<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 17, 1997
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. 8 /x/
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 /x/
AMENDMENT NO. 155 /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)
/x/ immediately upon filing pursuant to paragraph (b)
/ / on (date) 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.
TITLE OF SECURITIES BEING REGISTERED: Shares of Beneficial
Interest, par value $.10 per share
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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 Pricing(SM) System;
Additional Information
Item 7. Purchase of Securities Being
Offered..................... Cover Page; Fee Table; Merrill
Lynch Select Pricing(SM)
System; Purchase of Shares;
Shareholder Services;
Additional Information;
Inside Back Cover Page
Item 8. Redemption or Repurchase...... Fee Table; Merrill Lynch
Select Pricing(SM) 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
</TABLE>
PART C
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 17, 1997
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 that seeks 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 U.S. Virgin Islands and Guam, which pay interest
exempt, in the opinion of bond counsel to the issuer, 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 10.
------------------------
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 that have entered into selected 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, except that for participants in certain
fee-based programs the minimum initial purchase is $500 and the minimum
subsequent purchase is $50. Merrill Lynch may charge its customers a processing
fee (presently $5.35) for confirming purchases and repurchases. Purchases and
redemptions made directly through Merrill Lynch Financial Data Services, Inc.
(the '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 NOR HAS THE 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 17, 1997 (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 Commission maintains a Web site
(http://www.sec.gov) that contains the Statement of Additional Information,
material incorporated by reference and other information regarding the Fund. 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............................ 0.01% 0.01% 0.01% 0.01%
Shareholder Servicing Costs(i)............ 0.04% 0.05% 0.05% 0.04%
Other..................................... 0.14% 0.14% 0.14% 0.14%
----- ----- ----- -----
Total Other Expenses.................... 0.19% 0.20% 0.20% 0.19%
----- ----- ----- -----
Total Fund Operating Expenses............... 0.74% 1.25% 1.35% 0.84%
===== ===== ===== =====
</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 23 and 'Shareholder Services--Fee-Based Programs'--page 34.
(b) Class B shares convert to Class D shares automatically approximately ten years after initial purchase. See
'Purchase of Shares--Deferred Sales Charge Alternatives--Class B and Class C Shares'--page 25.
(c) Reduced for purchases of $25,000 and over, and waived for purchases of Class A shares by participants 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 23.
(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 that 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 certain fee-based programs. See 'Shareholder Services--Fee-Based Programs'--page 34.
(e) The CDSC may be modified in connection with certain fee-based programs. See 'Shareholder Services--Fee-Based
Programs'-- page 34.
(f) The CDSC may be waived in connection with certain fee-based programs. See 'Shareholder Services--Fee-Based
Programs'--page 34.
(g) See 'Management of the Trust--Management and Advisory Arrangements'--page 20.
(h) See 'Purchase of Shares--Distribution Plans'--page 28.
(i) See 'Management of the Trust--Transfer Agency Services'--page 21.
</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 (including
any applicable CDSC for Class B and Class C shares):
Class A......................................................... $ 47 $63 $80 $128
Class B......................................................... $ 53 $60 $69 $151
Class C......................................................... $ 24 $43 $74 $162
Class D......................................................... $ 48 $66 $85 $140
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 $80 $128
Class B......................................................... $ 13 $40 $69 $151
Class C......................................................... $ 14 $43 $74 $162
Class D......................................................... $ 48 $66 $85 $140
</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 RATES 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. (the 'NASD').
Merrill Lynch may charge its customers a processing fee (presently $5.35) for
confirming purchases and repurchases. Purchases and redemptions made 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(SM) 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
that 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
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 CDSCs and distribution fees with respect to the Class B and Class C
shares in that the sales charges and distribution fees 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 or her 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 four 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 by participants 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 certain
fee-based programs. See 'Class A' and 'Class D' below.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs was 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 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 of 4.00% is
reduced for purchases of $25,000 and over and waived for purchases by
participants 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 certain fee-based
programs. Sales charges also are reduced under a right of accumulation
that 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 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
1.0% CDSC if they are redeemed within one year of purchase. Such CDSC
may be waived in connection with 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. The maximum initial sales charge of 4.00% is reduced
for purchases of $25,000 and over. 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 purchase 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 certain fee-based programs. The schedule of
initial sales charges and reductions for 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 that 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 that 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 that 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, Class C and Class D share holdings, will count toward a
right of accumulation that 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 that 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, 1997 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
--------------------------------------------------------------------------------
FOR THE PERIOD
FOR THE YEAR ENDED JULY 31, AUG. 31
-------------------------------------------------------------- 1990+ TO
1997 1996 1995 1994 1993 1992 JULY 31, 1991
------- ------- ------- ------- ------- ------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.... $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04 $ 10.27 $10.00
------- ------- ------- ------- ------- ------- ------
Investment income--net.................. .60 .61 .62 .60 .63 .67 .61
Realized and unrealized gain (loss)
on investments--net................... .45 .10 .07 (.33) .36 .77 .27
------- ------- ------- ------- ------- ------- ------
Total from investment operations........ 1.05 .71 .69 .27 .99 1.44 .88
------- ------- ------- ------- ------- ------- ------
Less dividends and distributions:
Investment income--net.................. (.60) (.61) (.62) (.60) (.63) (.67) (.61)
Realized gain on investments--net..... (.03) -- -- (.04) (.01) -- --
In excess of realized gain on
investments--net.................... -- -- -- (.02) -- -- --
------- ------- ------- ------- ------- ------- ------
Total dividends and distributions....... (.63) (.61) (.62) (.66) (.64) (.67) (.61)
------- ------- ------- ------- ------- ------- ------
Net asset value, end of period.......... $ 11.59 $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04 $10.27
------- ------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------- ------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share...... 9.72% 6.53% 6.54% 2.37% 9.30% 14.53% 9.30%#
------- ------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------- ------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.......... .74% .76% .77% .75% .69% .55% .39%*
------- ------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------- ------
Expenses................................ .74% .76% .77% .75% .81% .97% 1.57%*
------- ------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------- ------
Investment income--net.................. 5.36% 5.41% 5.72% 5.30% 5.70% 6.33% 6.71%*
------- ------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------- ------
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)............................ $21,179 $21,626 $23,040 $28,239 $27,639 $17,144 $9,402
------- ------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------- ------
Portfolio turnover...................... 49.82% 58.33% 59.17% 37.73% 9.69% 4.14% --
------- ------- ------- ------- ------- ------- ------
------- ------- ------- ------- ------- ------- ------
</TABLE>
- ------------------
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
8
<PAGE>
FINANCIAL HIGHLIGHTS--(CONTINUED)
<TABLE>
<CAPTION>
CLASS B
-------------------------------------------------------------------------------------
FOR THE PERIOD
FOR THE YEAR ENDED JULY 31, AUG. 31
------------------------------------------------------------------- 1990+ TO
1997 1996 1995 1994 1993 1992 JULY 31, 1991
-------- -------- -------- -------- -------- ------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
$ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04 $ 10.27 $ 10.00
-------- -------- -------- -------- -------- ------- -------
.55 .55 .56 .54 .58 .62 .57
.45 .10 .07 (.33) .36 .77 .27
-------- -------- -------- -------- -------- ------- -------
1.00 .65 .63 .21 .94 1.39 .84
-------- -------- -------- -------- -------- ------- -------
(.55) (.55) (.56) (.54) (.58) (.62) (.57)
(.03) -- -- (.04) (.01) -- --
-- -- -- (.02) -- -- --
-------- -------- -------- -------- -------- ------- -------
(.58) (.55) (.56) (.60) (.59) (.62) (.57)
-------- -------- -------- -------- -------- ------- -------
$ 11.59 $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04 $ 10.27
-------- -------- -------- -------- -------- ------- -------
-------- -------- -------- -------- -------- ------- -------
9.17% 5.98% 6.00% 1.86% 8.75% 13.94% 8.81%#
-------- -------- -------- -------- -------- ------- -------
-------- -------- -------- -------- -------- ------- -------
1.25% 1.27% 1.28% 1.25% 1.19% 1.06% .90%*
-------- -------- -------- -------- -------- ------- -------
-------- -------- -------- -------- -------- ------- -------
1.25% 1.27% 1.28% 1.25% 1.32% 1.48% 2.07%*
-------- -------- -------- -------- -------- ------- -------
-------- -------- -------- -------- -------- ------- -------
4.85% 4.91% 5.21% 4.80% 5.19% 5.81% 6.21%*
-------- -------- -------- -------- -------- ------- -------
-------- -------- -------- -------- -------- ------- -------
$109,070 $120,565 $123,260 $130,418 $109,463 $65,599 $ 30,435
-------- -------- -------- -------- -------- ------- -------
49.82% 58.33% 59.17% 37.73% 9.69% 4.14% --
-------- -------- -------- -------- -------- ------- -------
-------- -------- -------- -------- -------- ------- -------
<CAPTION>
CLASS C CLASS D
------------------------------- ------------------------------
FOR THE FOR THE
FOR THE YEAR PERIOD FOR THE YEAR PERIOD
ENDED OCTOBER 21, ENDED OCTOBER 21,
JULY 31, 1994+ JULY 31, 1994+
---------------- TO JULY 31, ---------------- TO JULY 31,
1997 1996 1995 1997 1996 1995
------ ------ ----------- ------ ------ -----------
<S> <C> <C> <C> <C> <C> <C>
$11.17 $11.07 $ 10.68 $11.18 $11.08 $ 10.68
------ ------ ----------- ------ ------ -----------
.53 .54 .43 .59 .60 .47
.45 .10 .39 .45 .10 .40
------ ------ ----------- ------ ------ -----------
.98 .64 .82 1.04 .70 .87
------ ------ ----------- ------ ------ -----------
(.53) (.54) (.43) (.59) (.60) (.47)
(.03) -- -- (.03) -- --
-- -- -- -- -- --
------ ------ ----------- ------ ------ -----------
(.56) (.54) (.43) (.62) (.60) (.47)
------ ------ ----------- ------ ------ -----------
$11.59 $11.17 $ 11.07 $11.60 $11.18 $ 11.08
------ ------ ----------- ------ ------ -----------
------ ------ ----------- ------ ------ -----------
9.06% 5.87% 7.83%# 9.61% 6.42% 8.36%#
------ ------ ----------- ------ ------ -----------
------ ------ ----------- ------ ------ -----------
1.35% 1.37% 1.38%* .84% .86% .87%*
------ ------ ----------- ------ ------ -----------
------ ------ ----------- ------ ------ -----------
1.35% 1.37% 1.38%* .84% .86% .87%*
------ ------ ----------- ------ ------ -----------
------ ------ ----------- ------ ------ -----------
4.75% 4.80% 5.05%* 5.26% 5.31% 5.65%*
------ ------ ----------- ------ ------ -----------
------ ------ ----------- ------ ------ -----------
$6,145 $4,722 $ 1,868 $5,348 $3,583 $ 2,630
------ ------ ----------- ------ ------ -----------
49.82% 58.33% 59.17% 49.82% 58.33% 59.17%
------ ------ ----------- ------ ------ -----------
------ ------ ----------- ------ ------ -----------
</TABLE>
- ------------------
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
9
<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 U.S. 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
bearing interest exempt from Federal income taxes are referred to herein as
'Municipal Bonds' and obligations the interest on which is 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 Services ('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, to
obligations in which the Fund may invest. Municipal 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 or
which, in the Manager's judgment, possess similar credit characteristics. 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
10
<PAGE>
Information for additional information regarding ratings of debt securities. The
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 that 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, the 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
determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Pennsylvania personal 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
11
<PAGE>
determined by Moody's), SP-1 or 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 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
consisting primarily 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 of investing in the Fund 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 investment. Certain instruments in which the Fund may invest may be
characterized as derivative securities. 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
and conditions 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. As of the date of this Prospectus, Pennsylvania's general
obligation bonds are rated AA- by Standard & Poor's, AA by Fitch and Aa3 by
Moody's.
12
<PAGE>
The value of Municipal Bonds generally may be affected by uncertainties in
the municipal markets as a result of legislation or litigation changing the
taxation of Municipal Bonds or the rights of Municipal Bond holders in the event
of a bankruptcy. Municipal bankruptcies are rare, and certain provisions of the
U.S. Bankruptcy Code governing such bankruptcies are unclear. Further, the
application of state law to Municipal Bond issuers could produce varying results
among the states or among Municipal Bond issuers within a state. These
uncertainties could have a significant impact on the prices of the Pennsylvania
Municipal Bonds or Municipal Bonds in which the Fund invests.
