October, 1996) was anticipated
to provide an additional $260 million of federal funds during fiscal 1997 and
enable the Commonwealth to reduce its appropriations for the medical assistance
program by a like amount for fiscal 1997. However, the U.S. Congress has not
approved the legislation making these changes and current expectations are that
additional federal funds will not be available at the time and in the amount as
anticipated in the approved fiscal 1997 budget. The Commonwealth expects to use
intergovernmental transfer funds obtained through a pooling transaction to help
make up the loss of this funding.
The fiscal 1997 budget assumes a drawdown of the $153.3 million fiscal year
beginning unappropriated surplus to fund the enacted level of appropriations
within the current estimate of revenues.
A disaster emergency was declared by the Governor and a federal major
disaster declaration was made by the President of the United States for certain
counties in the Commonwealth for a blizzard and subsequent flooding in January,
1996. Substantial damage to public and private facilities occurred and many
municipalities' financial resources have been strained by the costs of
responding to these weather-related conditions. A special session of the General
Assembly was convened by the Governor to consider legislation to respond to
these needs. Legislation was enacted that authorized $110 million of general
obligation debt to provide for the state's share of the required match for
federal public assistance and disaster mitigation funds. The legislation also
appropriated $13 million from tax amnesty receipts to fund the state match for
the federal individual assistance program, and authorized the use of current
Motor License Fund revenues for capital projects to repair flood damaged state
highways and bridges.
Pennsylvania has historically been identified as a heavy industry state
although that reputation has changed over the last thirty years as the coal,
steel and railroad industries declined and the Commonwealth's business
environment readjusted to reflect a more diversified industrial base. This
economic readjustment was a direct result of a long-term shift in jobs,
investment and workers away from the northeast part of the nation. Currently,
the major sources of growth in Pennsylvania are in the service sector, including
trade, medical and the health services, education and financial institutions.
Nonagricultural employment in Pennsylvania over the last ten years
increased at an annual rate of 1.02%. This compares to a .36% rate for the
Middle Atlantic region and 1.8% rate for the United States as a whole during the
period 1986 through 1995. For the last three years, employment in the
Commonwealth has increased 3.4%, as
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compared to 2.9% growth in the Middle Atlantic region. The unemployment rate in
Pennsylvania for August, 1996, stood at a seasonably adjusted rate of 5.3%. The
seasonably adjusted national unemployment rate for August, 1996, was 5.1%.
The current Constitutional provisions pertaining to Commonwealth debt
permit the issuance of the following types of debt: (i) debt to suppress
insurrection or rehabilitate areas affected by disaster, (ii)
electorate-approved debt, (iii) debt for capital projects subject to an
aggregate debt limit of 1.75 times the annual average tax revenues of the
preceding five fiscal years and (iv) tax anticipation notes payable in the
fiscal year of issuance. All debt except tax anticipation notes must be
amortized in substantial and regular amounts.
Debt service on all bonded indebtedness of Pennsylvania, except that issued
for highway purposes or the benefit of other special revenue funds, is payable
from Pennsylvania's General Fund, which receives all Commonwealth revenues that
are not specified by law to be deposited elsewhere. As of June 30, 1996, the
Commonwealth had $5,054.5 million of general obligation debt outstanding.
Other state-related obligations include 'moral obligations'. Moral
obligation indebtedness may be issued by the Pennsylvania Housing Finance Agency
('PHFA'), a state agency which provides financing for housing for lower and
moderate income families, and The Hospitals and Higher Education Facilities
Authority of Philadelphia, a municipal authority organized by the City of
Philadelphia to, among other things, acquire and prepare various sites for use
as intermediate care facilities for the mentally retarded. PHFA's bonds, but not
its notes, are partially secured by a capital reserve fund required to be
maintained by PHFA in an amount equal to the maximum annual debt service on its
outstanding bonds in any succeeding calendar year. PHFA is not permitted to
borrow additional funds as long as any deficiency exists in the capital reserve
fund.
The Commonwealth, through several of its departments and agencies, has
entered into various agreements to lease, as lessee, certain real property and
equipment, and to make lease payments for the use of such property and
equipment. Some of those leases and their respective lease payments are, with
the Commonwealth approval, pledged as security for debt obligations issued by
certain public authorities or other entities within the state. All lease
payments due from Commonwealth departments and agencies are subject to and
dependent upon an annual spending authorization approved through the
Commonwealth's annual budget process. The Commonwealth is not required by law to
appropriate or otherwise provide monies from which the lease payments are to be
made. The obligations to be paid from such lease payments are not bonded debt of
the Commonwealth.
Certain state-created agencies have statutory authorization to incur debt
for which state appropriations to pay debt service thereon is not required. The
debt of these agencies is funded by assets of, or revenues derived from, the
various projects financed and is not an obligation of the Commonwealth. Some of
these agencies, however, are indirectly dependent on Commonwealth operating
appropriations. In addition, the Commonwealth maintains pension plans covering
all state employees, public school employees and employees of certain state-
related organizations. For their fiscal years ended in 1995 the State Employees'
Retirement System had a $443 million surplus and the Public School Employees'
Retirement System had a total unfunded actuarial accrued liability of $3,102
million.
The City of Philadelphia is the largest city in the Commonwealth with an
estimated population of 1,585,577 according to the 1990 Census. Legislation
providing for the establishment of Pennsylvania Intergovernmental Cooperation
Authority ('PICA') to assist Philadelphia in remedying fiscal emergencies was
enacted by the Pennsylvania General Assembly and approved by the Governor in
June, 1991. PICA is designed to provide assistance through the issuance of
funding debt and to make factual findings and recommendations to
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Philadelphia concerning its budgetary and fiscal affairs. At this time,
Philadelphia is operating under a five year fiscal plan approved by PICA on
April 30, 1996.
PICA has issued $1.76 billion of its Special Tax Revenue Bonds. This
financial assistance has included the refunding of certain city general
obligation bonds, funding of capital projects and the liquidation of the
Cumulative General Fund balance deficit as of June 30, 1992 of $224.9 million.
The audited General Fund balance of Philadelphia as of June 30, 1995 shows a
surplus of approximately $80.5 million, up from approximately $15.4 million as
of June 30, 1994.
No further bonds are to be issued by PICA for the purpose of financing a
capital project or deficit as the authority for such bond sales expired December
31, 1994. PICA's authority to issue debt for the purpose of financing a cash
flow deficit expires on December 31, 1996. Its ability to refund existing
outstanding debt is unrestricted. PICA had $1,146.2 million in special revenue
bonds outstanding as of December 31, 1996.
There is various litigation pending against the Commonwealth, its officers
and employees. In 1978, the Pennsylvania General Assembly approved a limited
waiver of sovereign immunity. Damages for any loss are limited to $250,000 for
each person and $1 million for each accident. The Supreme Court held that this
limitation is constitutional. Approximately 3,500 suits against the Commonwealth
are pending.
The following are among the cases with respect to which the Office of
Attorney General and the Office of General Counsel have determined that an
adverse decision may have a material effect on government operations of the
Commonwealth:
Baby Neal v. Commonwealth, et al.
In 1990, the American Civil Liberties Union and other various named
plaintiffs filed an action against the Commonwealth in Federal court seeking an
order that would require the Commonwealth to provide additional funding for
child welfare services. No figures for the amount of funding sought are
available. However, a similar lawsuit filed in the Commonwealth Court of
Pennsylvania was resolved through a court approved settlement which provides,
among other things, for Commonwealth funding for such services in fiscal year
1991 and a commitment to pay Pennsylvania counties $30 million over five years.
In December 1994, the Third Circuit Court of Appeals reversed the District
Court's denial of the plaintiff's motion for class certification with respect to
the interests of 16 minor plaintiffs. As a result, the District Court has
recently certified the class and the parties have resumed discovery.
County of Allegheny v. Commonwealth of Pennsylvania
On December 7, 1987, the Supreme Court of Pennsylvania held that the
statutory scheme for county funding of the judicial system is in conflict with
the Pennsylvania Constitution. However, judgment was stayed in order to afford
the General Assembly an opportunity to enact appropriate funding legislation
consistent with its opinion. Since that time, the Supreme Court has denied
various actions and motions by several Pennsylvania municipalities to compel the
Commonwealth to comply with the Supreme Court's 1987 decision or to restore
funding for local courts and district justices to levels existing in 1987. On
December 7, 1992, the State Association of County Commissioners filed a new
action in mandamus seeking to compel the Commonwealth to comply with the Supreme
Court's decision in County of Allegheny. The Commonwealth has filed a response
in opposition to the new action. The Court issued the writ on July 26, 1996, and
appointed a special master to devise and submit a plan for implementation.
Recently, the President of the Senate and the Speaker of the House filed a
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petition seeking reconsideration from the Court. The General Assembly has yet to
consider legislation implementing the Pennsylvania Supreme Court's judgment.
Fidelity Bank v. Commonwealth of Pennsylvania
On November 30, 1989, Fidelity Bank, N.A. ('Fidelity') filed an action in
challenging the constitutional validity of a 1989 amendment increasing the bank
shares tax and related legislation. The Commonwealth Court ruled in favor of the
Commonwealth finding no constitutional deficiencies in the tax increase, but
invalidating one element of the legislation which provided a credit to new banks
(the 'new bank tax credit'). Fidelity, the Commonwealth and certain intervener
banks appealed to the Pennsylvania Supreme Court. However, pursuant to a
Settlement Agreement dated as of April 21, 1995, the Commonwealth agreed to
enter a credit in favor of Fidelity in the amount of $4,100,000 in settlement of
the constitutional and non-constitutional issues. The credit represents
approximately 5% of the potential claim of Fidelity, had the constitutional
issues been resolved in its favor.
Pursuant to a separate Settlement Agreement dated as of April 21, 1995, the
Commonwealth also settled with the intervening banks with respect to issues
concerning the new bank tax credit.
Notwithstanding the foregoing settlements, other banks have filed
protective petitions which are currently pending at the various administrative
agencies challenging the validity of the 1989 tax increase. Depending on the
outcome of those administrative appeals, one or more of these banks may seek to
raise the issues which were adjudicated by Fidelity, although not brought to
resolution by the Pennsylvania Supreme Court.
Pennsylvania Association of Rural and Small Schools (PARSS) v. Casey
In January 1991, an association of rural and small schools and several
other parties filed a lawsuit against then Governor Robert P. Casey and former
Secretary of Education, Donald M. Carroll challenging the constitutionality of
the Commonwealth system for funding local school districts. The litigation
consists of two parallel cases, one in the Commonwealth Court of Pennsylvania
and one in the United States District Court for the Middle District of
Pennsylvania. The federal court case has been indefinitely stayed pending
resolution of the state court case. The Judge in the state court case has issued
an order scheduling trial to commence January 6, 1997. Because of the number of
witnesses identified by the petitioners and the interviews that had not been
previously disclosed, the Court has authorized the Commonwealth respondents to
conduct additional discovery depositions.
