<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 29, 1998
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. 9 [X]
AND/OR
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 158 [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)
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY 08536
(Address of Principal Executive Offices)
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: Michael J. Hennewinkel, Esq.
BROWN & WOOD LLP MERRILL LYNCH ASSET
One World Trade Center MANAGEMENT
New York, New York 10048-0557 P.O. Box 9011
Attention: Thomas R. Smith, Jr., Esq. Princeton, New Jersey 08543-9011
Brian M. Kaplowitz, Esq.
</TABLE>
------------------------
It is proposed that this filing will become effective (check appropriate box)
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[X] 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> 2
[MERRILL LYNCH LOGO]
Merrill Lynch Pennsylvania Municipal Bond Fund
of Merrill Lynch Multi-State Municipal Series Trust
[MERRILL LYNCH ARTWORK]
THIS PROSPECTUS CONTAINS INFORMATION YOU SHOULD
KNOW BEFORE INVESTING, INCLUDING
INFORMATION ABOUT RISKS. PLEASE READ IT BEFORE YOU
INVEST AND KEEP IT FOR FUTURE REFERENCE.
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT
APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED
UPON THE ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
PROSPECTUS - , 1998
<PAGE> 3
Table of Contents
<TABLE>
<CAPTION>
PAGE
<S> <C>
[KEY FACTS ICON]
KEY FACTS
- -----------------------------------------------------------------
The Merrill Lynch Pennsylvania Municipal Bond Fund at a 3
Glance......................................................
Risk/Return Bar Chart....................................... 4
Fees and Expenses........................................... 5
[DETAILS ABOUT THE FUND ICON]
DETAILS ABOUT THE FUND
- -----------------------------------------------------------------
How the Fund Invests........................................ 7
Investment Risks............................................ 8
[YOUR ACCOUNT ICON]
YOUR ACCOUNT
- -----------------------------------------------------------------
Merrill Lynch Select Pricing(SM) System..................... 12
How to Buy, Sell, Transfer and Exchange Shares.............. 17
Participation in Merrill Lynch Fee-Based Programs........... 21
[MANAGEMENT OF THE FUND ICON]
MANAGEMENT OF THE FUND
- -----------------------------------------------------------------
Fund Asset Management....................................... 24
Financial Highlights........................................ 25
[FOR MORE INFORMATION ICON]
FOR MORE INFORMATION
- -----------------------------------------------------------------
Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
</TABLE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 4
[KEY FACTS LOGO]
KEY FACTS
IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
INVESTMENT GRADE -- any of the four highest debt obligation ratings by
recognized rating agencies, including Moody's Investors Service, Inc., Standard
& Poor's or Fitch IBCA, Inc.
PENNSYLVANIA MUNICIPAL BOND -- a debt obligation issued by or on behalf of a
governmental entity in Pennsylvania or other qualifying issuer that pays
interest exempt from Pennsylvania personal income taxes as well as from Federal
income tax.
[ICON]
THE MERRILL LYNCH PENNSYLVANIA
MUNICIPAL BOND FUND AT A GLANCE
- --------------------------------------------------------------------------------
WHAT ARE THE FUND'S GOALS?
The Fund's main goal is to provide a high level of income that is exempt from
Federal and Pennsylvania personal income taxes. The Fund tries to accomplish
this goal by investing primarily in long-term INVESTMENT GRADE Pennsylvania
municipal bonds. The Fund cannot guarantee that it will achieve its goal.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in a portfolio of long-term investment grade
PENNSYLVANIA MUNICIPAL BONDS. These may be obligations of a variety of issuers
including governmental entities in Pennsylvania and issuers located in Puerto
Rico, the U.S. Virgin Islands and Guam. Generally, the Fund will invest at least
80% of its assets in municipal bonds, with at least 65% of its assets in
Pennsylvania municipal bonds.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments, and therefore
the value of your Fund shares, may go up or down. The value of the Fund's
investments may change in response to interest rate changes or other factors
that may affect a particular issuer or obligation. Generally, when interest
rates go up, the value of debt instruments like municipal bonds goes down. If
the value of the Fund's investments goes down, you may lose money.
In addition to these risks, the investment of at least 65% of its assets in
Pennsylvania municipal bonds makes the Fund more susceptible to negative
political or economic factors that affect Pennsylvania than funds investing in
municipal bonds of more than one state.
WHO SHOULD INVEST?
The Fund may be an appropriate investment for you if you:
- Are looking for income that is exempt from Federal and
Pennsylvania personal income tax;
- Want a professionally managed portfolio without the
administrative burdens of direct investments in municipal bonds;
- Are looking for liquidity;
- Can tolerate the risk of loss caused by negative political or
economic developments in Pennsylvania or adverse changes in the
price of bonds in general.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 3
<PAGE> 5
[KEY FACTS LOGO] Key Facts
RISK/RETURN BAR CHART
- --------------------------------------------------------------------------------
The bar chart and table shown below provide an indication of the risks of
investing in the Fund. The bar chart shows changes in the Fund's performance for
Class B shares from year to year since the Fund's inception. Sales loads and
account fees are not reflected in the bar chart. If these amounts were
reflected, returns would be less than those shown. The table compares the
average annual total returns for each class of the Fund's shares for one and
five years and since the Fund's inception with those of the Lehman Brothers
Municipal Bond Index. How the Fund performed in the past is not necessarily an
indication of how the Fund will perform in the future.
[BAR CHART]
1990+ 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ----
Class B Shares 3% 12% 9% 13% (6)% 17% 3% 9%
During the period shown in the bar chart, the highest return for a quarter was
7.97% (quarter ended February 28, 1995) and the lowest return for a quarter was
- - 6.35% (quarter ended April 30, 1994). The Fund's year-to-date return as of
August 31, 1998 was 4.32%.
+ Inception date is August 31, 1990.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS (AS OF THE
CALENDAR YEAR ENDED PAST PAST SINCE
DECEMBER 31, 1997) ONE YEAR 5 YEARS INCEPTION
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Merrill Lynch
Pennsylvania Municipal Bond Fund* A 4.72% 6.31% 7.69%+
- ----------------------------------------------------------------------------
B 4.53% 6.64% 7.75%+
- ----------------------------------------------------------------------------
C 7.42% N/A 7.96%++
- ----------------------------------------------------------------------------
D 4.70% N/A 7.19%++
- ----------------------------------------------------------------------------
Lehman Brothers Municipal Bond Index** 9.19% 7.35% 8.47%
- ----------------------------------------------------------------------------
</TABLE>
* Includes sales charge.
** This unmanaged Index consists of long-term revenue bonds, prerefunded bonds,
general obligation bonds and insured bonds. Past performance is not
predictive of future performance.
+ Inception date is August 31, 1990.
++ Inception date is October 21, 1994.
4 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 6
UNDERSTANDING EXPENSES
Fund investors pay various fees and expenses, either directly or indirectly.
Listed below are some of the main types of expenses, which all mutual funds may
charge:
EXPENSES PAID DIRECTLY BY THE SHAREHOLDER:
SHAREHOLDER FEES -- fees paid directly from your investment. These include sales
charges which you may pay when you buy or sell shares of the Fund.
EXPENSES PAID INDIRECTLY BY THE SHAREHOLDER (These costs are deducted from the
Fund's total assets.):
ANNUAL FUND OPERATING EXPENSES -- expenses that cover the costs of operating the
Fund.
MANAGEMENT FEE -- a fee paid to the investment adviser for managing the Fund.
DISTRIBUTION FEES -- fees used to support the Fund's marketing and distribution
efforts, such as advertising and promotion.
ACCOUNT MAINTENANCE FEES -- fees used to compensate
securities dealers for account maintenance activities.
FEES AND EXPENSES
- --------------------------------------------------------------------------------
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not everyone
is eligible to buy every class. After determining which classes you are eligible
to buy, decide which class best suits your needs. Your Merrill Lynch Financial
Consultant can help you with this decision.
This table shows the different fees and expenses that you may pay if you buy and
hold the different classes of shares of the Fund. Future expenses may be greater
or less than those indicated below.
<TABLE>
<CAPTION>
SHAREHOLDER FEES: CLASS A CLASS B(a) CLASS C CLASS D
<S> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on purchases
(as a percentage of offering price) 4.00%(b) None None 4.00%(b)
- ----------------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load) (as a
percentage of original purchase price or redemption
proceeds, whichever is lower) None(c) 4.0%(b) 1.0%(b) None(c)
- ----------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load) imposed on Dividend
Reinvestments None None None None
- ----------------------------------------------------------------------------------------------------
Redemption Fee None None None None
- ----------------------------------------------------------------------------------------------------
Exchange Fee None None None None
- ----------------------------------------------------------------------------------------------------
Maximum Account Fee None None None None
- ----------------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES:
- ----------------------------------------------------------------------------------------------------
MANAGEMENT FEE(d) 0.55% 0.55% 0.55% 0.55%
- ----------------------------------------------------------------------------------------------------
DISTRIBUTION AND/OR ACCOUNT MAINTENANCE (12b-1)
FEES(e) None 0.50% 0.60% 0.10%
- ----------------------------------------------------------------------------------------------------
Other Expenses (including transfer agency fees)(f) 0.18% 0.19% 0.19% 0.18%
- ----------------------------------------------------------------------------------------------------
TOTAL ANNUAL FUND OPERATING EXPENSES 0.73% 1.24% 1.34% 0.83%
- ----------------------------------------------------------------------------------------------------
</TABLE>
(a) Class B shares automatically convert to Class D shares about ten years after
you buy them. Then they will no longer be subject to distribution fees and
will pay lower account maintenance fees.
(b) Some investors may qualify for reductions in the sales charge (load).
(c) You may pay a deferred sales charge if you purchase $1 million or more and
you redeem within one year.
(d) The Fund pays the Manager a fee at the annual rate of 0.55% of the average
daily net assets of the Fund for the first $500 million; 0.525% of net
assets from $500 million to $1 billion; and 0.50% of net assets above $1
billion. For the fiscal year ended July 31, 1998, the Manager received a fee
equal to 0.55% of the Fund's average daily net assets. The Manager provides
accounting services to the Fund at its cost. For the fiscal year ended July
31, 1998, the Fund reimbursed the Manager $57,018 for these services.
(e) If you hold Class B or Class C shares for a long time, it may cost you more
in distribution (12b-1) fees than the maximum sales charge that you would
have paid if you had bought one of the other classes.
(f) The Fund pays the Transfer Agent $11.00 for each Class A and Class D
shareholder account and $14.00 for each Class B and Class C shareholder
account and reimburses the Transfer Agent's out-of-pocket expenses. The Fund
pays a 0.10% fee for certain accounts that participate in the Merrill Lynch
Mutual Fund Advisor program. The Fund also pays a $0.20 monthly closed
account charge, which is assessed upon all accounts that close during the
year. This fee begins the month following the month the account is closed
and ends at the end of the calendar year. For the fiscal year ended July 31,
1998, the Fund paid the Transfer Agent fees totaling $66,263.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
5
<PAGE> 7
[KEY FACTS LOGO] Key Facts
EXAMPLES:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same. This assumption is not meant to indicate you
will receive a 5% annual rate of return. Your annual return may be more or less
than the 5% used in this example. Although your actual costs may be higher or
lower, based on these assumptions your costs would be:
EXPENSES IF YOU DID REDEEM YOUR SHARES:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Class A $472 $624 $790 $1,270
- ---------------------------------------------------------------------------------------
Class B $526 $593 $681 $1,500
- ---------------------------------------------------------------------------------------
Class C $237 $425 $734 $1,613
- ---------------------------------------------------------------------------------------
Class D $481 $654 $842 $1,384
- ---------------------------------------------------------------------------------------
</TABLE>
EXPENSES IF YOU DID NOT REDEEM YOUR SHARES:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Class A $472 $624 $790 $1,270
- ---------------------------------------------------------------------------------------
Class B $126 $393 $681 $1,500
- ---------------------------------------------------------------------------------------
Class C $137 $425 $734 $1,613
- ---------------------------------------------------------------------------------------
Class D $481 $654 $842 $1,384
- ---------------------------------------------------------------------------------------
</TABLE>
In addition, Merrill Lynch may charge clients a processing fee (currently $5.35)
when a client buys or redeems shares.
6 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 8
[DETAILS ABOUT THE FUND LOGO]
DETAILS ABOUT THE FUND
ABOUT THE PORTFOLIO MANAGER
William R. Bock is the portfolio manager of the Fund. Mr. Bock has been a Vice
President of Merrill Lynch Asset Management since 1989.
ABOUT THE MANAGER
The Fund is managed by Fund Asset Management.
HOW THE FUND INVESTS
- --------------------------------------------------------------------------------
The Fund's main goal is to seek a high level of income that is exempt from
Federal and Pennsylvania personal income taxes. The Fund invests primarily in
long-term, investment grade Pennsylvania municipal bonds. These may be
obligations of a variety of issuers including governmental entities or other
qualifying issuers. Issuers may be located in Pennsylvania or in other
qualifying jurisdictions such as Puerto Rico, the U.S. Virgin Islands and Guam.
The Fund may invest in either fixed rate or variable rate obligations. At least
80% of the Fund's total assets will be invested in investment grade securities.
The Fund will limit its investments in high yield or junk bonds to no more than
20% of its total assets. These bonds are generally more speculative and involve
greater price fluctuations than investment grade securities.
The Fund generally will invest at least 65% of its total assets in Pennsylvania
municipal bonds. For temporary periods, however, the Fund may invest up to 35%
of its total assets in short-term tax-exempt or taxable money market
obligations. No more than 20% of the Fund's net assets will be invested in
taxable money market obligations. However, during unusual market conditions, the
Fund may invest a larger percentage of its assets in short-term obligations.
Short-term investments may limit the potential for tax-exempt income on your
shares.
The Fund's investments may include private activity bonds that may subject
certain shareholders to an alternative minimum tax.
The Manager considers a variety of factors when choosing investments, such as:
CREDIT QUALITY OF ISSUERS -- based on bond ratings and other factors including
economic and financial conditions.
YIELD ANALYSIS -- takes into account factors such as the different yields
available on different types of obligations. This analysis also considers the
shape of the yield curve (longer term obligations typically have higher yields).
MATURITY ANALYSIS -- the average maturity of the portfolio will be maintained
within a desirable range as determined from time to time. Factors considered
include portfolio activity, maturity of the supply of available bonds and the
shape of the yield curve.
In addition, the Manager considers the availability of features that protect
against an early call of the bond by the issuer.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 7
<PAGE> 9
[DETAILS ABOUT THE FUND LOGO] DETAILS ABOUT THE FUND
INVESTMENT RISKS
- --------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period of
time.
MARKET AND SELECTION RISK -- Market risk is the risk that the bond markets will
suffer a general decline, including the possibility that the market will go down
sharply and unpredictably. Selection risk is the risk that the investments that
Fund management selects will underperform the market or other funds with similar
investment objectives and investment strategies.
CREDIT RISK -- The risk that the issuer will be unable to pay interest or
principal when due is generally referred to as credit risk. The degree of credit
risk will depend not only on the financial condition of the issuer but on the
terms of the specific bonds.
INTEREST RATE RISK -- Prices of municipal bonds generally increase when interest
rates decline and decrease when interest rates increase. This risk is known as
interest rate risk. Prices of longer term securities generally fluctuate more in
response to interest rate changes than do prices of shorter term securities.
STATE SPECIFIC RISK -- The Fund will invest primarily in Pennsylvania municipal
bonds. Therefore, an investment in the Fund may be riskier than an investment in
a fund that invests in shorter term securities and/or does not concentrate its
portfolio in municipal bonds relating to a single state.
CALL AND REDEMPTION RISK -- Investments in bonds carry the risk that a bond's
issuer will call the bond for redemption prior to the bond's maturity. If there
is an early call of a bond, the Fund may lose income and may require the Fund to
invest the proceeds of the redemption in bonds with lower yields than the called
bond.
Risks associated with certain types of obligations in which the Fund may invest
include:
GENERAL OBLIGATION BONDS -- The faith, credit and taxing power of the municipal
entity that issues a general obligation bond secures the payment of interest and
repayment of principal on such bond. Timely payments depend on the issuer's
credit quality, its ability to raise tax revenues and its ability to maintain an
adequate tax base.
REVENUE BONDS -- Bonds on which the payments of interest and principal are made
only from the revenues generated by a particular facility or class of
8 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 10
facilities or, in some cases, the proceeds of a special tax or other revenue
source. Payments on the Fund's investment in a revenue bond depend on the money
earned by the particular facility or group of facilities. Industrial development
bonds, which are discussed separately below, are usually revenue bonds.
INDUSTRIAL DEVELOPMENT BONDS -- Municipalities and other public authorities
issue industrial development bonds to finance development of industrial
facilities for use by a private enterprise. The private enterprise pays the
principal and interest on the bond, and the issuer does not pledge its faith,
credit and taxing power for repayment. If the private enterprise defaults on its
payments, the Fund may not receive any income or get its money back from the
investment.
MORAL OBLIGATION BONDS -- Moral obligation bonds generally are issued by special
purpose public authorities. If the issuer is unable to meet its obligations, the
repayment of such bond becomes a moral commitment, but not a legal obligation,
of the relevant state or municipality.
MUNICIPAL NOTES -- Municipal notes include notes issued as interim financing in
anticipation of tax collection, bond sales or revenue receipts. Failure or
shortfall in the anticipated tax, bond or revenue proceeds securing the notes
presents some risk to the Fund.
MUNICIPAL COMMERCIAL PAPER -- Municipal commercial paper is generally unsecured
and issued to meet short-term financing needs. The lack of security presents
some risk to the Fund.
MUNICIPAL LEASE OBLIGATIONS -- In a municipal lease obligation, the issuer
agrees to budget for and appropriate municipal funds to make payments due on the
lease obligation, but this does not ensure that funds will actually be
appropriated in future years. The issuer does not pledge its unlimited taxing
power for payment of the lease obligation. The obligation may be secured by the
leased property, but it may be difficult to sell this property after
foreclosure. In addition, there is no guarantee that proceeds received would
cover the loss of the Fund's investment.
INSURED MUNICIPAL BONDS -- Bonds purchased by the Fund may be covered by
insurance that guarantees timely interest payments and repayment of principal on
maturity. If a bond's insurer fails to fulfill its obligations or loses its
credit rating, the value of the bond could drop.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 9
<PAGE> 11
[DETAILS ABOUT THE FUND LOGO] DETAILS ABOUT THE FUND
JUNK BONDS -- Junk bonds are debt securities rated below investment grade by the
major ratings agencies or unrated securities of comparable quality. Although
junk bonds generally pay higher rates of interest than investment grade bonds,
they are high risk investments that may cause income and principal losses for
the Fund. Junk bonds generally are less liquid and experience more price
volatility than higher rated obligations. The issuers of junk bonds may be
highly leveraged (i.e., have a large amount of outstanding debt) and may be less
creditworthy than other debt issuers. Junk bonds frequently are ranked junior to
claims by other creditors and are more subject to call and redemption risk than
higher rated obligations.
WHEN-ISSUED SECURITIES, DELAYED-DELIVERY SECURITIES AND FORWARD
COMMITMENTS -- When-issued, delayed-delivery securities and forward commitments
involve the risk that the security the Fund buys will lose value prior to its
delivery to the Fund. There also is the risk that the security will not be
issued or that the other party will not meet its obligation, in which case the
Fund loses the investment opportunity of the assets it has set aside to pay for
the security and any gain in the security's price.
VARIABLE RATE DEMAND OBLIGATIONS -- Variable rate demand obligations are
floating rate securities that couple an interest in a long-term municipal bond
with the unconditional right to demand payment prior to the bond's maturity from
a bank or other financial institution. If the bank or other financial
institution is unable to pay on demand, the Fund may be adversely affected. In
addition, these securities are subject to credit risk.
ILLIQUID INVESTMENTS -- The Fund may invest up to 15% of its assets in illiquid
securities that it cannot easily resell within seven days at market value or
that have contractual or legal restrictions on resale. If the Fund buys illiquid
securities it may be unable to quickly resell them on short notice or may be
able to sell them only at a price below fair market value.
DERIVATIVES -- The Fund may use instruments referred to as "derivatives."
Derivatives are financial instruments the value of which is derived from another
security, a commodity (such as gold or oil) or an index (a measure of value or
rates, such as the S&P 500 or the prime lending rate). Types of derivatives that
the Fund may use include futures, options, indexed securities and inverse
securities.