The Manager does not believe that the current economic conditions in
Pennsylvania or other factors described above will have a significant adverse
effect on the Fund's ability to invest in high quality Pennsylvania Municipal
Bonds. Because the Fund's portfolio will be comprised primarily of investment
grade securities, the Fund is expected to be less subject to market and credit
risks than a fund that invests primarily in lower quality Pennsylvania Municipal
Bonds. See 'Description of Municipal Bonds' in the Statement of Additional
Information and see also Appendix I--'Economic and Financial Conditions in
Pennsylvania' in 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 referred to as Municipal Bonds if the interest paid thereon
is excluded from gross income for purposes of Federal income taxation and as
Pennsylvania Municipal Bonds if the interest thereon is exempt from Federal
income tax and 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's 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 payments 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.
13
<PAGE>
The Fund may purchase IDBs and private activity bonds. IDBs and private
activity bonds are, in most cases, tax-exempt securities issued by states,
municipalities or public authorities 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 private 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 of such bonds. Therefore, an investor
should be aware that repayment of such bonds generally depends on the revenues
of a private entity and should 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 entity, capital structure, demand for its
products or services, competition, general economic conditions, governmental
regulation and the entity'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 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.
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
14
<PAGE>
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 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 that have been adopted by the Board of
Trustees and subject to the supervision of the Board of Trustees, 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 entity 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 that 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.
15
<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 and limitations. 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. Recent legislation has created new categories of capital gains
taxable at different rates which the Fund may be able to pass through to
shareholders. 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, U.S. 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
16
<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) 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.
This requirement will no longer apply to the Fund after its fiscal year ending
July 31, 1998. 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.
17
<PAGE>
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
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
all other illiquid investments, would 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
18
<PAGE>
affirmative vote of a majority (as defined under the 1940 Act) of the
outstanding shares, the Fund continues to be governed by such investment
policies.
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 as a 'regulated investment
company' for purposes of 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'); and Executive
Vice President of ML & Co.
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.
19
<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 140 registered investment companies. MLAM also
offers portfolio management and portfolio analysis services to individuals and
institutions. As of October 31, 1997, the Manager and MLAM had a total of
approximately $271.9 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 R. Bock became the Portfolio Manager of the Fund in August 1997 and
is responsible for the day-to-day management of the Fund's investment portfolio.
He has been a Vice President of MLAM since 1989.
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, 1997, the
total fee paid by the Fund to the Manager was $798,487 (based on average daily
net assets of approximately $145.2 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, 1997, the Fund reimbursed the Manager $84,022 for accounting services. For
the fiscal year ended July 31, 1997, the ratio of total expenses to average net
assets was .74% for Class A shares, 1.25% for Class B shares, 1.35% for Class C
shares and .84% 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 that 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 '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 that at the time is being purchased
or sold (as the case may be), or to
20
<PAGE>
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
The Transfer Agent, which is a 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 Transfer
Agent receives an annual fee of up to $11.00 per Class A or Class D account and
up to $14.00 per Class B or Class C account, and is entitled to reimbursement
for certain transaction charges and out-of-pocket expenses incurred by the
Transfer Agent under the Transfer Agency Agreement. Additionally, a $.20 monthly
closed account charge will be assessed on all accounts which close during the
calendar year. Application of this fee will commence the month following the
month the account is closed. At the end of the calendar year, no further fees
will be due. For purposes of the Transfer Agent Agreement, the term 'account'
includes a shareholder account maintained directly by the Transfer Agent and any
other account representing the beneficial interest of a person in the relevant
share class on a recordkeeping system, provided the recordkeeping system is
maintained by a subsidiary of ML & Co. For the fiscal year ended July 31, 1997,
the total fee paid by the Fund to the Transfer Agent was $72,284 pursuant to the
Transfer Agency Agreement.
PURCHASE OF SHARES
The Distributor, an affiliate of each 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, except that for participants in certain fee-based programs, the
minimum initial purchase is $500 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 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 on that day, such orders shall be deemed received on the next
business day. The Trust or the Distributor may suspend the 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
21
<PAGE>
customers a processing fee (presently $5.35) to confirm a sale of shares to
such customers. Purchases made 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 (except that Class B shareholders may vote upon any material changes to
expenses charged under the Class D Distribution Plan). 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 CDSCs and distribution fees with respect to Class B and Class C shares in
that the sales charges and distribution fees 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, that are eligible
to sell shares.
22
<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 followed by a more detailed description of each class.
<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 four years, at 0.25% 0.25% B shares convert to D shares
a rate of 4.0% during the first automatically after approximately
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 by participants 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 certain
fee-based programs.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs was 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 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)
23
<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 by participants 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 purchase 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 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, 1997, the Fund sold 463,882 Class
A shares for aggregate net proceeds of $5,214,824. The gross sales charges for
the sale of Class A shares of the Fund for the year were $8,982, of which, $809
and $8,173 were received by the Distributor and Merrill Lynch, respectively. For
the fiscal year ended July 31, 1997, 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,
1997, the Fund sold 215,211 Class D shares for aggregate net proceeds of
$2,406,083. The gross sales charges for the sale of Class D shares of the Fund
for the year were $2,793, of which $225 and $2,568 were received by the
Distributor and Merrill Lynch, respectively. For the fiscal year ended July 31,
1997, 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 and U.S. branches of foreign
banking institutions provided that the program or branch 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, collective investment trusts for which
Merrill Lynch Trust Company serves as trustee 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
24
<PAGE>
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.'
Provided applicable threshold requirements are met, either Class A or Class
D shares are offered at net asset value to Employee Access(Service Mark)
Accounts available through authorized employers. Class A shares are offered at
net asset value to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
and, subject to certain conditions, 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,
which declines each year, 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.'
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 fees 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 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 dealers' 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. The proceeds from the ongoing account
maintenance fees are used to compensate the Distributor and Merrill Lynch
(pursuant to a sub-agreement) for providing continuing account maintenance
activities. 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
25
<PAGE>
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.
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 that 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>
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, 1997, the Distributor received CDSCs of
$139,750 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch. Additional CDSCs payable to the Distributor may have been
waived or converted to a contingent obligation in connection with a
shareholder's participation in certain fee-based programs.
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).
26
<PAGE>
The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Code) of a shareholder. The Class B CDSC also is
waived for any Class B shares that are purchased within qualifying Employee
Access(SM) Accounts. 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 certain fee-based programs. See
'Shareholder Services--Fee-Based Programs.'
Contingent Deferred Sales Charges--Class C Shares. Class C shares that 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. The Class C CDSC may be waived in connection with
certain fee-based programs. See 'Shareholder Services--Fee-Based Programs.' For
the fiscal year ended July 31, 1997, the Distributor received CDSCs of $1,630
with respect to redemptions of Class C shares, all of which were paid to Merrill
Lynch.
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 applicable 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 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
27
<PAGE>
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 also may be modified for investors who participate in
certain fee-based programs. See 'Shareholder Services--Fee-Based Programs.'
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 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. 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, 1997, the Fund paid the Distributor
$570,543 pursuant to the Class B Distribution Plan (based on average daily net
assets subject to such Class B Distribution Plan of approximately $114.1
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, 1997, the Fund paid the
Distributor $31,881 pursuant to the Class C Distribution Plan (based on average
daily net assets subject to such Class C Distribution Plan of approximately $5.3
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, 1997, the Fund paid the
Distributor $4,386 pursuant to the Class D Distribution Plan (based on average
daily net assets subject to such Class D Distribution Plan of approximately $4.4
million), all of which was paid to Merrill Lynch for providing account
maintenance activities in connection with Class D shares.
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 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
28
<PAGE>
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, 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, 1996, 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 $1,933,000
(1.67% of Class B net assets at that date). As of July 31, 1997, direct cash
revenues for the period since the commencement of operations of Class B shares
exceeded direct cash expenses by $1,560,063 (1.43% of Class B net assets at that
date). As of December 31, 1996, the fully allocated accrual expenses incurred by
the Distributor and Merrill Lynch for the period since the commencement of
operations of Class C shares exceeded fully allocated accrual revenues by
approximately $33,000 (0.61% of Class C net assets at that date). As of July 31,
1997, direct cash revenues for the period since the commencement of operations
of Class C shares exceeded direct cash expenses by $59,273 (0.53% 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 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
29
<PAGE>
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 that 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 redemption request 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 to the Trust not later
than 30 minutes after the close of business on the NYSE in order to obtain that
day's closing price.
30
<PAGE>
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 that 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 $5.35) to confirm a repurchase of shares
to such customers. Repurchases made 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.
Redemption payments will be made within seven days of the proper tender of
the certificates, if any, and stock power or letter requesting redemption, in
each instance with signatures guaranteed as noted 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
described below that are 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
31
<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. 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 such shares and then must turn the certificates over to
the new firm for re-registration as described in the preceding sentence.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund 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 the 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 or her 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 that 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
32
<PAGE>
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 MLAM-advised mutual
fund from which the exchange has been made.
Exercise of the exchange privilege is treated as a sale of the exchanged
shares and a purchase of the acquired shares 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 to Merrill Lynch if the shareholder's account is maintained with
Merrill Lynch, or by written notification or by telephone (1-800-MER-FUND) to
the Transfer Agent if the shareholder's account is maintained with 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. The Fund is not responsible for any failure of delivery to
the shareholder's address of record and no interest will accrue on amounts
represented by uncashed distribution or redemption checks. 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 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. A 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. With respect to redemptions of Class B or Class C shares
pursuant to a systematic withdrawal plan, the maximum number of Class B or Class
C shares that can be redeemed from an account annually shall not exceed 10% of
the value of shares of such class in that account at the time the election to
join the systematic withdrawal plan was made. Any CDSC that otherwise might be
due on such redemption of Class B or Class C shares will be waived. Shares
redeemed pursuant to a systematic withdrawal plan will be redeemed in the same
order as Class B or Class C shares are otherwise redeemed. See 'Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C
Shares--Contingent Deferred Sales Charges--Class B Shares' and '-- Contingent
Deferred Sales Charges--Class C Shares.' Where the systematic withdrawal plan is
applied to Class B Shares, upon conversion of the last Class B shares in an
account to Class D shares, the systematic withdrawal plan will automatically be
applied thereafter to Class D shares. See 'Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares--Conversion of Class B Shares to
Class D Shares.'
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.
33
<PAGE>
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 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 the Transfer Agent at
(800) MER-FUND or (800) 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 Fund
may not purchase securities, including Municipal Bonds, during the existence of
any underwriting syndicate of which Merrill Lynch is a member or in a private
placement in which Merrill Lynch serves as placement agent except pursuant to
procedures approved by the Trustees of the Trust which either comply with rules
adopted by the Commission or with interpretations of the Commission staff. 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
34
<PAGE>
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.
All net realized 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. As
long as 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 such 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
35
<PAGE>
Pennsylvania personal income tax purposes. In the case of residents of the City
of Philadelphia, distributions that 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. Distributions from investment income and capital gains from the Fund,
including exempt-interest dividends, may be subject to 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 with their tax advisors with respect to the
application of such taxes to an investment in the Fund, to the receipt of Fund
dividends and to their tax situation in general.
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. Recent legislation creates additional
categories of capital gain taxable at different rates. Not later than 60 days
after the close of its taxable year, the Fund will provide its shareholders with
a written notice designating the amounts of any exempt-interest dividends,
ordinary income dividends or capital gain dividends, as well as the amount of
capital gain dividends in the different categories of capital gain referred to
above. 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 gains
36
<PAGE>
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 its 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 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.
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. Shareholders should consult their tax advisors regarding the
state and local tax consequences relating to the conversion of Class B shares
into Class D shares or any other exchange of 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.
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.
37
<PAGE>
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.
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 waiver of the CDSC in the
case of Class B shares and Class C 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 CDSC, 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.
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<PAGE>
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,
1997 was 4.56% for Class A shares, 4.25% for Class B shares, 4.15% for Class C
shares and 4.47% for Class D shares and the tax-equivalent yield for the same
period (based on a Federal income tax rate of 28%) was 6.33% for Class A shares,
5.90% for Class B shares, 5.76% for Class C shares and 6.21% 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.