Austin v. Department of Corrections, et al.
In November 1990, the American Civil Liberties Union filed a class action
lawsuit in the United States District Court for the Eastern District of
Pennsylvania on behalf of inmate populations in various Pennsylvania
correctional institutions, challenging the conditions of confinement and seeking
injunctive relief. On January 17, 1995, the Court approved a Settlement
Agreement between the parties, pursuant to which the Commonwealth paid $1.3
million in attorney's fees to the plaintiffs' attorneys, with an additional
$100,000 to be paid upon dismissal of a preliminary injunction relating to
certain health issues. The parties are presently complying with monitoring
provisions outlined in the Settlement Agreement. The monitoring phase will
expire on January 8, 1998. The attorney's fees for the 3-year monitoring period
will not exceed $60,000 in any one year.
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Envirotest/Synterra Partners
On December 15, 1995, Envirotest Systems Corporation, Envirotest Partners
('Envirotest') and the Commonwealth of Pennsylvania entered into a Settlement
Agreement pursuant to which the parties settled all claims which Envirotest
might have against the Commonwealth arising from the suspension of an emissions
testing program. Under the Settlement Agreement, Envirotest is to receive $145
million, with interest at 6% per annum, in payments of $25 million in 1995, and
$40 million each in 1996, 1997 and 1998. An additional $15 million may be
required to be paid in 1998 depending on the results of property liquidations by
Envirotest.
Pennsylvania Human Relations Commission v. School District of Philadelphia, et
al. v. Commonwealth of Pennsylvania, et al.
On November 3, 1995, the Commonwealth of Pennsylvania and the Governor of
Pennsylvania, along with the City of Philadelphia and the Mayor of Philadelphia,
were joined as additional respondents in an enforcement action commenced in
Commonwealth Court in 1973 by the Pennsylvania Human Relations Commission
against the School District of Philadelphia pursuant to the Pennsylvania Human
Relations Act. The enforcement action was pursued to remedy unintentional
conditions of segregation in the public schools of Philadelphia. The
Commonwealth and the City were joined in the 'remedial phase' of the proceeding
'to determine their liability, if any, to pay additional costs necessary to
remedy the unlawful conditions found to exist in the Philadelphia public
schools.'
On February 28, 1996, the School District of Philadelphia filed a
third-party complaint against the Commonwealth of Pennsylvania asking
Commonwealth Court to require the Commonwealth to 'supply such funding as is
necessary for full compliance with the November 28, 1994 and other remedial
orders of the Commonwealth Court.' In addition, a group of interveners on March
4, 1996 filed a third-party complaint against the Commonwealth of Pennsylvania
and the City of Philadelphia requesting Commonwealth Court to declare that 'it
is the obligation of the Commonwealth and the City to supply the additional
funds identified as necessary for the District to fully comply with the orders
of the Commonwealth Court,' and to require the Commonwealth and the City to
supply such additional funding as is necessary for the District to comply with
the orders.
On April 30, 1996, Commonwealth Court Judge Doris A. Smith overruled the
Commonwealth's and City's preliminary objections seeking dismissal of the claims
against them. The Commonwealth and the City thereafter filed answers to the
complaints, asserting numerous defenses. The Commonwealth also asserted a
cross-claim against the City of Philadelphia claiming that if any party is
liable, sole liability rests with the City; in the alternative, the Commonwealth
argued that if it is held to be liable, it has a right of indemnity of
contribution against the City.
Trial commenced on May 30, 1996. During the course of the trial, upon
motion of the Commonwealth, the Pennsylvania Supreme Court on July 3, 1996
assumed extraordinary plenary jurisdiction and directed Judge Smith to conclude
the proceedings within 60 days and to file with the Supreme Court findings of
fact, conclusions of law and a final opinion.
On August 20, 1996, Judge Smith issued an Opinion and Order pursuant to
which judgment was entered in favor of the School District of Philadelphia and
the interveners and against the Commonwealth of Pennsylvania and the Governor of
Pennsylvania. Judgment was also entered in favor of the City of Philadelphia
and the Mayor of Philadelphia with respect to the intervener's claim and on the
cross-claim filed by the Commonwealth and Governor. The Judge ordered the
Commonwealth and Governor to submit a plan to the Court within thirty
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days detailing the means by which the Commonwealth will effectuate the transfer
of additional funds payable to the School District of Philadelphia to enable it
to comply with the remedial order during fiscal year 1996-1997 and any future
years during which the School District establishes its fiscal incapacity to fund
the remedial programs. Judge Smith specifically found that '[b]ecause of the
lack of adequate funds to comply with the remedial order, the School District is
entitled to additional resources for 1996-1997 of $45.1 million.'
On August 30, 1996, the Commonwealth filed exceptions to the Findings of
Fact, Conclusions of Law and Opinion and Order of Judge Smith along with a
Motion to Vacate the purported Order and a Notice of Appeal and Jurisdictional
Statement.
On September 10, 1996, the Pennsylvania Supreme Court issued an order
granting the Commonwealth's Motion to Vacate and directed its Prothonotary to
establish a briefing schedule and date for oral argument. It also issued a
further order limiting the issues to be addressed and stated that the
Commonwealth Court is divested of jurisdiction of the matter and all further
proceedings in the Commonwealth Court are stayed pending further order of the
Supreme Court. The Supreme Court retained jurisdiction in the matter.
* * *
Currently, Pennsylvania general obligation bonds are rated AA- by Standard
& Poor's and Fitch, and A1 by Moody's. There can be no assurance that the
economic conditions on which these ratings are based will continue or that
particular bond issues will not be adversely affected by changes in economic or
political conditions.
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APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ('MOODY'S') MUNICIPAL BOND
RATINGS
<TABLE>
<S> <C>
Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of
investment risk and are generally referred to as 'gilt edge'. Interest payments are protected by a
large or by an exceptionally stable margin and principal is secure. While the various protective
elements are likely to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa
group they comprise what are generally known as high grade bonds. They are rated lower than the best
bonds because margins of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements present which make the
long-term risks appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and are to be considered as
upper medium grade obligations. Factors giving security to principal and interest are considered
adequate, but elements may be present which suggest a susceptibility to impairment sometime in the
future.
Baa Bonds which are rated Baa are considered as medium grade obligations; i.e., they are neither highly
protected nor poorly secured. Interest payment and principal security appear adequate for the present
but certain protective elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in fact have speculative
characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered
as well assured. Often the protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of
interest and principal payment or of maintenance of other terms of the contract over any long period
of time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present
elements of danger with respect to principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues
are often in default or have other marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as
having extremely poor prospects of ever attaining any real investment standing.
</TABLE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
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Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes 'best
quality . . . strong protection by established cash flows'; MIG 2/VMIG2 denotes
'high quality' with ample margins of protection; MIG 3/VMIG3 notes are of
'favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades'; MIG 4/VMIG4 notes are of 'adequate quality . . .
[p]rotection commonly regarded as required of an investment security is present
. . . there is specific risk.'
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Excerpts from Moody's description of its corporate bond ratings:
Aaa--judged to be the best quality, carry the smallest degree of investment
risk; Aa--judged to be of high quality by all standards; A--possess many
favorable investment attributes and are to be considered as upper medium grade
obligations.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; and well established access
to a range of financial markets and assured sources of alternate liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP ('STANDARD & POOR'S') MUNICIPAL
DEBT RATINGS
A Standard & Poor's municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers, or
lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
49
<PAGE>
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform any audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default--capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded to, and relative position of, the obligation
in the event of bankruptcy, reorganization or other arrangement under the
laws of bankruptcy and other laws affecting creditor's rights.
<TABLE>
<S> <C>
AAA Debt rated 'AAA' has the highest rating assigned by Standard & Poor's. Capacity to pay interest and
repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay principal and differs from the
higher rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay principal although it is somewhat more
susceptible to the adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay interest and repay principal.
Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than for debt in higher-rated categories.
BB Debt rated 'BB', 'B', 'CCC' and 'CC' is regarded, on balance, as predominantly speculative with
B respect to capacity to pay interest and repay principal in accordance with the terms of the
CCC obligations. 'BB' indicates the lowest degree of speculation and 'C' the highest degree of
CC speculation. While such debt will likely have some quality and protective characteristics, these are
C outweighed by large uncertainties or major risk exposures to adverse conditions.
CI The rating 'CI' is reserved for income bonds on which no interest is being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is used when interest payments or
principal payments are not made on the date due even if the applicable grace period has not expired,
unless Standard & Poor's believes that such payments will be made during such grace period. The 'D'
rating also will be used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
</TABLE>
Plus (+) or Minus (-): The ratings from 'AA' to 'CCC' may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
50
<PAGE>
DESCRIPTION OF STANDARD & POOR'S CORPORATE BOND RATINGS
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. Debt rated
'AAA' has the highest rating assigned by Standard & Poor's. Capacity to pay
interest and repay principal is extremely strong. Debt rated 'AA' has a very
strong capacity to pay interest and to repay principal and differs from the
highest rated issues only in small degree. Debt rated 'A' has a strong capacity
to pay interest and repay principal although it is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than a
debt of a higher rated category. Debt rated 'BBB' is regarded as having an
adequate capacity to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and
repay principal for debt in this category than for debt in higher rated
categories.
The ratings from 'AA' to 'BBB' may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. Ratings are applicable to
both taxable and tax-exempt commercial paper. Issues assigned the highest rating
are regarded as having the greatest capacity for timely payment. Issues in this
category are further refined with the designation 1, 2, and 3 to indicate the
relative degrees of safety. The three designations in the 'A' category are as
follows:
<TABLE>
<S> <C>
A-1 This designation indicates that the degree of safety regarding timely payment is either overwhelming
or very strong. Those issues determined to possess extremely strong safety characteristics are denoted
with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is satisfactory. However, the relative
degree of safety is not as high as for issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely payment. They are, however,
somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying
the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for timely payment.
C This rating is assigned to short-term debt obligations with a doubtful capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is used when interest payments or
principal payments are not made on the date due, even if the applicable grace period has not expired,
unless Standard & Poor's believes that such payments will be made during such grace period.
</TABLE>
A Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
51
<PAGE>
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive a
note rating. Notes maturing beyond 3 years will most likely receive a long-term
debt rating. The following criteria will be used in making that assessment.
-- Amortization schedule (the larger the final maturity relative to
other maturities, the more likely it will be treated as a note).