Derivatives allow the Fund to increase or decrease the level of risk to which
the Fund is exposed more quickly and efficiently than transactions in other
types of instruments. Derivatives, however, are volatile and involve significant
risks, including credit risk, leverage risk, liquidity risk and index risk.
10 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 12
- Credit risk -- the risk that the counterparty on a derivative
transaction will be unable to honor its financial obligation to the
Fund.
- Leverage risk -- the risk associated with certain types of
investments or trading strategies that relatively small market
movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- Liquidity risk -- the risk that certain securities may be
difficult or impossible to sell at the time that the seller would
like or at the price that the seller believes the security is
currently worth.
- Index risk -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
Please see the Statement of Additional Information for detailed information
regarding the types of derivatives used by the Fund and the risks associated
with these instruments.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 11
<PAGE> 13
[YOUR ACCOUNT LOGO]
YOUR ACCOUNT
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
- --------------------------------------------------------------------------------
The Fund offers four share classes, each with its own sales charge and expense
structure, allowing you to invest in the way that best suits your needs. Each
share class represents an ownership interest in the same investment portfolio.
When you choose your class of shares you should consider the size of your
investment and how long you plan to hold your shares. Your Merrill Lynch
Financial Consultant can help you determine which share class is best suited to
your personal financial goals.
For example, if you select Class A or D shares, you generally pay a sales charge
at the time of purchase. If you buy Class D shares, you also pay an ongoing
account maintenance fee of 0.10% payable over time. You may be eligible for a
sales charge waiver.
If you select Class B or C shares, you will invest the full amount of your
purchase price, but you will be subject to a distribution fee of 0.25% on Class
B shares and 0.35% on Class C shares and an account maintenance fee of 0.25% on
both classes. Because these fees are paid out of the Fund's assets on an ongoing
basis, over time these fees increase the cost of your investment and may cost
you more than paying an initial sales charge. In addition, you may be subject to
a deferred sales charge when you sell Class B or C shares.
The Fund's shares are distributed by Merrill Lynch Funds Distributor, a division
of Princeton Funds Distributor, Inc., an affiliate of Merrill Lynch. The Fund is
a series of the Merrill Lynch Multi-State Municipal Series Trust.
12 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 14
The table below summarizes key features of the Merrill Lynch Select Pricing(SM)
System.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Availability Limited to certain Generally available Generally available
investors including: - through Merrill Lynch. through Merrill Lynch.
- Current Class A Limited availability Limited availability
shareholders through other securities through other securities
- Participants in dealers. dealers.
certain Merrill Lynch
sponsored programs -
- Certain affiliates of
Merrill Lynch.
- ---------------------------------------------------------------------------------------------------------------
Initial Sales Charge? Yes. Payable at time of No. Entire purchase No. Entire purchase
purchase. Lower sales price is invested in price is invested in
charges available for shares of the Fund. shares of the Fund.
larger investments.
- ---------------------------------------------------------------------------------------------------------------
Deferred Sales No. (May be charged for Yes. Payable if you Yes. Payable if you
Charge? purchases over $1 redeem within four years redeem within one year
million that are of purchase. of purchase.
redeemed within one
year.)
- ---------------------------------------------------------------------------------------------------------------
Account Maintenance No. 0.25% Account 0.25% Account
and Distribution Maintenance Fee 0.25% Maintenance Fee 0.35%
Fees? Distribution Fee. Distribution Fee.
- ---------------------------------------------------------------------------------------------------------------
Conversion to Class D No. Yes, automatically after No.
shares? approximately ten years.
- ---------------------------------------------------------------------------------------------------------------
<CAPTION>
CLASS D
<S> <C>
Availability Generally available
through Merrill Lynch.
Limited availability
through other securities
dealers.
- ------------------------------------------------------------------------
Initial Sales Charge? Yes. Payable at time of
purchase. Lower sales
charges available for
larger investments.
- -------------------------------------------------------------------------------------------------
Deferred Sales No. (May be charged for
Charge? purchases over $1
million that are
redeemed within one
year.)
- ---------------------------------------------------------------------------------------------------------------
Account Maintenance 0.10% Account
and Distribution Maintenance Fee No
Fees? Distribution Fee.
- ---------------------------------------------------------------------------------------------------------------
Conversion to Class D No.
shares?
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 13
<PAGE> 15
[YOUR ACCOUNT LOGO] YOUR ACCOUNT
RIGHT OF ACCUMULATION -- permits you to pay the sales charge that would apply to
the cost or value (whichever is higher) of all shares you own in the Merrill
Lynch mutual funds that offer Select Pricing options.
LETTER OF INTENT -- permits you to pay the sales charge that would be applicable
if you add up all shares of Merrill Lynch Select Pricing System funds that you
agree to buy within a 13 month period. Certain restrictions apply.
CLASS A AND CLASS D SHARES -- INITIAL SALES CHARGE OPTIONS
If you select Class A or Class D shares, you will pay a sales charge at the time
of purchase.
<TABLE>
<CAPTION>
DEALER
COMPENSATION
AS A % OF AS A % OF AS A % OF
YOUR INVESTMENT OFFERING PRICE YOUR INVESTMENT* 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>
* Rounded to the nearest one-hundredth percent.
** If you invest $1,000,000 or more in Class A or Class D shares, you may not
pay an initial sales charge. However, if you redeem your shares within one
year after purchase, you may be charged a deferred sales charge. This charge
is 1% of the lesser of the original cost of the shares being redeemed or your
redemption proceeds.
No initial sales charge applies to Class A or Class D shares that you buy
through reinvestment of dividends or distributions.
A reduced or waived sales charge on a purchase of Class A or Class D shares may
apply for:
- Purchases under a RIGHT OF ACCUMULATION or LETTER OF INTENT.
- TMA(SM) Managed Trusts.
- Certain Merrill Lynch investment or central asset accounts.
- Purchases using proceeds from the sale of certain Merrill Lynch
closed-end funds under certain circumstances.
14 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 16
- Certain investors, including directors or trustees of Merrill
Lynch mutual funds and Merrill Lynch employees.
- Certain Merrill Lynch fee-based programs.
Only certain investors are eligible to buy Class A shares. Your Merrill Lynch
Financial Consultant can help you determine whether you are eligible to buy
Class A shares or to participate in any of these programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class A and Class D shares, you should buy Class A
since Class D shares are subject to a 0.10% account maintenance fee, while Class
A shares are not.
If you redeem Class A or Class D shares and within 30 days buy new shares of the
same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your Merrill Lynch
Financial Consultant or the Fund's Transfer Agent at 1-800-MER-FUND.
CLASS B AND CLASS C SHARES -- DEFERRED SALES CHARGE OPTIONS
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within four
years after purchase or your Class C shares within one year after purchase, you
may be required to pay a deferred sales charge. You will also pay distribution
fees of 0.25% for Class B shares and 0.35% for Class C shares and account
maintenance fees of 0.25% for Class B and Class C shares each year. Because
these fees are paid out of the Fund's assets on an ongoing basis, over time
these fees increase the cost of your investment and may cost you more than
paying an initial sales charge. The Distributor uses the money that it receives
from the deferred sales charges and the distribution fees to cover the costs of
marketing, advertising and compensating the Merrill Lynch Financial Consultant
or other securities dealer who assists you in purchasing Fund shares.
Class B Shares
If you redeem Class B shares within four years after purchase, you may be
charged a deferred sales charge. The amount of the charge gradually
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 15
<PAGE> 17
[YOUR ACCOUNT LOGO] Your Account
decreases as you hold your shares over time, according to the following
schedule:
<TABLE>
<CAPTION>
YEARS SINCE PURCHASE SALES CHARGE*
- --------------------------------------------
<S> <C>
0 - 1 4.00%
- --------------------------------------------
1 - 2 3.00%
- --------------------------------------------
2 - 3 2.00%
- --------------------------------------------
3 - 4 1.00%
- --------------------------------------------
4 AND THEREAFTER 0.00%
- --------------------------------------------
</TABLE>
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends or distributions are not subject to a
deferred sales charge. Not all Merrill Lynch funds have identical deferred
sales charge schedules. If you exchange your shares for shares of another
fund, the higher charge will apply.
The deferred sales charge relating to Class B shares will be reduced or waived
in certain circumstances, such as:
- Redemption in connection with participation in certain Merrill
Lynch fee-based programs.
- Withdrawals resulting from shareholder death or disability as
long as the waiver request is made within one year of death or
disability.
- Withdrawal through the Merrill Lynch Systematic Withdrawal Plan
of up to 10% per year of your Class B account value at the time
the plan is established.
Your Class B shares convert automatically into Class D shares approximately ten
years after purchase. Any Class B shares received through reinvestment of
dividends or distributions paid on converting shares will also convert at that
time. Class D shares are subject to lower annual expenses than Class B shares.
The conversion of Class B to Class D shares is not a taxable event for federal
income tax purposes.
16 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 18
Different conversion schedules apply to Class B shares of different Merrill
Lynch mutual funds. For example, Class B shares of a fixed-income fund convert
approximately ten years after purchase compared to approximately eight years for
equity funds. If you acquire your Class B shares in an exchange from another
fund with a shorter conversion schedule, the Fund's ten year conversion schedule
will apply. If you exchange your Class B shares in the Fund for Class B shares
of a fund with a shorter conversion schedule, the other fund's conversion
schedule will apply. The length of time that you hold both the original and
exchanged Class B shares in both funds will count toward the conversion
schedule. The conversion schedule may be modified in certain other cases as
well.
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of 1.00%. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends or distributions.
Class C shares do not offer a conversion privilege.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
- --------------------------------------------------------------------------------
The chart beginning on page 18 summarizes how to buy, sell, transfer and
exchange shares through Merrill Lynch or other securities dealers. You may also
buy shares through the Transfer Agent. To learn more about buying shares through
the Transfer Agent, call 1-800-MER-FUND. Because the selection of a mutual fund
involves many considerations, your Merrill Lynch Financial Consultant may help
you with this decision.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 17
<PAGE> 19
[YOUR ACCOUNT LOGO] Your Account
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BUY SHARES First, select the share class Refer to the Merrill Lynch Select Pricing table on page 13.
appropriate for you Be sure to read this prospectus carefully.
-------------------------------------------------------------------------------------------------------
Next, determine the amount of your The minimum initial investment for the Fund is $1,000 for
investment all accounts except that certain Merrill Lynch fee-based
programs have a $250 initial minimum.
(The minimums for initial investments may be waived or
reduced under certain circumstances.)
-------------------------------------------------------------------------------------------------------
Have your Merrill Lynch Financial Any purchase orders received by Merrill Lynch from a
Consultant or securities dealer securities dealer within thirty minutes after the close of
submit your purchase order business on the New York Stock Exchange will be priced at
the net asset value determined that day.
Purchase orders received after that time will be priced at
the net asset value determined on the next business day. The
Fund may reject any order to buy shares and may suspend the
sale of shares at any time. Merrill Lynch may charge a
processing fee to confirm a purchase. This fee is currently
$5.35.
-------------------------------------------------------------------------------------------------------
Or contact the Transfer Agent You can purchase shares of the Fund directly by mailing a
purchase order to the Transfer Agent at the address on the
inside back cover of this prospectus.
- --------------------------------------------------------------------------------------------------------------------------------
ADD TO YOUR Purchase additional shares The minimum investment for additional purchases is $50.
INVESTMENT (The minimum for additional purchases may be waived under
certain circumstances.)
-------------------------------------------------------------------------------------------------------
Acquire additional shares through the All dividends and capital gains distributions are
automatic dividend reinvestment plan automatically reinvested without a sales charge.
-------------------------------------------------------------------------------------------------------
Participate in the automatic You may invest a specific amount on a periodic basis through
investment plan certain Merrill Lynch investment or central asset accounts.
- --------------------------------------------------------------------------------------------------------------------------------
TRANSFER SHARES TO Transfer to a participating You may transfer your Fund shares only to another securities
ANOTHER SECURITIES securities dealer dealer that has entered into an agreement with Merrill
DEALER Lynch. All shareholder services will be available for the
transferred shares. You may only purchase additional shares
of funds previously owned before the transfer. All future
trading of these assets must be coordinated by the receiving
firm.
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
18 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 20
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
TRANSFER SHARES TO Transfer to a non-participating You must either:
ANOTHER SECURITIES securities dealer - Transfer your shares to an account with the Transfer
DEALER (CONTINUED) Agent; or
- Sell your shares.
- --------------------------------------------------------------------------------------------------------------------------------
SELL YOUR SHARES Have your Merrill Lynch Financial To ensure that your redemption request will be priced at the
Consultant or securities dealer net asset value on the day of your request, you must submit
submit your sales order your request to your dealer before that day's close of
business on the New York Stock Exchange (generally 4:00 p.m.
Eastern time). The Fund accepts redemption requests from
dealers on any business day until thirty minutes after the
close of business on the New York Stock Exchange. Any
redemption request received from a dealer after that time
will be priced at the net asset value at the close of
business on the next business day.
Securities dealers, including Merrill Lynch, may charge a
fee to process a redemption of shares. Merrill Lynch
currently charges a fee of $5.35. No processing fee is
charged if you redeem shares directly through the Transfer
Agent.
The Fund may reject an order to sell shares under certain
circumstances.
-------------------------------------------------------------------------------------------------------
Sell through the Transfer Agent You may sell shares held at the Transfer Agent by writing to
the Transfer Agent at the address on the inside back cover
of this prospectus. All shareholders on the account must
sign the letter and signatures must be guaranteed. If you
hold stock certificates, return the certificates with the
letter. The Transfer Agent will normally mail redemption
proceeds within seven days following receipt of a properly
completed request. If you make a redemption request before
the Fund has collected payment for the purchase of shares,
the Fund or the Transfer Agent may delay mailing your
proceeds. This delay will usually not exceed ten days.
If you hold share certificates, they must be delivered to
the Transfer Agent before they can be converted. Check with
the Transfer Agent or your Merrill Lynch Financial
Consultant for details.
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 19
<PAGE> 21
[YOUR ACCOUNT LOGO] Your Account
<TABLE>
<CAPTION>
IF YOU WANT TO YOUR CHOICES INFORMATION IMPORTANT FOR YOU TO KNOW
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SELL SHARES Participate in the Fund's Systematic You can choose to receive systematic payments from your Fund
SYSTEMATICALLY Withdrawal Plan account either by check or through direct deposit to your
bank account on a monthly or quarterly basis. If you have a
Merrill Lynch CMA(R), CBA(R) or Retirement Account you can
arrange for systematic redemptions of a fixed dollar amount
on a monthly, bi-monthly, quarterly, semi-annual or annual
basis, subject to certain conditions. Under either method
you must have dividends and other distributions
automatically reinvested. For Class B and C shares your
total annual withdrawals cannot be more than 10% per year of
the value of your shares at the time your plan is
established. The deferred sales charge is waived for
systematic redemptions. Ask your Merrill Lynch Financial
Consultant for details.
- --------------------------------------------------------------------------------------------------------------------------------
EXCHANGE YOUR Select the fund into which you want You can exchange your shares of the Fund for shares of many
SHARES to exchange. Be sure to read that other Merrill Lynch mutual funds. You must have held the
fund's prospectus shares used in the exchange for at least 15 calendar days
(including money funds) before you can exchange to another
fund.
Each class of Fund shares is generally exchangeable for
shares of the same class of another fund. If you own Class A
shares and wish to exchange into a fund in which you have no
Class A shares, you will exchange into Class D shares.
Some of the Merrill Lynch mutual funds impose a different
initial or deferred sales charge schedule. If you exchange
Class A or D shares for shares of a fund with a higher
initial sales charge than you originally paid, you will be
charged the difference at the time of exchange. If you
exchange Class B shares for shares of a fund with a
different deferred sales charge schedule, the higher
schedule will apply. The time you hold Class B or C shares
in both funds will count when determining your holding
period for calculating a deferred sales charge at
redemption. If you exchange Class A or D shares for money
market fund shares, you will receive Class A shares of
Summit Cash Reserves Fund. Class B or C shares of the Fund
will be exchanged for Class B shares of Summit.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may be
modified or terminated at any time in the future.
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
20 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 22
NET ASSET VALUE -- the market value of the Fund's total assets after deducting
liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
- --------------------------------------------------------------------------------
When you buy shares, you pay the NET ASSET VALUE, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open, fifteen minutes after the close of business on the Exchange
(the Exchange generally closes at 4:00 p.m. Eastern time). The net asset value
used in determining your price is the one calculated after your purchase or
redemption order is received.
Generally, Class A shares will have the highest net asset value because that
class has the lowest expenses, and Class D shares will have a higher net asset
value than Class B or Class C shares. Also dividends paid on Class A and Class D
shares will generally be higher than dividends paid on Class B and Class C
shares because Class A and Class D shares have lower expenses.
PARTICIPATION IN MERRILL LYNCH FEE-BASED PROGRAMS
- --------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by Merrill Lynch, you
may be able to buy Class A shares at net asset value, including by exchanges
from other share classes. Sales charges on the shares being exchanged may be
reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or automatically
exchanged into another class of Fund shares or into a money market fund. The
class you receive may be the class you originally owned when you entered the
program, or in certain cases, a different class. If the exchange is into Class B
shares, the period before conversion to Class D shares may be modified. Any
redemption or exchange will be at net asset value. However, if you participate
in the program for less than a specified period, you may be charged a fee in
accordance with the terms of the program.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 21
<PAGE> 23
[YOUR ACCOUNT LOGO] Your Account
DIVIDENDS -- income paid to shareholders. Dividends may be reinvested in
additional Fund shares as they are paid.
DISTRIBUTIONS -- capital gains paid to shareholders. Distributions may be
reinvested in additional Fund shares as they are paid.
"BUYING A DIVIDEND"
You may want to avoid buying shares shortly before the Fund pays a dividend or
distribution, although the impact on you will be significantly less than if you
were invested in a Fund paying fully taxable dividends. The reason? If you
bought shares when the Fund had realized but not yet distributed taxable income
(if any) or capital gains, you would pay the full price for the shares and then
could receive a portion of the price back in the form of a distribution all or,
more likely, part of which could be taxable. Before investing you may want to
consult your tax adviser.
Details about these features and the relevant charges are included in the client
agreement for each fee-based program and are available from your Merrill Lynch
Financial Consultant.
DIVIDENDS, CAPITAL GAINS AND TAXES
- --------------------------------------------------------------------------------
The Fund will distribute any net investment income monthly, and any net realized
long or short-term capital gains at least annually. The Fund may also pay a
special distribution at the end of the calendar year to comply with federal tax
requirements. If your account is with Merrill Lynch and you would like to
receive DIVIDENDS and DISTRIBUTIONS in cash, contact your Merrill Lynch
Financial Consultant. If your account is with the Transfer Agent and you would
like to receive dividends and distributions in cash, contact the Transfer Agent.
TAXES
To the extent that the dividends distributed by the Fund are from municipal bond
interest income, they are exempt from Federal income tax. However, certain
investors may be subject to alternative minimum tax on dividends received from
the Fund. To the extent that the dividends distributed by the Fund are derived
from Pennsylvania municipal bond interest income, they are also exempt from
Pennsylvania personal income tax. Interest income from other investments may
produce taxable distributions. If you are subject to income tax in a state other
than Pennsylvania, the dividends derived from Pennsylvania municipal bonds will
not be exempt from income tax in that state. Dividends, or portions thereof,
that are derived from capital gains may fall into different categories of
capital gain that are taxable at different rates for Federal income tax
purposes.
Generally, within 60 days after the end of the Fund's taxable year, the Fund
will tell you the amount of exempt-interest dividends, ordinary income dividends
or capital gain dividends, including the different categories of capital gains,
you received that year. The capital gains rate or rates applicable to capital
gain dividends depends on how long the Fund held an asset before selling it for
a gain; it is not related to how long you have held your shares. The tax
treatment of distributions from the Fund is the same whether you choose to
receive distributions in cash or to have them reinvested in shares of the Fund.
22 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 24
If you cannot provide a taxpayer identification number or social security
number, Fund distributions of capital gains, certain ordinary income dividends
and redemptions will have a 31% withholding tax deduction.
If you redeem Fund shares or exchange them for shares of another fund, any gain
on the transaction may be subject to Federal income tax.
This section summarizes some of the consequences of an investment in the Fund
under current Federal and Pennsylvania tax laws. It is not a substitute for
personal tax advice. Consult your personal tax adviser about the potential tax
consequences to you of an investment in the Fund under all applicable tax laws.