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 (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) 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 generally will 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.
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<PAGE>
ORGANIZATION OF THE TRUST
The Trust is a 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 again 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 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, $.10 par value per share, 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 relating to the account maintenance associated with
such shares, and Class B and Class C shares bear certain expenses relating to
the distribution of such shares. Each class has exclusive voting rights with
respect to matters relating to distribution and/or account maintenance
expenditures, as applicable. See 'Purchase of Shares.' The Trustees of the Trust
may classify and reclassify the shares of any Series into additional or other
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, 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. Upon
liquidation or dissolution of a Series, each issued and outstanding share of
that Series is entitled to participate equally in dividends and distributions
declared by the respective Series and in net assets of such Series 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 each 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
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<PAGE>
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
matter 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.
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42
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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>
Name...........................................................................
First Name Initial Last Name
Name of Co-Owner (if any).......................................................
First Name Initial Last Name
Address.........................................................................
................................................................................
(Zip Code)
Date......................................................, 19..................
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.)
- --------------------------------------------------------------------------------
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.
43
<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 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>
44
<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
Address.........................................................................
................................................................................
(Zip Code)
Account Number .................................................................
(if existing account)
- --------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--(SEE TERMS AND CONDITIONS IN THE STATEMENT OF
ADDITIONAL INFORMATION).
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for quarterly,
of / / Class A, / / Class B*, / / Class C* 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 THE AMOUNT OF THE WITHDRAWAL YOU WOULD LIKE PAID TO YOU (CHECK ONE): / /
$_________, of / / Class A, / / Class B*, / / Class C* 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.
* ANNUAL WITHDRAWAL CANNOT EXCEED 10% OF THE VALUE OF SHARES OF EACH CLASS HELD
IN THE ACCOUNT AT THE TIME THE ELECTION TO JOIN THE SYSTEMATIC WITHDRAWAL PLAN
IS MADE.
45
<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.
...................................... .......................................
Date Signature of Depositor
.......................................
Signature of Depositor
(If joint account, both must sign)
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.
46
<PAGE>
[This page intentionally left blank]
<PAGE>
[This page intentionally left blank]
<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.............. 10
Potential Benefits........................... 12
Special and Risk Considerations Relating to
Municipal Bonds............................ 12
Description of Municipal Bonds............... 13
Call Rights.................................. 15
When-Issued Securities and Delayed Delivery
Transactions............................... 15
Financial Futures Transactions and Options... 16
Repurchase Agreements........................ 18
Investment Restrictions...................... 18
Management of the Trust........................ 19
Trustees..................................... 19
Management and Advisory Arrangements......... 20
Code of Ethics............................... 20
Transfer Agency Services..................... 21
Purchase of Shares............................. 21
Initial Sales Charge Alternatives--
Class A and Class D Shares................. 23
Deferred Sales Charge Alternatives--
Class B and Class C Shares................. 25
Distribution Plans........................... 28
Limitations on the Payment of Deferred Sales
Charges.................................... 29
Redemption of Shares........................... 30
Redemption................................... 30
Repurchase................................... 30
Reinstatement Privilege--
Class A and Class D Shares................. 31
Shareholder Services........................... 31
Investment Account........................... 31
Exchange Privilege........................... 32
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 33
Systematic Withdrawal Plans.................. 33
Automatic Investment Plans................... 33
Fee-Based Programs........................... 34
Portfolio Transactions......................... 34
Distributions and Taxes........................ 35
Distributions................................ 35
Taxes........................................ 35
Performance Data............................... 38
Additional Information......................... 39
Determination of Net Asset Value............. 39
Organization of the Trust.................... 40
Shareholder Reports.......................... 40
Shareholder Inquiries........................ 41
Authorization Form............................. 43
</TABLE>
Code #11197-1197
Merrill Lynch
Pennsylvania Municipal Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
(Art)
PROSPECTUS
November 17, 1997
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 U.S. Virgin Islands and Guam, which pay interest
exempt, in the opinion of bond counsel to the issuer, 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 Pricing(SM) 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 17, 1997 (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 17, 1997.
<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 U.S. 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 personal 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 political
subdivisions of the State, revenue bonds to finance utility systems, highways,
bridges, port and airport facilities, colleges, hospitals, housing facilities,
etc., and industrial development bonds 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 primarily 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 Services ('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 personal 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, under normal circumstances, will 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 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 an alternative
2
<PAGE>
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 set forth in this paragraph 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
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
short-term market rates increase and increase as short-term 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 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 holding a
Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such
3
<PAGE>
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. The Fund does not intend to purchase debt securities that
are in default or which the Manager believes will be in default.
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 or obligors
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. In addition, the market for high yield municipal securities is
relatively new and has not weathered a major economic recession, and it is
unknown what effects such a recession might have on such securities. During such
periods, 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 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
4
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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 owned or operated facilities. Such obligations are
included within the term Municipal Bonds if the interest paid thereon is, in the
opinion of bond counsel to the issuer, 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 industrial development
bonds or private activity bonds, the proceeds of which are used for the
construction, equipment, repair or improvement of privately operated industrial
or commercial facilities, may also constitute Municipal Bonds, although current
Federal tax laws place substantial limitations on the size of such issues.
The two principal classifications of Municipal Bonds are 'general
obligation' bonds 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.
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 payments 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 a pledge of the credit or taxing 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 letter of
credit, bond insurance or other security is furnished. The Fund also may invest
in Municipal Bonds that are 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
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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. 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 of
Trustees, determines to be liquid. The Manager will deem lease obligations
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 entity 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 also is 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, 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.
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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 VRDOs at approximately the par value of the VRDOs on the
adjustment date. The adjustments typically are set at a rate determined by the
remarketing agent or 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 or 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 therefore will 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 and VRDOs 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, issued by companies having an outstanding debt issue rated at least A
by Standard & Poor's, Moody's or Fitch. 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 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.
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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 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 will
be in accordance with the Fund's investment policies and limitations. See
'Investment Objective and Policies--Investment Restrictions' in the Prospectus.
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 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
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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 'marking to
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 obligation 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, U.S. 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 that may become available if the Manager and the 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
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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
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 that 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
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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 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 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
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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.
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.
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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.
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. As a matter of
policy, however, the Fund will not purchase shares of any registered open-
end investment company or registered unit investment trust, in reliance on
Section 12(d)(l)(F) or (G) (the 'fund of funds' provisions) of the 1940
Act, at any time the Fund's shares are owned by another investment company
that is part of the same group of investment companies as the Fund.
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 that 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.
d. 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
13
<PAGE>
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 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 and executive officers of the Trust and the
portfolio manager of the Fund, 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 (65)--President and Trustee(1)(2)--President of the Manager
(which term, as used herein, includes its corporate predecessors) since 1977;
President of Merrill Lynch Asset Management, L.P. ('MLAM') (which term, as used
herein, includes its 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.
JAMES H. BODURTHA (53)--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 (58)--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; President, Hudson Institute since 1997 and
Trustee since 1980; Dean, Gallatin Division of New York University from 1976 to
1993; Distinguished Fellow, Herman Kahn Chair, Hudson Institute from 1984 to
1985; Director, Damon
14
<PAGE>
Corporation from 1991 to 1995; Overseer, Center for Naval Analyses from 1983 to
1993; Limited Partner, Hypertech LP in 1996.
ROBERT R. MARTIN (70)--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 (68)--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 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 (45)--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 and TIBCO from 1994 to 1996.
TERRY K. GLENN (57)--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 Merrill Lynch Funds
Distributor, Inc. ('MLFD' or the 'Distributor') since 1986 and Director thereof
since 1991; President of Princeton Adminstrators, L.P. since 1988.
VINCENT R. GIORDANO (53)--Senior Vice President(1)(2)--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 (46)--Vice President(1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1984 to 1997; Vice President of the
Manager since 1984.
WILLIAM R. BOCK (61)--Vice President and Portfolio Manager of the
Fund(1)(2)--Vice President of MLAM since 1989.
DONALD C. BURKE (37)--Vice President(1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997; Director of Taxation of
MLAM since 1990.
GERALD M. RICHARD (48)--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.
ROBERT E. PUTNEY, III (37)--Secretary(1)(2)--Director (Legal Advisory) of
MLAM since 1997; Vice President of MLAM from 1994 to 1997; Attorney employed by
MLAM from 1991 to 1994; Attorney in private practice prior thereto.
- ------------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director, trustee or officer of certain other
investment companies for which the Manager or MLAM acts as investment
adviser or manager.
At October 31, 1997, the Trustees and officers of the Trust as a group (13
persons) owned an aggregate of less than 1% of the outstanding shares of the
Fund. At such date, Mr. Zeikel, a Trustee and officer of the Trust, and the
other officers of the Trust owned an aggregate of less than 1% of the
outstanding shares of Common Stock of ML & Co.
15
<PAGE>
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. 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, 1997, fees and expenses paid to
non-affiliated Trustees that were allocated to the Fund aggregated $7,472.
The following table sets forth for the fiscal year ended July 31, 1997,
compensation paid by the Fund to the non-affiliated Trustees and, for the
calendar year ended December 31, 1996, the aggregate compensation paid by all
registered investment companies (including the Trust) advised by the Manager and
its affiliate, MLAM ('FAM/MLAM Advised Funds') to the non-affiliated Trustees:
<TABLE>
<CAPTION>
AGGREGATE
PENSION OR COMPENSATION
RETIREMENT FROM TRUST AND
BENEFITS OTHER
ACCRUED AS FAM/MLAM
PART OF ADVISED FUNDS
COMPENSATION TRUST'S PAID TO
NAME OF TRUSTEE FROM FUND EXPENSES TRUSTEE(1)
- ------------------------------------------------------------------- ------------ -------------- --------------
<S> <C> <C> <C>
James H. Bodurtha.................................................. $1,505 None $148,500
Herbert I. London.................................................. $1,505 None $148,500
Robert R. Martin................................................... $1,505 None $148,500
Joseph L. May...................................................... $1,505 None $148,500
Andre F. Perold.................................................... $1,505 None $148,500
</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).
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
16
<PAGE>
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, 1995, 1996 and 1997, the total advisory fees paid by the
Fund to the Manager were $827,537, $845,927 and $798,487, 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 incurred in its
operation and a portion of the Trust's general administrative expenses 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 that 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 as 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,
1995, 1996 and 1997, the Fund reimbursed the Manager $40,065, $62,902 and
$84,022, respectively, for accounting 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 account maintenance and the distribution of Class B
and Class C shares will be financed by the Fund pursuant to the Distribution
Plans 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.
17
<PAGE>
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
Pricing(SM) 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 class pursuant to which account
maintenance and/or distribution fees are paid (except that Class B shareholders
may vote upon any material changes to expenses changed under the Class D
Distribution Plan). Each class has different exchange privileges. See
'Shareholder Services--Exchange Privilege.'
The Merrill Lynch Select Pricing(SM) 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 that utilize the Merrill Lynch Select
Pricing(SM) 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, 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 A shares for the fiscal year ended July 31, 1997
were $8,982, of which the Distributor received $809 and Merrill Lynch received
$8,173. 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. The gross sales charges for the sale of Class D shares
for the fiscal year ended July 31, 1997 were $2,793, of which the Distributor
received $225 and Merrill Lynch received $2,568. For the fiscal years ended July
31, 1995, 1996 and 1997, 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 years ended July 31, 1996 and
1997, 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.
18
<PAGE>
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 or her spouse and their children under
the age of 21 years purchasing shares for his, her 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 that 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 the Manager or MLAM
who purchased such closed-end fund shares prior to October 21, 1994, the date
the Merrill Lynch Select Pricing(Service Mark) System commenced operations, and
wish to reinvest the net proceeds from 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.
19
<PAGE>
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 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 at least 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(SM) Accounts. Provided applicable threshold requirements
are met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. 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.
20
<PAGE>
TMA(SM) Managed Trusts. Class A shares are offered at net asset value to
TMA(SM) 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 a 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.
Class D shares of the Fund are also 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 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 that
might result from an acquisition of assets having net unrealized appreciation
that 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 that (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, that
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
21
<PAGE>
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
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 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. (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 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
22
<PAGE>
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.