-- Source of payment (the more dependent the issue is on the market
for its refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
<TABLE>
<S> <C>
SP-1 A very strong, or strong, capacity to pay principal and interest. Issues that possess overwhelming
safety characteristics will be given a '+' designation.
SP-2 A satisfactory capacity to pay principal and interest.
SP-3 A speculative capacity to pay principal and interest.
</TABLE>
Standard & Poor's may continue to rate note issues with a maturity greater
than three years in accordance with the same rating scale employed for municipal
bond ratings.
Unrated: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuers belongs to a group of securities that is not
rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or
issuer.
4. The issue was privately placed, in which case the rating is not
published in Standard & Poor's publications.
Suspension or withdrawal may occur if new and material circumstances arise,
the effects of which preclude satisfactory analysis; if there is no longer
available reasonable up-to-date information to permit a judgment to be formed;
if a bond is called for redemption; or for other reasons.
DESCRIPTION OF FITCH INVESTORS SERVICE, INC.'S ('FITCH') INVESTMENT GRADE BOND
RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operative performance of the issuer and any guarantor,
as well as the political and economic environment that might affect the issuer's
future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
52
<PAGE>
Bonds that have the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
<TABLE>
<S> <C>
AAA Bonds considered to be investment grade and of the highest credit quality. The obligor has an
exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by
reasonably forseeable events.
AA Bonds considered to be investment grade and of very high quality. The obligor's ability to pay
interest and repay principal is very strong, although not quite as strong as bonds rated 'AAA'.
Because bonds rated in the 'AAA' and 'AA' categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated 'F-1+'.
A Bonds considered to be investment grade and of high credit quality. The obligor's ability to pay
interest and repay principal is considered to be strong, but may be more vulnerable to adverse
changes in economic conditions and circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit quality. The obligor's ability to
pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have adverse impact on these bonds, and therefore,
impair timely payment. The likelihood that the ratings of these bonds will fall below investment
grade is higher than for bonds with higher ratings.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the 'AAA' category.
Credit Trend Indicator: Credit trend indicators show whether credit
fundamentals are improving, stable, declining, or uncertain, as follows:
<TABLE>
<S> <C>
Improving Arrow Ascending
Stable Left & Right Arrows
Declining Arrow Descending
Uncertain Up & Down Arrows
</TABLE>
Credit trend indicators are not predictions that any rating change will
occur, and have a longer-term time frame than issues placed on FitchAlert.
<TABLE>
<S> <C>
NR: Indicates that Fitch does not rate the specific issue.
Conditional: A conditional rating is premised on the successful completion of a project or the occurrence
of a specific event.
</TABLE>
53
<PAGE>
<TABLE>
<S> <C>
Suspended: A rating is suspended when Fitch deems the amount of information available from the issuer to
be inadequate for rating purposes.
Withdrawn: A rating will be withdrawn when an issue matures or is called or refinanced and, at Fitch's
discretion, when an issuer fails to furnish proper and timely information.
FitchAlert: Ratings are placed on FitchAlert to notify investors of the occurrence that is likely to
result in a rating change and the likely direction of such change. These are designated as
'Positive' indicating a potential upgrade, 'Negative' for potential downgrade, or 'Evolving'
where ratings may be raised or lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
</TABLE>
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a security. The ratings ('BB' to
'C') represent Fitch's assessment of the likelihood of timely payment of
principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ('DDD' to 'D') is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, the
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since rating categories cannot fully reflect the
differences in degrees of credit risk.
<TABLE>
<S> <C>
BB Bonds are considered speculative. The obligor's ability to pay interest and repay
principal may be affected over time by adverse economic changes. However, business and
financial alternatives can be identified which could assist the obligor in satisfying
its debt service requirements.
B Bonds are considered highly speculative. While bonds in this class are currently meeting
debt service requirements, the probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and the need for reasonable
business and economic activity throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not remedied, may lead to
default. The ability to meet obligations requires an advantageous business and economic
environment.
CC Bonds are minimally protected. Default in payment of interest and/or principal seems
probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD, DD, and D Bonds are in default of interest and/or principal payments. Such bonds are extremely
speculative and should be valued on the basis of their ultimate recovery value in
liquidation or reorganization of the obligor. 'DDD' represents the highest potential for
recovery on these bonds, and 'D' represents the lowest potential for recovery.
</TABLE>
54
<PAGE>
Plus (+) Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the 'DDD', 'DD', or 'D' categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
Fitch short-term ratings are as follows:
<TABLE>
<S> <C>
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as having the
strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely payment only
slightly less in degree than issues rated 'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree of assurance for timely
payment, but the margin of safety is not as great as the 'F-1+' and 'F-1' ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics suggesting that the degree of
assurance for timely payment is adequate, however, near-term adverse changes could cause these
securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have characteristics suggesting a minimal degree
of assurance for timely payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
D Default. Issues carrying this rating are in actual or imminent payment default.
LOC The symbol, LOC, indicates that the rating is based on a letter of credit issued by a commercial
bank.
INS The symbol 'INS' indicates that the rating is based on an insurance policy or financial guaranty
issued by an insurance company.
</TABLE>
55
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Merrill Lynch Pennsylvania Municipal Bond Fund of
Merrill Lynch Multi-State Municipal Series Trust:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch Pennsylvania Municipal Bond Fund
of Merrill Lynch Multi-State Municipal Series Trust as of July 31, 1996, the
related statements of operations for the year then ended and changes in net
assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the five-year period then ended.
These financial statements and the financial highlights are the responsibility
of the Fund's management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at July 31,
1996 by correspondence with the custodian and broker. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
Pennsylvania Municipal Bond Fund of Merrill Lynch Multi-State Municipal Series
Trust as of July 31, 1996, the results of its operations, the changes in its net
assets, and the financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
September 5, 1996
56
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
PORTFOLIO ABBREVIATIONS
To simplify the listings of Merrill Lynch Pennsylvania
Municipal Bond Fund's portfolio holdings in the Schedule
of Investments, we have abbreviated the names of many
of the securities according to the list below and at right.
AMT Alternative Minimum Tax (subject to)
GO General Obligation Bonds
HFA Housing Finance Agency
IDA Industrial Development Authority
IDR Industrial Development Revenue Bonds
MVRICS Municipal Variable Rate Inverse Class Securities
PCR Pollution Control Revenue Bonds
RIB Residual Interest Bonds
S/F Single-Family
UPDATES Unit Priced Demand Adjustable Tax-Exempt Securities
UT Unlimited Tax
VRDN Variable Rate Demand Notes
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Pennsylvania--94.0%
<S> <C> <C> <C> <C>
NR* A $2,000 Allegheny County, Pennsylvania, Hospital Development Authority Revenue
Bonds (South Hills Health System), Series A, 6.50% due 5/01/2014 $ 2,043
AAA Aaa 4,785 Allegheny County, Pennsylvania, IDA, Revenue Refunding Bonds (Commercial
Development MPB Association Project), 7.70% due 12/01/2013 (e) 5,899
AAA Aaa 475 Allegheny County, Pennsylvania, Institutional District Bonds, UT, Series 18,
7.30% due 4/01/2009 (c) 515
AAA Aaa 750 Allegheny County, Pennsylvania, Sanitation Authority, Sewer Revenue Bonds,
Series C, 6.50% due 12/01/2001 (d)(f)(k) 817
AAA Aaa 1,430 Berks County, Pennsylvania, GO, UT, Second Series, 5.65%** due 5/15/2020 (d) 341
AAA Aaa 3,500 Bethlehem, Pennsylvania, Water Authority, Revenue Refunding Bonds,
5.20% due 11/15/2021 (c) 3,227
AAA Aaa 2,000 Bristol Township, Pennsylvania, School District, GO, Series A, 6.625%
due 2/15/2002 (c)(f) 2,217
AAA Aaa 3,550 Cambria County, Pennsylvania, Refunding, GO, UT, Series A, 6.625%
due 8/15/2014 (d) 3,826
A A3 500 Dauphin County, Pennsylvania, IDA, Water Development Revenue Bonds (Dauphin
Consolidated Water Supply), AMT, Series A, 6.90% due 6/01/2024 550
AAA NR* 3,500 Delaware County, Pennsylvania, College Authority Revenue Bonds (Neumann
College), 5.625% due 10/01/2025 (g) 3,315
A- NR* 2,350 Delaware County, Pennsylvania, Hospital Authority Revenue Bonds (Riddle
Memorial Hospital), 6.50% due 1/01/2022 2,365
A1+ P1 100 Delaware County, Pennsylvania, IDA, PCR (BP Oil Inc. Project), UPDATES,