The Fund's Statement of Additional Information has more information about taxes.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 23
<PAGE> 25
[MANAGEMENT OF THE FUND LOGO]
MANAGEMENT OF THE FUND
FUND ASSET MANAGEMENT
- --------------------------------------------------------------------------------
Fund Asset Management, the Fund's Manager, manages the Fund's investments and
its business operations under the overall supervision of the Trust's Board of
Trustees. The Manager has the responsibility for making all investment decisions
for the Fund. The Fund pays the Manager a fee at the annual rate of 0.55% of the
average daily net assets of the Fund for the first $500 million; 0.525% of net
assets from $500 million to $1 billion; and 0.50% of net assets above $1
billion. For the fiscal year ended July 31, 1998 the manager received a fee
equal to 0.55% of the Fund's average daily net assets.
Fund Asset Management is a part of the Merrill Lynch Asset Management Group. The
Asset Management Group had approximately $473 billion in investment company and
other portfolio assets under management as of August 1998. This amount includes
assets managed for Merrill Lynch affiliates.
24 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 26
[MANAGEMENT OF THE FUND LOGO]
Management of the Fund
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.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements.
<TABLE>
<CAPTION>
CLASS A
----------------------------------------------------------------
FOR THE YEAR ENDED JULY 31,
INCREASE (DECREASE) IN ----------------------------------------------------------------
NET ASSET VALUE: 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
- --------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $ 11.59 $ 11.17 $ 11.07 $ 11.00 $ 11.39
- --------------------------------------------------------------------------------------------------------
Investment income -- net .59 .60 .61 .62 .60
- --------------------------------------------------------------------------------------------------------
Realized and unrealized gain
(loss) on investments -- net .08 .45 .10 .07 (.33)
- --------------------------------------------------------------------------------------------------------
Total from investment operations .67 1.05 .71 .69 .27
- --------------------------------------------------------------------------------------------------------
Less dividends and distributions:
Investment income -- net (.59) (.60) (.61) (.62) (.60)
Realized gain on
investments -- net (.15) (.03) -- -- (.04)
In excess of realized gain on
investments -- net -- -- -- -- (.02)
- --------------------------------------------------------------------------------------------------------
Total dividends and distributions (.74) (.63) (.61) (.62) (.66)
- --------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 11.52 $ 11.59 $ 11.17 $ 11.07 $ 11.00
- --------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
- --------------------------------------------------------------------------------------------------------
Based on net asset value per share 6.02% 9.72% 6.53% 6.54% 2.37%
- --------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- --------------------------------------------------------------------------------------------------------
Expenses .73% .74% .76% .77% .75%
- --------------------------------------------------------------------------------------------------------
Investment income -- net 5.12% 5.36% 5.41% 5.72% 5.30%
- --------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- --------------------------------------------------------------------------------------------------------
Net assets, end of year (in
thousands) $ 20,613 $ 21,179 $ 21,626 $ 23,040 $ 28,239
- --------------------------------------------------------------------------------------------------------
Portfolio turnover 46.87% 49.82% 58.33% 59.17% 37.73%
- --------------------------------------------------------------------------------------------------------
<CAPTION>
CLASS B
---------------------------------------------------------------------
FOR THE YEAR ENDED JULY 31,
INCREASE (DECREASE) IN ---------------------------------------------------------------------
NET ASSET VALUE: 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
- --------------------------------------------------------------------------------------------------------
Net asset value, beginning of year $ 11.59 $ 11.17 $ 11.07 $ 11.00 $ 11.39
- --------------------------------------------------------------------------------------------------------
Investment income -- net .53 .55 .55 .56 .54
- --------------------------------------------------------------------------------------------------------
Realized and unrealized gain
(loss) on investments -- net .09 .45 .10 .07 (.33)
- --------------------------------------------------------------------------------------------------------
Total from investment operations .62 1.00 .65 .63 .21
- --------------------------------------------------------------------------------------------------------
Less dividends and distributions:
Investment income -- net (.53) (.55) (.55) (.56) (.54)
Realized gain on
investments -- net (.15) (.03) -- -- (.04)
In excess of realized gain on
investments -- net -- -- -- -- (.02)
- --------------------------------------------------------------------------------------------------------
Total dividends and distributions (.68) (.58) (.55) (.56) (.60)
- --------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 11.53 $ 11.59 $ 11.17 $ 11.07 $ 11.00
- --------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:*
- --------------------------------------------------------------------------------------------------------
Based on net asset value per share 5.57% 9.17% 5.98% 6.00% 1.86%
- --------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- --------------------------------------------------------------------------------------------------------
Expenses 1.24% 1.25% 1.27% 1.28% 1.25%
- --------------------------------------------------------------------------------------------------------
Investment income -- net 4.61% 4.85% 4.91% 5.21% 4.80%
- --------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- --------------------------------------------------------------------------------------------------------
Net assets, end of year (in
thousands) $ 103,261 $ 109,070 $ 120,565 $ 123,260 $ 130,418
- --------------------------------------------------------------------------------------------------------
Portfolio turnover 46.87% 49.82% 58.33% 59.17% 37.73%
- --------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude the effects of sales loads.
MERRILL LYNCH PENNSYLVANIAMUNICIPAL BOND FUND 25
<PAGE> 27
[MANAGEMENT OF THE FUND ICON] Management of the Fund
FINANCIAL HIGHLIGHTS (continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS C
---------------------------------------------------------
FOR THE YEAR ENDED FOR THE PERIOD
JULY 31, OCT. 21, 1994
------------------------------------ TO JULY 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
- ------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ 11.59 $ 11.17 $ 11.07 $ 10.68
- ------------------------------------------------------------------------------------------------------
Investment income -- net .52 .53 .54 .43
- ------------------------------------------------------------------------------------------------------
Realized and unrealized gain on
investments -- net .09 .45 .10 .39
- ------------------------------------------------------------------------------------------------------
Total from investment operations .61 .98 .64 .82
- ------------------------------------------------------------------------------------------------------
Less dividends and distributions:
Investment income -- net (.52) (.53) (.54) (.43)
Realized gain on investments -- net (.15) (.03) -- --
- ------------------------------------------------------------------------------------------------------
Total dividends and distributions (.67) (.56) (.54) (.43)
- ------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 11.53 $ 11.59 $ 11.17 $ 11.07
- ------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
- ------------------------------------------------------------------------------------------------------
Based on net asset value per share 5.47% 9.06% 5.87% 7.83%#
- ------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- ------------------------------------------------------------------------------------------------------
Expenses 1.34% 1.35% 1.37% 1.38%*
- ------------------------------------------------------------------------------------------------------
Investment income -- net 4.51% 4.75% 4.80% 5.05%*
- ------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- ------------------------------------------------------------------------------------------------------
Net assets, end of period (in
thousands) $ 6,928 $ 6,145 $ 4,722 $ 1,868
- ------------------------------------------------------------------------------------------------------
Portfolio turnover 46.87% 49.82% 58.33% 59.17%
- ------------------------------------------------------------------------------------------------------
<CAPTION>
CLASS D
---------------------------------------------------------
FOR THE YEAR ENDED FOR THE PERIOD
JULY 31, OCT. 21, 1994
------------------------------------ TO JULY 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
- ------------------------------------------------------------------------------------------------------
Net asset value, beginning of period $ 11.60 $ 11.18 $ 11.08 $ 10.68
- ------------------------------------------------------------------------------------------------------
Investment income -- net .58 .59 .60 .47
- ------------------------------------------------------------------------------------------------------
Realized and unrealized gain on
investments -- net .09 .45 .10 .40
- ------------------------------------------------------------------------------------------------------
Total from investment operations .67 1.04 .70 .87
- ------------------------------------------------------------------------------------------------------
Less dividends and distributions:
Investment income -- net (.58) (.59) (.60) (.47)
Realized gain on investments -- net (.15) (.03) -- --
- ------------------------------------------------------------------------------------------------------
Total dividends and distributions (.73) (.62) (.60) (.47)
- ------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 11.54 $ 11.60 $ 11.18 $ 11.08
- ------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
- ------------------------------------------------------------------------------------------------------
Based on net asset value per share 6.00% 9.61% 6.42% 8.36%#
- ------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
- ------------------------------------------------------------------------------------------------------
Expenses .83% .84% .86% .87%*
- ------------------------------------------------------------------------------------------------------
Investment income -- net 5.01% 5.26% 5.31% 5.65%*
- ------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
- ------------------------------------------------------------------------------------------------------
Net assets, end of period (in
thousands) $ 8,143 $ 5,348 $ 3,583 $ 2,630
- ------------------------------------------------------------------------------------------------------
Portfolio turnover 46.87% 49.82% 58.33% 59.17%
- ------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<C> <S>
* Annualized.
** Total investment returns exclude the effects of sales loads.
+ Commencement of operations.
# Aggregate total investment return.
</TABLE>
26 MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<PAGE> 28
[MANAGEMENT OF THE FUND LOGO]
Management of the Fund
A NOTE ABOUT YEAR 2000
Many computer systems were designed using only two digits to designate years.
These systems may not be able to distinguish the Year 2000 from the Year 1900
(commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by the Fund's management or other Fund
service providers do not properly address this problem before January 1, 2000.
The Fund's management expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told the Fund management that they also
expect to resolve the Year 2000 Problem, and the Fund management will continue
to monitor the situation as the Year 2000 approaches. However, if the problem
has not been fully addressed, the Fund could be negatively affected. The Year
2000 Problem could also have a negative impact on the issuers of securities in
which the Fund invests, and this could hurt the Fund's investment returns.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND 27
<PAGE> 29
<TABLE>
<S> <C>
POTENTIAL
INVESTORS
Open an account (two options)
1 2
MERRILL LYNCH TRANSFER AGENT
FINANCIAL CONSULTANT
OR SECURITIES DEALER Financial Data Services, Inc.
P.O. Box 45289
Advises shareholders on their Fund investments. Jacksonville, Florida 32232-5289
Performs recordkeeping and reporting services.
DISTRIBUTOR
Merrill Lynch Funds Distributor,
a division of Princeton Funds Distributor, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
Arranges for the sale of Fund shares.
COUNSEL THE FUND CUSTODIAN
Brown & Wood LLP The Board of Trustees State Street Bank
One World Trade Center oversees the Fund. and Trust Company
New York, New York 10048-0557 P.O. Box 351
Boston, Massachusetts 02101
Provides legal advice to the Fund.
Holds the Fund's assets for safekeeping.
INDEPENDENT AUDITORS INVESTMENT ADVISER
Deloitte & Touche LLP. Fund Asset Management, LP.
117 Campus Drive
Princeton, New Jersey 08540-6400 ADMINISTRATIVE OFFICES
800 Scudders Mill Road
Audits the financial Plainsboro, New Jersey 08536
statements of the Fund on behalf of
the shareholders. MAILING ADDRESS
P.O. Box 9011
Princeton, New Jersey 08543-9011
TELEPHONE NUMBER
1-800-MER-FUND
Manages the Fund's day-to-day activities.
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
</TABLE>
<PAGE> 30
[FOR MORE INFORMATION LOGO]
FOR MORE INFORMATION LOGO
SHAREHOLDER REPORTS
Additional information about the Fund's investments is available in the Fund's
annual and semi-annual For More Information reports to shareholders. In the
Fund's annual report you will find a discussion of the market conditions and
investment strategies that significantly affected the Fund's performance during
its last fiscal year. You may obtain these reports at no cost by calling 1-
800-MER-FUND.
The Fund will send you one copy of each shareholder report and
certain other mailings, regardless of the number of Fund accounts you have. To
receive separate shareholder reports for each account, call your Merrill Lynch
Financial Consultant or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and Merrill Lynch
brokerage or mutual fund account number. If you have any questions, please call
your Merrill Lynch Financial Consultant or the Transfer Agent at 1-800-
MER-FUND.
STATEMENT OF ADDITIONAL INFORMATION
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing or calling the Fund
at the address and telephone number indicated on the inside back cover of this
prospectus.
Contact your Merrill Lynch Financial Consultant or the Fund at the telephone
number or address indicated on the inside back cover of this prospectus if you
have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-800-SEC-0330 for information on the operation of the public
reference room. This information is also available on the SEC's Internet site at
http://www.sec.gov and copies may be obtained upon payment of a duplicating fee
by writing the Public Reference Section of the SEC, Washington, D.C. 20549-6009.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT.
Investment Company Act file #811-4375
Code #11197-11-98
(C) Fund Asset Management, L.P.
[MERRILL LYNCH LOGO]
Merrill Lynch Pennsylvania
Municipal Bond Fund
of Merrill Lynch Multi-State Municipal
Series Trust
[MERRILL LYNCH ARTWORK]
PROSPECTUS - , 1998
<PAGE> 31
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
OF 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 series of
Merrill Lynch Multi-State Municipal Series Trust (the "Trust"), a
non-diversified, open-end 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 seeks
to achieve its objective while providing investors with the opportunity to
invest primarily in a diversified portfolio of long-term obligations issued by
or on behalf 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 income tax
and Pennsylvania personal income taxes. 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, see "Investment Objective and Policies."
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 Pricing(SM) 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
"Purchase of Shares."
------------------------
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
, 1998 (the "Prospectus"), which has been filed with the Securities
and Exchange Commission (the "Commission") and can be obtained, without charge,
by calling (800) 637-3863 or by writing the Fund at the above address. The
Prospectus is incorporated by reference into this Statement of Additional
Information, and this Statement of Additional Information is incorporated by
reference into the Prospectus.
------------------------
FUND ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is , 1998.
<PAGE> 32
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies........................... 2
General................................................... 2
Risk Factors and Special Considerations Relating to
Municipal Bonds........................................ 3
Description of Municipal Bonds............................ 4
Financial Futures Transactions and Options................ 8
Description of Temporary Investments...................... 11
Investment Restrictions................................... 13
Portfolio Turnover........................................ 15
Management of the Trust..................................... 15
Trustees and Officers..................................... 15
Compensation of Trustees.................................. 16
Management and Advisory Arrangements...................... 17
Code of Ethics............................................ 19
Purchase of Shares.......................................... 19
Initial Sales Charge Alternatives -- Class A and Class D
Shares................................................. 20
Deferred Sales Charge Alternatives -- Class B and Class C
Shares................................................. 24
Distribution Plans........................................ 26
Limitations on the Payment of Deferred Sales Charges...... 28
Redemption of Shares........................................ 29
Redemption................................................ 29
Repurchase................................................ 29
Reinstatement Privilege -- Class A and Class D Shares..... 30
Pricing of Shares........................................... 30
Determination of Net Asset Value.......................... 30
Computation of Offering Price Per Share................... 31
Portfolio Transactions...................................... 31
Transactions in Portfolio Securities...................... 31
Shareholder Services........................................ 33
Investment Account........................................ 33
Exchange Privilege........................................ 33
Fee-Based Programs........................................ 35
Automated Investment Plans................................ 35
Automatic Dividend Program................................ 36
Systematic Redemption Program............................. 36
Distributions and Taxes..................................... 37
Dividends and Distributions............................... 37
Taxes..................................................... 38
Tax Treatment of Options and Futures Transactions......... 41
Performance Data............................................ 41
General Information......................................... 44
Description of Shares..................................... 44
Independent Auditors...................................... 45
Custodian................................................. 45
Transfer Agent............................................ 45
Legal Counsel............................................. 46
Reports to Shareholders................................... 46
Shareholder Inquiries..................................... 46
Additional Information.................................... 46
Financial Statements........................................ 46
Appendix I -- Economic and Financial Conditions in
Pennsylvania.............................................. I-1
Appendix II -- Ratings of Municipal Bonds................... II-1
</TABLE>
<PAGE> 33
INVESTMENT OBJECTIVE AND POLICIES
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 seeks to achieve its objective by
investing primarily in a portfolio of long-term obligations issued by or on
behalf of the State 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 income tax
and Pennsylvania personal income taxes. Obligations exempt from Federal income
taxes are referred to herein as "Municipal Bonds," and obligations exempt from
Federal income tax 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 the Fund's total assets invested in
Pennsylvania Municipal Bonds. The investment objective as set forth in the first
sentence of this paragraph is a fundamental policy and may not be changed
without a vote of a majority of the outstanding shares of the Fund. See "How the
Fund Invests" in the Prospectus for a general discussion of the Fund's goals,
main investment strategies and main risks.
GENERAL
Under normal circumstances, except when acceptable securities are
unavailable as determined by Fund Asset Management, L.P. (the "Manager" or
"FAM"), the Fund's manager, the Fund will invest at least 65% of its total
assets in Pennsylvania Municipal Bonds. 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 will be in excess of ten years. For temporary 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 Fund may also invest in variable rate demand obligations ("VRDOs") and
VRDOs in the form of participation interests ("Participating VRDOs") in variable
rate tax-exempt obligations held by a financial institution. See "Description of
Temporary Investments." 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.
At least 80% of the Municipal Bonds purchased by the Fund will be what are
commonly referred to as "investment grade" securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ("Moody's") (currently Aaa,
Aa, A and Baa), Standard & Poor's ("S&P") (currently AAA, AA, A and BBB) or
Fitch IBCA, Inc. ("Fitch") (currently AAA, AA, A and BBB). If unrated, such
securities will possess creditworthiness comparable, in the opinion of the
Manager, to other obligations in which the Fund may invest.
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 S&P 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. See
"Description of Municipal Bonds -- 'High Yield' or 'Junk' Bonds." 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
2
<PAGE> 34
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
that provides the credit enhancement.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal income tax 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 to the issuer, from Federal income tax,
but not Pennsylvania personal income tax. 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 could include trust certificates or other
instruments evidencing interest in one or more long-term municipal 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 applicable law. Non-Municipal Tax-Exempt Securities
will be considered "Municipal Bonds" for purposes of the Fund's investment
objective and policies. 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
taxation. However, interest received on certain otherwise tax-exempt securities
that 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 total assets invested in "private activity bonds"
will vary during the year. 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. See "Distributions and Taxes -- Taxes."
RISK FACTORS AND SPECIAL CONSIDERATIONS RELATING TO MUNICIPAL BONDS
The risks and special considerations involved in investment in Municipal
Bonds vary with the types of instruments being acquired. Investments in
Non-Municipal Tax-Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as derivative instruments. See "Investment Objective and
Policies -- Description of Municipal Bonds" and "-- Financial Futures
Transactions and Options."
The Fund ordinarily will invest at least 65% of its assets in Pennsylvania
Municipal Bonds, and therefore it is more susceptible to factors adversely
affecting issuers of Pennsylvania Municipal Bonds than is a municipal bond
mutual fund that is not concentrated in issuers of Pennsylvania Municipal Bonds
to this degree. Many different social, environmental and economic factors may
affect the financial condition of Pennsylvania and its political subdivisions.
From time to time Pennsylvania and certain of its political subdivisions have
encountered financial difficulties which 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. Operations during the
Pennsylvania's General Fund's 1998 fiscal year increased the unappropriated
balance of Commonwealth revenues for that period by $86.4 million to $488.7
million at June 30, 1998 (prior to transfers to the Tax Stabilization Reserve
Fund). Commonwealth revenues, prior to tax refunds, totaled $18,123.2 million
($676.1 million or 3.9% above the estimate made at the time the budget was
enacted. Expenditures for fiscal 1998 totaled $17,229.8 million (excluding
pooled financing expenditures and net of current year lapses), and represented a
4.5% increase over fiscal 1997 appropriation expenditures. As of August 1, 1998,
Pennsylvania's general obligation bonds were rated AA- by Standard & Poor's, AA
by Fitch and Aa3 by Moody's.
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.
3
<PAGE> 35
These uncertainties could have a significant impact on the prices of the
Municipal Bonds or the Pennsylvania 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. For a discussion of economic and other conditions in Pennsylvania, see
Appendix I -- "Economic and Financial Conditions in Pennsylvania."
The suitability for any particular investor of a purchase of shares of the
Fund will depend upon, among other things, such investor's investment objectives
and such investor's ability to accept the risks of investing in such markets,
including the loss of principal.
DESCRIPTION OF MUNICIPAL BONDS
Set forth below is a detailed description of the Municipal Bonds and
Temporary Investments in which the Fund may invest. Information with respect to
ratings assigned to tax-exempt obligations that the Fund may purchase is set
forth in Appendix II to this Statement of Additional Information. See "How the
Fund Invests" in the Prospectus.
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including the 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, including
certain facilities for the local furnishing of electric energy or gas, sewage
facilities, solid waste disposal facilities and other specialized facilities.
Such obligations are included within the term Municipal Bonds if the interest
paid thereon is 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 or
improvement of privately operated industrial or commercial facilities, may
constitute Municipal Bonds, although the current Federal tax laws place
substantial limitations on the size of such issues. The interest on Municipal
Bonds may bear a fixed rate or be payable at a variable or floating rate. 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. 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 its 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. 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.