The following table sets forth comparative information as of July 31, 1997
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, 1997
----------------------------------------------------------------------------------------
(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, 1997:
Under NASD Rule as Adopted.............. $161,079 $10,067 $3,824 $13,891 $2,671 $11,220 $ 273
Under Distributor's Voluntary Waiver.... $161,079 $10,067 $ 805 $10,872 $2,671 $ 8,201 $ 273
CLASS C SHARES FOR THE PERIOD OCTOBER
21, 1994 (COMMENCEMENT OF OPERATIONS) TO
JULY 31, 1997:
Under NASD Rule as Adopted.............. $ 6,583 $ 411 $ 59 $ 470 $ 38 $ 432 $ 22
</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. See
'Purchase of Shares--Distribution Plans' in the Prospectus. This figure may
include CDSCs that were deferred when a shareholder redeemed shares prior to
the expiration of the applicable CDSC period and invested the proceeds,
without the imposition of a sales charge, in Class A shares in conjunction
with the shareholder's participation in the Merrill Lynch Mutual Fund
Advisor (Merrill Lynch MFA(Service Mark)) Program (the 'MFA Program'). The
CDSC is booked as a contingent obligation that may be payable if the
shareholder terminates participation in the MFA Program.
(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 (with respect to Class B shares) or
the NASD maximum (with respect to Class B and Class C shares).
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 for more than seven days 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
23
<PAGE>
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.
The value of shares at the time of the redemption may be more or less than
the shareholder's cost, depending in part on the market value of the securities
held by the Fund at such time.
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, in certain circumstances,
including following the death or disability of a Class B shareholder.
Redemptions for which the waiver applies in the case of such withdrawals 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 redemption is requested within one year of the
death or initial determination of disability. For the fiscal years ended July
31, 1995, 1996, and 1997, the Distributor received CDSCs of $302,369, $195,896
and $139,750, respectively, with respect to redemptions of Class B shares, all
of which were paid to Merrill Lynch. Additional CDSCs payable to the Distributor
may have been waived or converted to a contingent obligation in connection with
a shareholder's participation in certain fee-based programs. For the fiscal
period October 21, 1994 (commencement of operations) to July 31, 1995, and for
the fiscal years ended July 31, 1996 and 1997, the Distributor received CDSCs of
$621, $2,273 and $1,630, 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' and 'Portfolio
Transactions' 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 ('OTC') 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 years ended July 31, 1995 and 1997, 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. Affiliated persons of the Trust may serve as
broker for the Fund in OTC 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.
The Fund may not purchase securities, including Municipal Bonds, during the
existence of any underwriting syndicate of which Merrill Lynch is a member or in
a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Trustees of the Trust which either comply
with rules adopted by the Commission or with interpretations of the Commission
staff. Rule 10f-3 under the 1940 Act sets forth conditions under which the Fund
may purchase municipal bonds from an underwriting syndicate of which Merrill
Lynch is a member. The rule sets forth requirements relating to, among other
things, the terms of
24
<PAGE>
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.
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. As a result of the investment policies described in
the Prospectus, the Fund's annual portfolio turnover rate may be higher than
that of other investment companies. 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, 1996 and 1997, were 58.33% and 49.82%,
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 that 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
Reference is made to 'Additional Information--Determination of Net Asset
Value' in the Prospectus for information concerning the 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, Martin Luther
King, Jr. 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 (including
interest and dividends accrued but not yet received) minus all liabilities
(including accrued expenses) by the total number of shares outstanding at such
time, rounded to the nearest cent.
25
<PAGE>
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 the
Fund's Class B and Class C shares generally will be lower than the per
share net asset value of its 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 OTC municipal bond and money markets and are
valued at the last available bid price in the OTC 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
26
<PAGE>
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 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 he or she is 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 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 Merrill Lynch in writing if their
account is maintained with Merrill Lynch or notify the Transfer Agent in writing
or by telephone (1-800-MER-FUND) if their account is maintained with the
Transfer Agent 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
A shareholder may elect to make systematic withdrawals from an Investment
Account of Class A, Class B, Class C or Class D shares in the form of payments
by check or through automatic payment by direct deposit to such shareholder's
bank account on either a monthly or quarterly basis as provided below. Quarterly
withdrawals are available for shareholders who have acquired 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 shares having a
value of $10,000 or more.
27
<PAGE>
At the time of each withdrawal payment, sufficient 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 the dollar amount and
class of shares to be redeemed. 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
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 shares in the Investment Account are reinvested
automatically in shares of the Fund. A shareholder's Systematic Withdrawal Plan
may be terminated at any time, without a charge or penalty, by the shareholder,
the Trust, the Fund's Transfer Agent or the Distributor.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares that
can be redeemed from an account annually shall not exceed 10% of the value of
shares of such class in that account at the time the election to join the
systematic withdrawal plan was made. Any CDSC that otherwise might be due on
such redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic sithdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See 'Purchase of
Shares--Deferred Sales Charge Alternatives-- Class B and Class C
Shares-Contingent Deferred Sales Charges-Class B Shares' and --'Contingent
Deferred Sales Charges-Class C Shares' in the Prospectus. Where the systematic
withdrawal plan is applied to Class B shares, upon conversion of the last Class
B shares in an account to Class D shares, the systematic withdrawal plan will
automatically be applied thereafter to Class D shares. See 'Purchase of
Shares--Deferred Sales Charge Alternative-Class B and Class C Shares--Conversion
of Class B Shares to Class D Shares' in the Prospectus; if an investor wishes to
change the amount being withdrawn in a systematic withdrawal plan the investor
should contact his or her Financial Consultant.
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 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 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 is greater. Periodic investments may not be made into an Investment
Account in which the shareholder has elected to make systematic withdrawals.
Alternatively, a 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 $50. The proceeds of systematic redemptions will be posted to the
shareholder's account three business days after the date the shares are
redeemed. All redemptions are made at net asset value. A shareholder may elect
to have his or her shares redeemed on the first, second, third, or fourth Monday
of each month, in the case of monthly redemptions, or of every other month, in
the case of bimonthly redemptions. For quarterly, semiannual or annual
redemptions, the shareholder may select the month in which the shares are to be
redeemed and may designate whether the redemption is to be made on the first,
second, third or fourth Monday of the month. If the Monday selected is not a
business day, the redemption will be processed at net asset value on the next
business day. The CMA(Registered) or CBA(Registered) Systematic Redemption
Program is not available if Fund shares are being purchased within the account
28
<PAGE>
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
U.S. 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 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, but does not hold Class A shares of the second fund in his or her
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 at least 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
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 with a reduced or 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,
29
<PAGE>
of another MLAM-advised mutual fund ('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 CDSC 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 CDSC
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 Special Value Fund 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 that 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 Fund's Class B
shares for two and a half years and three years later decide to redeem the
shares of Institutional Fund for cash. 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 that 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 MLAM-advised funds 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 at any time and thereafter may 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.
30
<PAGE>
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ('RICs') under the Code. As
long as 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
its income. So long as the Fund qualifies as a 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 that are attributable to interest
on tax-exempt obligations and are 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, including new categories of 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 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
advisors 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.
31
<PAGE>
The portion of 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.
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 advisors 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.
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. Recent legislation creates additional
categories of capital gains taxable at different rates. Not later than 60 days
after the close of its taxable year, the Fund will provide its shareholders with
a written notice designating the amounts of any exempt-interest dividends,
ordinary income dividends or capital gain dividends, as well as the amount of
capital gain dividends in the different categories of capital gain referred to
above. 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 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
32
<PAGE>
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 its 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. Shareholders should consult their tax advisors regarding the
state and local tax consequences relating to the conversion of Class B shares
into Class D shares or any other exchange of 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.
33
<PAGE>
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 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 advisors 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.
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. Under recently enacted
legislation, this requirement will no longer apply to the Fund after its fiscal
year ending July 31, 1998.
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,
34
<PAGE>
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 CLASS C SHARES
------------------------------------ ------------------------------------ -----------------
REDEEMABLE VALUE REDEEMABLE VALUE
OF A OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL EXPRESSED AS
A PERCENTAGE $1,000 A PERCENTAGE $1,000 A PERCENTAGE
BASED ON A INVESTMENT BASED ON A INVESTMENT BASED ON A
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END OF HYPOTHETICAL
PERIOD $1,000 INVESTMENT OF THE PERIOD $1,000 INVESTMENT THE PERIOD $1,000 INVESTMENT
- ------------------------------ ----------------- ---------------- ----------------- ---------------- -----------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C> <C>
One year ended July 31, 1997.. 5.34% $ 1,053.40 5.17% $ 1,051.70 8.06%
Five years ended July 31, 1997 5.99% $ 1,337.80 6.32% $ 1,358.60 --
Inception (August 31, 1990) to
July 31, 1997............... 7.74% $ 1,674.60 7.83% $ 1,684.40 --
Inception (October 21, 1994)
to July 31, 1997............ -- -- -- -- 8.22%
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C> <C>
Year ended July 31, 1997...... 9.72% $ 1,097.20 9.17% $ 1,091.70 9.06%
Year ended July 31, 1996...... 6.53% $ 1,065.30 5.98% $ 1,059.80 5.87%
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............ -- -- -- -- 7.83%
<CAPTION>
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C> <C>
Inception (August 31, 1990) to
July 31, 1997............... 67.46% $ 1,674.60 68.44% $ 1,684.40 --
Inception (October 21, 1994)
to July 31, 1997............ -- -- -- -- 24.51%
<CAPTION>
YIELD
<S> <C> <C> <C> <C> <C>
30 days ended July 31, 1997... 4.56% -- 4.25% -- 4.15%
<CAPTION>
TAX EQUIVALENT YIELD*
<S> <C> <C> <C> <C> <C>
30 days ended July 31, 1997... 6.33% -- 5.90% -- 5.76%
<CAPTION>
CLASS D SHARES
------------------------------------
REDEEMABLE VALUE REDEEMABLE VALUE
OF A OF A
HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
$1,000 A PERCENTAGE $1,000
INVESTMENT BASED ON A INVESTMENT
AT THE END HYPOTHETICAL AT THE END
PERIOD OF THE PERIOD $1,000 INVESTMENT OF THE PERIOD
- ------------------------------ ---------------- ----------------- ----------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C>
One year ended July 31, 1997.. $ 1,080.60 5.23% $ 1,052.30
Five years ended July 31, 1997 -- -- --
Inception (August 31, 1990) to
July 31, 1997............... -- -- --
Inception (October 21, 1994)
to July 31, 1997............ $ 1,245.10 7.22% $ 1,213.40
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C>
Year ended July 31, 1997...... $ 1,090.60 9.61% $ 1,096.10
Year ended July 31, 1996...... $ 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............ $ 1,078.30 8.36% $ 1,083.60
<CAPTION>
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C>
Inception (August 31, 1990) to
July 31, 1997............... -- -- --
Inception (October 21, 1994)
to July 31, 1997............ $ 1,245.10 21.34% $ 1,213.40
YIELD
30 days ended July 31, 1997... -- 4.47% --
TAX EQUIVALENT YIELD*
30 days ended July 31, 1997... -- 6.21% --
</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 CDSC
and, therefore, may reflect greater total return since, due to the reduced sales
charges or the waiver of the CDSC, a lower amount of expenses may be 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 $.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 Class B, Class C and Class D shares bear certain expenses related to
account maintenance and/or distribution expenditures. The Board of Trustees may
classify and reclassify the shares of any Series into additional or other
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, as appropriate, being borne solely by such class. Each
issued and outstanding share of a Series is entitled to one vote and to
participate equally in dividends and distributions declared with respect to that
Series and, upon liquidation or dissolution of the Series, in the net assets of
such Series remaining after satisfaction of outstanding liabilities, except
that, as noted above, expenses relating to distribution and/or account
maintenance of the Class B, Class C and Class D shares are borne solely by the
respective 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 advisory arrangements, of a material
increase in distribution fees or of a change in the fundamental policies,
objectives or restrictions of a Series.
37
<PAGE>
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 will be 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, other than amendments necessary to
conform the Declaration to certain laws or regulations, to change the name of
the Trust, or to make certain non-material changes, without the affirmative vote
of a majority of the outstanding shares of the Trust or of the affected Series
or class, as applicable.