3.60% due 12/01/2009 (a) 100
AA- Aa3 1,000 Delaware County, Pennsylvania, IDA, Revenue Refunding Bonds (Resource Recovery
Project), Series A, 8.10% due 12/01/2013 1,044
Emmaus, Pennsylvania, General Authority Revenue Bonds, VRDN (a):
SP1+ NR* 100 Series B, 3.15% due 3/01/2024 100
A1 NR* 100 Sub-Series B-10, 3.65% due 3/01/2024 100
A1 NR* 200 Sub-Series B-12, 3.65% due 3/01/2024 200
Erie County, Pennsylvania, IDA, PCR, Refunding (International Paper Co.):
A- A3 1,000 7.15% due 9/01/2013 1,059
A- A3 425 Series A, 7.60% due 9/01/2010 456
NR* NR* 920 Erie--Western Pennsylvania Port Authority, General Revenue Bonds, 6.875%
due 6/15/2016 (j) 934
</TABLE>
57
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Pennsylvania (continued)
<S> <C> <C> <C> <C>
AAA Aaa $1,155 Exeter Township, Pennsylvania, School District, GO, UT, 6.65% due 5/15/2002
(d)(f) $ 1,268
A1+ NR* 4,200 Geisinger, Pennsylvania, Health Systems Revenue Bonds, VRDN, Series B,
3.60% due 7/01/2022 (a) 4,200
A- NR* 4,990 Gettysburg, Pennsylvania, Municipal Authority, College Revenue Refunding Bonds
(Gettysburg College Project), 6.60% due 2/15/2012 5,237
AAA Aaa 2,960 Hollidaysburg, Pennsylvania, Area School District, Improvement Bonds, UT,
6.50% due 6/01/2020 (b) 3,131
NR* Baa1 1,500 Latrobe, Pennsylvania, IDA, College Revenue Bonds (Saint Vincent College
Project), 6.75% due 5/01/2024 1,516
BBB+ NR* 2,000 Lebanon County, Pennsylvania, Good Samaritan Hospital Authority, Revenue
Refunding Bonds (Good Samaritan Hospital Project), 6% due 11/15/2018 1,852
A A 2,585 Lehigh County, Pennsylvania, General Purpose Authority, Revenue Refunding Bonds
(Muhlenberg Hospital Center), Series A, 5.75% due 7/15/2010 2,503
Luzerne County, Pennsylvania, IDA, Exempt Facilities Revenue Refunding Bonds
(Pennsylvania Gas and Water Company Project), AMT, Series A:
BBB- Baa3 3,600 7.20% due 10/01/2017 3,804
AAA Aaa 2,000 7% due 12/01/2017 (b) 2,205
Montgomery County, Pennsylvania, Higher Education and Health Authority,
Hospital Revenue Bonds:
AAA Aaa 2,500 (Abington Hospital), MVRICS, Series A, 9.445% due 6/01/2011 (b)(h) 2,825
NR* NR* 225 (Jeanes Health System Project), 8.625% due 7/01/2000 (f) 261
BBB NR* 1,435 (Northwestern Corporation), 7% due 6/01/2012 1,474
BBB+ Baa2 2,665 Montgomery County, Pennsylvania, IDA, PCR, Refunding (Philadelphia Electric
Company), AMT, Series A, 7.60% due 4/01/2021 2,844
BBB+ NR* 475 Moon Transportation Authority, Pennsylvania, Highway Improvement Revenue
Bonds, 9.50% due 2/01/2016 (j) 529
AAA Aaa 3,300 North Penn, Pennsylvania, Water Authority Revenue Bonds, 7% due 11/01/2004
(d)(f) 3,800
AAA Aaa 4,000 North Wales, Pennsylvania, Water Authority Revenue Bonds, 7% due 11/01/2004
(d)(f) 4,579
AAA NR* 2,095 Northampton County, Pennsylvania, Higher Education Authority Revenue Bonds
(Moravian College), 8.20% due 6/01/2001 (f) 2,452
Pennsylvania Convention Center Authority, Revenue Refunding Bonds, Series A:
BBB- Baa 1,555 6.70% due 9/01/2014 1,656
BBB- Baa 2,500 6.75% due 9/01/2019 2,669
BBB- Baa2 1,500 Pennsylvania Economic Development Financing Authority, Exempt Facilities
Revenue Bonds (MacMillan Limited Partnership Project), AMT, 7.60%
due 12/01/2020 1,648
BBB+ Baa1 4,000 Pennsylvania Economic Development Financing Authority, Wastewater Treatment
Revenue Bonds (Sun Company Inc.--R & M Project), AMT, Series A, 7.60%
due 12/01/2024 4,402
Pennsylvania, HFA, RIB, AMT (h):
AA Aa 2,000 8.414% due 4/01/2025 1,870
AA Aa 1,000 Refunding, Series 1991-31C, 10.074% due 10/01/2023 1,050
Pennsylvania Intergovernmental Cooperative Authority, City of Philadelphia
Funding Program, Special Tax Revenue Bonds:
NR* Aaa 2,500 6.80% due 6/15/2002 (f) 2,765
AAA Aaa 3,000 5.625% due 6/15/2023 (c) 2,862
AAA Aaa 1,000 Refunding, Series A, 5% due 6/15/2013 (c) 920
</TABLE>
58
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
<?R>
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Pennsylvania (concluded)
<S> <C> <C> <C> <C>
A NR* $2,000 Pennsylvania State Finance Authority, Revenue Refunding Bonds (Municipal
Capital Improvements Program), 6.60% due 11/01/2009 $ 2,123
AA- A1 2,285 Pennsylvania State, GO, UT, Second Series A, 6.60% due 11/01/2011 2,450
Pennsylvania State, HFA, S/F Mortgage Revenue Bonds, AMT:
AA+ Aa 1,145 Series 28, 7.65% due 10/01/2023 1,205
AA+ Aa 2,165 Series 40, 6.90% due 4/01/2025 2,254
AA+ Aa 1,500 Series 41-B, 6.65% due 4/01/2025 1,535
Pennsylvania State Higher Educational Facilities Authority, College and
University Revenue Bonds:
NR* Baa 2,295 (Delaware Valley College of Science & Agriculture), 7% due 4/01/2022 2,360
NR* NR* 1,030 (Pennsylvania College of Podiatric Medicine), 8.50% due 10/01/2014 1,111
BBB+ NR* 1,250 Refunding (Allegheny College Project), Series B, 6% due 11/01/2022 1,189
A+ Aa 2,000 Pennsylvania State Higher Educational Facilities Authority, Revenue
Refunding Bonds (Thomas Jefferson University), Series A, 6.625% due 8/15/2009 2,167
A- NR* 1,225 Pennsylvania State, IDA, Economic Development Revenue Bonds, Series A,
7% due 7/01/2001 (f) 1,367
A+ NR* 1,895 Philadelphia, Pennsylvania, Authority for IDR (National Board of Medical
Examiners Project), 6.75% due 5/01/2012 2,035
Philadelphia, Pennsylvania, Gas Works Revenue Bonds:
AAA Aaa 1,440 12th Series B, 7% due 5/15/2020 (c)(i) 1,660
AAA Aaa 750 13th Series, 7.70% due 6/15/2001 (f) 862
Philadelphia, Pennsylvania, Hospitals and Higher Education Facilities
Authority Revenue Bonds:
A- NR* 1,015 (Children's Seashore House), Series A, 7% due 8/15/2017 1,066
A- NR* 3,000 (Children's Seashore House), Series B, 7% due 8/15/2022 3,133
BBB NR* 3,100 (Northwestern Corp.), 7.125% due 6/01/2018 3,211
A- Baa1 1,500 Refunding (Chestnut Hill Hospital), 6.50% due 11/15/2022 1,510
AAA Aaa 1,000 Refunding (Magee Rehabilitation Hospital), 7% due 12/01/2010 (b) 1,092
AAA NR* 3,000 Refunding (Presbyterian Medical Center), 6.65% due 12/01/2019 (i) 3,348
AAA Aaa 360 Philadelphia, Pennsylvania, Municipal Authority, Revenue Refunding Bonds,
7.80% due 4/01/2000 (d)(f) 400
AAA Aaa 1,770 Philadelphia, Pennsylvania, School District, Series B, 5.50% due 9/01/2025 (b) 1,698
AAA Baa 1,000 Philadelphia, Pennsylvania, Water and Sewer Revenue Bonds, 16th Series,
7.50% due 8/01/2001 (f) 1,144
AAA Aaa 2,250 Philadelphia, Pennsylvania, Water and Wastewater Revenue Bonds, 5.60% due
8/01/2018 (c) 2,200
AAA Aaa 4,000 Pittsburgh, Pennsylvania, Water and Sewer Authority, Water and Sewer System
Revenue Bonds, Series A, First Lien, 5.65% due 9/01/2025 (d) 3,921
AAA Aaa 1,000 Reading, Pennsylvania, GO, Refunding, UT, 6.50% due 11/15/2002 (b)(f) 1,097
A- NR* 1,750 Scranton-Lackawanna, Pennsylvania, Health and Welfare Authority, Revenue
Refunding Bonds (University of Scranton Project), Series A, 6.50%
due 3/01/2013 1,835
</TABLE>
59
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Puerto Rico--1.4%
<S> <C> <C> <C> <C>
AAA Baa1 $ 310 Puerto Rico Commonwealth, Aqueduct and Sewer Authority Revenue Bonds,
Series A, 7% due 7/01/1998 (f) $ 333
A Baa1 800 Puerto Rico Commonwealth, Highway Authority, Highway Revenue Refunding
Bonds, Series R, 6.75% due 7/01/2000 (f) 876
AAA NR* 740 Puerto Rico Commonwealth, Public Improvement, GO, 7.70% due 7/01/2000 (f) 840
AAA NR* 100 Puerto Rico Electric Power Authority, Revenue Refunding Bonds, Series M,
8% due 7/01/1998 (f) 109
Total Investments (Cost--$136,012)--95.4% 143,561
Variation Margin on Financial Futures Contracts--(0.1%)+ (103)
Other Assets Less Liabilities--4.7% 7,038
--------
Net Assets--100.0% $150,496
========
</TABLE>
[FN]
(a)The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate
in effect at July 31, 1996.
(b)AMBAC Insured.
(c)MBIA Insured.
(d)FGIC Insured.
(e)FSA Insured.
(f)Prerefunded.
(g)Connie Lee Insured.
(h)The interest rate is subject to change periodically and
inversely based upon prevailing market rates. The interest
rate shown is the rate in effect at July 31, 1996.
(i)Escrowed to maturity.
(j)Bank Qualified.
(k)All or a portion of security held as collateral in connection
with open financial futures contracts.
*Not Rated.
**Represents a zero coupon bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
+Financial futures contracts sold as of July 31, 1996 (in
thousands) were as follows:
Number of Expiration Value
Contracts Issue Date (Notes 1a & 1b)
150 US Treasury Bonds September 1996 $ 16,368
Total Financial Futures Contracts Sold
(Total Contract Price--$16,327) $ 16,368
========
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
60
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of July 31, 1996
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$136,011,644) (Note 1a) $143,561,198
Cash 92,005
Receivables:
Securities sold $ 5,162,858
Interest 2,412,436
Beneficial interest sold 161,351 7,736,645
------------
Prepaid registration fees and other assets (Note 1e) 16,287
------------
Total assets 151,406,135
------------
Liabilities: Payables:
Beneficial interest redeemed 389,367
Dividends to shareholders (Note 1f) 186,523
Variation margin (Note 1b) 103,125
Investment adviser (Note 2) 70,114
Distributor (Note 2) 53,791 802,920
------------
Accrued expenses and other liabilities 107,213
------------
Total liabilities 910,133
------------
Net Assets: Net assets $150,496,002
============
Net Assets Class A Shares of beneficial interest, $.10 par value, unlimited
Consist of: number of shares authorized $ 193,560
Class B Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 1,079,147
Class C Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 42,259
Class D Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 32,042
Paid-in capital in excess of par 143,650,698
Accumulated realized capital losses on investments--net (2,009,851)
Unrealized appreciation on investments--net 7,508,147
------------
Net assets $150,496,002
============
Net Asset Value: Class A--Based on net assets of $21,625,751 and 1,935,599 shares
of beneficial interest outstanding $ 11.17
============
Class B--Based on net assets of $120,565,055 and 10,791,465 shares
of beneficial interest outstanding $ 11.17
============
Class C--Based on net assets of $4,721,914 and 422,593 shares
of beneficial interest outstanding $ 11.17
============
Class D--Based on net assets of $3,583,282 and 320,418 shares
of beneficial interest outstanding $ 11.18
============
</TABLE>
See Notes to Financial Statements.