IDBs and Private Activity Bonds. 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
4
<PAGE> 36
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 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 generally are 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 be aware of
the risks that such an investment may entail. Continued ability of an entity 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, government regulation and the entity's dependence on revenues for
the operation of the particular facility being financed. The Fund may invest
more than 25% of its total assets in IDBs or private activity bonds.
"Moral Obligation" Bonds. The Fund also may invest in "moral obligation"
bonds. In Pennsylvania, moral obligation financing is a financing arrangement in
which designated officials of the Commonwealth, its departments or agencies
agree, when necessary, to request the General Assembly to appropriate funds as
may be required to make up any deficiency in a debt service reserve fund
established to assume payment of obligations issued under such an arrangement.
The General Assembly is not required to approve such appropriation requests.
Lease Obligations. 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 typically constitute general obligations of
the issuer for which the issuer's unlimited taxing power is pledged, a lease
obligation is frequently backed by the issuer's covenant to budget for,
appropriate and make the payments due under the lease obligation. However,
certain lease obligations contain "non-appropriation" clauses which provide that
the issuer has no obligation to make lease or installment purchase payments in
future years unless money is appropriated for such purpose on a yearly basis.
Although "non-appropriation" lease obligations are secured by the leased
property, disposition of the property in the event of foreclosure might prove
difficult. These securities represent a type of financing that has not yet
developed the depth of marketability associated with more conventional
securities. Certain investments in lease obligations may be illiquid. The Fund
may not invest in illiquid lease obligations if such investments, together with
all other illiquid investments, would exceed 15% of the Fund's total assets. The
Fund may, however, invest without regard to such limitation in lease obligations
which the Manager, pursuant to guidelines which have been adopted by the Board
of Trustees and subject to the supervision of the Board, determines to be
liquid. The Manager will deem lease obligations to be liquid if they are
publicly offered and have received an investment grade rating of Baa or better
by Moody's, or BBB or better by S&P 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.
Index and Inverse Floating Obligations. 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 the 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 variable long-term
interest rates typically
5
<PAGE> 37
decline as short-term market rates increase and increase as short-term market
rates decline. The Fund's return on such 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 limited 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 high 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, however, believes 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.
When-Issued Securities and Delayed Delivery Transactions. 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 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. 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 obligation generally will decrease. The
Fund will maintain a separate account at its custodian bank consisting of cash,
cash equivalents or liquid securities (valued on a daily basis) equal at all
times to the amount of the when-issued commitment.
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 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 illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets.
"High Yield" or "Junk" Bonds. 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
S&P or Fitch or which, in the Manager's judgment, possess similar credit
characteristics. See Appendix II -- "Ratings of Municipal Bonds" for additional
information regarding ratings of debt securities. 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 ratings assigned by S&P,
Moody's or Fitch, the issuer's financial resources, its sensitivity to economic
conditions and trends, its operating history, the quality of its management and
regulatory matters.
High yield securities are considered by S&P, 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. 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. Investments in
high yield securities will be made only when, in the
6
<PAGE> 38
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 generally will not invest in debt securities in the
lowest rating categories (those rated CC or lower by S&P 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 generally are
greater than is the case with higher rated securities. For example, during an
economic downturn or a sustained period of rising interest rates, issuers or
obligors of high yield securities may be more likely to experience financial
stress, especially if such issuers or obligors are highly leveraged. During 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 are generally available on many high yield securities only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales.
It is expected that a significant portion of the high yield securities
acquired by the Fund will be purchased upon issuance, which may involve special
risks because the securities so acquired are new issues. In such instances the
Fund may be a substantial purchaser of the issue and therefore have the
opportunity to participate in structuring the terms of the offering. Although
this may enable the Fund to seek to protect itself against certain of such
risks, the considerations discussed herein would nevertheless remain applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent that it is required to seek recovery upon a default on a portfolio
holding or participate in the restructuring of the obligation.
Yields. 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 maturity of the obligation and the rating of the issue. The ability
of the Fund to achieve its investment objective is also dependent on the
continuing ability of the issuers of the securities 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
7
<PAGE> 39
similar laws and court decisions affecting the rights of creditors generally and
to general equitable principles, which may limit the enforcement of certain
remedies.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to "How the Fund Invests" in the Prospectus. Set forth
below is additional information concerning these transactions.
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. 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. 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. 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. 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 pass
through to shareholders. See "Distributions and Taxes -- Taxes."
Description of Futures Contracts. A futures contract is an agreement
between two parties to buy and sell a security or, in the case of an index-based
futures contract, to make and accept a cash settlement for a set price on a
future date. A majority of transactions in futures contracts, however, do not
result in the actual delivery of the underlying instrument or cash settlement,
but are settled through liquidation, i.e., by entering into an offsetting
transaction. Futures contracts have been designed by boards of trade which have
been designated "contracts markets" by the Commodity Futures Trading Commission
("CFTC").
The purchase or sale of a futures contract differs from the purchase or
sale of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the purchaser
and seller under the futures contract. Subsequent payments to and from the
broker, called "variation margin," are required to be made on a daily basis as
the price of the futures contract fluctuates making the long and short positions
in the futures contract more or less valuable, a process known as "marking to
the market." At any time prior to the settlement date of the futures contract,
the position may be closed out by taking an opposite position that 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 purchaser 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 S&P
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
8
<PAGE> 40
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 nonprofit organization managed by the exchange
membership which is also responsible for handling daily accounting of deposits
or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to U.S. Government
securities, currently there are financial futures contracts based on long-term
U.S. Treasury bonds, Treasury notes, Government National Mortgage Association
("GNMA") Certificates and three-month U.S. Treasury bills. The Fund may purchase
and write call and put options on futures contracts on U.S. Government
securities and purchase and sell Municipal Bond Index futures contracts 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
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.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as a
result of the shortening of maturities. The sale of futures contracts provides
an alternative means of hedging against declines in the value of its investments
in Municipal Bonds. As such values decline, the value of the Fund's positions in
the futures contracts will tend to increase, thus offsetting all or a portion of
the depreciation in the market value of the Fund's Municipal Bond investments
that 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 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 may also 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 upon which
it is based or 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.
9
<PAGE> 41
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 a put option on a
futures contract is analogous to the purchase of a protective put option on
portfolio securities. The Fund will purchase a put option on a futures contract
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 which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit
initial and variation margin pursuant to requirements similar to those
applicable to futures contracts. Premiums received from the writing of an option
will be included in initial margin. The writing of an option on a futures
contract involves risks similar to those relating to futures contracts.
The Trust has received an order from the Commission exempting it from the
provisions of Section 17(f) and Section 18(f) of the Investment Company Act of
1940, as amended (the "Investment Company 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 Fund and commodities brokers with
respect to initial and variation margin. Section 18(f) of the Investment Company
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 Investment Company 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 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.
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
10
<PAGE> 42
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
Municipal Bonds held by the Fund may be greater. Municipal Bond Index futures
contracts were approved for trading in 1986. Trading in such futures contracts
may tend to be less liquid than trading 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.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. In such situations, if the Fund has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. The inability to
close out futures positions also could have an adverse impact on the Fund's
ability to hedge effectively its investments in Municipal Bonds. The 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 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 upon 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. 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. 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 fully reflected in the value of the
option purchased.
DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject
to the limitations set forth above and in the Prospectus under "How the Fund
Invests." The tax-exempt money market securities may
11
<PAGE> 43
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. 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 smaller institutions if such
certificates are fully insured by the FDIC.
VRDOs and Participating VRDOs. 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 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 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.
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, the 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 for Federal income tax purposes.
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
period 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 will be ultimately responsible for
such determinations.
The Temporary Investments, VRDOs and Participating VRDOs in which the Fund
may invest 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 determined by Moody's), SP-1 through SP-2 for
notes and A-1 through A-3 for VRDOs and commercial paper (as determined by S&P),
or F-1 through F-3 for notes, VRDOs and commercial paper (as determined by
Fitch). Temporary Investments, if not rated, must be of comparable quality in
the opinion of the Manager. 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.
12
<PAGE> 44
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 primary dealer or an affiliate
thereof, in U.S. Government securities. Under such agreements, the bank or
primary dealer or an affiliate thereof 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 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 shall be dependent upon 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 all other illiquid
investments, 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. The treatment of purchase and sales contracts is less
certain.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental investment
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 Investment Company 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, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).
(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 that
invest in real estate or interests therein.
(4) Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
(5) Issue senior securities to the extent such issuance would violate
applicable law.
(6) Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company 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
13
<PAGE> 45
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 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.
In addition, the Fund has adopted non-fundamental investment restrictions
that may be changed by the Board of Trustees without a vote of the Fund's
shareholders. Under the non-fundamental investment restrictions, the Fund may
not:
(a) Purchase securities of other investment companies, except to the
extent 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)(1)(F) or
(G) (the "fund of funds" provisions) of the Investment Company 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 that 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 that mature
within seven days or securities, that 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,
and then only from banks as a temporary measure for extraordinary or
emergency purposes.
In addition, to comply with 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 with the Manager, the Fund is
prohibited from engaging in certain transactions involving Merrill Lynch or its
affiliates except pursuant to an exemptive order under the Investment Company
Act. See "Portfolio Transactions." Without such an exemptive order the Fund
would be prohibited from engaging in portfolio transactions with Merrill Lynch
or any of its affiliates acting as principal.
14
<PAGE> 46
PORTFOLIO TURNOVER
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 the Manager. As a result of the investment policies described
herein, the Fund's portfolio turnover rate may be higher than that of other
investment companies; however, it is extremely difficult to predict portfolio
turnover rates with any degree of accuracy. Higher portfolio turnover may
contribute to higher transaction costs in the form of dealer spreads and
brokerage commissions which are borne directly by the Fund. High portfolio
turnover may also result in negative tax consequences, such as an increase in
capital gains dividends or in ordinary income dividends of accrued market
discount. See "Distributions and Taxes -- Taxes." 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.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
The Trustees of the Trust consist of six individuals, five of whom are not
"interested persons" of the Trust as defined in the Investment Company Act (the
"non-interested Trustees"). The Trustees are responsible for the overall
supervision of the operations of the Trust and perform the various duties
imposed on the directors or trustees of investment companies by the Investment
Company Act.
Information about the Trustees, executive officers and the portfolio
manager of the Trust, including their ages and their principal occupations for
at least the last five years, is set forth below. Unless otherwise noted, the
address of each Trustee, executive officer and the portfolio manager is P.O. Box
9011, Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL (66) -- President and Trustee(1)(2) -- Chairman of the
Manager and Merrill Lynch Asset Management, L.P. ("MLAM") (which terms as used
herein include their corporate predecessors) since 1997; President of the
Manager and MLAM from 1977 to 1997; Chairman of Princeton Services, Inc.
("Princeton Services") since 1997 and Director thereof since 1993; President of
Princeton Services from 1993 to 1997; Executive Vice President of Merrill Lynch
& Co., Inc. ("ML & Co.") since 1990.
JAMES H. BODURTHA (54) -- Trustee(2)(3) -- 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 (59) -- Trustee(2)(3) -- 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 thereof 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 Corporation from 1991 to 1995;
Overseer, Center for Naval Analyses from 1983 to 1993; Limited Partner,
Hypertech LP since 1996.
ROBERT R. MARTIN (71) -- Trustee(2)(3) -- 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.
15
<PAGE> 47
JOSEPH L. MAY (69) -- Trustee(2)(3) -- 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 (46) -- Trustee(2)(3) -- 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 (58) -- 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 Princeton Funds
Distributor, Inc. ("PFD") since 1986 and Director thereof since 1991; President
of Princeton Administrators, L.P. since 1988.
VINCENT R. GIORDANO (54) -- 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 (47) -- 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 (62) -- Vice President and Portfolio Manager of the
Fund(1)(2) -- Vice President of MLAM since 1989.
DONALD C. BURKE (38) -- 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 (49) -- 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 PFD since 1984 and Vice
President thereof since 1981.
ROBERT E. PUTNEY, III (38) -- Secretary(1)(2) -- Director (Legal Advisory)
of MLAM and Princeton Administrators, L.P. since 1997; Vice President of MLAM
from 1994 to 1997; Vice President of Princeton Administrators, L.P. from 1996 to
1997; Attorney with MLAM from 1991 to 1994.
- ---------------
(1) Interested person, as defined in the Investment Company Act, of the Trust.
(2) Such Trustee or officer is a director, trustee or officer of certain other
investment companies for which FAM or MLAM acts as the investment adviser or
manager.
(3) Member of the Trust's Audit and Nominating Committee, which is responsible
for the selection of the independent auditors and the selection and
nomination of non-interested Trustees.
As of the date of this Statement of Additional Information, 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.
COMPENSATION OF TRUSTEES
The Trust pays each non-interested 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-interested
Trustees, a fee of $2,000 per year plus $500 per Committee meeting attended. The
Trust reimburses each non-interested 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.
The following table shows the compensation earned by the non-interested
Trustees for the fiscal year ended July 31, 1998 and the aggregate compensation
paid to them from all registered investment companies
16
<PAGE> 48
advised by the Manager and its affiliate, MLAM ("MLAM/FAM-advised funds"), for
the calendar year ended December 31, 1997.
<TABLE>
<CAPTION>
AGGREGATE
PENSION OR ESTIMATED COMPENSATION FROM
RETIREMENT BENEFITS ANNUAL TRUST AND OTHER
POSITION WITH COMPENSATION ACCRUED AS PART OF BENEFITS UPON MLAM/FAM-
NAME TRUST FROM FUND FUND EXPENSE RETIREMENT ADVISED FUNDS(1)
- ---- ------------- ------------ ------------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
James H. Bodurtha..... Trustee $1,573 None None $148,500
Herbert I. London..... Trustee $1,573 None None $148,500
Robert R. Martin...... Trustee $1,573 None None $148,500
Joseph L. May......... Trustee $1,573 None None $148,500
Andre F. Perold....... Trustee $1,573 None None $148,500
</TABLE>
- ---------------
(1) The Trustees serve on the boards of MLAM/FAM-advised funds as follows: Mr.
Bodurtha (23 registered investment companies consisting of 41 portfolios);
Mr. London (23 registered investment companies consisting of 41 portfolios);
Mr. Martin (23 registered investment companies consisting of 41 portfolios);
Mr. May (23 registered investment companies consisting of 41 portfolios);
and Mr. Perold (23 registered investment companies consisting of 41
portfolios).
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.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Management Services. The Manager provides the Fund with investment
advisory and management services. Subject to the supervision 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 Trust and the Fund.
Management Fee. The Trust has entered into a management agreement on
behalf of the Fund with the Manager (the "Management Agreement"), pursuant to
which the Manager receives for its services to the Fund monthly compensation 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. The table below sets forth information about the total management
fees paid by the Fund to the Manager for the periods indicated.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JULY 31, MANAGEMENT FEE
-------------------------- --------------
<S> <C>
1998.............................. $773,590
1997.............................. $798,487
1996.............................. $845,927
</TABLE>
Payment of Fund Expenses. 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 fees 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
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 Merrill Lynch Funds Distributor, a division of PFD (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
17
<PAGE> 49
of the respective Series include fees and expenses of non-interested Trustees,
state franchise taxes, costs of printing proxies and other expenses relating to
shareholder meetings and other expenses properly payable by the Trust. The
organizational expenses of the Trust were paid by the Trust, and if additional
Series are added to the Trust, the organizational expenses will be allocated
among the Series 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 Trust
by the Manager and the Trust reimburses the Manager for its costs in connection
with such services. For the fiscal years 1996, 1997 and 1998, the Fund
reimbursed the Manager $62,902, $84,022 and $57,018, 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 the
account maintenance and distribution of Class B and Class C shares will be
financed by the Trust pursuant to the Distribution Plans in compliance with Rule
12b-1 under the Investment Company Act. See "Purchase of Shares -- Distribution
Plans." Reference is made to "Management of the Fund" in the Prospectus for
certain information concerning the management and advisory arrangements of the
Trust.
Organization of the Manager. The Manager is a limited partnership, the
partners of which are ML & Co., a financial services holding company and the
parent of Merrill Lynch, and Princeton Services. ML & Co. and Princeton Services
are "controlling persons" of the Manager as defined under the Investment Company
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 Investment Company 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 or by
vote of the shareholders of the Fund.
Transfer Agency Services. Financial Data Services, Inc. (the "Transfer
Agent"), 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
a 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 Agency 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.
Distribution Expenses. 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 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.
18
<PAGE> 50
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the Investment Company Act which incorporates the Code of Ethics of the
Manager (together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Manager and, as described below,
impose additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager pre-clear any personal
securities investment (with limited exceptions, such as government securities).
The pre-clearance 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 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).
PURCHASE OF SHARES
Reference is made to "How to Buy, Sell, Transfer and Exchange Shares" in
the Prospectus.
The Fund offers 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 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 (also known as service 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 contingent deferred sales charges ("CDSCs"), distribution fees
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 do 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 are calculated in the same
manner at the same time and 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 Merrill Lynch Select Pricing(SM) System is used by more than 50
registered investment companies advised by MLAM or FAM. Funds advised by MLAM or
FAM that utilize the Merrill Lynch Select Pricing(SM) System are referred to
herein as "Select Pricing Funds."
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Neither the Distributor nor the dealers are permitted to withhold
placing orders to benefit themselves by a price change. Merrill Lynch may charge
its customers a processing fee (presently $5.35) to confirm a sale of shares to
such customers. Purchases made directly through the Transfer Agent are not
subject to the processing fee.
19
<PAGE> 51
INITIAL SALES CHARGE ALTERNATIVES -- CLASS A AND CLASS D SHARES
Investors who prefer an initial sales charge alternative may elect to
purchase Class D shares or, if an eligible investor, Class A shares. Investors
choosing the initial sales charge alternative who are eligible to purchase Class
A shares should purchase Class A shares rather than Class D shares because there
is an account maintenance fee imposed on Class D shares. Investors qualifying
for significantly 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 deferred sales charges imposed
in connection with purchases of Class B or Class C shares. Investors not
qualifying for reduced initial sales charges who expect to maintain their
investment for an extended period of time also may elect to purchase Class A or
Class D shares, because over time the accumulated ongoing account maintenance
and distribution fees on Class B or Class C shares may exceed the initial sales
charges and, in the case of Class D shares, the account maintenance fee.
Although some investors who previously purchased Class A shares may no longer be
eligible to purchase Class A shares of other Select Pricing 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 which may qualify the
investor for a reduced initial sales charge 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.
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 Investment Company 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.
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
who currently own Class A shares are entitled to purchase additional Class A
shares of the Fund in that account. Class A shares are available at net asset
value to corporate warranty insurance reserve fund programs provided that the
program has $3 million or more initially invested in Select Pricing Funds. Also
eligible to purchase Class A shares at net asset value are participants in
certain investment programs including TMA(SM) 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
certain 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. 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 are met. In addition, Class A shares of the Fund and certain
other Select Pricing Funds are offered at net asset value to shareholders of
Merrill Lynch Senior Floating Rate Fund, Inc. and, if certain conditions 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
Select Pricing Funds.
20
<PAGE> 52
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.
Class A and Class D Sales Charge Information
CLASS A SHARES
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
For the Fiscal Year Gross Sales Sales Charges Sales Charges CDSCs Received on
Ended Charges Retained by Paid to Redemption of
July 31, Collected Distributor Merrill Lynch Load-Waived Shares
- ---------------------- ------------- --------------- --------------- --------------------
<S> <C> <C> <C> <C>
1998 $ 8,160 $ 894 $ 7,266 $0
1997 $ 8,982 $ 809 $ 8,173 $0
1996 $13,189 $1,089 $12,100 $0
</TABLE>
CLASS D SHARES
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
For the Fiscal Year Gross Sales Sales Charges Sales Charges CDSCs Received on
Ended Charges Retained by Paid to Redemption of
July 31, Collected Distributor Merrill Lynch Load-Waived Shares
- ---------------------- ------------- --------------- --------------- --------------------
<S> <C> <C> <C> <C>
1998 $16,305 $2,023 $14,282 $0
1997 $ 2,793 $ 225 $ 2,568 $0
1996 $16,399 $1,544 $14,855 $0
</TABLE>
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.
Reduced Initial Sales Charges
Reinvested Dividends and Capital Gains. 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.