Under Massachusetts law, shareholders of a business trust may, under
certain circumstances, be held personally liable as partners for the trust's
obligations. However, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which both
inadequate insurance existed and the trust itself was unable to meet its
obligations.
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. 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, 1997 is calculated as set
forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
----------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Net Assets............................................ $21,178,764 $109,070,243 $6,145,035 $5,347,512
----------- ------------ ---------- ----------
----------- ------------ ---------- ----------
Number of Shares Outstanding.......................... 1,827,891 9,413,550 530,303 461,085
----------- ------------ ---------- ----------
----------- ------------ ---------- ----------
Net Asset Value Per Share (net assets divided by
number of shares outstanding)....................... $ 11.59 $ 11.59 $ 11.59 $ 11.60
Sales Charge (for Class A and Class D shares: 4.00% of
offering price; 4.17% of net asset value per
share)*............................................. .48 ** ** .48
----------- ------------ ---------- ----------
Offering Price........................................ $ 12.07 $ 11.59 $ 11.59 $ 12.08
----------- ------------ ---------- ----------
----------- ------------ ---------- ----------
</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 selection of
independent auditors is subject to approval by the independent Trustees of the
Trust. 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 3, 1997.
39
<PAGE>
APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN PENNSYLVANIA
The following information is a brief summary of factors affecting the
economy of the Commonwealth of Pennsylvania 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 of the most recent publicly
available offering statements relating to debt offerings of Pennsylvania
issuers; however, it has not been updated nor will it be updated during the
year. The Fund has not independently verified the information.
Many factors affect the financial condition of the Commonwealth of
Pennsylvania (also referred to herein 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, sometimes referred to herein as the 'City') 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.
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 from fiscal 1992 through fiscal 1996, revenues and
other sources (determined on a 'GAAP' basis) increased by an average annual rate
of 4.6%. Intergovernmental revenues increased by an average annual rate of 13.2%
due, in part, to an accounting change. Tax revenues during this period increased
an average of 2.5% as modest economic growth, low inflation rates and several
tax rate reductions and other tax reduction measures constrained growth of tax
revenues. The tax reduction measures followed a $2.7 billion tax increase
adopted for the 1992 fiscal year.
Expenditures and other uses during the fiscal 1992 through 1996 period rose
at an average annual rate of 6.0%, led by increases of 14.2% for protection of
persons and property program costs. The costs of a prison expansion program and
other correctional program expenses are responsible for the large percentage
increases. Efforts to control costs for various social welfare programs and the
presence of favorable economic conditions have led to a modest 5.6% increase for
public health and welfare costs for the five year period.
The fund balance at June 30, 1996 totaled $635.2 million, a $547.7 million
increase from the balance of $87.5 million at June 30, 1992.
The fiscal 1996 unappropriated surplus (prior to transfer to the Tax
Stabilization Reserve Fund) was $183.8 million, $65.5 million above estimate.
Expenditures from revenues, including $113 million of supplemental
appropriations (but excluding pooled financing expenditures), totaled $16,074.7
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 0.7%). Tax rate reductions and other tax law changes
40
<PAGE>
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.
For GAAP purposes, the fiscal 1996 fund balance was drawn down $53.1
million to $635.2 million. A planned drawdown of the budgetary unappropriated
surplus during the fiscal year contributed to expenditures and other uses
exceeding revenues and other sources by $28.0 million. As a result, the
unreserved fund balance declined by $61.1 million, reducing the balance to
$381.8 million at the end of fiscal 1996. Total revenues and other sources
increased by 8.7% for the fiscal year, led by a 24.2% increase in
intergovernmental revenues (due mainly to an accounting change). Expenditures
and other uses increased by 8.6% for fiscal 1996.
The unappropriated balance of Commonwealth revenues increased during the
1997 fiscal year by $432.9 million to $591.4 million (prior to reserves for
transfer to the Tax Stabilization Reserve Fund) at the close of the fiscal year.
Higher than estimated revenues and slightly lower expenditures than budgeted
caused the increase. Transfers to the Tax Stabilization Reserve Fund for fiscal
1997 operations will be $88.7 million representing the normal fifteen percent of
the ending unappropriated balance, plus an additional $100 million authorized by
the General Assembly when it enacted the fiscal 1998 budget.
Commonwealth revenues (prior to tax refunds) during the fiscal year totaled
$17,320.6 million, $576.1 million (3.4%) above the estimate made at the time the
budget was enacted. Revenue from taxes was the largest contributor to higher
than estimated receipts. Tax revenue in fiscal 1997 grew 6.1% over tax revenues
in fiscal 1996. This rate of increase was not adjusted for legislated tax
reductions that affected receipts during both of those fiscal years and therefor
understates the actual underlying rate of growth of tax revenue during fiscal
1997. Non-tax revenues were $19.8 million (5.8%) over estimate mostly due to
higher than anticipated interest earnings.
Expenditures from Commonwealth revenues (excluding pooled financing
expenditures) during fiscal 1997 totaled $16,347.7 million and were close to the
estimate made in February 1997 with the presentation of the Governor's fiscal
1998 budget request. Total expenditures represent an increase over fiscal 1996
expenditures of 1.7%. Lapses of appropriation authority during the fiscal year
totaled $200.6 million compared to an estimate of $100 million. The higher
amount of appropriation lapses was used to support an additional $79.8 million
in fiscal 1997 supplemental appropriations over the February 1997 estimate.
Supplemental appropriations for fiscal 1997 totaled $169.3 million.
The budget for fiscal 1998 was enacted in May 1997. Commonwealth revenues
for the fiscal year at that time were estimated to be $17,435.4 million before
reserves for tax refunds. That estimate represented an increase over estimated
fiscal 1997 Commonwealth revenues of 1.0%. Although fiscal 1997 revenues
exceeded the estimate, the adopted fiscal 1998 budget revenue estimate remains
unchanged and represents a 0.7% increase over actual fiscal 1997 revenues.
Fiscal 1998 estimates for Commonwealth revenues are based on an economic
forecast for national economic growth to slow through the remainder of calendar
year 1997. A growth rate of just above 1.0% is anticipated to be maintained for
the last two quarters of the fiscal year and result in a 1.2% growth rate in
real gross domestic product for the second calendar quarter of 1998 over the
second quarter of 1997. This anticipated rate of economic growth is a result of
anticipated slowing of gains in consumer spending, business investment and
residential housing. Inflation is projected to remain modest and the
unemployment rate is expected to reach 6.0% by the second calendar quarter of
1998.
The rate of anticipated growth of Commonwealth revenues is also affected by
the enactment of tax reductions and tax revenue dedications effective for the
1998 fiscal year. Excluding these newly enacted changes, revenues are projected
to increase by 2.4% during fiscal 1998. Tax reductions enacted for the 1998
fiscal year
41
<PAGE>
budget totaled an estimated $170.6 million, including $16.2 million that is
reflected in higher projected tax refunds. Major changes to taxes enacted for
fiscal 1998 include: (i) the repeal of the sales and use tax on computer
services ($79.1 million); (ii) an increase in the amount of income that is
exempt from the personal income tax for low-income families ($25.4 million);
(iii) enactment of a research and development tax credit program for business
($15.0 million); (iv) conforming state tax laws to federal laws for subchapter S
corporations and limited liability companies ($16.3 million); and various other
miscellaneous changes.
The reserve for tax refunds for fiscal 1998 has been increased by 21.3% to
$655.0 million. A portion of the additional reserves reflect tax refund
liabilities that are expected to result in cash payments in a subsequent fiscal
year.
Appropriations enacted for fiscal 1998 are 3.7% ($618 million) above
appropriations enacted for fiscal 1997 (including supplemental appropriations).
Major funding increases provided by the fiscal 1998 budget include: (i) $166
million of appropriations for elementary and secondary education plus an
estimated $51 million in reduced employer retirement contributions payable by
local school districts due to a reduction in the contribution rate; (ii) $42
million for higher education institutions plus $16 million for student
scholarships; (iii) $70 million for higher caseload, utilization, and cost of
nursing home care; (iv) $60 million for economic development assistance through
programs providing incentive grants and loans; and (v) $38 million for
corrections including $17 million for operating costs for new and expanded
facilities. The balance of the increase is spread over many other departments
and program operations.
Based on current expectations and the adopted budget for fiscal 1998 and
excluding any estimate for appropriation lapses during the fiscal year, the
unappropriated surplus is projected to decline from $402.7 million at the
beginning of the fiscal year to $16.7 million at fiscal year-end (prior to
transfers to the Tax Stabilization Reserve Fund).
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 ten year period that
ended in 1996 increased at an annual rate of 1.03%. This compares to a 0.41%
rate for the Middle Atlantic region and a 1.8% rate for the United States as a
whole during the period 1986 through 1996. For the last three years, employment
in the Commonwealth has increased 3.6%, as compared to 3.0% growth in the Middle
Atlantic region. The unemployment rate in Pennsylvania for August 1997 stood at
a seasonably adjusted rate of 5.3%. The seasonably adjusted national
unemployment rate for August 1997 was 4.9%.
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
42
<PAGE>
Commonwealth revenues that are not specified by law to be deposited elsewhere.
As of June 30, 1997, the Commonwealth had $4,795.1 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
(the 'PHFA'), a state-created 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's 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 Commonwealth-created organizations have statutory authorization to
issue debt for which Commonwealth appropriations to pay debt service thereon are
not required. The debt of these agencies is funded by assets of, or revenues
derived from, the various projects financed and is not a statutory or moral
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 1996 the State Employees' Retirement System had an accrued
unfunded surplus of $904 million and the Public School Employees' Retirement
System had a total unfunded actuarial accrued liability of $1,459 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 (the '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 Philadelphia
concerning its budgetary and fiscal affairs. At this time, Philadelphia is
operating under a five year fiscal plan approved by PICA on May 20, 1997.
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, 1996 shows a
surplus of approximately $118.5 million. The balance as of June 30, 1997 is not
known.
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 expired on December 31, 1996. Its ability to refund existing
outstanding debt is unrestricted. PICA had $1,102.4 million in Special Revenue
Bonds outstanding as of June 30, 1997.
43
<PAGE>
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. A similar lawsuit filed in the Commonwealth Court of Pennsylvania was
resolved through a court approved settlement which provides, among other things,
for more 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 in the federal action 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. 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 Court issued the writ on July 26, 1996, and appointed a special master to
devise and submit a plan for implementation. Following the issuance of the writ,
the President Pro Tempore of the Senate and the Speaker of the House filed a
petition seeking reconsideration from the Court. On January 28, 1997, the
Supreme Court granted an extension of time within which the special master must
file his report and announced the establishment of a committee comprised of
members of the Executive Department, the Legislative Department and the special
master, to develop an implementation plan. On January 26, 1997, the 'Interim
Report of the Master' was filed setting forth a state funding proposal.
Objections to the report were due by September 1, 1997. 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.
44
<PAGE>
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 petitions
challenging the validity of the 1989 tax increase. One of these banks, Royal
Bank of Pennsylvania, has filed a Stipulation of Facts and is in effect
proceeding forward on behalf of the other banks. The issues in these cases
include those 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. In the state case, trial and post-trial
briefing have been completed and oral argument was heard on September 8, 1997.
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 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 6, 1998. The attorney's fees for the three-year monitoring period will
not exceed $60,000 in any one year.
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 $11 million may be
required to be paid in 1998 depending on the results of property liquidations by
Envirotest. Pursuant to a Consent to Assignment entered into in November 1996,
Envirotest has assigned its right, title and interest in the base settlement.
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
45
<PAGE>
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 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. On January
28, 1997, the
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<PAGE>
Supreme Court issued an Order directing the parties to brief certain specific
issues relative to the lower court proceedings. Briefs have been filed but oral
arguments have not been scheduled.
Ridge v. State Employees' Retirement Board
On December 29, 1993, Joseph H. Ridge, a former judge of the Allegheny
Court of Common Pleas, filed in the Commonwealth Court a Petition for Review in
the Nature of Complaint in Mandamus and for a Declaratory Judgment against the
State Employees' Retirement Board alleging that the use of gender distinct
actuarial factors for benefits based upon his pre-August 1, 1983 service
violates the equal protection and equal rights clauses of the Pennsylvania
Constitution. The lawsuit requests that the petitioner's benefits be 'topped up'
to equal those that a similarly situated female would be receiving. A decision
adverse to the Retirement Board could be applicable to other members of the
State Employees' Retirement System and Public School Employees' Retirement
System. The Commonwealth Court granted the Retirement Board's preliminary
objection to Judge Ridge's claims for punitive damages, attorney's fees and
compensatory damages (other than a recalculation of his pension benefits should
he prevail). On November 20, 1996, the Commonwealth Court heard oral arguments
en banc on Judge Ridge's motion for judgment of the pleadings. On February 13,
1997, the Commonwealth Court denied Judge Ridge's motion for judgment on the
pleadings.