61
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Statement of Operations
<CAPTION>
For the Year Ended
July 31, 1996
<S> <C> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 9,524,107
(Note 1d):
Expenses: Investment advisory fees (Note 2) $ 845,927
Account maintenance and distribution fees--Class B (Note 2) 621,816
Printing and shareholder reports 87,425
Transfer agent fees--Class B (Note 2) 68,958
Accounting services (Note 2) 62,902
Professional fees 62,775
Account maintenance and distribution fees--Class C (Note 2) 21,538
Registration fees (Note 1e) 12,130
Pricing fees 11,332
Transfer agent fees--Class A (Note 2) 10,301
Custodian fees 9,107
Trustees' fees and expenses 7,603
Account maintenance fees--Class D (Note 2) 3,286
Transfer agent fees--Class C (Note 2) 2,072
Transfer agent fees--Class D (Note 2) 1,523
Amortization of organization expenses (Note 1e) 1,244
Other 4,319
------------
Total expenses 1,834,258
------------
Investment income--net 7,689,849
------------
Realized & Realized gain on investments--net 415,112
Unrealized Change in unrealized appreciation on investments--net 999,490
Gain on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 9,104,451
(Notes 1b, 1d & 3): ============
</TABLE>
See Notes to Financial Statements.
<TABLE>
Statements of Changes in Net Assets
<CAPTION>
For the Year Ended July 31,
Increase (Decrease) in Net Assets: 1996 1995
<S> <C> <C> <C>
Operations: Investment income--net $ 7,689,849 $ 7,974,336
Realized gain (loss) on investments--net 415,112 (2,162,672)
Change in unrealized appreciation on investments--net 999,490 2,862,358
------------ ------------
Net increase in net assets resulting from operations 9,104,451 8,674,022
------------ ------------
Dividends to Investment income--net:
Shareholders Class A (1,225,179) (1,403,188)
(Note 1f): Class B (6,116,920) (6,445,060)
Class C (172,681) (36,471)
Class D (175,069) (89,617)
------------ ------------
Net decrease in net assets resulting from dividends to shareholders (7,689,849) (7,974,336)
------------ ------------
Beneficial Net decrease in net assets derived from beneficial
Interest interest transactions (1,716,500) (8,558,779)
Transactions ------------ ------------
(Note 4):
Net Assets: Total decrease in net assets (301,898) (7,859,093)
Beginning of year 150,797,900 158,656,993
------------ ------------
End of year $150,496,002 $150,797,900
============ ============
</TABLE>
See Notes to Financial Statements.
62
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights
<CAPTION>
The following per share data and ratios have been derived Class A
from information provided in the financial statements.
For the Year Ended July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.07 $ 11.00 $ 11.39 $ 11.04 $ 10.27
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .61 .62 .60 .63 .67
Realized and unrealized gain (loss) on
investments--net .10 .07 (.33) .36 .77
-------- -------- -------- -------- --------
Total from investment operations .71 .69 .27 .99 1.44
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.61) (.62) (.60) (.63) (.67)
Realized gain on investments--net -- -- (.04) (.01) --
In excess of realized gain on
investments--net -- -- (.02) -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.61) (.62) (.66) (.64) (.67)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 6.53% 6.54% 2.37% 9.30% 14.53%
Return:* ======== ======== ======== ======== ========
Ratios to Expenses, net of reimbursement .76% .77% .75% .69% .55%
Average ======== ======== ======== ======== ========
Net Assets: Expenses .76% .77% .75% .81% .97%
======== ======== ======== ======== ========
Investment income--net 5.41% 5.72% 5.30% 5.70% 6.33%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $ 21,626 $ 23,040 $ 28,239 $ 27,639 $ 17,144
Data: ======== ======== ======== ======== ========
Portfolio turnover 58.33% 59.17% 37.73% 9.69% 4.14%
======== ======== ======== ======== ========
</TABLE>
[FN]
*Total investment returns exclude the effect of
sales loads.
See Notes to Financial Statements.
63
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights (continued)
<CAPTION>
The following per share data and ratios have been derived Class B
from information provided in the financial statements.
For the Year Ended July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.07 $ 11.00 $ 11.39 $ 11.04 $ 10.27
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .55 .56 .54 .58 .62
Realized and unrealized gain (loss) on
investments--net .10 .07 (.33) .36 .77
-------- -------- -------- -------- --------
Total from investment operations .65 .63 .21 .94 1.39
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.55) (.56) (.54) (.58) (.62)
Realized gain on investments--net -- -- (.04) (.01) --
In excess of realized gain on
investments--net -- -- (.02) -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.55) (.56) (.60) (.59) (.62)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 5.98% 6.00% 1.86% 8.75% 13.94%
Return:* ======== ======== ======== ======== ========
Ratios to Expenses, net of reimbursement 1.27% 1.28% 1.25% 1.19% 1.06%
Average ======== ======== ======== ======== ========
Net Assets: Expenses 1.27% 1.28% 1.25% 1.32% 1.48%
======== ======== ======== ======== ========
Investment income--net 4.91% 5.21% 4.80% 5.19% 5.81%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands). $120,565 $123,260 $130,418 $109,463 $ 65,599
Data: ======== ======== ======== ======== ========
Portfolio turnover 58.33% 59.17% 37.73% 9.69% 4.14%
======== ======== ======== ======== ========
</TABLE>
[FN]
*Total investment returns exclude the effect of
sales loads.
See Notes to Financial Statements.
64
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Bund July 31, 1996
FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights (concluded)
<CAPTION> Class C Class D
For the For the For the For the
The following per share data and ratios have been derived Year Period Year Period
from information provided in the financial statements. Ended Oct. 21, 1994+ Ended Oct. 21, 1994+
July 31, to July 31, July 31, to July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1996 1995
<S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 11.07 $ 10.68 $ 11.08 $ 10.68
Operating -------- -------- -------- --------
Performance: Investment income--net .54 .43 .60 .47
Realized and unrealized gain on investments--net .10 .39 .10 .40
-------- -------- -------- --------
Total from investment operations .64 .82 .70 .87
-------- -------- -------- --------
Less dividends from investment income--net. (.54) (.43) (.60) (.47)
-------- -------- -------- --------
Net asset value, end of period $ 11.17 $ 11.07 $ 11.18 $ 11.08
======== ======== ======== ========
Total Investment Based on net asset value per share 5.87% 7.83%+++ 6.42% 8.36%+++
Return:** ======== ======== ======== ========
Ratios to Expenses 1.37% 1.38%* .86% .87%*
Average Net ======== ======== ======== ========
Assets: Investment income--net 4.80% 5.05%* 5.31% 5.65%*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 4,722 $ 1,868 $ 3,583 $ 2,630
Data: ======== ======== ======== ========
Portfolio turnover 58.33% 59.17% 58.33% 59.17%
======== ======== ======== ========
</TABLE>
[FN]
*Annualized.
**Total investment returns exclude the effect of
sales loads.
+Commencement of Operations.
++Aggregate total investment return.
See Notes to Financial Statements.
65
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1996
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Pennsylvania Municipal Bond Fund (the "Fund") is part
of Merrill Lynch Multi-State Municipal Series Trust (the "Trust").
The Fund is registered under the Investment Company Act of 1940 as a
non-diversified, open-end management investment company. The Fund
offers four classes of shares under the Merrill Lynch Select
Pricing SM System. Shares of Class A and Class D are sold with a
front-end sales charge. Shares of Class B and Class C may be subject
to a contingent deferred sales charge. All classes of shares have
identical voting, dividend, liquidation and other rights and the
same terms and conditions, except that Class B, Class C and Class D
Shares bear certain expenses related to the account maintenance of
such shares, and Class B and Class C Shares also bear certain
expenses related to the distribution of such shares. Each class has
exclusive voting rights with respect to matters relating to its
account maintenance and distribution expenditures. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter municipal bond and money markets and are valued at
the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Short-term
investments with remaining maturities of sixty days or less are
valued at amortized cost, which approximates market value.
Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust,
which may utilize a matrix system for valuations. The procedures of
the pricing service and its valuations are reviewed by the officers
of the Trust under the general super-vision of the Trustees.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell interest
rate futures contracts and options on such futures contracts for the
purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required
by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Deferred organization expenses and prepaid registration fees--
Deferred organization expenses are charged to expense on a straight-
line basis over a five-year period. Prepaid registration fees are
charged to expense as the related shares are issued.
66
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1996
(f) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner. The Fund has also entered into a Distribution
Agreement and Distribution Plans with Merrill Lynch Funds
Distributor, Inc. ("MLFD" or "Distributor"), a wholly-owned
subsidiary of Merrill Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee based upon the average daily
value of the Fund's net assets at the following annual rates: 0.55%
of the Fund's average daily net assets not exceeding $500 million;
0.525% of average daily net assets in excess of $500 million but not
exceeding $1 billion; and 0.50% of average daily net assets in
excess of $1 billion. The Investment Advisory Agreement obligates
FAM to reimburse the Fund to the extent the Fund's expenses
(excluding interest, taxes, distribution fees, brokerage fees and
commissions, and extraordinary items) exceed 2.5% of the Fund's
first $30 million of average daily net assets, 2.0% of the next $70
million of average daily net assets, and 1.5% of the average daily
net assets in excess thereof. FAM's obligation to reimburse the Fund
is limited to the amount of the management fee. No fee payment will
be made to FAM during any fiscal year which will cause such expenses
to exceed expense limitation at the time of payment.
Pursuant to the distribution plans (the "Distribution Plans")
adopted by the Fund in accordance with Rule 12b-1 under the
Investment Company Act of 1940, the Fund pays the Distributor
ongoing account maintenance and distribution fees. The fees are
accrued daily and paid monthly at annual rates based upon the
average daily net assets of the shares as follows:
Account Distribution
Maintenance Fee Fee
Class B 0.25% 0.25%
Class C 0.25% 0.35%
Class D 0.10% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), a subsidiary of ML & Co.,
also provides account maintenance and distribution services to the
Fund. The ongoing account maintenance fee compensates the
Distributor and MLPF&S for providing account maintenance services to
Class B, Class C and Class D shareholders. The ongoing distribution
fee compensates the Distributor and MLPF&S for providing shareholder
and distribution-related services to Class B and Class C
shareholders.
For the year ended July 31, 1996, MLFD earned underwriting discounts
and MLPF&S earned dealer concessions on sales of the Fund's Class A
and Class D Shares as follows:
MLFD MLPF&S
Class A $1,089 $12,100
Class D $1,544 $14,855
For the year ended July 31, 1996, MLPF&S received contingent
deferred sales charges of $195,896 and $2,273 relating to
transactions in Class B and Class C Shares, respectively.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended July 31, 1996 were $85,452,752 and $92,800,165,
respectively.