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 any other Select Pricing 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 Intent. 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
Select Pricing Funds made within a 13-month period starting with the first
purchase pursuant to a Letter of Intent. The Letter of Intent is available only
to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit plans
for which Merrill Lynch provides plan participant recordkeeping services. The
Letter of Intent 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 Intent may be included under a
subsequent Letter of Intent 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 Select Pricing
Funds presently held, at cost or maximum offering price (whichever is higher),
on the date of the first purchase
21
<PAGE> 53
under the Letter of Intent, 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 Intent (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 5.0% 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 Intent must be at least 5.0% 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 the further reduced percentage sales charge that would be
applicable to a single purchase equal to the total dollar value of the Class A
or Class D shares then being purchased under such Letter, but there will be no
retroactive reduction of the sales charge 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 Intent will be deducted from
the total purchases made under such Letter. An exchange from the Summit Cash
Reserves Fund ("Summit") into the Fund that creates a sales charge will count
toward completing a new or existing Letter of Intent from the Fund.
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.
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 investment for such accounts is $500, except that the initial minimum
investment for shares purchased for such accounts pursuant to the Automatic
Investment Program is $50.
Purchase Privilege of Certain Persons. Trustees of the Trust, members of
the Boards of other MLAM-advised funds, ML & Co. and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes MLAM, FAM
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 that 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
shares 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 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 that has a business relationship with a Merrill
Lynch Financial Consultant and that 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 that has a business relationship with a Merrill Lynch
Financial Consultant and that 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
22
<PAGE> 54
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.
Closed-End Fund Investment Option. Class A shares of the Fund and certain
other Select Pricing Funds ("Eligible Class A Shares") are offered at net asset
value to shareholders of certain closed-end funds advised by FAM or MLAM who
purchased such closed-end fund shares prior to October 21, 1994 (the date the
Merrill Lynch Select Pricing(SM) 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 Select Pricing 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
Eligible 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.
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, which
are not restricted as to transfer either by law or liquidity of market (except
that the Fund may acquire through such transactions restricted or illiquid
securities to the extent the Fund does not exceed the applicable limits on
acquisition of such securities set forth under "Investment Objective and
Policies" herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
in obtaining such investments.
23
<PAGE> 55
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 Select Pricing Funds.
Because no initial sales charges are deducted at the time of the 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
the reduction in initial sales charges. Both Class B and Class C shares are
subject to ongoing account maintenance fees and distribution 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.
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. See "Pricing of Shares -- Determination of Net Asset Value" below.
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. In determining whether a CDSC is applicable to a
redemption, the calculation will be determined in the manner that results in the
lowest applicable rate being charged. 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. 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. 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.
The following table sets forth the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A PERCENTAGE
OF DOLLAR AMOUNT
YEAR SINCE PURCHASE PAYMENT MADE SUBJECT TO CHARGE
-------------------------------- --------------------
<S> <C>
0-1............................................... 4.0%
1-2............................................... 3.0%
2-3............................................... 2.0%
3-4............................................... 1.0%
4 and thereafter.................................. None
</TABLE>
To provide an example, assume an investor purchased 100 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 or her 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 charge 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 rate in the third year after purchase).
The Class B CDSC is waived on redemptions of shares in certain
circumstances, including 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. The Class B
CDSC also is waived for any Class B shares that are purchased within
24
<PAGE> 56
qualifying Employee AccessSM Accounts. The terms of the CDSC may be modified in
connection with certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
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 value 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.
Shareholders should consult their own tax advisors regarding the state and local
tax consequences (including the Pennsylvania state and local tax consequences)
relating to the conversion of Class B shares into Class D shares, or any other
exchange of shares.
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 the 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.
In general, Class B shares of equity Select Pricing Funds will convert
approximately eight years after initial purchase and Class B shares of taxable
and tax-exempt fixed income Select Pricing Funds will convert approximately ten
years after initial purchase. If, during the Conversion Period, a shareholder
exchanges Class B shares with an eight-year Conversion Period for Class B shares
with a ten-year Conversion Period, or vice versa, the Conversion Period
applicable to the Class B shares acquired in the exchange will apply and the
holding period for the shares exchanged will be tacked on to the holding period
for the shares acquired. The conversion period also may be modified for
investors that participate in certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
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.
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.
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. 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. 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.
It will be assumed that the redemption is first of shares held for over one year
or shares acquired pursuant to reinvestment of dividends or distributions and
then of shares held longest during the one-year period. The charge will not be
applied to dollar amounts representing an increase in the net asset value since
the time of purchase. A transfer of shares from a shareholder's account to
another account will be assumed to be made in the same order as a redemption.
The Class C CDSC may be waived in connection with certain fee-based programs.
See "Shareholder Services -- Fee-Based Programs."
25
<PAGE> 57
Class B and Class C Sales Charge Information
<TABLE>
<CAPTION>
CLASS B SHARES*
- ----------------------------------------------------------------------------
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended July 31, by Distributor Merrill Lynch
- ------------------------ ------------------------ ------------------------
<S> <C> <C>
1998 $103,979 $103,979
1997 $139,750 $139,750
1996 $195,896 $195,896
</TABLE>
* Additional Class B CDSCs payable to the Distributor
with respect to the fiscal years ended July 31, 1997
and 1998 may have been waived or converted to a
contingent obligation in connection with a
shareholder's participation in certain fee-based
programs.
<TABLE>
<CAPTION>
CLASS C SHARES
- ----------------------------------------------------------------------------
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended July 31, by Distributor Merrill Lynch
- ------------------------ ------------------------ ------------------------
<S> <C> <C>
1998 $1,865 $1,865
1997 $1,630 $1,630
1996 $2,273 $2,273
</TABLE>
Merrill Lynch compensates its Financial Consultants for selling Class B and
Class C shares at the time of purchase from its own funds. Proceeds from the
CDSC and the distribution fee are paid to the Distributor and are used in whole
or in part by the Distributor to defray the expenses of dealers (including
Merrill Lynch) related to providing distribution-related services to the Fund in
connection with the sale of the Class B and Class C shares, such as the payment
of compensation to financial consultants for selling Class B and Class C shares
from the dealer's own funds. The combination of the CDSC and the ongoing
distribution fee facilitates the ability of the Fund to sell the Class B and
Class C shares without a sales charge being deducted at the time of purchase.
See "Distribution Plans" below. 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.
DISTRIBUTION PLANS
Reference is made to "Fees and Expenses" 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 Investment Company Act (each
a "Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes.
The Distribution Plans for Class B, Class C and Class D shares each
provides 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 with respect to Class B, Class C
and Class D shares. Each of those classes has exclusive voting rights with
respect to the 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).
The Distribution Plans for Class B and Class C shares each provides 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 rates 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
26
<PAGE> 58
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.
The Fund's Distribution Plans are subject to the provisions of Rule 12b-1
under the Investment Company Act. 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 each
related class of shareholders. Each Distribution Plan further provides that, so
long as the Distribution Plan remains in effect, the selection and nomination of
non-interested Trustees shall be committed to the discretion of the non-
interested Trustees then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the non-interested 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 non-interested 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 of the
related class of shareholders and all material amendments are required to be
approved by the vote of Trustees, including a majority of the non-interested
Trustees who have no direct or indirect financial interest in the Distribution
Plan, cast in person at a meeting called for that purpose. Rule 12b-1 further
requires that the Fund preserve copies of the Distribution Plan and any report
made pursuant to such plan for a period of not less than six years from the date
of the Distribution Plan or such report, the first two years in an easily
accessible place.
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. Payments under the Distribution Plans 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 their
deliberations as to the continuance of the Class B and Class C Distribution
Plans annually, as of December 31 of each year, on a "fully allocated accrual"
basis and quarterly on a "direct expense and revenue/cash" basis. On the fully
allocated accrual basis, revenues consist of the account maintenance fees,
distribution fees, the CDSCs and certain other related revenues, and expenses
consist of financial consultant compensation, branch office and regional
operation center selling and transaction processing expenses, advertising, sales
promotion and marketing expenses, corporate overhead and interest expense. On
the direct expense and revenue/cash basis, revenues consist of the account
maintenance fees, distribution fees and CDSCs and the expenses consist of
financial consultant compensation.
As of December 31, 1997, the last date for which fully allocated accrual
data is available, the fully allocated accrual expenses incurred by the
Distributor and Merrill Lynch for the period since the commencement of
operations of Class B shares exceeded the fully allocated accrual revenues by
approximately $1,777,000 (1.68% of Class B net assets at that date). As of July
31, 1998, direct cash revenues for the period since the commencement of
operations of Class B shares exceeded direct cash expenses by $1,975,650 (1.91%
of Class B net assets at that date). As of December 31, 1997, 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 the fully
allocated revenues by approximately $34,000 (0.49% of Class C net assets at that
date). As of July 31, 1998, direct cash revenues for the period since the
commencement of operations of Class C shares exceeded direct cash expenses by
$58,030 (0.84% of Class C net assets at that date).
For the fiscal year ended July 31, 1998, the Fund paid the Distributor
$529,371 pursuant to the Class B Distribution Plan (based on average daily net
assets subject to such Class B Distribution Plan of approximately $105.3
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, 1998, the Fund paid the
Distributor $41,048 pursuant to the Class C Distribution Plan (based on average
daily net assets subject to such Class C Distribution Plan of approximately $6.8
million), all of which was paid to
27
<PAGE> 59
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, 1998, the Fund paid the Distributor $6,803 pursuant to the Class
D Distribution Plan (based on average daily net assets subject to such Class D
Distribution Plan of approximately $6.8 million), all of which was paid to
Merrill Lynch for providing account maintenance activities in connection with
Class D shares.
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 Class C shares but not the account maintenance
fee. The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of eligible
gross sales of Class B shares and Class C shares, computed separately (defined
to exclude shares issued pursuant to dividend reinvestments and exchanges), plus
(2) interest on the unpaid balance for the respective class, computed
separately, at the prime rate plus 1% (the unpaid balance being the maximum
amount payable minus amounts received from the payment of the distribution fee
and the CDSC). In connection with the Class B shares, the Distributor has
voluntarily agreed to waive interest charges on the unpaid balance in excess of
0.50% of eligible gross sales. Consequently, the maximum amount payable to the
Distributor (referred to as the "voluntary maximum") in connection with the
Class B shares is 6.75% of eligible gross sales. The Distributor retains the
right to stop waiving the interest charges at any time. To the extent payments
would exceed the voluntary maximum, the Fund will not make further payments of
the distribution fee with respect to Class B shares and any CDSCs will be paid
to the Fund rather than to the Distributor; however, the Fund will continue to
make payments of the account maintenance fee. In certain circumstances the
amount payable pursuant to the voluntary maximum may exceed the amount payable
under the NASD formula. In such circumstances payment in excess of the amount
payable under the NASD formula will not be made.
The following table sets forth comparative information as of July 31, 1998
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, 1998
-------------------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE AMOUNTS FEE AT
ELIGIBLE ALLOWABLE INTEREST ON MAXIMUM PREVIOUSLY AGGREGATE CURRENT NET
GROSS AGGREGATE UNPAID AMOUNT PAID TO UNPAID ASSET
SALES(1) SALES CHARGE 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, 1998
Under NASD Rule as Adopted.......... $172,124 $10,758 $4,957 $15,715 $3,071 $12,644 $258
Under Distributor's Voluntary
Waiver............................ $172,124 $10,758 $ 861 $11,619 $3,071 $ 8,548 $258
CLASS C SHARES, FOR THE PERIOD
OCTOBER 21, 1994 (COMMENCEMENT OF
OPERATIONS) TO JULY 31, 1998
Under NASD Rule as Adopted.......... $ 9,016 $ 564 $ 109 $ 673 $ 64 $ 609 $ 24
</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 "What
are the Fund's fees and expenses?" 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 MFASM) 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.
28
<PAGE> 60
(footnotes continued)
(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 "How to Buy, Sell, Transfer and Exchange Shares" in
the Prospectus.
The Fund 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 in
part on the market value of the securities held by the Fund at such time.
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 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.
REDEMPTION
A shareholder wishing to redeem shares held with the Transfer Agent may do
so without charge by tendering the shares directly to the Transfer Agent at
Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289.
Redemption requests delivered other than by mail should be delivered to
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 Fund. 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 requests 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 "Exchange Act"), 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 Fund may be requested to redeem 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 Fund may delay or cause to be delayed the
mailing of a redemption check until such time as it has assured itself that good
payment (e.g., cash, Federal funds or certified check drawn on a United States
bank) has been collected for the purchase of such Fund shares, which will not
exceed 10 days.
REPURCHASE
The Fund also will repurchase Fund shares through a shareholder's listed
securities dealer. The Fund 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
29
<PAGE> 61
repurchase is received by the dealer prior to the regular close of business on
the NYSE (generally, 4:00 p.m., Eastern time) on the day received, and such
request is received by the Fund 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 Fund not later than
30 minutes after the close of business on the NYSE, in order to obtain that
day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (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 Fund. 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 Transfer Agent on
accounts held at the Transfer Agent are not subject to the processing fee. The
Fund 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 Fund may redeem Fund shares as set forth above.
REINSTATEMENT PRIVILEGE -- CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares of the Fund
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.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "How Shares are Priced" in the Prospectus.
The net asset value of the shares of all classes of the Fund is determined
by the Manager once daily Monday through Friday as of 15 minutes after the close
of business on the NYSE on each day the NYSE is open for trading. The NYSE
generally closes at 4:00 p.m., Eastern time. The NYSE is not open for trading 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.
The net asset value is computed by dividing 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 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 the Class D shares; moreover, the per share net asset
value of the Class B and Class C shares generally will be lower than the per
share net asset value of Class D shares reflecting the daily expense accruals of
the distribution fees 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 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.
30
<PAGE> 62
The Municipal Bonds and other portfolio securities in which the Fund
invests are traded primarily in over-the-counter ("OTC") municipal bond and
money markets and are valued at the last available bid price for long positions
and at the last available ask price for short positions 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.
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, 1998 is set forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
----------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Net Assets................................... $20,612,627 $103,261,489 $6,927,947 $8,142,501
=========== ============ ========== ==========
Number of Shares Outstanding................. 1,788,517 8,959,748 601,073 705,792
=========== ============ ========== ==========
Net Asset Value Per Share (net assets divided
by number of shares outstanding)........... $ 11.52 $ 11.53 $ 11.53 $ 11.54
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............................... $ 12.00 $ 11.53 $ 11.53 $ 12.02
=========== ============ ========== ==========
</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 -- Merrill Lynch Select Pricing(SM) System" and "-- Deferred Sales
Charge Alternatives -- Contingent Deferred Sales Charges -- Class B Shares"
and "-- Contingent Deferred Sales Charges -- Class C Shares" herein.
PORTFOLIO TRANSACTIONS
TRANSACTIONS IN PORTFOLIO SECURITIES
Subject to policies established by the Trustees, the Manager is primarily
responsible for the execution of the Fund's 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. 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 results in
conducting portfolio transactions for the Fund, taking into account such factors
as price (including the applicable dealer spread or commission), the size, type
and difficulty of the transaction involved, the firm's general execution and
operations facilities and the firm's risk in positioning the securities
involved. The portfolio securities of the Fund generally are traded on a
principal 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. While reasonable
competitive spreads or commissions are sought, the Fund will not necessarily be
paying the lowest spread or commission available. Transactions with respect to
the securities of
31
<PAGE> 63
small and emerging growth companies in which the Fund may invest may involve
specialized services on the part of the broker or dealer and thereby entail
higher commissions or spreads than would be the case with transactions involving
more widely traded securities.
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 expense of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information.
Supplemental investment research obtained from such dealers might be used by the
Manager in servicing all of its accounts and all such research might not be used
by the Manager in connection with the Fund. 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.
Because of the affiliation of Merrill Lynch with the Manager, the Fund is
prohibited from engaging in certain transactions involving such firm or its
affiliates except pursuant to an exemptive order under the Investment Company
Act. Included among such restricted transactions are purchases from or sales to
Merrill Lynch of securities in transactions in which it acts as principal. Under
an exemptive order, the Trust may effect principal transactions with Merrill
Lynch in high quality, short-term, tax-exempt securities subject to conditions
set forth in such order. Information regarding transactions executed pursuant to
the exemptive order is set forth in the following table:
<TABLE>
<CAPTION>
APPROXIMATE AGGREGATE
FOR THE FISCAL YEAR NUMBER OF MARKET VALUE OF
ENDED JULY 31, TRANSACTIONS TRANSACTIONS
------------------- ------------ ---------------------
<S> <C> <C>
1998.......................... 0 --
1997.......................... 0 --
1996.......................... 1 $200,000
</TABLE>
An affiliated person 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 Investment Company 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 Investment Company 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 an issue of Municipal Bonds purchased by the
Fund, the amount of Municipal Bonds that may be purchased in any one issue and
the assets of the Fund that may be invested in a particular issue.
Section 11(a) of the Exchange Act 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
32
<PAGE> 64
aggregate compensation will be provided to 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 MLAM.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Manager or an affiliate when one or
more clients of the Manager or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the Manager
or an affiliate acts as manager, 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 an affiliate 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.
SHAREHOLDER SERVICES
The Fund 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 and
instructions as to how to participate in the various services or plans, or how
to change options with respect thereto, can be obtained from the Fund, 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 capital gain distributions. The statements will also show any other activity
in the account since the preceding statement. Shareholders will also receive
separate confirmations for each purchase or sale transaction other than
automatic investment purchases and the reinvestment of ordinary income dividends
and capital gains distributions. A shareholder with an account held at the
Transfer Agent may make additions to his or her Investment Account at any time
by mailing a check directly to the Transfer Agent. A shareholder may also
maintain an account through Merrill Lynch. Upon the transfer of shares out of a
Merrill Lynch brokerage account, an Investment Account in the transferring
shareholder's name may be opened automatically at the Transfer Agent.
Share certificates are issued only for full shares and only upon the
specific request of a shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be aware
that, if the firm to which the Class A or Class D shares are to be transferred
will not take delivery of shares of the Fund, a shareholder either must redeem
the Class A or Class D shares (paying any applicable CDSC) so that the cash
proceeds can be transferred to the account at the new firm or 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 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 in the new brokerage firm's name.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other MLAM-advised mutual funds, including Select Pricing
Funds and Summit Cash Reserves Fund
33
<PAGE> 65
("Summit"), a MLAM-advised money market mutual fund specifically designated as
available for exchange by holders of Class A, Class B, Class C and Class D
shares of Select Pricing Funds. 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. Before
effecting an exchange, shareholders should obtain a currently effective
prospectus of the fund into which the exchange is to be 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.
Exchanges of Class A and Class D Shares. Class A shareholders may exchange
Class A shares of the Fund for Class A shares of a second Select Pricing 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 Select
Pricing 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 Select Pricing 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 D shares are
exchangeable with shares of the same class of other Select Pricing Funds.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of other Select Pricing Funds or
for Class A shares of Summit, a money market 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 or 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, respectively, of the other
funds with a reduced sales charge or without a sales charge.
Exchanges of Class B and Class C Shares. Each Select Pricing Fund with
Class B or Class C shares outstanding ("outstanding Class B or Class C shares")
offers to exchange its Class B or Class C shares for Class B or Class C shares,
respectively (or, in the case of Summit, for Class B shares), of another Select
Pricing Fund or for Class B shares of Summit ("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 or Class C shares of the fund from which the exchange has been
made. For purposes of computing the CDSC 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 or Class C 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 Fund
Class B shares to the three-
34
<PAGE> 66
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.
Exchanges for Shares of a Money Market Fund. Class A and Class D shares
will be exchangeable for Class A shares of Summit and Class B and Class C shares
will be exchangeable for Class B shares of Summit. Class A shares of Summit have
an exchange privilege back into Class A or Class D shares of Select Pricing
Funds; Class B shares of Summit have an exchange privilege back into Class B or
Class C shares of Select Pricing Funds. The period of time that Class B shares
of Summit are held will count toward satisfaction of the holding period
requirement for purposes of reducing any CDSC and toward satisfaction of any
conversion period with respect to Class B shares. Class B shares of Summit will
be subject to a distribution fee at an annual rate of 0.75% of average daily net
assets of such Class B shares. This exchange privilege does not apply with
respect to certain Merrill Lynch fee-based programs, for which alternative
exchange arrangements may exist. Please see your Merrill Lynch Financial
Consultant for further information.
Exercise of the Exchange Privilege. 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 Select Pricing 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 in
accordance with the rules of the Commission. The Fund reserves the right to
limit the number of times an investor may exercise the exchange privilege.
Certain funds may suspend the continuous offering of their shares to the general
public at any time and may thereafter resume such offering from time to time.