Yesenia Marrerro, et al. v. Commonwealth, et al.
On February 24, 1997, five residents of the City of Philadelphia, on their
own behalf, and on behalf of their school-aged children, joined by the City of
Philadelphia, the School District of Philadelphia, and two non-profit
organizations, filed in the Commonwealth Court a civil action for declaratory
judgment against the Commonwealth of Pennsylvania, the General Assembly of
Pennsylvania, the presiding officers of the General Assembly, the Governor of
Pennsylvania, the State Board of Education, the Department of Education, and the
Secretary of Education, claiming that the statutory education financing system
is unconstitutional as applied to the School District of Philadelphia and that
the system of funding public education violates the constitutional mandate to
provide a thorough and efficient system of education in the City of
Philadelphia. The lawsuit also alleges that a scheme for financing public
education precludes the Commonwealth from providing the constitutionally
required 'thorough and efficient system of public education' in the
circumstances faced by the School District of Philadelphia, and that the
defendants have failed to provide the School District of Philadelphia with
resources and other assistance necessary to provide all of its students with the
quality of education to which they are constitutionally entitled. Among other
things, the petitioners seek a declaration that the legislature must amend the
present or enact new education legislation so as to assure that education
funding for the School District of Philadelphia accounts and makes adequate
provision for the greater and special educational challenges and needs of
students in the School District in order to address their disadvantage.
* * *
As of the date of this Statement of Additional Information, Pennsylvania
general obligation bonds are rated AA- by Standard & Poor's, AA by Fitch
and Aa3 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.
47
<PAGE>
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 payments 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.
48
<PAGE>
Short-term Notes: The four ratings of Moody's for short-term notes are
MIG1/VMIG1, MIG2/VMIG2, MIG3/VMIG3 and MIG4/VMIG4; MIG1/VMIG1 denotes 'best
quality . . . strong protection by established cash flows'; MIG2/VMIG2 denotes
'high quality' with ample margins of protection; MIG3/VMIG3 notes are of
'favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades'; MIG4/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 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 ability of
rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of short-term promissory obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: leading market
positions in well-established industries; high rates of return on funds
employed; conservative capitalization structure with moderate reliance on debt
and ample asset protection; broad margins in earning 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 supporting institutions) have a strong ability
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, may 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 supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require 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 SERVICES ('STANDARD & POOR'S')
MUNICIPAL DEBT RATINGS
A Standard & Poor's municipal debt rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program. It
takes into consideration the creditworthiness of guarantors, insurers or other
forms of credit enhancement on the obligation.
The debt rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
The ratings are based on current information furnished by the obligors or
obtained by Standard & Poor's from other sources it considers reliable. Standard
& Poor's does not perform an 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 based on other circumstances.
49
<PAGE>
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of payment--capacity and willingness of the obligor to
meet its financial commitment on an obligation in accordance with the terms
of the obligation;
II. Nature of and provisions of the obligation; and
III. Protection afforded by, 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 meet its financial
commitment on the obligation is extremely strong.
AA Debt rated 'AA' differs from the highest-rated obligations only in small degree. The obligor's
capacity to meet its financial commitment on the obligation is very strong.
A Debt rated 'A' is somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than debt in higher-rated categories. However, the obligor's capacity to meet its
financial commitment on the obligation is still strong.
BBB Debt rated 'BBB' exhibits adequate protection parameters. However, adverse economic conditions or
changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its
financial commitment on the obligation.
BB Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' are regarded as having significant speculative
B characteristics. 'BB' indicates the least degree of speculation and 'C' the highest degree of
CCC speculation. While such bonds will likely have some quality and protective characteristics, these may
CC be outweighed by large uncertainties or major exposures to adverse conditions.
C
D Debt rated 'D' is in payment default. The 'D' rating category is used when payments on an obligation
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 or the taking of a similar action if payments on an
obligation 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 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. These categories are as
follows:
<TABLE>
<S> <C>
A-1 This designation indicates that the degree of safety regarding timely payment is 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 an adequate capacity for timely payment. They are, however, 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 and 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.
DESCRIPTION OF STANDARD & POOR'S SHORT-TERM ISSUE CREDIT RATINGS
A Standard & Poor's note rating reflects the liquidity factors and market
access risks unique to notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three 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 Strong capacity to pay principal and interest. An issue determined to possess a very strong capacity
to pay debt service is given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some vulnerability to adverse financial and
economic changes over the term of the notes.
SP-3 Speculative capacity to pay principal and interest.
</TABLE>
51
<PAGE>
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 economic and political 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.
Bonds carrying 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 credit 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.
<TABLE>
<S> <C>
NR Indicates that Fitch does not rate the specific issue.
</TABLE>
52
<PAGE>
<TABLE>
<S> <C>
Conditional A conditional rating is premised on the successful completion of a project or the occurrence
of a specific event.
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 an 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.
Ratings Outlook: An outlook is used to describe the most likely direction of any rating change
over the intermediate term. it is described as 'Positive' or 'Negative'. The absence of a
designation indicates a stable outlook.
</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 particular 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, its
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.
</TABLE>
53
<PAGE>
<TABLE>
<S> <C>
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 D Bonds are in default on 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>
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 '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 as for issues assigned '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.
</TABLE>
54
<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, 1997, 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,
1997 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, 1997, 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, 1997
55
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Pennsylvania (continued)
<S> <C> <C> <C> <C>
Montgomery County, Pennsylvania, Higher Education and Health Authority,
Hospital Revenue Bonds:
AAA Aaa $ 2,500 (Abington Hospital), MVRICS, Series A, 9.455% due 6/01/2011 (b)(g) $ 2,925
BBB NR* 2,835 (Northwestern Corporation), 7% due 6/01/2012 3,012
BBB+ Baa2 2,665 Montgomery County, Pennsylvania, IDA, PCR, Refunding (Philadelphia Electric
Company), AMT, Series A, 7.60% due 4/01/2021 2,911
NR* NR* 475 Moon Transportation Authority, Pennsylvania, Highway Improvement Revenue
Bonds, 9.50% due 2/01/1998 (f) 488
AAA Aaa 3,300 North Penn, Pennsylvania, Water Authority Revenue Bonds, 7% due 11/01/2004
(d)(f) 3,851
AAA Aaa 4,000 North Wales, Pennsylvania, Water Authority Revenue Bonds, 7% due 11/01/2004
(d)(f) 4,639
Pennsylvania Convention Center Authority, Revenue Refunding Bonds, Series A:
BBB Baa 1,555 6.70% due 9/01/2014 1,709
BBB Baa 2,500 6.75% due 9/01/2019 2,751
BBB- Baa2 1,500 Pennsylvania Economic Development Financing Authority, Exempt Facilities
Revenue Bonds (MacMillan Limited Partnership Project), AMT, 7.60% due
12/01/2020 1,740
BBB Baa3 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 4,625
AA Aa2 1,000 Pennsylvania, HFA, Refunding, RIB, AMT, Series 1991-31C, 9.712% due
10/01/2023 (g) 1,168
Pennsylvania, HFA, S/F Mortgage Revenue Bonds, AMT:
AA+ Aa 930 Series 28, 7.65% due 10/01/2023 983
AA+ Aa 2,165 Series 40, 6.90% due 4/01/2025 2,350
AA+ Aa 1,500 Series 41-B, 6.65% due 4/01/2025 1,607
A NR* 2,000 Pennsylvania State Finance Authority, Revenue Refunding Bonds
(Municipal Capital Improvements Program), 6.60% due 11/01/2009 2,198
Pennsylvania State Higher Educational Facilities Authority,
College and University Revenue Bonds:
NR* Baa3 2,295 (Delaware Valley College of Science & Agriculture), 7% due 4/01/2022 2,459
NR* NR* 1,030 (Pennsylvania College of Podiatric Medicine), 8.50% due 10/01/2014 1,099
A1+ NR* 1,000 Refunding (Carnegie Mellon University), VRDN, Series D, 3.60% due
11/01/2030 (a) 1,000
BBB+ NR* 2,000 (Ursinus College), 5.90% due 1/01/2027 2,048
A+ Aa3 2,000 Pennsylvania State Higher Educational Facilities Authority, Revenue
Refunding Bonds (Thomas Jefferson University), Series A, 6.625% due
8/15/2009 2,207
NR* NR* 1,225 Pennsylvania State, IDA, Pooled Loan Revenue Bonds, Series A, 7% due
7/01/2001 (f) 1,368
AAA Aaa 2,000 Philadelphia, Pennsylvania, Airport Revenue Bonds (Philadelphia Airport
System), Series B, AMT, 5.40% due 6/15/2027 (d) 1,988
A+ NR* 1,895 Philadelphia, Pennsylvania, Authority for IDR (National Board of Medical
Examiners Project), 6.75% due 5/01/2012 2,079
AA Aa3 1,690 Philadelphia, Pennsylvania, Authority for Industrial Development, Industrial
and Commercial Revenue Bonds (Girard Estate Coal Mining Project), 5.50% due
11/15/2016 1,726
</TABLE>
56
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
SCHEDULE OF INVESTMENTS (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Pennsylvania--100.9%
<S> <C> <C> <C> <C>
Allegheny County, Pennsylvania, Hospital Development Authority Revenue
Bonds:
A1 VMIG1+ $ 100 (Presbyterian Health Center), VRDN, Series B, 3.65% due 3/01/2020 (a)(c) $ 100
NR* A3 2,000 (South Hills Health System), Series A, 6.50% due 5/01/2014 2,176
Allegheny County, Pennsylvania, IDA, Revenue Refunding Bonds:
AAA Aaa 4,785 (Commercial Development MPB Association Project), Mercy Hospital of
Pittsburgh, 7.70% due 12/01/2013 (e) 6,258
BBB- Baa3 2,000 (Environmental Improvement--USX Corporation Project), 6.10% due 7/15/2020 2,083
AAA Aaa 3,500 Allegheny County, Pennsylvania, Sanitation Authority, Sewer Revenue Bonds,
5.375% due 12/01/2024 (c) 3,514
AAA Aaa 1,430 Berks County, Pennsylvania, GO, UT, Second Series, 5.65%** due 5/15/2020 (d) 427
AAA Aaa 3,550 Cambria County, Pennsylvania, Refunding, GO, UT, Series A, 6.625% due
8/15/2014 (d) 4,016
BBB+ NR* 2,000 Cumberland County, Pennsylvania, Municipal Authority Revenue Bonds
(Presbyterian Homes Inc. Project), 6% due 12/01/2026 2,036
A- NR* 5,350 Delaware County, Pennsylvania, Hospital Authority Revenue Bonds
(Riddle Memorial Hospital), 6.50% due 1/01/2022 5,636
A1+ P1 6,500 Delaware County, Pennsylvania, IDA, PCR (BP Oil Inc. Project),
UPDATES, 3.65% due 12/01/2009 (a) 6,500
NR* NR* 920 Erie--Western Pennsylvania, Port Authority, General Revenue Bonds, 6.875%
due 6/15/2016 962
A- NR* 4,990 Gettysburg, Pennsylvania, Municipal Authority, College Revenue Refunding
Bonds (Gettysburg College Project), 6.60% due 2/15/2012 5,315
AAA Aaa 2,960 Hollidaysburg, Pennsylvania, Area School District, Improvement Bonds,
UT, 6.50% due 6/01/2020 (b) 3,266
NR* Baa1 3,000 Latrobe, Pennsylvania, IDA, College Revenue Bonds (Saint Vincent College
Project), 6.75% due 5/01/2024 3,247
AAA Aaa 3,000 Lehigh County, Pennsylvania, General Purpose Authority Revenue Bonds
(Saint Lukes Hospital--Bethlehem), 6.25% due 7/01/2022 (b) 3,213
Luzerne County, Pennsylvania, IDA, Exempt Facilities Revenue Refunding
Bonds (Pennsylvania Gas and Water Company Project), AMT, Series A:
BBB A3 3,600 7.20% due 10/01/2017 3,958
AAA Aaa 2,000 7% due 12/01/2017 (b) 2,273
NR* Aaa 2,900 Montgomery County, Pennsylvania, GO, UT, 5.40% due 9/15/2019 2,937
</TABLE>
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
57
<PAGE>
<TABLE>
<CAPTION>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Pennsylvania(concluded)
<S> <C> <C> <C> <C>
Philadelphia, Pennsylvania, Gas Works Revenue Bonds:
AAA Aaa $ 1,440 12th Series B, 7% due 5/15/2020 (c)(h) $ 1,729
AAA Aaa 750 13th Series, 7.70% due 6/15/2001 (f) 858
Philadelphia, Pennsylvania, Hospitals and Higher Education Facilities
Authority Revenue Bonds:
A1+ VMIG1++ 1,000 (Children's Hospital of Philadelphia Project), VRDN, 3.60% due
3/01/2027 (a) 1,000
A- NR* 1,015 (Children's Seashore House), Series A, 7% due 8/15/2017 1,106
A- NR* 3,000 (Children's Seashore House), Series B, 7% due 8/15/2022 3,248
BBB NR* 2,595 (Northwestern Corp.), 7.125% due 6/01/2018 2,801
A- Baa1 3,750 Refunding (Chestnut Hill Hospital), 6.50% due 11/15/2022 3,984
AAA NR* 3,000 Refunding (Presbyterian Medical Center), 6.65% due 12/01/2019 (h) 3,493
AAA Baa 1,000 Philadelphia, Pennsylvania, Water and Sewer Revenue Bonds, 16th Series,
7.50% due 8/01/2001 (f) 1,140
AAA Aaa 1,000 Reading, Pennsylvania, GO, Refunding, UT, 6.50% due 11/15/2002 (b)(f) 1,108
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 1,872
AAA Aaa 3,000 University of Pittsburgh, Pennsylvania, Higher Educational Refunding
Bonds, Series B, 5% due 6/01/2021 (c) 2,906
AA Aa3 7,000 Upper Saint Clair Township, Pennsylvania, School District Refunding
Bonds, UT, 5.20% due 7/15/2027 6,989
Total Investments (Cost--$131,961)--100.9% 143,082
Liabilities in Excess of Other Assets--0.9% (1,340)
--------
Net Assets--100.0% $141,742
========
</TABLE>
(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, 1997.