67
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1996
NOTES TO FINANCIAL STATEMENTS(concluded)
Net realized and unrealized gains (losses) as of
July 31, 1996 were as follows:
Realized Unrealized
Gains Gains
(Losses) (Losses)
Long-term investments $ 1,337,856 $ 7,549,554
Financial futures contracts (922,744) (41,407)
----------- -----------
Total $ 415,112 $ 7,508,147
=========== ===========
As of July 31, 1996, net unrealized appreciation for Federal income
tax purposes aggregated $7,463,117, of which $7,918,251 related to
appreciated securities and $455,134 related to depreciated
securities. The aggregate cost of investments at July 31, 1996 for
Federal income tax purposes was $136,098,081.
4. Beneficial Interest Transactions:
Net decrease in net assets derived from beneficial interest
transactions was $1,716,500 and $8,558,779 for the years ended July
31, 1996 and July 31, 1995, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 109,752 $ 1,229,333
Shares issued to share-
holders in reinvestment of
dividends 58,364 656,749
----------- -----------
Total issued 168,116 1,886,082
Shares redeemed (314,476) (3,540,925)
----------- -----------
Net decrease (146,360) $(1,654,843)
=========== ===========
Class A Shares for the Year Dollar
Ended July 31, 1995 Shares Amount
Shares sold 252,327 $ 2,701,007
Shares issued to share-
holders in reinvestment of
dividends 70,449 759,029
----------- -----------
Total issued 322,776 3,460,036
Shares redeemed (808,932) (8,690,691)
----------- -----------
Net decrease (486,156) $(5,230,655)
=========== ===========
Class B Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 1,605,962 $18,118,584
Shares issued to share-
holders in reinvestment of
dividends 267,930 3,014,759
----------- -----------
Total issued 1,873,892 21,133,343
Shares redeemed (2,176,649) (24,491,107)
Automatic conversion of
shares (44,290) (494,541)
----------- -----------
Net decrease (347,047) $(3,852,305)
=========== ===========
Class B Shares for the Year Dollar
Ended July 31, 1995 Shares Amount
Shares sold 1,773,889 $19,140,874
Shares issued to share-
holders in reinvestment of
dividends 290,703 3,133,419
----------- -----------
Total issued 2,064,592 22,274,293
Shares redeemed (2,786,939) (29,948,409)
Automatic conversion of
shares (25) (252)
----------- -----------
Net decrease (722,372) $(7,674,368)
=========== ===========
Class C Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 310,698 $ 3,488,268
Shares issued to share-
holders in reinvestment of
dividends 10,054 113,133
----------- -----------
Total issued 320,752 3,601,401
Shares redeemed (66,907) (753,080)
----------- -----------
Net increase 253,845 $ 2,848,321
=========== ===========
Class C Shares for the Period Dollar
Oct. 21, 1994+ to July 31, 1995 Shares Amount
Shares sold 190,095 $ 2,057,684
Shares issued to share-
holders in reinvestment of
dividends 2,162 23,850
----------- -----------
Total issued 192,257 2,081,534
Shares redeemed (23,509) (258,434)
----------- -----------
Net increase 168,748 $ 1,823,100
=========== ===========
[FN]
+Commencement of Operations.
68
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1996
Class D Shares for the Year Dollar
Ended July 31, 1996 Shares Amount
Shares sold 174,458 $ 1,955,538
Automatic conversion of
shares 44,251 494,541
Shares issued to share-
holders in reinvestment of
dividends 10,521 118,715
----------- -----------
Total issued 229,230 2,568,794
Shares redeemed (146,212) (1,626,467)
----------- -----------
Net increase 83,018 $ 942,327
=========== ===========
Class D Shares for the Period Dollar
Oct. 21, 1994+ to July 31, 1995 Shares Amount
Shares sold 241,043 $ 2,563,252
Automatic conversion of
shares 25 252
Shares issued to share-
holders in reinvestment of
dividends 6,269 67,928
----------- -----------
Total issued 247,337 2,631,432
Shares redeemed (9,937) (108,288)
----------- -----------
Net increase 237,400 $ 2,523,144
=========== ===========
[FN]
+Commencement of Operations.
69
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies.............. 2
Description of Municipal Bonds and Temporary
Investments.................................... 5
Description of Municipal Bonds................. 5
Description of Temporary Investments......... 6
Repurchase Agreements........................ 8
Financial Futures Transactions and Options... 8
Investment Restrictions........................ 13
Management of the Trust........................ 15
Trustees and Officers........................ 15
Compensation of Trustees..................... 16
Management and Advisory Arrangements......... 17
Purchase of Shares............................. 18
Initial Sales Charge Alternatives--Class A
and Class D Shares......................... 19
Reduced Initial Sales Charges................ 20
Distribution Plans........................... 22
Limitations on the Payment of Deferred Sales
Charges.................................... 23
Redemption of Shares........................... 24
Deferred Sales Charges--
Class B and Class C Shares................. 24
Portfolio Transactions......................... 25
Determination of Net Asset Value............... 26
Shareholder Services........................... 27
Investment Account........................... 27
Automatic Investment Plans................... 27
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 28
Systematic Withdrawal Plans--Class A and
Class D Shares............................. 28
Exchange Privilege........................... 29
Distributions and Taxes........................ 31
Environmental Tax............................ 34
Tax Treatment of Options and Futures
Transactions............................... 34
Pennsylvania Taxation........................ 35
Performance Data............................... 35
General Information............................ 37
Description of Shares........................ 37
Computation of Offering Price Per Share...... 38
Independent Auditors......................... 39
Custodian.................................... 39
Transfer Agent............................... 39
Legal Counsel................................ 39
Reports to Shareholders...................... 39
Additional Information....................... 39
Appendix I--Economic and Financial Conditions
in Pennsylvania................................ 40
Appendix II--Ratings of Municipal Bonds........ 48
Independent Auditors' Report................... 56
Financial Statements........................... 57
</TABLE>
Code #11198-1196
Merrill Lynch
Pennsylvania Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
(Art)
STATEMENT OF
ADDITIONAL
INFORMATION
November 15, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(A) FINANCIAL STATEMENTS:
CONTAINED IN PART A:
Financial Highlights for each of the years in the five-year
period ended July 31, 1996 and for the period August 31, 1990
(commencement of operations) to July 31, 1991.
CONTAINED IN PART B:
Schedule of Investments as of July 31, 1996.
Statement of Assets and Liabilities as of July 31, 1996.
Statement of Operations for the year ended July 31, 1996.
Statements of Changes in Net Assets for each of the years in the
two-year period ended July 31, 1996.
Financial Highlights for each of the years in the five-year
period ended July 31, 1996.
(B) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -------------------------------------------------------------------
<S> <C> <C>
1(a) -- Declaration of Trust of the Registrant, dated August 2, 1985.(a)
(b) -- Amendment to Declaration of Trust, dated September 18, 1987.(a)
(c) -- Amendment to Declaration of Trust, dated December 21, 1987.(a)
(d) -- Amendment to Declaration of Trust, dated October 3, 1988.(a)
(e) -- Amendment to Declaration of Trust, dated October 17, 1994 and
instrument establishing Class C and Class D shares of beneficial
interest.(a)
(f) -- Instrument establishing Merrill Lynch Pennsylvania Municipal Bond
Fund (the 'Fund') as a series of Registrant.(a)
(g) -- Instrument establishing Class A and Class B shares of beneficial
interest of the Fund.(a)
2 -- By-Laws of Registrant.(a)
3 -- None.
4 -- Portions of the Declaration of Trust, Establishment and Designation
and By-Laws of the Registrant defining the rights of holders of the
Fund as a series of the Registrant.(b)
5(a) -- Management Agreement between Registrant and Fund Asset Management,
Inc.(a)
(b) -- Supplement to Management Agreement between Registrant and Fund
Asset Management, Inc.(e)
6(a) -- Form of Revised Class A Shares Distribution Agreement between
Registrant and Merrill Lynch Funds Distributor, Inc. (including
Form of Selected Dealers Agreement).(e)
(b) -- Form of Class B Shares Distribution Agreement between Registrant
and Merrill Lynch Funds Distributor, Inc.(a)
(c) -- Form of Class C Shares Distribution Agreement between Registrant
and Merrill Lynch Funds Distributor, Inc. (including Form of
Selected Dealers Agreement).(e)
(d) -- Form of Class D Shares Distribution Agreement between Registrant
and Merrill Lynch Funds Distributor, Inc. (including Form of
Selected Dealers Agreement).(e)
(e) -- Letter Agreement between the Fund and Merrill Lynch Funds
Distributor, Inc., dated September 15, 1993, in connection with the
Merrill Lynch Mutual Fund Adviser program.(c)
7 -- None.
8 -- Form of Custody Agreement between Registrant and State Street Bank
& Trust Company.(d)
9 -- Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between Registrant and Merrill Lynch
Financial Data Services, Inc. (formerly Financial Data Services,
Inc.)(f)
10 -- Opinion of Brown & Wood LLP, counsel for the Registrant.
</TABLE>
C-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -------------------------------------------------------------------
11 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
<S> <C> <C>
12 -- None.
13 -- Certificate of Fund Asset Management, Inc.(a)
14 -- None.
15(a) -- Amended and Restated Class B Shares Distribution Plan and Class B
Shares Distribution Plan Sub-Agreement.(c)
(b) -- Form of Class C Shares Distribution Plan and Class C Shares
Distribution Plan Sub-Agreement of the Registrant.(e)
(c) -- Form of Class D Shares Distribution Plan and Class D Shares
Distribution Plan Sub-Agreement of the Registrant.(e)
16(a) -- Schedule for computation of each performance quotation provided in
the Registration Statement in response to Item 22 relating to Class
A Shares.(a)
(b) -- Schedule for computation of each performance quotation provided in
the Registration Statement in response to Item 22 relating to Class
B Shares.(a)
(c) -- Schedule for computation of each performance quotation provided in
the Registration Statement in response to Item 22 relating to Class
C Shares.(a)
(d) -- Schedule for computation of each performance quotation provided in
the Registration Statement in response to Item 22 relating to Class
D Shares.(a)
17(a) -- Financial Data Schedule for Class A shares.
(b) -- Financial Data Schedule for Class B shares.
(c) -- Financial Data Schedule for Class C shares.
(d) -- Financial Data Schedule for Class D shares.
18 -- Merrill Lynch Select Pricing(Service Mark) System Plan Pursuant to
Rule 18f-3.(g)
</TABLE>
- ------------------
(a) Filed on November 14, 1995 as an Exhibit to Post-Effective Amendment No. 6
to the Registrant's Registration Statement on Form N-1A under the Securities
Act of 1933, as amended (File No. 33-35442)
(the 'Registration Statement').