The exchange privilege is available only to U.S. shareholders in states where
the exchange legally may be made. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
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
1-800-MER-FUND or 1-800-637-3863.
AUTOMATED 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) or
Class B, Class C or Class D shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities dealer,
or by mail directly to the Transfer Agent, acting as agent for such securities
dealer. Voluntary accumulation also can be made through a service known as the
Fund's Automatic Investment Plan. The Fund would be authorized, on a regular
basis, to provide systematic additions to the Investment Account of such
shareholder through charges of $50 or more to the regular bank account of the
shareholder by either pre-authorized checks or automated
35
<PAGE> 67
clearing house debits. Alternatively, an investor that maintains a CMA(R) or
CBA(R) account may arrange to have periodic investments, of amounts of $100 or
more made in the Fund through the CMA(R) or CBA(R) Automated Investment Program
from his or her CMA(R) or CBA(R) account or from certain related accounts.
AUTOMATIC DIVIDEND PROGRAM
Unless specific instructions are given as to the method of payment,
dividends and capital gains distributions will be automatically reinvested,
without sales charge, in additional full and fractional 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 NYSE on the monthly payment date for such dividends and
distributions. No CDSC will be imposed upon redemption of shares issued as a
result of the automatic reinvestment of dividends or capital gains
distributions.
Shareholders may, at any time, by written notification to Merrill Lynch if
their account is maintained with Merrill Lynch, or by written notification or by
telephone (1-800-MER-FUND) to the Transfer Agent, if their 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 shares of
the Fund or vice versa (provided that, in the event that a payment on an account
maintained at the Transfer Agent would amount to $10.00 or less, a shareholder
will not receive such payment in cash and such payment will automatically be
reinvested in additional shares). Commencing ten days after the receipt by the
Transfer Agent of such notice, those instructions will be effected. 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 checks. Cash payments can also be directly deposited to the
shareholder's bank account.
SYSTEMATIC REDEMPTION PROGRAM
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders that 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.
At the time of each withdrawal payment, sufficient Class A, Class B, Class
C or Class D shares are redeemed from those on deposit in the shareholder's
account to provide the withdrawal payment specified by the shareholder. The
shareholder may specify the dollar amount and the class of shares to be
redeemed. With respect to shareholders who hold accounts directly at the
Transfer Agent, 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., Eastern
time) on the 24th day of each month or the 24th day of the last month of each
quarter, whichever is applicable. With respect to shareholders who hold accounts
with their broker-dealer, redemptions will be made at net asset value as
determined 15 minutes after the close of business on the NYSE on the first,
second, third or fourth Monday of each month or the first, second, third or
fourth Monday 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 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 Fund shares. A
shareholder's Systematic Withdrawal Plan may be terminated at any time, without
charge or penalty, by the shareholder, the Fund, the Transfer Agent or the
Distributor.
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."
Where the systematic withdrawal plan is applied to
36
<PAGE> 68
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. 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. 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 Fund will not knowingly accept purchase orders for shares of the Fund from
investors that maintain a Systematic Withdrawal Plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Automatic 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(R) or
CBA(R) Account may elect to have shares redeemed on a monthly, bimonthly,
quarterly, semiannual or annual basis through the CMA(R) or CBA(R) 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(R) or CBA(R) Systematic Redemption Program is not available if Fund shares
are being purchased within the account pursuant to the Automated Investment
Program. For more information on the CMA(R) or CBA(R) Systematic Redemption
Program, eligible shareholders should contact their Financial Consultant.
DISTRIBUTIONS AND TAXES
DIVIDENDS AND 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, the NYSE closes at 4:00 p.m.,
Eastern 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 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 of the Fund 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 "Pricing of Shares -- 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.
37
<PAGE> 69
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.
As discussed in "General Information -- Description of Shares," 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. Losses in
one Series do not offset gains in another Series, and the requirements (other
than certain organizational requirements) for qualifying for RIC status will be
determined 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 the Fund's
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 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. 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 upon the gross income that is
allocable to the 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.
Exempt-interest dividends 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 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 (the Pennsylvania personal income tax is a tax on
specified classes of income, so that expenses and deductions are generally not
permitted). 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.
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.
38
<PAGE> 70
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.
As a result of a pronouncement by the Pennsylvania Department of Revenue,
an investment in the Pennsylvania Fund by a corporate shareholder will
apparently qualify as an exempt asset for purposes of the single asset
apportionment fraction available in computing the Pennsylvania capital
stock/foreign franchise tax to the extent that the portfolio securities of the
Pennsylvania Fund comprise investments in Pennsylvania and/or United States
Government Securities that would be exempt assets if owned directly by the
corporation. 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 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 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 created additional
categories of capital gains taxable at different rates. Additional legislation
eliminates the highest 28% category for most sales of capital assets occurring
after December 31, 1997. Generally 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 gains from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated for
Federal income tax purposes as ordinary income rather than capital gain. This
rule may increase the amount of ordinary income dividends received by
shareholders. Distributions in excess of the Fund's earnings and profits will
first reduce the adjusted tax basis of a holder's shares and, after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Any loss upon the sale
or exchange of Fund shares held for six months or less will be disallowed to the
extent of any exempt-interest dividends received by the shareholder. In
addition, any such loss that is not disallowed under the rule stated above will
be treated as long-term capital loss to the extent of any capital gain dividends
received by the shareholder. If the Fund pays a dividend in January which was
declared in the previous October, November or December to shareholders of record
on a specified date in one of such months, then such dividend will be treated
for Federal income 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
39
<PAGE> 71
those generally performed by governmental units and which benefit
non-governmental entities (e.g., bonds used for industrial development or
housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject certain investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds," and the Trust will report to shareholders within
60 days after the Fund's taxable year-end the portion of the Fund's dividends
declared during the year which constitute 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 "Investment
Objective and Policies -- Description of Municipal Bonds." Furthermore, the Fund
may also invest in instruments the return on which includes non-traditional
features such as indexed principal or interest payments ("non-traditional
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
non-traditional 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 (including the Pennsylvania 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 will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund reduces any sales charge the 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 if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Ordinary income dividends paid to shareholders that are nonresident aliens
or foreign entities will be subject to a 30% United States 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 United States withholding
tax.
Under certain provisions of the Code, 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 shareholder 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.
40
<PAGE> 72
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase and 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 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 fair 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
contacts 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.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Pennsylvania tax laws presently
in effect. For the complete provisions, reference should be made to the
pertinent Code sections, the Treasury regulations promulgated thereunder and
Pennsylvania 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 exemptions 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 and
other total return data, as well as yield and tax-equivalent yield, in
advertisements or information furnished to present or prospective shareholders.
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 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 Class B and Class C
shares.
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 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
41
<PAGE> 73
(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.
42
<PAGE> 74
Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for the
periods indicated.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
---------------------------- ----------------------------
REDEEMABLE REDEEMABLE
EXPRESSED AS VALUE OF A EXPRESSED AS VALUE OF A
A PERCENTAGE HYPOTHETICAL A PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END OF $1,000 AT THE END OF
INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------------ ------------- ------------ -------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C>
One year ended July 31, 1998................. 1.78% $1,017.80 1.59% $1,015.90
Five years ended July 31, 1998............... 5.35% $1,297.60 5.69% $1,318.90
Inception (August 31, 1990) to July 31,
1998....................................... 7.52% $1,775.40 7.54% $1,778.20
Inception (October 21, 1994) to July 31,
1998.......................................
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Year ended July 31, 1998..................... 6.02% $1,060.20 5.57% $1,055.70
Year ended July 31, 1997..................... 9.72% $1,097.20 9.17% $1,091.70
Year ended July 31, 1996..................... 6.53% $1,065.30 5.98% $1,059.80
Year ended July 31, 1995..................... 6.54% $1,065.40 6.00% $1,060.00
Year ended July 31, 1994..................... 2.37% $1,023.70 1.86% $1,018.60
Year ended July 31, 1993..................... 9.30% $1,093.00 8.75% $1,087.50
Year ended July 31, 1992..................... 14.53% $1,145.30 13.94% $1,139.40
Inception (August 31, 1990) to July 31,
1991....................................... 9.30% $1,093.00 8.81% $1,088.10
Inception (October 21, 1994) to July 31,
1995.......................................
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
Inception (August 31, 1990) to July 31,
1998....................................... 77.54% $1,775.40 77.82% $1,778.20
Inception (October 21, 1994) to July 31,
1998.......................................
YIELD
30 days ended July 31, 1998.................. 4.29% -- 3.96% --
TAX EQUIVALENT YIELD*
30 days ended July 31, 1998.................. 5.96% -- 5.50% --
<CAPTION>
CLASS C SHARES CLASS D SHARES
---------------------------- ----------------------------
REDEEMABLE REDEEMABLE
EXPRESSED AS VALUE OF A EXPRESSED AS VALUE OF A
A PERCENTAGE HYPOTHETICAL A PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END OF $1,000 AT THE END OF
INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------------ ------------- ------------ -------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C>
One year ended July 31, 1998................. 4.47% $1,044.70 1.76% $1,017.60
Five years ended July 31, 1998...............
Inception (August 31, 1990) to July 31,
1998.......................................
Inception (October 21, 1994) to July 31,
1998....................................... 7.48% $1,313.20 6.90% $1,286.30
ANNUAL TOTAL RETURN
Year ended July 31, 1998..................... 5.47% $1,054.70 6.00% $1,060.00
Year ended July 31, 1997..................... 9.06% $1,090.60 9.61% $1,096.10
Year ended July 31, 1996..................... 5.87% $1,058.70 6.42% $1,064.20
Year ended July 31, 1995.....................
Year ended July 31, 1994.....................
Year ended July 31, 1993.....................
Year ended July 31, 1992.....................
Inception (August 31, 1990) to July 31,
1991.......................................
Inception (October 21, 1994) to July 31,
1995....................................... 7.83% $1,078.30 8.36% $1,083.60
AGGREGATE TOTAL RETURN
Inception (August 31, 1990) to July 31,
1998.......................................
Inception (October 21, 1994) to July 31,
1998....................................... 31.32% $1,313.20 28.63% $1,286.30
YIELD
30 days ended July 31, 1998.................. 3.86% -- 4.19%
TAX EQUIVALENT YIELD*
30 days ended July 31, 1998.................. 5.36% -- 5.82%
</TABLE>
- ---------------
* Based on a Federal income tax rate of 28%.
43
<PAGE> 75
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"
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 not take into account the CDSC, and, therefore, may reflect greater total
return since, due to the reduced sales charges or the waiver of CDSCs, a lower
amount of expenses may be deducted.
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.
GENERAL INFORMATION
DESCRIPTION OF SHARES
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 as discussed
in "Distributions and Taxes -- Taxes," 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 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. 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 Jersey Municipal Bond Fund, Merrill Lynch New Mexico Municipal
Bond Fund, Merrill Lynch New York Municipal Bond Fund, Merrill Lynch North
Carolina Municipal Bond Fund, Merrill Lynch Oregon Municipal Bond Fund, Merrill
Lynch Ohio Municipal Bond Fund and Merrill Lynch Texas Municipal Bond Fund.
Shareholder approval is not required 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 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. All shares of the Trust have equal
voting rights. Each class has exclusive voting rights with respect to matters
relating to distribution and/or account maintenance expenditures, as applicable
(except that Class B shareholders may vote upon any material changes to expenses
charged under the Class D Distribution Plan). 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.
Each issued and outstanding share of a Series is entitled to one vote and
to participate equally in dividends and distributions 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
44
<PAGE> 76
borne solely by the respective class. There normally will be no meetings 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 in
accordance with the requirements of the Investment Company Act to seek approval
of new management and advisory arrangements, of a material increase in
distribution fees or a change in the fundamental policies, objectives or
restrictions of a Series.
The obligations and liabilities of a particular Series are restricted to
the assets of that Series and do not extend to the assets of the Trust
generally. The shares of each Series, when issued, will be fully paid and
nonassessable, have no preference, preemptive, conversion, exchange or similar
rights and 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.
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. 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.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Trust. The selection of
independent auditors is subject to approval by the non-interested 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
receipt and delivery of securities and collecting interest on the Fund's
investments.
TRANSFER AGENT
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 "How to Buy, Sell,
Transfer and Exchange Shares -- Through the Transfer Agent" in the Prospectus.
45
<PAGE> 77
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 the Fund's shareholders, 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.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
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 Securities and Exchange
Commission, Washington, D.C., under the Securities Act and the Investment
Company Act, to which reference is hereby made.
To the knowledge of the Trust, no person or entity owned beneficially 5% or
more of the Fund's shares as of November , 1998.
FINANCIAL STATEMENTS
The Fund's audited financial statements are included in its 1998 annual
report to shareholders, which is incorporated by reference in this Statement of
Additional Information. You may request a copy of the annual report at no charge
by calling (800) 456-4587 ext. 789 between 8:00 a.m. and 8:00 p.m. on any
business day.
46
<PAGE> 78
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.
The period from fiscal year 1993 through fiscal 1997 was a time of steady,
modest economic growth and low rates of inflation. These economic conditions,
together with tax reductions in the several years following the tax rate
increases and tax base expansions enacted in fiscal 1991 for the General Fund,
produced tax revenue gains averaging 4.1% per year during the period. Total
revenues during this same period increased at a 4.7% average rate.
Intergovernmental revenue recorded the largest percentage gain during this
period, averaging 8.1% (due, in part, to an accounting change). Expenditures and
other uses during the fiscal 1993 through fiscal 1997 period rose at a 3.8%
rate, led by and average 13.8% annual increase for protection of persons and
property program costs. This high rate of increase reflects the costs to
acquire, staff and operate expanded prison facilities to house a larger prison
population. Public health and welfare program costs expanded an average 5.4%
annually during this period, the second largest rate of increase for program
categories.
The fund balance at June 30, 1997 totaled $1,364.9 million, a $729.7
million increase over the $635.2 million balance at June 30, 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
therefore 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
I-1
<PAGE> 79
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 $79.8 million in fiscal 1997
supplemental appropriations over the February 1997 estimate. Supplemental
appropriations for fiscal 1997 totaled $169.3 million.
For GAAP purposes, assets increased $563.4 million and liabilities declined
$166.3 million to produce a $729.7 million increase in the fund balance at June
30, 1997. Total revenues and other sources rose 3.5% for fiscal 1997. An
increase of 5.5% in tax revenue aided by an improving state economy was
partially offset by a $175.2 million decline in intergovernmental revenues.
Expenditures and other uses increased by 1% for this fiscal year.
Operations during the 1998 fiscal year increased the unappropriated balance
of Commonwealth revenues during that period by $86.4 million to $488.7 million
at June 30, 1998 (prior to reserves for transfer to the Tax Stabilization
Reserve Fund). Higher than estimated revenues, offset in part by increased
reserves for tax refunds, and slightly lower expenditures than budgeted were
responsible for the increase. Transfers to the Tax Stabilization Reserve Fund
for fiscal 1998 operations will total $223.3 million consisting of $73.3 million
representing the required transfer of fifteen percent of the ending
unappropriated surplus balance, plus an additional $150 million authorized by
the General Assembly when it enacted the fiscal 1999 budget. With these
transfers, the balance in the Tax Stabilization Reserve Fund will exceed $664
million and represent 3.7% of fiscal 1998 revenues.
Commonwealth revenues (prior to tax refunds) during the fiscal year totaled
$18,123.2 million, $676.1 million (3.9%) above the estimate made at the time the
budget was enacted. Tax revenue received in fiscal 1998 grew 4.8% over tax
revenues received during fiscal 1997. This rate of increase includes the effect
of legislated tax reductions that affected receipts during both fiscal years and
therefore understates the actual underlying rate of growth of tax revenue during
fiscal 1998. Receipts from the personal income tax produced the largest single
component of higher revenues during fiscal 1998.
Expenditures from all fiscal 1998 appropriations of Commonwealth revenues
totaled $17,229.8 million (excluding pooled financing expenditures and net of
current year lapses). This amount represents an increase of 4.5% over fiscal
1997 appropriation expenditures. Lapses of appropriation authority during the
fiscal year totaled $161.8 million including $58.8 million from fiscal 1998
appropriations. These appropriation lapses were used to fund $120.5 million of
supplemental fiscal 1998 appropriations.
Reserves established during fiscal 1998 for tax refunds totaled $910
million. This amount is a $370 million increase over tax refund reserves for
fiscal 1997 representing an increase of 68.5%. The fiscal 1998 amount includes a
one-time addition intended to fund all fiscal 1998 tax refund liabilities,
including that portion to be paid during fiscal 1999. In prior fiscal years, tax
refunds generally were budgeted for the year in which the disbursement was
anticipated to occur. This change in the recognition of tax refund liabilities
on a budgetary basis is expected to reduce the difference between the budgetary
basis unappropriated balance and the GAAP basis unreserved and undesignated
balance (when computed) for the 1998 fiscal year.
The budget for fiscal 1999 was enacted in April 1998 at which time the
official revenue estimate for the 1999 fiscal year was established at $18,456.6
million. Only Commonwealth funds are included in the official revenue estimate.
The official revenue estimate is based on an economic forecast for national
gross domestic product, on a year-over-year basis, to slow from an estimated
annualized 3.9% rate in the fourth quarter of 1997 to a projected 1.8%
annualized growth rate by the second quarter of 1999. The forecast of slowing
economic activity is based on the expectation that consumers will reduce their
pace of spending, particularly on motor vehicles, housing and other durable
goods. Business is also expected to trim its spending on fixed investments.
Foreign demand for domestic goods is expected to decline in reaction to economic
difficulties in Asia and Latin America, while an economic recovery in Europe is
expected to proceed slowly. The underlying growth rate, excluding any effect of
scheduled or proposed tax changes, for the General Fund fiscal 1999 official
revenue estimate is 3.0% over actual fiscal 1998 revenues. When adjusted to
include the estimated effect of enacted tax changes, fiscal 1999 Commonwealth
revenues are projected to increase by 1.66% over actual Commonwealth revenues
for fiscal 1998.
I-2
<PAGE> 80
Tax reductions anticipated to be included in the enacted 1999 fiscal year
budget totaled an estimated $241.0 million for fiscal 1999. Of the anticipated
reductions, legislation representing tax reductions totaling $15 million has not
yet been passed by the General Assembly. All estimates for fiscal 1999 assume
enactment of those tax reductions currently pending before the General Assembly.
The major components of the enacted tax reductions and their estimated fiscal
1999 cost are: (a) reduce the capital stock and franchise tax rate from 12.75
mills to 11.99 mills ($72.5 million); (b) increase the eligibility income limit
for qualification for personal income tax forgiveness ($57.1 million); (c)
eliminate personal income tax on gains from the sale of an individual's
residence ($30 million); (d) extend the time period from three to ten years over
which net operating loss deductions may be taken for the corporate net income
tax ($17.8 million); (e) expand various sales tax exemptions ($40.4 million);
and (f) reduce various other miscellaneous items ($23.2 million). The major tax
changes were enacted with January 1, 1998 effective dates. Consequently, the
first year's cost of these changes may be above the expected annualized cost.
Reserves for tax refunds for fiscal 1999 total $603.9 million. This amount
includes $33.1 million of tax refunds anticipated to be due to the enacted
fiscal 1999 tax changes and included in the estimated cost of those changes.
Reserves for tax refunds for fiscal 1999 are $306.1 million below the reserve
established for fiscal 1998. The fiscal 1998 amount (described above) includes a
one-time addition intended to fund all fiscal 1998 tax refund liabilities,
including that portion to be paid during fiscal 1999. Without the necessity to
pay fiscal 1998 tax refund liabilities from fiscal 1999 reserves, the fiscal
1999 reserve need only be in an amount equal to the estimated fiscal 1999
estimate for tax refund liabilities.
Appropriations enacted for fiscal 1999 are 4.1% ($705.1 million) above the
appropriations enacted for fiscal 1998 (including supplemental appropriations).
Major increases in expenditures budgeted for fiscal 1999 include: (a) $249.5
million in direct support of local school district education costs (local school
districts will also benefit from an estimate $104 million of reduced
contributions by school districts to their worker's retirement cost from a
reduced employer contribution rate); (b) $60.4 million for higher education,
including scholarship grants; (c) $56.5 million to fund the correctional system,
including $21 million to operate a new correctional facility; (d) $121.1 million
for long-term care medical assistance costs; (e) $14.4 million for technology
and Year 2000 investments; (f) $55.9 million to fund the first year's cost of a
July 1, 1998 annuitant cost of living increase for state and school district
employees; and (g) $20 million to replace bond funding for equipment loans for
volunteer fire and rescue companies. The balance of the increase is spread over
many departments and program operations.