(b)AMBAC Insured.
(c)MBIA Insured.
(d)FGIC Insured.
(e)FSA Insured.
(f)Prerefunded.
(g)The interest rate is subject to change periodically and inversely
based upon prevailing rates. The interest rate shown is the rate in
effect at July 31, 1997.
(h)Escrowed to maturity.
*Not Rated.
**Represents a zero coupon bond; the interest rate shown is the
effective yield at the time of purchase by the Fund.
+Highest short-term rating by Moody's Investors Services, Inc.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
58
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
FINANCIAL INFORMATION
Statement of Assets and Liabilities as of July 31, 1997
<TABLE>
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$131,960,502) (Note 1a) $143,081,650
Cash 87,568
Receivables:
Interest $ 1,991,617
Beneficial interest sold 391,510 2,383,127
------------
Prepaid registration fees and other assets (Note 1e) 16,854
------------
Total assets 145,569,199
------------
Liabilities: Payables:
Securities purchased 2,876,414
Beneficial interest redeemed 556,777
Dividends to shareholders (Note 1f) 185,308
Investment adviser (Note 2) 65,877
Distributor (Note 2) 49,776 3,734,152
------------
Accrued expenses and other liabilities 93,493
------------
Total liabilities 3,827,645
------------
Net Assets: Net assets $141,741,554
============
Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 182,789
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 941,355
Class C Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 53,030
Class D Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 46,109
Paid-in capital in excess of par 129,854,667
Accumulated realized capital losses on investments--net (457,544)
Unrealized appreciation on investments--net 11,121,148
------------
Net assets $141,741,554
============
Net Asset Value: Class A--Based on net assets of $21,178,764 and 1,827,891
shares of beneficial interest outstanding $ 11.59
============
Class B--Based on net assets of $109,070,243 and 9,413,550
shares of beneficial interest outstanding $ 11.59
============
Class C--Based on net assets of $6,145,035 and 530,303
shares of beneficial interest outstanding $ 11.59
============
Class D--Based on net assets of $5,347,512 and 461,085
shares of beneficial interest outstanding $ 11.60
============
</TABLE>
See Notes to Financial Statements.
59
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
FINANCIAL INFORMATION (continued)
Statement of Operations
<TABLE>
<CAPTION>
For the Year Ended
July 31, 1997
<S> <C> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 8,858,592
(Note 1d):
Expenses: Investment advisory fees (Note 2) $ 798,487
Account maintenance and distribution fees--Class B (Note 2) 570,543
Accounting services (Note 2) 84,022
Professional fees 59,883
Transfer agent fees--Class B (Note 2) 58,782
Printing and shareholder reports 35,917
Account maintenance and distribution fees--Class C (Note 2) 31,881
Registration fees (Note 1e) 14,339
Transfer agent fees--Class A (Note 2) 8,936
Pricing fees 8,675
Custodian fees 8,659
Trustees' fees and expenses 7,472
Account maintenance fees--Class D (Note 2) 4,386
Transfer agent fees--Class C (Note 2) 2,754
Transfer agent fees--Class D (Note 2) 1,812
Other 2,847
------------
Total expenses 1,699,395
------------
Investment income--net 7,159,197
------------
Realized & Realized gain on investments--net 1,919,585
Unrealized Gain on Change in unrealized appreciation on investments--net 3,613,001
Investments--Net ------------
(Notes 1b, 1d & 3): Net Increase in Net Assets Resulting from Operations $ 12,691,783
============
</TABLE>
See Notes to Financial Statements.
60
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
FINANCIAL INFORMATION (continued)
Statements of Changes in Net Assets
<TABLE>
<CAPTION>
For the Year
Ended July 31,
Increase (Decrease) in Net Assets: 1997 1996
<S> <C> <C> <C>
Operations: Investment income--net $ 7,159,197 $ 7,689,849
Realized gain on investments--net 1,919,585 415,112
Change in unrealized appreciation on investments--net 3,613,001 999,490
------------ ------------
Net increase in net assets resulting from operations 12,691,783 9,104,451
------------ ------------
Dividends & Investment income--net:
Distributions to Class A (1,144,917) (1,225,179)
Shareholders Class B (5,531,327) (6,116,920)
(Note 1f): Class C (252,297) (172,681)
Class D (230,656) (175,069)
Realized gain on investments--net:
Class A (52,975) --
Class B (290,647) --
Class C (13,183) --
Class D (10,473) --
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders (7,526,475) (7,689,849)
------------ ------------
Beneficial Interest Net decrease in net assets derived from beneficial interest
Transactions transactions (13,919,756) (1,716,500)
(Note 4): ------------ ------------
Net Assets: Total decrease in net assets (8,754,448) (301,898)
Beginning of year 150,496,002 150,797,900
------------ ------------
End of year $141,741,554 $150,496,002
============ ============
</TABLE>
See Notes to Financial Statements.
61
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
FINANCIAL INFORMATION (continued)
Financial Highlights
The following per share data and ratios have been derived from information
provided in the financial statements.
<TABLE>
<CAPTION>
Class A
For the Year Ended July 31,
Increase (Decrease) in Net Asset Value: 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .60 .61 .62 .60 .63
Realized and unrealized gain (loss) on
investments--net .45 .10 .07 (.33) .36
-------- -------- -------- -------- --------
Total from investment operations 1.05 .71 .69 .27 .99
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.60) (.61) (.62) (.60) (.63)
Realized gain on investments--net (.03) -- -- (.04) (.01)
In excess of realized gain on investments
--net -- -- -- (.02) --
-------- -------- -------- -------- --------
Total dividends and distributions (.63) (.61) (.62) (.66) (.64)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.59 $ 11.17 $ 11.07 $ 11.00 $ 11.39
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 9.72% 6.53% 6.54% 2.37% 9.30%
Return:* ======== ======== ======== ======== ========
Ratios to Expenses, net of reimbursement .74% .76% .77% .75% .69%
Average ======== ======== ======== ======== ========
Net Assets: Expenses .74% .76% .77% .75% .81%
======== ======== ======== ======== ========
Investment income--net 5.36% 5.41% 5.72% 5.30% 5.70%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $ 21,179 $ 21,626 $ 23,040 $ 28,239 $ 27,639
Data: ======== ======== ======== ======== ========
Portfolio turnover 49.82% 58.33% 59.17% 37.73% 9.69%
======== ======== ======== ======== ========
<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: 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.17 $ 11.07 $ 11.00 $ 11.39 $ 11.04
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .55 .55 .56 .54 .58
Realized and unrealized gain (loss) on
investments--net .45 .10 .07 (.33) .36
-------- -------- -------- -------- --------
Total from investment operations 1.00 .65 .63 .21 .94
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.55) (.55) (.56) (.54) (.58)
Realized gain on investments--net (.03) -- -- (.04) (.01)
In excess of realized gain on investments
--net -- -- -- (.02) --
-------- -------- -------- -------- --------
Total dividends and distributions (.58) (.55) (.56) (.60) (.59)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.59 $ 11.17 $ 11.07 $ 11.00 $ 11.39
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 9.17% 5.98% 6.00% 1.86% 8.75%
Return:* ======== ======== ======== ======== ========
Ratios to Expenses, net of reimbursement 1.25% 1.27% 1.28% 1.25% 1.19%
Average ======== ======== ======== ======== ========
Net Assets: Expenses 1.25% 1.27% 1.28% 1.25% 1.32%
======== ======== ======== ======== ========
Investment income--net 4.85% 4.91% 5.21% 4.80% 5.19%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands). $109,070 $120,565 $123,260 $130,418 $109,463
Data: ======== ======== ======== ======== ========
Portfolio turnover 49.82% 58.33% 59.17% 37.73% 9.69%
======== ======== ======== ======== ========
</TABLE>
*Total investment returns exclude the effects of sales loads.
See Notes to Financial Statements.
62
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
FINANCIAL INFORMATION (concluded)
Financial Highlights (concluded)
<TABLE>
<CAPTION>
Class C Class D
For the For the
Period Period
The following per share data and ratios have been derived For the Oct. 21, For the Oct. 21,
from information provided in the financial statements. Year Ended 1994+ to Year Ended 1994+ to
July 31, July 31, July 31, July 31,
Increase (Decrease) in Net Asset Value: 1997 1996 1995 1997 1996 1995
<S> <C> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of
Operating period $ 11.17 $ 11.07 $ 10.68 $ 11.18 $ 11.08 $ 10.68
Performance: -------- -------- -------- -------- -------- --------
Investment income--net .53 .54 .43 .59 .60 .47
Realized and unrealized gain on
investments--net .45 .10 .39 .45 .10 .40
-------- -------- -------- -------- -------- --------
Total from investment operations .98 .64 .82 1.04 .70 .87
-------- -------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.53) (.54) (.43) (.59) (.60) (.47)
Realized gain on investments--net (.03) -- -- (.03) -- --
-------- -------- -------- -------- -------- --------
Total dividends and distributions (.56) (.54) (.43) (.62) (.60) (.47)
-------- -------- -------- -------- -------- --------
Net asset value, end of period $ 11.59 $ 11.17 $ 11.07 $ 11.60 $ 11.18 $ 11.08
======== ======== ======== ======== ======== ========
Total Investment Based on net asset value per share 9.06% 5.87% 7.83%++ 9.61% 6.42% 8.36%++
Return:** ======== ======== ======== ======== ======== ========
Ratios to Average Expenses 1.35% 1.37% 1.38%* .84% .86% .87%*
Net Assets: ======== ======== ======== ======== ======== ========
Investment income--net 4.75% 4.80% 5.05%* 5.26% 5.31% 5.65%*
======== ======== ======== ======== ======== ========
Supplemental Net assets, end of period
Data: (in thousands) $ 6,145 $ 4,722 $ 1,868 $ 5,348 $ 3,583 $ 2,630
======== ======== ======== ======== ======== ========
Portfolio turnover 49.82% 58.33% 59.17% 49.82% 58.33% 59.17%
======== ======== ======== ======== ======== ========
</TABLE>
*Annualized.