(b) Reference is made to Article II, Section 2.3 and Articles V, VI, VIII, IX, X
and XI of the Registrant's Declaration of Trust, as amended, filed as
Exhibits 1(a), 1(b), 1(c), 1(d) and 1(e) with Post-Effective Amendment No. 6
to the Registrant's Registration Statement; to the Certificates of
Establishment and Designation establishing the Fund as a series of the
Registrant and establishing Class A and Class B shares of beneficial
interest of the Fund, which as Exhibits 1(f) and 1(g), respectively, with
Post-Effective Amendment No. 6 to the Registration Statement; and to
Articles I, V and VI of the Registrant's By-Laws, filed as Exhibit 2 with
Post-Effective Amendment No. 6 to the Registration Statement.
(c) Filed on November 8, 1993 as an Exhibit to Post-Effective Amendment No. 4 to
the Registrant's Registration Statement.
(d) Incorporated by reference to Exhibit 8 to Post-Effective Amendment No. 3 to
the Registrant's Registration Statement on Form N-1A under the Securities
Act of 1933, as amended, filed on October 14, 1994, relating to shares of
Merrill Lynch Minnesota Municipal Bond Fund series of the Registrant (File
No. 33-44734).
(e) Filed on October 19, 1994 as an Exhibit to Post-Effective Amendment No. 5 to
the Registrant's Registration Statement.
(f) Incorporated by reference to Exhibit 9 to Post-Effective Amendment No. 5 to
the Registrant's Registration Statement on Form N-1A under the Securities
Act of 1933, as amended, filed on October 20, 1995, relating to shares of
Merrill Lynch Arizona Municipal Bond Fund series of the Registrant (File No.
33-41311).
(g) Incorporated by reference to Exhibit 18 to Post-Effective Amendment No. 13
to the Registrant's Registration Statement on Form N-1A under the Securities
Act of 1933 as amended, filed on January 25, 1996, relating to shares of
Merrill Lynch New York Municipal Bond Fund series of the Registrant (File
No. 2-99473).
C-2
<PAGE>
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
Registrant is not controlled by or under common control with any person.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
<TABLE>
<CAPTION>
NUMBER OF
RECORD HOLDERS AT
TITLE OF CLASS SEPTEMBER 30, 1996*
- -------------------------------------------------- ---------------------
<S> <C>
Class A shares of beneficial interest, par value
$0.10 per share................................. 568
Class B shares of beneficial interest, par value
$0.10 per share................................. 3,821
Class C shares of beneficial interest, par value
$0.10 per share................................. 177
Class D shares of beneficial interest, par value
$0.10 per share................................. 105
</TABLE>
- ------------------
*The number of holders includes holders of record plus beneficial owners, whose
shares are held of record by Merrill Lynch, Pierce, Fenner & Smith
Incorporated.
ITEM 27. INDEMNIFICATION.
Section 5.3 of the Registrant's Declaration of Trust provides as follows:
'The Trust shall indemnify each of its Trustees, officers, employees and
agents (including persons who serve at its request as directors, officers or
trustees of another organization in which it has any interest as a shareholder,
creditor or otherwise) against all liabilities and expenses (including amounts
paid in satisfaction of judgments, in compromise, as fines and penalties and as
counsel fees) reasonably incurred by him in connection with the defense or
disposition of any action, suit or other proceeding, whether civil or criminal,
in which he may be involved or with which he may be threatened, while in office
or thereafter, by reason of his being or having been such a trustee, officer,
employee or agent, except with respect to any matter as to which he shall have
been adjudicated to have acted in bad faith, willful misfeasance, gross
negligence or reckless disregard of his duties; provided, however, that as to
any matter disposed of by a compromise payment by such person, pursuant to a
consent decree or otherwise, no indemnification either for said payment or for
any other expenses shall be provided unless the Trust shall have received a
written opinion from independent legal counsel approved by the Trustees to the
effect that if either the matter of willful misfeasance, gross negligence or
reckless disregard of duty, or the matter of good faith and reasonable belief as
to the best interests of the Trust, had been adjudicated, it would have been
adjudicated in favor of such person. The rights accruing to any Person under
these provisions shall not exclude any other right to which he may be lawfully
entitled; provided that no person may satisfy any right in indemnity or
reimbursement granted herein or in Section 5.1 or to which he may be otherwise
entitled except out of the property of the Trust, and no Shareholder shall be
personally liable to any Person with respect to any claim for indemnity or
reimbursement or otherwise. The Trustees may make advance payments in connection
with indemnification under this Section 5.3, provided that the indemnified
person shall have given a written undertaking to reimburse the Trust in the
event it is subsequently determined that he is not entitled to such
indemnification.'
Insofar as the conditional advancing of indemnification monies for actions
based upon the Investment Company Act of 1940, as amended, may be concerned,
such payments will be made only on the following conditions: (i) the advances
must be limited to amounts used, or to be used, for the preparation or
presentation of a defense to the action, including costs connected with the
preparation of a settlement; (ii) advances may be made only upon receipt of a
written promise by, or on behalf of, the recipient to repay that amount of the
advance which exceeds the amount which it is ultimately determined he is
entitled to receive from the Registrant by reason of indemnification; and
(iii)(a) such promise must be secured by a surety bond, other suitable insurance
or an equivalent form of security which assures that any repayments may be
obtained by the Registrant without delay or litigation, which bond, insurance or
other form of security must be provided by the recipient of the advance, or (b)
a majority of a quorum of the Registrant's disinterested, non-party Trustees, or
an independent legal counsel in a written opinion, shall determine, based upon a
review of readily available facts that the recipient of the advance ultimately
will be found entitled to indemnification.
C-3
<PAGE>
In Section 9 of the Distribution Agreements relating to the securities
being offered hereby, the Registrant agrees to indemnify the Distributor and
each person, if any, who controls the Distributor within the meaning of the
Securities Act of 1933, as amended (the '1933 Act'), against certain types of
civil liabilities arising in connection with the Registration Statement or
Prospectus and Statement of Additional Information.
Insofar as indemnification for liabilities arising under the 1933 Act may
be permitted to Trustees, officers and controlling persons of the Registrant and
the principal underwriter pursuant to the foregoing provisions or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
1933 Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a Trustee, officer, or controlling
person of the Registrant and the principal underwriter in connection with the
successful defense of any action, suit or proceeding) is asserted by such
Trustee, officer or controlling person or the principal underwriter in
connection with the shares being registered, the Registrant will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the 1933 Act and
will be governed by the final adjudication of such issue.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
Fund Asset Management, L.P. (the 'Manager' or 'FAM') acts as the investment
adviser for the following open-end investment companies: CBA Money Fund, CMA
Government Securities Fund, CMA Money Fund, CMA Multi-State Municipal Series
Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The Corporate Fund Accumulation
Program, Inc., Financial Institutions Series Trust, Merrill Lynch Basic Value
Fund, Inc., Merrill Lynch California Municipal Series Trust, Merrill Lynch
Corporate Bond Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc., Merrill
Lynch Federal Securities Trust, Merrill Lynch Funds for Institutions Series,
Merrill Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill Lynch
Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond Fund, Inc.,
Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Special Value Fund, Inc.,
Merrill Lynch World Income Fund, Inc., and The Municipal Fund Accumulation
Program, Inc.; and the following closed-end investment companies: Apex Municipal
Fund, Inc., Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc.,
Income Opportunities Fund 1999, Inc., Income Opportunities Fund 2000, Inc.,
Merrill Lynch Municipal Strategy Fund, Inc., MuniAssets Fund Inc., MuniEnhanced
Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc.,
MuniVest California Insured Fund, Inc., MuniVest Florida Fund, MuniVest Michigan
Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest New York Insured
Fund, Inc., MuniVest Pennsylvania Insured Fund, MuniYield Arizona Fund, Inc.,
MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield
Florida Insured Fund, MuniYield Fund, Inc., MuniYield Insured Fund, Inc.,
MuniYield Insured Fund II, Inc., MuniYield Michigan Fund, Inc., MuniYield
Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New
Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield New
York Insured Fund II, Inc., MuniYield New York Insured Fund III, Inc., MuniYield
Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield Quality Fund II,
Inc., Senior High Income Portfolio, Inc., Taurus MuniCalifornia Holdings, Inc.,
Taurus MuniNew York Holdings, Inc. and Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ('MLAM'), an affiliate of the Manager,
acts as the investment adviser for the following open-end investment companies:
Merrill Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas
Income Fund, Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch
Asset Growth Fund, Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch
Capital Fund, Inc., Merrill Lynch Developing Capital Markets Fund, Inc., Merrill
Lynch Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch Fund for
Tomorrow, Inc., Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch
Global Bond Fund for Investment and Retirement, Merrill Lynch Global Allocation
Fund, Inc., Merrill Lynch Global Convertible Fund, Inc., Merrill Lynch Global
Holdings, Inc., Merrill Lynch Global Resources Trust, Merrill Lynch Global
SmallCap Fund, Inc., Merrill Lynch Global Utility Fund, Inc., Merrill Lynch
Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch Healthcare
Fund, Inc., Merrill Lynch Institutional Intermediate Fund, Merrill Lynch
International Equity Fund, Merrill Lynch Latin America Fund, Inc., Merrill Lynch
Middle East/Africa Fund, Inc., Merrill Lynch Municipal Series Trust, Merrill
Lynch Pacific Fund, Inc., Merrill Lynch
C-4
<PAGE>
Ready Assets Trust, Merrill Lynch Retirement Series Trust, Merrill Lynch Series
Fund, Inc., Merrill Lynch Short-Term Global Income Fund, Inc., Merrill Lynch
Strategic Dividend Fund, Merrill Lynch Technology Fund, Inc., Merrill Lynch U.S.
Treasury Money Fund, Merrill Lynch U.S.A. Government Reserves, Merrill Lynch
Utility Income Fund, Inc., and Merrill Lynch Variable Series Funds, Inc. and the
following closed-end investment companies: Convertible Holdings, Inc., Merrill
Lynch High Income Municipal Bond Fund, Inc. and Merrill Lynch Senior Floating
Rate Fund, Inc.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch Funds
for Institutions Series and Merrill Lynch Institutional Intermediate Fund is One
Financial Center, 15th Floor, Boston, Massachusetts 02111-2646. The address of
the Manager, MLAM, Princeton Services, Inc. ('Princeton Services') and Princeton
Administrators, L.P. is also P.O. Box 9011, Princeton, New Jersey 08543-9011.