The enacted fiscal 1999 budget assumes the drawn down of the $265.4 million
beginning budgetary balance by $141.1 million to an estimated closing balance,
prior to transfer of the required portion to the Tax Stabilization Reserve Fund,
of $124.3 million. The amount of the anticipated drawn down does not consider
the availability of appropriation lapses normally occurring during a fiscal year
that are used to fund supplemental appropriations or increase unappropriated
surplus.
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 1997 increased at an annual rate of 0.76%. This compares to a 0.17%
rate for the Middle Atlantic region and a 1.69% rate for the United States as a
whole during the period 1988 through 1997. For the five years ended with 1997,
employment in the Commonwealth has increased 5.4%. The growth in employment
during this period is higher than the 4.8% growth in the Middle Atlantic region.
The unemployment rate in Pennsylvania for June 1998 stood at a seasonably
adjusted rate of 4.3%. The seasonably adjusted national unemployment rate for
June 1998 was 4.5%.
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,
I-3
<PAGE> 81
(ii) electorate-approved debt, (iii) debt for capital projects subject to an
aggregate debt limit of 1.75 times the annual average tax revenues of the
preceding five fiscal years and (iv) tax anticipation notes payable in the
fiscal year of issuance. All debt except tax anticipation notes must be
amortized in substantial and regular amounts.
Debt service on all bonded indebtedness of Pennsylvania, except that issued
for highway purposes or the benefit of other special revenue funds, is payable
from Pennsylvania's General Fund, which receives all Commonwealth revenues that
are not specified by law to be deposited elsewhere. As of June 30, 1998, the
Commonwealth had $4,724.5 million of general obligation debt outstanding.
Other state-related obligations include "moral obligations." Moral
obligation indebtedness may be issued by the Pennsylvania Housing Finance Agency
(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. The Commonwealth may choose
to take action to financially assist these organizations. In addition, the
Commonwealth may choose to take action to financially assist these
organizations. The Commonwealth also maintains pension plans covering all state
employees, public school employees and employees of certain state-related
organizations. For their fiscal years ended in 1997 the State Employees'
Retirement System had no accrued unfunded surplus or liability and the Public
School Employees' Retirement System had a total unfunded actuarial accrued
surplus of $1,633 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 June 9, 1998.
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, 1997 shows a
surplus of approximately $128.8 million.
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
I-4
<PAGE> 82
financing a cash flow deficit expired on December 31, 1996. Its ability to
refund existing outstanding debt is unrestricted. PICA had $1,055 million in
Special Revenue bonds outstanding as of June 30, 1998.
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, the City of Philadelphia
and others in federal court seeking an order that, among other things, 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. The Commonwealth sought
dismissal of the federal action based, among other things, on the settlement of
the Commonwealth Court case. 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. In July 1998, the plaintiffs entered into a
settlement agreement with the City of Philadelphia and related parties and
submitted the agreement to the district court for approval. The plaintiffs have
indicated that they intend to proceed with their claims against the Commonwealth
and other non-settling parties. The Commonwealth intends to defend.
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 July 26, 1997, the "Interim Report
of the Master" was filed setting forth a state funding proposal. Numerous
objections to the report were filed, but the Court has taken no action on them.
On April 22, 1998, the Pennsylvania General Assembly enacted legislation
appropriating approximately $12 million to the Supreme Court for the purpose of
funding county court administrators. The appropriation was designed to enable
the Commonwealth to implement Phase I of the special master's plan. However, the
legislation also provides that no funds from the appropriation may be expended
until legislation has been approved by the General Assembly providing for the
payment of Commonwealth compensation of county court administrators. Because no
such legislation has yet been enacted, the $12 million appropriated to the
Judicial Department cannot be used.
On May 11, 1998, the Administrative Governing Board of the First Judicial
District (comprising the Court of Common Pleas of Philadelphia, the Philadelphia
Municipal Court, and the Traffic Court of Philadelphia) filed an action in
mandamus in the Commonwealth Court of Pennsylvania against the City of
I-5
<PAGE> 83
Philadelphia and several City officials, claiming that the City government had
failed to provide adequate funds for the operation of the courts of the First
Judicial District. The petitioners have demanded that the court order the City
of Philadelphia to disburse all funds reasonably necessary for the continued
operation of the courts during fiscal year 1998-99 in an amount totaling at
least $110 million. The case is captioned Alex Bonavitacola, et al. v. Edward G.
Rendell, et al.
Also on May 11, 1998, the City of Philadelphia and related respondents in
Bonavitacola filed a complaint joining the Commonwealth of Pennsylvania, the
General Assembly and its elected leadership as additional respondents. In their
complaint, the City respondents assert that under the Supreme Court's order
issued July 26, 1996 in Pa. State Ass'n of County Commissioners v. Commonwealth
of Pennsylvania, the General Assembly was obligated to enact a funding scheme
for a unified court system no later than January 1, 1998. Because the General
Assembly has not done so, the City respondents allege, the Commonwealth has
failed to comply with the Supreme Court's order. Thus, the City respondents have
requested Commonwealth Court to require the General Assembly to comply with the
Supreme Court's mandamus order and to order the Commonwealth to pay whatever
sums are necessary to fund the cost of operating the courts in fiscal 1998-99.
The First Judicial District Governing Board joined in the City respondents'
request as an alternative to its demanded relief against the City defendants.
On June 15, 1998, the Supreme Court of Pennsylvania assumed extraordinary
jurisdiction over the case and directed Commonwealth Court, on an expedited
basis, to prepare proposed findings of fact and conclusions of law. Acting
pursuant to the Supreme Court's June 15, 1998 order, President Judge James
Gardner Colins of Commonwealth Court on June 17, 1998 issued findings of fact,
conclusions of law and a proposed order. In his proposed order, President Judge
Colins recommended that the Supreme Court order the President of the
Philadelphia Council immediately to introduce legislation to fund the courts of
the First Judicial District for fiscal year 1998-99 and to take all necessary
steps to ensure its passage. President Judge Colins also recommended that the
Supreme Court order the General Assembly to pass legislation, prior to June 30,
1999, to fund the entire state judicial system. By order entered June 23, 1998,
Commonwealth Court forwarded its findings of fact and conclusions of law and
proposed order to the Supreme Court for final disposition. The Commonwealth and
the General Assembly have objected to President Judge Colins' proposed order.
Subsequent to Commonwealth Court's issuance of its findings of fact,
conclusions of law and proposed order, the City Council and Mayor of
Philadelphia acceded (at least temporarily) to President Judge Colins' proposed
mandate that the City fund the First Judicial District's courts for fiscal year
1998-99, thus obviating the First Judicial District's request for emergency
relief. However, the First Judicial District petitioners and the City of
Philadelphia respondents continue to press their demands that the General
Assembly be required to enact legislation providing for state funding of the
courts. In addition, the County of Allegheny has petitioned the Supreme Court
for leave to intervene in the Bonavitacola case to secure the same relief
against the Commonwealth -- an order requiring Commonwealth to fund its courts.
The Bonavitacola case remains pending before the Supreme Court for disposition.
Bank Shares Tax Litigation
On November 30, 1989, the Fidelity Bank, N.A. ("Fidelity") filed an action
in challenging the constitutional validity of a 1989 amendment increasing the
bank shares tax and related legislation. The Commonwealth Court ruled in favor
of the Commonwealth finding no constitutional deficiencies in the tax increase,
but invalidating one element of the legislation which provided a credit to new
banks (the "new bank tax credit"). Fidelity, the Commonwealth and certain
intervener banks appealed to the Pennsylvania Supreme Court. However, pursuant
to a Settlement Agreement dated as of April 21, 1995, the Commonwealth agreed to
enter a credit in favor of Fidelity in the amount of $4,100,000 in settlement of
the constitutional and non-constitutional issues. The credit represents
approximately 5% of the potential claim of Fidelity, had the constitutional
issues been resolved in its favor.
Pursuant to a separate Settlement Agreement dated as of April 21, 1995, the
Commonwealth also settled with the intervening banks with respect to issues
concerning the new bank tax credit.
I-6
<PAGE> 84
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. By decision dated January 8, 1998,
a panel of the Commonwealth Court ruled in favor of the Commonwealth, finding no
constitutional violation. Royal Bank filed exceptions which were denied by the
Commonwealth Court on July 30, 1998. On August 18, 1998, Royal Bank filed a
notice of appeal with 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. On July 9, 1998, Commonwealth Court Judge
Dan Pellegrini issued an opinion and decree nisi dismissing the petitioners'
claim in its entirety, holding that Pennsylvania's system for funding public
schools is constitutional under both the education clause and the equal
protection clause of the Pennsylvania Constitution.
On July 20, 1998, the petitioners filed a motion for post-trial relief,
taking exception to many of Judge Pellegrini's findings of fact and conclusions
of law, and again asking the Commonwealth Court to declare Pennsylvania's public
school funding system to be unconstitutional. The court was scheduled to hear
oral argument on the petitioner's motion on September 14, 1998. Also, the
petitioners on July 21, 1998 filed an application asking the Supreme Court of
Pennsylvania to assume extraordinary, plenary jurisdiction over the case to
decide one legal issue -- whether the petitioners' constitutional claims are
justiciable in the courts of the Commonwealth. The petitioners have asked the
court to consider the issue in conjunction with a separate appeal pending in
another case, Marrerro v. Commonwealth of Pennsylvania, involving the same
provisions of the Constitution and a similar issue of justiciability. The
Commonwealth opposes the petitioners' request that the Supreme Court assume
extraordinary jurisdiction in PARSS.
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. Monitoring provisions outlined in the Agreement expired on
January 6, 1998.
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.
I-7
<PAGE> 85
Pennsylvania Human Relations Commission v. School District of Philadelphia, et
al. v. Commonwealth of Pennsylvania, et al.
On November 3, 1995, the Commonwealth of Pennsylvania and the Governor of
Pennsylvania, along with the City of Philadelphia and the Mayor of Philadelphia,
were joined as additional respondents in an enforcement action commenced in
Commonwealth Court in 1973 by the Pennsylvania Human Relations Commission
against the School District of Philadelphia pursuant to the Pennsylvania Human
Relations Act. The enforcement action was pursued to remedy unintentional
conditions of segregation in the public schools of Philadelphia. The
Commonwealth and the City were joined in the "remedial phase" of the proceeding
"to determine their liability, if any, to pay additional costs necessary to
remedy the unlawful conditions found to exist in the Philadelphia public
schools."
On February 28, 1996, the School District of Philadelphia filed a
third-party complaint against the Commonwealth of Pennsylvania asking
Commonwealth Court to require the Commonwealth to "supply such funding as is
necessary for full compliance with the November 28, 1994 and other remedial
orders of the Commonwealth Court." In addition, a group of interveners on March
4, 1996 filed a third-party complaint against the Commonwealth of Pennsylvania
and the City of Philadelphia requesting Commonwealth Court to declare that "it
is the obligation of the Commonwealth and the City to supply the additional
funds identified as necessary for the District to fully comply with the orders
of the Commonwealth Court," and to require the Commonwealth and the City to
supply such additional funding as is necessary for the District to comply with
the orders.
On April 30, 1996, Commonwealth Court Judge Doris A. Smith overruled the
Commonwealth's and City's preliminary objections seeking dismissal of the claims
against them. The Commonwealth and the City thereafter filed answers to the
complaints, asserting numerous defenses. The Commonwealth also asserted a
cross-claim against the City of Philadelphia claiming that if any party is
liable, sole liability rests with the City; in the alternative, the Commonwealth
argued that if it is held to be liable, it has a right of indemnity of
contribution against the City.
Trial commenced on May 30, 1996. During the course of the trial, upon
motion of the Commonwealth, the Pennsylvania Supreme Court on July 3, 1996
assumed extraordinary plenary jurisdiction and directed Judge Smith to conclude
the proceedings within 60 days and to file with the Supreme Court findings of
fact, conclusions of law and a final opinion.
On August 20, 1996, Judge Smith issued an Opinion and Order pursuant to
which judgment was entered in favor of the School District of Philadelphia and
the interveners and against the Commonwealth of Pennsylvania and the Governor of
Pennsylvania. Judgment was also entered in favor of the City of Philadelphia and
the Mayor of Philadelphia with respect to the intervener's claim and on the
cross-claim filed by the Commonwealth and Governor. The Judge ordered the
Commonwealth and Governor to submit a plan to the Court within thirty 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 Supreme Court issued an Order directing the parties to brief
certain specific issues
I-8
<PAGE> 86
relative to the lower court proceedings. The Supreme Court heard oral argument
on February 3, 1998 and took the matter under advisement.
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. On June 30, 1998, the Commonwealth Court ordered Judge Ridge to show
cause why his claim should not be dismissed for want of prosecution, returnable
July 20, 1998.
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 the 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. The
respondents filed preliminary objections seeking dismissal of the action. On
March 2, 1998, Commonwealth Court sustained the respondents' preliminary
objections and dismissed the case on the grounds that the issues presented are
not justiciable. An appeal to the Supreme Court of Pennsylvania is pending and
briefing is complete, but the Court has not scheduled oral argument.
As of August 1, 1998, Pennsylvania general obligation bonds were 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.
I-9
<PAGE> 87
APPENDIX II
RATINGS OF MUNICIPAL BONDS
Description of Moody's Investors Service, Inc.'s ("Moody's") Long-Term Debt
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 edged." 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 risk
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 Bond 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.
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";
II-1
<PAGE> 88
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 SHORT-TERM DEBT RATINGS
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 senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by the many 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 earnings coverage of fixed
financial charges and high internal cash generation; and well established access
to a range of financial markets and assured sources of alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt 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 senior short-term debt obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and 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 ("STANDARD & POOR'S") ISSUE CREDIT RATING
DEFINITIONS
A Standard & Poor's issue credit 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
(including ratings on medium term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account the
currency in which the obligation is denominated.
The issue credit 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.
Issue credit 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
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
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 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 creditors' rights.
II-2
<PAGE> 89
LONG-TERM ISSUE CREDIT RATINGS
<TABLE>
<C> <S>
AAA An obligation rated "AAA" has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its
financial commitment on the obligation is extremely strong.
AA An obligation 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 An obligation rated "A" is somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than obligations in higher-rated categories.
However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB An obligation 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 An obligation rated "BB," "B," "CCC," "CC" and "C" is
B regarded as having significant speculative characteristics.
CCC "BB" indicates the least degree of speculation and "C" the
CC highest degree of speculation. While such bonds will likely
C have some quality and protective characteristics, these may
be outweighed by large uncertainties or major exposures to
adverse conditions.
D An obligation 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.
SHORT-TERM ISSUE CREDIT RATINGS
<TABLE>
<C> <S>
A-1 A short-term obligation rated "A-1" is rated in the highest
category by Standard & Poor's. The obligor's capacity to
meet its financial commitment on the obligation is strong.
Within this category, certain obligations are designated
with a plus sign (+). This indicates that the obligor's
capacity to meet its financial commitment on these
obligations is extremely strong.
A-2 A short-term obligation rated "A-2" is somewhat more
susceptible to the adverse effects of changes in
circumstances and economic conditions than obligations in
higher rating categories. However, the obligor's capacity to
meet its financial commitment on the obligation is
satisfactory.
A-3 A short-term obligation rated "A-3" 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.
B A short-term obligation rated "B" is regarded as having
significant speculative characteristics. The obligor
currently has the capacity to meet its financial commitment
on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate
capacity to meet its financial commitment on the obligation.
C A short-term obligation rated "C" is currently vulnerable to
nonpayment and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet
its financial commitment on the obligation.
D A short-term obligation 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>
II-3
<PAGE> 90
DESCRIPTION OF FITCH IBCA, INC. ("FITCH") RATINGS
Fitch credit ratings are an opinion on the ability of an entity or of a
securities issue to meet financial commitments, such as interest, preferred
dividends, or repayment of principal, on a timely basis.
Credit ratings are used by investors as indications of the likelihood of
getting their money back in accordance with the terms on which they invested.
Thus, the use of credit ratings defines their function: "investment-grade"
ratings (international long-term "AAA" -- "BBB" categories; short-term
"F1" -- "F3") indicate a relatively low probability of default, while those in
the "speculative" or "non-investment grade" categories (international long-term
"BB" -- "D") either signal a higher probability of default or that a default has
already occurred. Ratings imply no specific prediction of default probability.
Entities or issues 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 credit and other 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 any payments of any security. The 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 or withdrawn
as a result of changes in, or the unavailability of, information or for other
reasons.
International Credit Ratings
Fitch's international credit ratings are applied to the spectrum of
corporate, structured, and public finance. They cover sovereign (including
supranational and subnational), financial, bank, insurance, and other corporate
entities and the securities they issue, as well as municipal and other public
finance entities, and securities backed by receivables or other financial
assets, and counterparties. When applied to an entity, these long- and
short-term ratings assets its general creditworthiness on a senior basis. When
applied to specific issues and programs, these ratings take into account the
relative preferential position of the holder of the security and reflect the
terms, conditions, and covenants attaching to that security.
Analytical Considerations
When assigning ratings, Fitch considers the historical and prospective
financial condition, quality of management, and operating performance of the
issuer and of any guarantor, any special features of a specific issue or
guarantee, the issue's relationship to other obligations of the issuer, as well
as developments in the economic and political environment that might affect the
issuer's financial strength and credit quality.
Investment-grade ratings reflect expectations of timeliness of payment.
However, ratings of different classes of obligations of the same issuer may vary
based on expectations of recoveries in the event of a default or liquidation.
Recovery expectations, which are the amounts expected to be received by
investors after a security defaults, are a relatively minor consideration in
investment-grade ratings, but Fitch does use "notching" of particular issues to
reflect their degree of preference in a winding up, liquidation, or
reorganization as well as other factors. Recoveries do, however, gain in
importance at lower rating levels, because of the greater likelihood of default,
and become the major consideration at the "DDD" category. Factors that affect
recovery expectations include collateral and seniority relative to other
obligations in the capital structure.
Variable rate demand obligations and other securities which contain a
demand feature will have a dual rating, such as "AAA/F1+." The first rating
denotes long-term ability to make principal and interest payments. The second
rating denotes ability to meet a demand feature in full and on time.
II-4
<PAGE> 91
International Long-Term Credit Ratings
Investment Grade
<TABLE>
<C> <S>
AAA Highest credit quality. "AAA" ratings denote the lowest
expectation of credit risk. They are assigned only in case
of exceptionally strong capacity for timely payment of
financial commitments. This capacity is highly unlikely to
be adversely affected by foreseeable events.
AA Very high credit quality. "AA" ratings denote a very low
expectation of credit risk. They indicate strong capacity
for timely payment of financial commitments. This capacity
is not significantly vulnerable to foreseeable events.
A High credit quality. "A" ratings denote a low expectation
of credit risk. The capacity for timely payment of financial
commitments is considered strong. This capacity may,
nevertheless, be more vulnerable to changes in circumstances
or in economic conditions than is the case for higher
ratings.
BBB Good credit quality. "BBB" ratings indicate that there is
currently a low expectation of credit risk. The capacity for
timely payment of financial commitments is considered
adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity.
This is the lowest investment grade category.
Speculative Grade
BB Speculative. "BB" ratings indicate that there is a
possibility of credit risk developing, particularly as the
result of adverse economic change over time; however,
business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this
category are not investment grade.
B Highly speculative. "B" ratings indicate that significant
credit risk is present, but a limited margin of safety
remains. Financial commitments are currently being met;
however, capacity for continued payment is contingent upon a
sustained, favorable business and economic environment.
CCC High default risk. Default is a real possibility. Capacity
for meeting financial commitments is solely
CC reliant upon sustained, favorable business or economic
developments. A "CC" rating indicated that
C default of some kind appears probable. "C" ratings signal
imminent default.
</TABLE>
<TABLE>
<C> <S>
DDD Default. Securities are not meeting current obligations and
DD are extremely speculative. "DDD" designates the highest
D potential for recovery of amounts outstanding on any
securities involved. For U.S. corporates, for example, "DD"
indicates expected recovery of 50%-90% of such outstandings,
and "D", the lowest recovery potential, i.e. below 50%.
</TABLE>
International Short-Term Credit Ratings
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
<TABLE>
<C> <S>
F1 Highest credit quality. Indicates the strongest capacity
for timely payment of financial commitments; may have an
added "+" to denote any exceptionally strong credit feature.