**Total investment returns exclude the effects of sales loads.
+Commencement of Operations.
++Aggregate total investment return.
See Notes to Financial Statements.
63
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
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, includ-
ing 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.
(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) Prepaid registration fees--Prepaid registration fees are charged
to expense as the related shares are issued.
(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.
64
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
NOTES TO FINANCIAL STATEMENTS (concluded)
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.
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, 1997, 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 $809 $8,173
Class D $225 $2,568
For the year ended July 31, 1997, MLPF&S received contingent
deferred sales charges of $171,892 and $1,630 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, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended July 31, 1997 were $69,058,161 and $79,278,809,
respectively.
Net realized and unrealized gains (losses) as of July 31, 1997 were
as follows:
Realized Unrealized
Gains (Losses) Gains
Long-term investments. $ 2,366,210 $11,121,148
Financial futures contracts (446,625) --
----------- -----------
Total $ 1,919,585 $11,121,148
=========== ===========
As of July 31, 1997, net unrealized appreciation for Federal income
tax purposes aggregated $11,121,148, of which $11,156,569 related to
appreciated securities and $35,421 related to depreciated
securities. The aggregate cost of investments at July 31, 1997 for
Federal income tax purposes was $131,960,502.
4. Beneficial Interest Transactions:
Net decrease in net assets derived from beneficial interest
transactions was $13,919,756 and $1,716,500 for the years ended July
31, 1997 and July 31, 1996, respectively.
65
<PAGE>
Merrill Lynch Pennsylvania Municipal Bond Fund July 31, 1997
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended July 31, 1997 Shares Amount
Shares sold 463,882 $ 5,214,824
Shares issued to share-
holders in reinvestment of
dividends and distributions 56,819 639,033
----------- -----------
Total issued 520,701 5,853,857
Shares redeemed (628,409) (7,047,455)
----------- -----------
Net decrease (107,708) $(1,193,598)
=========== ===========
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 B Shares for the Year Dollar
Ended July 31, 1997 Shares Amount
Shares sold 1,104,640 $ 12,428,694
Shares issued to share-
holders in reinvestment of
dividends and distributions 254,749 2,864,821
------------ ------------
Total issued 1,359,389 15,293,515
Automatic conversion of
shares (52,791) (595,361)
Shares redeemed (2,684,513) (30,214,153)
------------ ------------
Net decrease (1,377,915) $(15,515,999)
============ ============
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
Automatic conversion of
shares (44,290) (494,541)
Shares redeemed (2,176,649) (24,491,107)
----------- -----------
Net decrease (347,047) $(3,852,305)
=========== ===========
Class C Shares for the Year Dollar
Ended July 31, 1997 Shares Amount
Shares sold 185,567 $ 2,085,866
Shares issued to share-
holders in reinvestment of
dividends and distributions 15,175 170,763
----------- -----------
Total issued 200,742 2,256,629
Shares redeemed (93,032) (1,044,842)
----------- -----------
Net increase 107,710 $ 1,211,787
=========== ===========
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 D Shares for the Year Dollar
Ended July 31, 1997 Shares Amount
Shares sold 215,211 $ 2,406,083
Automatic conversion
of shares 52,734 595,361
Shares issued to share-
holders in reinvestment of
dividends and distributions 12,040 135,638
----------- -----------
Total issued 279,985 3,137,082
Shares redeemed (139,318) (1,559,028)
----------- -----------
Net increase 140,667 $ 1,578,054
=========== ===========
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
=========== ===========
66
<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........................ 12
Management of the Trust........................ 14
Trustees and Officers........................ 14
Compensation of Trustees..................... 16
Management and Advisory Arrangements......... 16
Purchase of Shares............................. 18
Initial Sales Charge Alternatives--Class A
and Class D Shares......................... 18
Reduced Initial Sales Charges................ 20
Distribution Plans........................... 22
Limitations on the Payment of Deferred Sales
Charges.................................... 22
Redemption of Shares........................... 23
Deferred Sales Charges--
Class B and Class C Shares................. 24
Portfolio Transactions......................... 24
Determination of Net Asset Value............... 25
Shareholder Services........................... 26
Investment Account........................... 26
Automatic Investment Plans................... 27
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 27
Systematic Withdrawal Plans.................. 27
Exchange Privilege........................... 29
Distributions and Taxes........................ 31
Tax Treatment of Options and Futures
Transactions............................... 34
Pennsylvania Taxation........................ 34
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................... 55
Financial Statements........................... 56
</TABLE>
Code #11198-1197
Merrill Lynch
Pennsylvania Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
(Art)
STATEMENT OF
ADDITIONAL
INFORMATION
November 17, 1997
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 six-year period
ended July 31, 1997 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, 1997.
Statement of Assets and Liabilities as of July 31, 1997.
Statement of Operations for the year ended July 31, 1997.
Statements of Changes in Net Assets for each of the years in the
two-year period ended July 31, 1997.
Financial Highlights for each of the years in the five-year
period ended July 31, 1997.
(B) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -------------------------------------------------------------------
<S> <C> <C>
(a1) -- 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.(f)
10 -- None.
11 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
</TABLE>
C-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -------------------------------------------------------------------
<S> <C> <C>
12 -- None.
13 -- Certificate of Fund Asset Management, Inc.(a)
14 -- None.
15(a) -- Amended and Restated Class B Distribution Plan and Class B
Distribution Plan Sub-Agreement of the Registrant.(c)
(b) -- Form of Class C Distribution Plan and Class C Distribution Plan
Sub-Agreement of the Registrant.(e)
(c) -- Form of Class D Distribution Plan and Class D 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.(h)
(b) -- Financial Data Schedule for Class B shares.(h)
(c) -- Financial Data Schedule for Class C shares.(h)
(d) -- Financial Data Schedule for Class D shares.(h)
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 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,
filed 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 Registration Statement.
(d) Incorporated by reference to Exhibit 8 to Post-Effective Amendment No. 3 to
the 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 Registration Statement.
(f) Incorporated by reference to Exhibit 9 to Post-Effective Amendment No. 5 to
the 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 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).
(h) Filed on November 6, 1996 as an Exhibit to the last Post-Effective Amendment
to the Registrant's Registration Statement on Form N1-A under the Securities
Act of 1933.
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 OCTOBER 31, 1997*
- -------------------------------------------------- ---------------------
<S> <C>
Class A shares of beneficial interest, par value
$0.10 per share................................. 739
Class B shares of beneficial interest, par value
$0.10 per share................................. 3,244
Class C shares of beneficial interest, par value
$0.10 per share................................. 215
Class D shares of beneficial interest, par value
$0.10 per share................................. 140
</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 registered 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 registered investment companies:
Apex Municipal Fund, Inc., Corporate High Yield Fund, Inc., Corporate High Yield
Fund II, Inc., Debt Strategies Fund, Inc., Income Opportunities Fund 1999, Inc.,
Income Opportunities Fund 2000, Inc., Merrill Lynch Municipal Strategy Fund,
Inc., MuniAssets Fund Inc., MuniEnhanced Fund, Inc., MuniHoldings California
Insured Fund, Inc., MuniHoldings Florida Insured Fund, MuniHoldings Fund, Inc.,
MuniHoldings New York Insured Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund,
Inc., MuniVest Fund II, Inc., MuniVest Florida Fund, MuniVest Michigan Insured
Fund, Inc., MuniVest New Jersey 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 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 Pennsylvania Fund, MuniYield Quality Fund,
Inc., MuniYield Quality Fund II, Inc., Senior High Income Portfolio, Inc.,
Taurus MuniCalifornia Holdings, Inc., Taurus MuniNewYork 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 registered 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 Convertible 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 Intermediate Government Bond
Fund, Merrill Lynch International Equity Fund, Merrill Lynch Latin America Fund,
Inc., Merrill Lynch Middle East/Africa Fund, Inc., Merrill Lynch Municipal
Series
C-4
<PAGE>
Trust, Merrill Lynch Pacific Fund, Inc., Merrill Lynch 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., Merrill Lynch Variable Series Funds, Inc. and Hotchkis and Wiley
Funds (advised by Hotchkis and Wiley, a division of MLAM); and the following
closed-end registered investment companies: Merrill Lynch High Income Municipal
Bond Fund, Inc. and Merrill Lynch Senior Floating Rate Fund, Inc. MLAM also acts
as sub-adviser to Merrill Lynch World Strategy Portfolio and Merrill Lynch Basic
Value Equity Portfolio, two investment portfolios of EQ Advisory Trust.
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 Intermediate Government Bond Fund is
One Financial Center, 23rd 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,
1995 for his, her or its own account or in the capacity of director, officer,
partner or trustee. In addition, Mr. Zeikel is President, Mr. Glenn is Executive
Vice President and Mr. Richard is Treasurer of substantially all of the
investment companies described in the first two paragraphs of this Item 28 and
Messrs. Giordano, Harvey, 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;
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
Linda L. Federici........ Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
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 Senior Vice President of Princeton
Services
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
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
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
POSITION(S)
WITH OTHER SUBSTANTIAL BUSINESS,
NAME THE MANAGER PROFESSION, VOCATION OR EMPLOYMENT
- ------------------------- --------------- -----------------------------------
<S> <C> <C>
Ronald M. Kloss.......... Senior Vice Senior Vice President and
President and Controller of MLAM; Senior Vice
Controller President and Controller of
Princeton Services
Debra W. Landsman- Senior Vice Senior Vice President of MLAM;
Yaros ................. President Vice President of MLFD;
Senior Vice President of Princeton
Services
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; Director of MLFD
Gerald M. Richard........ Senior Vice Senior Vice President and Treasurer
President and of MLAM; Senior Vice President and
Treasurer Treasurer of Princeton Services;
Vice President and Treasurer of
MLFD
Gregory Upah............. Senior Vice Senior Vice President of MLAM;
President Senior Vice President of Princeton
Services
Ronald L. Welburn........ 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, 23rd floor,
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
Richard L. Reller................... Director None
Thomas J. Verage.................... Director None
William E. Aldrich.................. Senior Vice President None
Robert W. Crook..................... Senior Vice President None
Michael J. Brady.................... Vice President None
William M. Breen.................... Vice President None
Michael G. Clark.................... 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
</TABLE>
C-6
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
- ------------------------------------ ------------------------------------ ------------------------------------
<S> <C> <C>
William Wasel....................... Vice President None
Robert Harris....................... Secretary None
</TABLE>
(c) Not applicable.
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, the 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 POST-EFFECTIVE 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 17TH DAY OF
NOVEMBER, 1997.
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
POST-EFFECTIVE AMENDMENT TO ITS 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)
GERALD M. RICHARD* Treasurer (Principal Financial and
- ------------------------- Accounting Officer)
(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 17, 1997
(GERALD M. RICHARD,
ATTORNEY-IN-FACT)
</TABLE>
C-8
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
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>
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. 8 to Registration
Statement No. 33-35442 of our report dated September 5, 1997 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 & Touche LLP
Princeton, New Jersey
November 14, 1997
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000819628
<NAME> MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
<SERIES>
<NUMBER> 041
<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1997
<PERIOD-START> AUG-01-1996
<PERIOD-END> JUL-31-1997
<INVESTMENTS-AT-COST> 131960502
<INVESTMENTS-AT-VALUE> 143081650
<RECEIVABLES> 2383127
<ASSETS-OTHER> 104422
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 145569199
<PAYABLE-FOR-SECURITIES> 2876414
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 951231
<TOTAL-LIABILITIES> 3827645
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 131077950
<SHARES-COMMON-STOCK> 1827891
<SHARES-COMMON-PRIOR> 1935599
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (457544)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 11121148
<NET-ASSETS> 21178764
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8858592
<OTHER-INCOME> 0
<EXPENSES-NET> (1699395)
<NET-INVESTMENT-INCOME> 7159197
<REALIZED-GAINS-CURRENT> 1919585
<APPREC-INCREASE-CURRENT> 3613001
<NET-CHANGE-FROM-OPS> 12691783
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (1144917)
<DISTRIBUTIONS-OF-GAINS> (52975)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 463882
<NUMBER-OF-SHARES-REDEEMED> (628409)
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