The address of Merrill Lynch Funds Distributor, Inc. ('MLFD') is P.O. Box 9081,
Princeton, New Jersey 08543-9081. The address of Merrill Lynch, Pierce, Fenner &
Smith Incorporated ('Merrill Lynch') and Merrill Lynch & Co., Inc. ('ML & Co.')
is World Financial Center, North Tower, 250 Vesey Street, New York, New York
10281. The address of the Fund's transfer agent, Merrill Lynch Financial Data
Services, Inc. ('MLFDS') is 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484.
Set forth below is a list of each executive officer and partner of the
Manager indicating each business, profession, vocation or employment of a
substantial nature in which each such person has been engaged since August 1,
1994 for his or its own account or in the capacity of director, officer, partner
or trustee. In addition, Mr. Zeikel is President, Mr. Richard is Treasurer and
Mr. Glenn is Executive Vice President of substantially all of the investment
companies described in the first two paragraphs of this Item 28 and Messrs.
Giordano, Harvey, Hewitt, Kirstein and Monagle are directors, trustees or
officers of one or more of such companies.
OFFICERS AND PARTNERS OF FAM ARE SET FORTH AS FOLLOWS:
<TABLE>
<CAPTION>
POSITION(S)
WITH OTHER SUBSTANTIAL BUSINESS,
NAME THE MANAGER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- --------------- -----------------------------------
<S> <C> <C>
ML & Co. ................ Limited Partner Financial Services Holding Company;
Limited Partner of MLAM
Princeton Services....... General Partner General Partner of MLAM
Arthur Zeikel............ President President of MLAM; President and
Director of Princeton Services;
Director of MLFD; Executive Vice
President of ML & Co.
Terry K. Glenn........... Executive Vice Executive Vice President of MLAM;
President Executive Vice President and
Director of Princeton Services;
President and Director of MLFD;
President of Princeton
Administrators, L.P.; Director of
MLFDS
Vincent R. Giordano...... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Elizabeth Griffin........ Senior Vice Senior Vice President of MLAM
President
Norman R. Harvey......... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Michael J. Hennewinkel... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
N. John Hewitt........... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Philip L. Kirstein....... Senior Vice Senior Vice President, General
President, Counsel and Secretary of MLAM;
General Senior Vice President, General
Counsel and Counsel, Director and Secretary
Secretary of Princeton Services; Director
of MLFD
Ronald M. Kloss.......... Senior Vice Senior Vice President and
President and Controller of MLAM; Senior Vice
Controller President and Controller of
Princeton Services
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
POSITION(S)
WITH OTHER SUBSTANTIAL BUSINESS,
NAME THE MANAGER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- --------------- -----------------------------------
<S> <C> <C>
Stephen M.M. Miller ..... Senior Vice Executive Vice President of
President Princeton Administrators, L.P.;
Senior Vice President of
Princeton Services
Joseph T. Monagle, Senior Vice Senior Vice President of MLAM;
Jr. ................... President Senior Vice President of Princeton
Services
Michael L. Quinn......... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services; Managing Director and
First Vice President of Merrill
Lynch from 1989 to 1995.
Richard L. Reller........ Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Gerald M. Richard........ Senior Vice Senior Vice President and Treasurer
President and of MLAM; Vice President and
Treasurer Treasurer of MLFD
Ronald L. Welburn........ Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Anthony Wiseman.......... Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
</TABLE>
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) MLFD acts as the principal underwriter for the Registrant and for each
of the open-end investment companies referred to in the first two paragraphs of
Item 28 except CBA Money Fund, CMA Government Securities Fund, CMA Money Fund,
CMA Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund,
The Corporate Fund Accumulation Program, Inc., and The Municipal Fund
Accumulation Program, Inc. and MLFD also acts as the principal underwriter for
the following closed-end investment companies: Merrill Lynch High Income
Municipal Bond Fund, Inc., Merrill Lynch Municipal Strategy Fund, Inc. and
Merrill Lynch Senior Floating Rate Fund, Inc.
(b) Set forth below is information concerning each director and officer of
MLFD. The principal business address of each such person is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Messrs. Aldrich,
Brady, Breen, Crook, Fatseas and Wasel is One Financial Center, Boston,
Massachusetts 02111-2646.
<TABLE>
<CAPTION>
POSITION(S) AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
- ------------------------------------ ------------------------------------ ------------------------------------
<S> <C> <C>
Terry K. Glenn...................... President and Director Executive Vice President
Arthur Zeikel....................... Director President and Trustee
Philip L. Kirstein.................. Director None
William E. Aldrich.................. Senior Vice President None
Robert W. Crook..................... Senior Vice President None
Kevin P. Boman...................... Vice President None
Michael J. Brady.................... Vice President None
William M. Breen.................... Vice President None
Mark A. DeSario..................... Vice President None
James T. Fatseas.................... Vice President None
Debra W. Landsman-Yaros............. Vice President None
Michelle T. Lau..................... Vice President None
Gerald M. Richard................... Vice President and Treasurer Treasurer
Salvatore Venezia................... Vice President None
William Wasel....................... Vice President None
Robert Harris....................... Secretary None
</TABLE>
(c) Not applicable.
C-6
<PAGE>
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended, and the rules
thereunder are maintained at the offices of the Registrant, 800 Scudders Mill
Road, Plainsboro, New Jersey 08536, and Merrill Lynch Financial Data Services,
Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
ITEM 31. MANAGEMENT SERVICES.
Other than as set forth under the caption 'Management of the
Trust--Management and Advisory Arrangements' in the Prospectus constituting Part
A of the Registration Statement and under 'Management of the Trust--Management
and Advisory Arrangements' in the Statement of Additional Information
constituting Part B of the Registration Statement, Registrant is not a party to
any management-related service contract.
ITEM 32. UNDERTAKINGS.
(a) Not applicable.
(b) Not applicable.
(c) Registrant undertakes to furnish each person to whom a prospectus is
delivered with a copy of the Registrant's latest annual report to shareholders,
upon request and without charge.
C-7
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933 AND THE
INVESTMENT COMPANY ACT OF 1940, THE REGISTRANT CERTIFIES THAT IT MEETS ALL OF
THE REQUIREMENTS FOR EFFECTIVENESS OF THIS POST-EFFECTIVE AMENDMENT TO ITS
REGISTRATION STATEMENT PURSUANT TO RULE 485(B) UNDER THE SECURITIES ACT OF 1933
AND HAS DULY CAUSED THIS AMENDMENT TO ITS REGISTRATION STATEMENT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE TOWNSHIP OF
PLAINSBORO, AND THE STATE OF NEW JERSEY, ON THE 5TH DAY OF NOVEMBER, 1996.
MERRILL LYNCH MULTI-STATE
MUNICIPAL SERIES TRUST
(Registrant)
By /s/ GERALD M. RICHARD
(GERALD M. RICHARD, TREASURER)
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------- ----------------------------------- ---------------
<S> <C> <C>
ARTHUR ZEIKEL* President and Trustee
- ------------------------- (Principal Executive Officer)
(ARTHUR ZEIKEL)
/s/ GERALD M. RICHARD Treasurer (Principal Financial and November 5,
- ------------------------- Accounting Officer) 1996
(GERALD M. RICHARD)
JAMES H. BODURTHA* Trustee
- -------------------------
(JAMES H. BODURTHA)
HERBERT I. LONDON* Trustee
- -------------------------
(HERBERT I. LONDON)
ROBERT R. MARTIN* Trustee
- -------------------------
(ROBERT R. MARTIN)
JOSEPH L. MAY* Trustee
- -------------------------
(JOSEPH L. MAY)
ANDRE F. PEROLD* Trustee
- -------------------------
(ANDRE F. PEROLD)
*By: /s/GERALD M. RICHARD November 5,
(GERALD M. RICHARD, 1996
ATTORNEY-IN-FACT)
</TABLE>
C-8
<PAGE>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission File due to ASCII-incompatibility and
cross-references this material to the location of each occurrence in the text.
<TABLE>
<CAPTION>
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
<S> <C>
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull.
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
10 -- Opinion of Brown & Wood LLP, counsel for the Registrant.
11 -- Consent of Deloitte & Touche LLP, independent auditors for the Registrant.
17(a) -- Financial Data Schedule for Class A shares.
(b) -- Financial Data Schedule for Class B shares.
(c) -- Financial Data Schedule for Class C shares.
(d) -- Financial Data Schedule for Class D shares.
</TABLE>
<PAGE>
November 6, 1996
Merrill Lynch Pennsylvania Municipal Bond Fund
of Merrill Lynch Multi-State Municipal Series Trust
P.O. Box 9011
Princeton, New Jersey 08543-9011
Ladies and Gentlemen:
This opinion is furnished in connection with the registration by
Merrill Lynch Multi-State Municipal Series Trust, a Massachusetts business
trust (the "Trust"), of shares of beneficial interest, par value $0.10 per
share (the "Shares") of the Merrill Lynch Pennsylvania Municipal Bond Fund, a
series of the Trust, under the Securities Act of 1933, as amended, pursuant to
a registration statement on Form N-1A (File No. 33-35442), as amended (the
"Registration Statement"), in the amount set forth under "Amount Being
Registered" on the facing page of the Registration Statement.
As counsel for the Trust, we are familiar with the proceedings taken
by it in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Declaration of Trust of
the Trust, as amended, the ByLaws of the Trust and such other documents as we
have deemed relevant to the matters referred to in this opinion.
<PAGE>
Based upon the foregoing, we are of the opinion that the Shares, upon
issuance and sale in the manner referred to in the Registration Statement for
consideration not less than the par value thereof, will be legally issued,
fully paid and non-assessable shares of beneficial interest, except that
shareholders of the Trust may under certain circumstances be held personally
liable for the Trust's obligations.
In rendering this opinion, we have relied as to matters of
Massachusetts law upon an opinion of Bingham, Dana & Gould rendered to the
Trust.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Prospectus and
Statement of Additional Information constituting parts thereof.
Very truly yours,
/s/ Brown & Wood
2
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Pennsylvania Municipal Bond Fund of
Merrill Lynch Multi-State Municipal Series Trust:
We consent to the use in Post-Effective Amendment No. 7 to Registration
Statement No. 33-35442 of our report dated September 5, 1996 appearing in the
Statement of Additional Information, which is a part of such Registration
Statement, and to the reference to us under the caption "Financial Highlights"
appearing in the Prospectus, which also is a part of such Registration
Statement.
Deloitte & Touch LLP
Princeton, New Jersey
November 4, 1996
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<NAME> MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
<SERIES>
<NUMBER> 041
<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
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WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
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<NAME> MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
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<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
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WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<NAME> MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
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<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
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WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<NAME> MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
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<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
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</TABLE>