F2 Good credit quality. A satisfactory capacity for timely
payment of financial commitments, but the margin of safety
is not as great as in the case of the higher ratings.
F3 Fair credit quality. The capacity for timely payment of
financial commitments is adequate; however, near-term
adverse changes could result in a reduction to
non-investment grade.
B Speculative. Minimal capacity for timely payment of
financial commitments, plus vulnerability to near-term
adverse changes in financial and economic conditions.
</TABLE>
II-5
<PAGE> 92
<TABLE>
<C> <S>
C High default risk. Default is a real possibility. Capacity
for meeting financial commitments is solely reliant upon a
sustained, favorable business and economic environment.
D Default. Denotes actual or imminent payment default.
</TABLE>
- ---------------
Notes:
"+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the "AAA" long-term
rating category, to categories below "CCC," or to short-term ratings other than
"F".
"NR" indicates that Fitch does not rate the issuer or issue in question.
"Withdrawn": A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
Rating Alert: Ratings are placed on Rating Alert to notify investors that
there is a reasonable probability of a rating change and the likely direction of
such change. These are designated as "Positive," indicating a potential upgrade,
"Negative," for a potential downgrade, or "Evolving," if ratings may be raised,
lowered or maintained. Rating Alert is typically resolved over a relatively
short period.
II-6
<PAGE> 93
PART C. OTHER INFORMATION
ITEM 23. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S> <C>
1(a) -- Declaration of Trust of the Registrant, dated August 2,
1985.(a)
(b) -- Amendment to Declaration of Trust, dated September 18,
1987.(a)
(c) -- Amendment to Declaration of Trust, dated December 21,
1987.(a)
(d) -- Amendment to Declaration of Trust, dated October 3, 1988.(a)
(e) -- Amendment to Declaration of Trust, dated October 17, 1994
and instrument establishing Class C and Class D shares of
beneficial interest.(a)
(f) -- Instrument establishing Merrill Lynch Pennsylvania Municipal
Bond Fund (the "Fund") as a series of the Registrant.(a)
(g) -- Instrument establishing Class A and Class B shares of
beneficial interest of the Fund.(a)
2 -- By-Laws of the Registrant.(a)
3 -- Portions of the Declaration of Trust, Certificate of
Establishment and Designation and By-Laws of the Registrant
defining the rights of holders of the Fund as a series of
the Registrant.(b)
4(a) -- Management Agreement between the Registrant and Fund Asset
Management, L.P.(a)
(b) -- Supplement to Management Agreement between the Registrant
and Fund Asset Management, L.P.(e)
5(a) -- Form of Revised Class A Distribution Agreement between the
Registrant and Merrill Lynch Funds Distributor, Inc. (now
known as Princeton Funds Distributor, Inc.)(the
"Distributor")(including Form of Selected Dealers
Agreement).(e)
(b) -- Form of Class B Distribution Agreement between the
Registrant and the Distributor.(a)
(c) -- Form of Class C Distribution Agreement between the
Registrant and the Distributor (including Form of Selected
Dealers Agreement).(e)
(d) -- Form of Class D Distribution Agreement between the
Registrant and the Distributor (including Form of Selected
Dealers Agreement).(e)
(e) -- Letter Agreement between the Fund and the Distributor, dated
September 15, 1993, in connection with the Merrill Lynch
Mutual Funds Advisor Program.(c)
6 -- None.
7 -- Form of Custody Agreement between the Registrant and State
Street Bank and Trust Company.(d)
8 -- Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between the Registrant and
Merrill Lynch Financial Data Services, Inc. (now known as
Financial Data Services, Inc.)(f)
9 -- Opinion of Brown & Wood LLP, counsel to the Registrant.(h)
10 -- Consent of Deloitte & Touche LLP, independent auditors for
the Registrant.
11 -- None.
12 -- Certificate of Fund Asset Management, L.P.(a)
13(a) -- Amended and Restated Class B Distribution Plan of the
Registrant and Amended and Restated Class B Distribution
Plan Sub-Agreement.(c)
(b) -- Form of Class C Distribution Plan of the Registrant and
Class C Distribution Plan Sub-Agreement.(e)
(c) -- Form of Class D Distribution Plan of the Registrant and
Class D Distribution Plan Sub-Agreement.(e)
</TABLE>
C-1
<PAGE> 94
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S> <C>
14(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.
15 -- Merrill Lynch Select Pricing(SM) System Plan pursuant to
Rule 18f-3.(g)
</TABLE>
- ---------------
<TABLE>
<S> <C>
(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 Registrant's Registration Statement on
Form N-1A under the Securities Act of 1933, as amended,
filed on October 14, 1994, relating to shares of Merrill
Lynch Minnesota Municipal Bond Fund series of the Registrant
(File No. 33-44734).
(e) Filed on October 19, 1994 as an Exhibit to Post-Effective
Amendment No. 5 to the Registration Statement.
(f) Incorporated by reference to Exhibit 9 to Post-Effective
Amendment No. 5 to Registrant's Registration Statement on
Form N-1A under the Securities Act of 1933, as amended,
filed on October 20, 1995, relating to shares of Merrill
Lynch Arizona Municipal Bond Fund series of the Registrant
(File No. 33-41311).
(g) Incorporated by reference to Exhibit 18 to Post-Effective
Amendment No. 13 to the 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) Previously filed as an Exhibit to the Registration
Statement.
</TABLE>
ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The Registrant is not controlled by or under common control with any other
person.
ITEM 25. 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
C-2
<PAGE> 95
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.
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 (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 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
Fund Asset Management, L.P. ("FAM" or the "Investment Adviser") 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 Corporate High Yield
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 for
C-3
<PAGE> 96
the following closed-end registered investment companies: Apex Municipal Fund,
Inc., Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc.,
Corporate High Yield Fund III, Inc., Debt Strategies Fund, Inc., Debt Strategies
Fund II, Inc., Debt Strategies Fund III, Inc., Income Opportunities Fund 1999,
Inc., Income Opportunities Fund 2000, Inc., Merrill Lynch Municipal Strategy
Fund, Inc., MuniAssets Fund, Inc., MuniEnhanced Fund, Inc., MuniHoldings Fund,
Inc., MuniHoldings Fund II, Inc., MuniHoldings California Insured Fund, Inc.,
MuniHoldings California Insured Fund II, MuniHoldings California Insured Fund
III, Inc., MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured Fund
II, MuniHoldings Insured Fund, Inc., MuniHoldings New Jersey Insured Fund, Inc.,
MuniHoldings New Jersey Insured Fund II, Inc., MuniHoldings New York 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. and
Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the
Investment Adviser, 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 Fundamental Growth Fund, Inc.,
Merrill Lynch Fund For Tomorrow, Inc., Merrill Lynch Global Allocation Fund,
Inc., Merrill Lynch Global Bond Fund for Investment and Retirement, Merrill
Lynch Global Growth Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill
Lynch Global Resources Trust, Merrill Lynch Global SmallCap Fund, Inc., Merrill
Lynch Global Technology 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 Trust,
Merrill Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets Trust, Merrill
Lynch Real Estate Fund, Inc., Merrill Lynch Retirement Series Trust, Merrill
Lynch Series Fund, Inc., Merrill Lynch Short-Term Global Income Fund, Inc.,
Merrill Lynch Strategic Dividend Fund, Merrill Lynch Technology Fund, Inc.,
Merrill Lynch U.S. Treasury Money Fund, Merrill Lynch U.S.A. Government
Reserves, Merrill Lynch Utility Income Fund, Inc. and Merrill Lynch Variable
Series Funds, Inc. and Hotchkis and Wiley funds (advised by Hotchkis and Wiley,
a division of MLAM); and for 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 Advisors Trust.
The address of each of these registered 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 02111-2665. The
address of FAM, MLAM, Princeton Services, Inc. ("Princeton Services") and
Princeton Administrators, L.P. ("Princeton Administrators") is also P.O. Box
9011, Princeton, New Jersey 08543-9011. The address of Princeton Funds
Distributor, Inc. ("PFD") and of Merrill Lynch Funds Distributor ("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 10281-1201. The address of the Fund's transfer agent, Financial
Data Services, Inc. ("FDS"), is 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484.
Set forth below is a list of each executive officer and partner of the
Investment Adviser indicating each business, profession, vocation or employment
of a substantial nature in which each such person or entity has been
C-4
<PAGE> 97
engaged since August 1, 1996 for his, her or its own account or in the capacity
of director, officer, partner or trustee. In addition, Mr. Zeikel is President,
Mr. Richard is Treasurer and Mr. Glenn is Executive Vice President of
substantially all of the investment companies described in the first two
paragraphs of this Item 26, and Messrs. Giordano, Harvey, Kirstein and Monagle
are directors, trustees or officers of one or more of such companies.
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME INVESTMENT ADVISER 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.................... Chairman Chairman of MLAM; President of FAM
and MLAM from 1977 to 1997;
Chairman and Director of Princeton
Services; President of Princeton
Services from 1993 to 1997;
Executive Vice President of ML &
Co.
Jeffrey M. Peek.................. President President of MLAM; President and
Director of Princeton Services;
Executive Vice President of ML &
Co.; Managing Director and Co-Head
of the Investment Banking Division
of Merrill Lynch in 1997, Senior
Vice President and Director of the
Global Securities and Economics
Division of Merrill Lynch from
1995 to 1997.
Terry K. Glenn................... Executive Vice President Executive Vice President of MLAM;
Executive Vice President and
Director of Princeton Services;
President and Director of PFD;
Director of FDS; President of
Princeton Administrators
Linda L. Federici................ Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Vincent R. Giordano.............. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Elizabeth A. Griffin............. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Norman R. Harvey................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Michael J. Hennewinkel........... Senior Vice President, Senior Vice President, Secretary
Secretary and General and General Counsel of MLAM;
Counsel Senior Vice President of Princeton
Services
Philip L. Kirstein............... Senior Vice President Senior Vice President of MLAM;
Senior Vice President, Director
and Secretary of Princeton
Services
</TABLE>
C-5
<PAGE> 98
<TABLE>
<CAPTION>
POSITION(S) WITH THE OTHER SUBSTANTIAL BUSINESS,
NAME INVESTMENT ADVISER PROFESSION, VOCATION OR EMPLOYMENT
---- ------------------------ ----------------------------------
<S> <C> <C>
Ronald M. Kloss.................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Debra Landsman-Yaros............. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services; Vice President of PFD
Stephen M. M. Miller............. Senior Vice President Executive Vice President of
Princeton Administrators; Senior
Vice President of Princeton
Services
Joseph T. Monagle, Jr. .......... Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Brian A. Murdock................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services; Director of PFD
Michael L. Quinn................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services; Managing Director and
First Vice President of Merrill
Lynch from 1989 to 1995
Gerald M. Richard................ Senior Vice President Senior Vice President and
and Treasurer Treasurer of MLAM; Senior Vice
President and Treasurer of
Princeton Services; Vice President
and Treasurer of PFD
Gregory D. Upah.................. Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
Ronald L. Welburn................ Senior Vice President Senior Vice President of MLAM;
Senior Vice President of Princeton
Services
</TABLE>
ITEM 27. PRINCIPAL UNDERWRITERS.
(a) MLFD, a division of PFD, acts as the principal underwriter for the
Registrant and for each of the open-end registered investment companies referred
to in the first two paragraphs of Item 26 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 registered investment
companies: Merrill Lynch High Income Municipal Bond Fund, Inc., Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch Senior Floating Rate Fund, Inc.
A separate division of PFD acts as the principal underwriter of a number of
other investment companies.
(b) Set forth below is information concerning each director and officer of
PFD. The principal business address of each such person is P.O. Box 9081,
Princeton, New Jersey 08543-9081, except that the address of Messrs. Breen,
Crook, Fatseas and Wasel is One Financial Center, 23rd Floor, Boston,
Massachusetts 02111-2665.
C-6
<PAGE> 99
<TABLE>
<CAPTION>
POSITION(S) AND OFFICE(S) POSITION(S) AND OFFICE(S)
NAME WITH PFD WITH REGISTRANT
---- ---------------------------- -------------------------
<S> <C> <C>
Terry K. Glenn........................... President and Director Executive Vice President
Brian A. Murdock......................... Director None
Thomas J. Verage......................... Director 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
William Wasel............................ Vice President None
Robert Harris............................ Secretary None
</TABLE>
(c) Not applicable.
ITEM 28. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by
Section 31(a) of the 1940 Act and the rules thereunder are maintained at the
offices of the Registrant (800 Scudders Mill Road, Plainsboro, New Jersey
08536), and its transfer agent, Financial Data Services, Inc. (4800 Deer Lake
Drive East, Jacksonville, Florida 32246-6484).
ITEM 29. MANAGEMENT SERVICES.
Other than as set forth under the caption "Management of the Trust -- Fund
Asset Management" 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 30. UNDERTAKINGS.
Not applicable.
C-7
<PAGE> 100
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant 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 29th day of September, 1998.
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 the Registration Statement has been signed below by
the following persons in the capacities and on the date(s) indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <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 September 29, 1998
- --------------------------------------------
(Gerald M. Richard, Attorney-in-Fact)
</TABLE>
C-8
<PAGE> 101
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S> <C>
10 Consent of Deloitte & Touche LLP, independent auditors for
the Registrant.
14(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>
C-9
<PAGE> 1
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch Pennsylvania Municipal Bond Fund of
Merrill Lynch Multi-State Municipal Series Trust:
We consent to the incorporation by reference in this Post-Effective Amendment
No. 9 to Registration Statement No. 33-35442 of our report dated September 9,
1998 appearing in the annual report to shareholders of the Merrill Lynch
Pennsylvania Municipal Bond Fund for the year ended July 31, 1998, and to the
reference to us under the caption "Financial Highlights" in the Prospectus,
which is part of such Registration Statement.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Princeton, New Jersey
September 28, 1998
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 041
<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-START> AUG-01-1997
<PERIOD-END> JUL-31-1998
<INVESTMENTS-AT-COST> 130,336,870
<INVESTMENTS-AT-VALUE> 139,877,984
<RECEIVABLES> 2,108,942
<ASSETS-OTHER> 74,956
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 142,061,882
<PAYABLE-FOR-SECURITIES> 2,553,776
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 563,542
<TOTAL-LIABILITIES> 3,117,318
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 129,039,580
<SHARES-COMMON-STOCK> 1,788,517
<SHARES-COMMON-PRIOR> 1,827,891
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 363,870
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 9,541,114
<NET-ASSETS> 20,612,627
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8,220,373
<OTHER-INCOME> 0
<EXPENSES-NET> (1,612,795)
<NET-INVESTMENT-INCOME> 6,607,578
<REALIZED-GAINS-CURRENT> 2,705,180
<APPREC-INCREASE-CURRENT> (1,580,034)
<NET-CHANGE-FROM-OPS> 7,732,724
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (1,081,075)
<DISTRIBUTIONS-OF-GAINS> (279,469)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 205,752
<NUMBER-OF-SHARES-REDEEMED> (310,567)
<SHARES-REINVESTED> 65,441
<NET-CHANGE-IN-ASSETS> (2,796,990)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (457,544)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 773,590
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1,612,795
<AVERAGE-NET-ASSETS> 21,018,714
<PER-SHARE-NAV-BEGIN> 11.59
<PER-SHARE-NII> .59
<PER-SHARE-GAIN-APPREC> .08
<PER-SHARE-DIVIDEND> (.59)
<PER-SHARE-DISTRIBUTIONS> (.15)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.52
<EXPENSE-RATIO> .73
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 042
<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-START> AUG-01-1997
<PERIOD-END> JUL-31-1998
<INVESTMENTS-AT-COST> 130,336,870
<INVESTMENTS-AT-VALUE> 139,877,984
<RECEIVABLES> 2,108,942
<ASSETS-OTHER> 74,956
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 142,061,882
<PAYABLE-FOR-SECURITIES> 2,553,776
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 563,542
<TOTAL-LIABILITIES> 3,117,318
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 129,039,580
<SHARES-COMMON-STOCK> 8,959,748
<SHARES-COMMON-PRIOR> 9,413,550
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 363,870
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 9,541,114
<NET-ASSETS> 103,261,489
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8,220,373
<OTHER-INCOME> 0
<EXPENSES-NET> (1,612,795)
<NET-INVESTMENT-INCOME> 6,607,578
<REALIZED-GAINS-CURRENT> 2,705,180
<APPREC-INCREASE-CURRENT> (1,580,034)
<NET-CHANGE-FROM-OPS> 7,732,724
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (4,877,251)
<DISTRIBUTIONS-OF-GAINS> (1,417,208)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 1,121,392
<NUMBER-OF-SHARES-REDEEMED> (1,847,121)
<SHARES-REINVESTED> 271,927
<NET-CHANGE-IN-ASSETS> (2,796,990)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (457,544)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 773,590
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1,612,795
<AVERAGE-NET-ASSETS> 105,297,218
<PER-SHARE-NAV-BEGIN> 11.59
<PER-SHARE-NII> .53
<PER-SHARE-GAIN-APPREC> .09
<PER-SHARE-DIVIDEND> (.53)
<PER-SHARE-DISTRIBUTIONS> (.15)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.53
<EXPENSE-RATIO> 1.24
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 043
<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-START> AUG-01-1997
<PERIOD-END> JUL-31-1998
<INVESTMENTS-AT-COST> 130,336,870
<INVESTMENTS-AT-VALUE> 139,877,984
<RECEIVABLES> 2,108,942
<ASSETS-OTHER> 74,956
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 142,061,882
<PAYABLE-FOR-SECURITIES> 2,553,776
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 563,542
<TOTAL-LIABILITIES> 3,117,318
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 129,039,580
<SHARES-COMMON-STOCK> 601,073
<SHARES-COMMON-PRIOR> 530,303
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 363,870
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 9,541,114
<NET-ASSETS> 6,927,947
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8,220,373
<OTHER-INCOME> 0
<EXPENSES-NET> (1,612,795)
<NET-INVESTMENT-INCOME> 6,607,578
<REALIZED-GAINS-CURRENT> 2,705,180
<APPREC-INCREASE-CURRENT> (1,580,034)
<NET-CHANGE-FROM-OPS> 7,732,724
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (308,230)
<DISTRIBUTIONS-OF-GAINS> (93,062)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 219,943
<NUMBER-OF-SHARES-REDEEMED> (173,447)
<SHARES-REINVESTED> 24,274
<NET-CHANGE-IN-ASSETS> (2,796,990)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (457,544)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 773,590
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1,612,795
<AVERAGE-NET-ASSETS> 6,803,982
<PER-SHARE-NAV-BEGIN> 11.59
<PER-SHARE-NII> .52
<PER-SHARE-GAIN-APPREC> .09
<PER-SHARE-DIVIDEND> (.52)
<PER-SHARE-DISTRIBUTIONS> (.15)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.53
<EXPENSE-RATIO> 1.34
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000774013
<NAME> MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
<SERIES>
<NUMBER> 044
<NAME> MERRILL LYNCH PENNSYLVANIA MUNICIPAL BOND FUND
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-START> AUG-01-1997
<PERIOD-END> JUL-31-1998
<INVESTMENTS-AT-COST> 130336870
<INVESTMENTS-AT-VALUE> 139877984
<RECEIVABLES> 2108942
<ASSETS-OTHER> 74956
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 142061882
<PAYABLE-FOR-SECURITIES> 2553776
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 563542
<TOTAL-LIABILITIES> 3117318
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 129039580
<SHARES-COMMON-STOCK> 705792
<SHARES-COMMON-PRIOR> 461085
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 363870
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 9541114
<NET-ASSETS> 8142501
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 8220373
<OTHER-INCOME> 0
<EXPENSES-NET> (1612795)
<NET-INVESTMENT-INCOME> 6607578
<REALIZED-GAINS-CURRENT> 2705180
<APPREC-INCREASE-CURRENT> (1580034)
<NET-CHANGE-FROM-OPS> 7732724
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (341022)
<DISTRIBUTIONS-OF-GAINS> (94027)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 316468
<NUMBER-OF-SHARES-REDEEMED> (94310)
<SHARES-REINVESTED> 22549
<NET-CHANGE-IN-ASSETS> (2796990)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (457544)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 773590
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 1612795
<AVERAGE-NET-ASSETS> 6766221
<PER-SHARE-NAV-BEGIN> 11.60
<PER-SHARE-NII> .58
<PER-SHARE-GAIN-APPREC> .09
<PER-SHARE-DIVIDEND> (.58)
<PER-SHARE-DISTRIBUTIONS> (.15)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.54
<EXPENSE-RATIO> .83
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
