FRANKLIN MUTUAL SERIES FUND INC, N-30D, 1998-02-25

FRANKLIN MUTUAL SERIES FUND INC
N-30D, 1998-02-25

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<PAGE> 1
ANNUAL REPORT

DECEMBER 31, 1997

MUTUAL EUROPEAN FUND

[LOGO] FRANKLIN TEMPLETON
<PAGE> 2
TECHNOLOGY UPDATE:
FRANKLIN TEMPLETON
COMBATS THE YEAR 2000 PROBLEM
By Charles B. Johnson,
President of Franklin Resources, Inc.

As we near the 21st century, Franklin Templeton is taking important steps to
tackle the computer glitch dubbed the Year 2000 Problem, Y2K, or the Millennium
Bug. The problem originated from the software designers' attempt to save memory
by recording years in a two-digit format -- "98" instead of "1998", for example
- -- but didn't take into account that the year 2000 or "00", could also be
interpreted as 1900. Uncorrected, this problem could prevent computers from
accurately processing date-sensitive data after 1999.

Franklin Templeton's Information Services & Technology division established a
Year 2000 Project Team that has already begun making the necessary software
changes to help ensure that our computer systems, which service the funds and
their shareholders, will be Year 2000 Compliant. As changes reach completion, we
will conduct comprehensive tests to verify their effectiveness. We will also
require all of our major software or data-services suppliers to be Year-2000
Compliant.

In addition, with an estimated 80% of businesses facing the Year 2000 Problem,
mutual fund portfolio managers must be aware of the impact it could have on
companies in their portfolios. That's why Franklin Templeton portfolio managers
consistently keep this issue in mind while selecting investments and managing
their portfolios.

<PAGE> 3

SHAREHOLDER LETTER

- -------------------------------------------------------------------------
Your Fund's Objective: The Mutual European Fund seeks capital appreciation,
with income as a secondary objective, by investing primarily in common and
preferred stocks, bonds, and convertible securities. The fund will normally
have at least 65% of its invested assets in the securities of issuers organized
under the laws of, or whose principal business operations or at least 50% of
whose revenue is earned from, European countries.
- -------------------------------------------------------------------------

Dear Shareholder:

We are pleased to bring you the second annual report of the Mutual European
Fund, which covers the period ended December 31, 1997. During the 12 months
under review, the fund's Class Z shares provided a 23.16% cumulative total
return, as discussed in the Performance Summary on page 5. The Morgan Stanley
Capital International(R) All Countries Europe Index returned 24.77%* for the
same period.

During the reporting period, European equity markets reacted strongly to events
in Asia and the U.S., creating severe volatility. However, these swings in stock
prices offered us opportunities to find value in

*Source: Bloomberg. Index is unmanaged and includes reinvested dividends. One
cannot invest directly in an index.

You may find a complete listing of the fund's portfolio holdings, including the
number of shares and dollar value, beginning on page 17 of this report.

CONTENTS

Shareholder Letter ................................ 1

Performance Summary
Class Z ......................................... 5
Class I ......................................... 8
Class II ........................................ 11

Financial Highlights & Statement of Investments ... 14

Financial Statements .............................. 22

Notes to Financial Statements ..................... 25

Report of Independent Auditors .................... 32

Tax Designation ................................... 33

FUND CATEGORY PYRAMID

<PAGE> 4

the securities of companies such as Triplex Lloyd Plc., a U.K. engineering firm
and Railtrack Group Plc., a privatized U.K. transportation company. The value of
these securities rose appreciably and benefited the fund's performance.

At the end of the period, we continued to feel that small and mid-capitalization
stocks offered better value than those of large capitalization companies. The
fears in Europe surrounding the Asian crises are logical, and the poor financial
condition of many large Asian institutions may have ramifications in Europe and
around the globe, especially if the problems worsen. Although we believe that
our portfolio is not overly exposed to problems in Asia, it may not totally
escape the repercussions of a growing financial crisis.

We believe that 1998 will be one of the most exciting years Europe has seen for
some time. As you are probably aware, Western Europe has proposed a single
currency, the euro, which is scheduled to be introduced on January 1, 1999.
Several countries, notably the United Kingdom, Sweden, and Denmark, have
deferred their inclusion and are waiting either to align their economic cycles
with the economies of France and Germany or to wait and see the track record of
the new currency. Since World War II, Europe has moved towards a democratic
unification. No one nation is a world power, but, as a unified force, Europe
hopes to command world power status. The continent has 350 million consumers
(vs. 260 million for the U.S.) and the lowered trade barriers and decreasing tax
rates that the European Union may bring should benefit their economy.

PORTFOLIO BREAKDOWN
Based on Total Net Assets
12/31/97

Equities ........................... 76.6%

Bonds .............................. 3.1%

Short-Term Investments &
Other Net Assets ................. 20.3%

TOP 10 COUNTRIES
12/31/97

% OF TOTAL
COUNTRY NET ASSETS
----------------------------------------------------------------
United Kingdom 21.9%

France 17.7%

Sweden 14.1%

Netherlands 4.5%

Finland 4.1%

Italy 3.3%

United States 3.2%

Denmark 2.7%

Spain 2.4%

Switzerland 1.8%

<PAGE> 5

Although it will be years before the success or failure of the European Union is
known, we anticipate problems and hope they force greater flexibility on the new
system. After World War II, European welfare states were created to avoid the
civil unrest that plagued the continent earlier in the century. These programs
were easy to create, but have been difficult to dismantle and disbanding these
expensive, unproductive welfare programs will take time. We are concerned that
the European Union will not be aggressive enough in its attempts to downsize its
programs. Additionally, Europe has not yet demonstrated much success at creating
jobs to offset downsizing. However, as unification unfolds, we expect
fine-tuning and look forward to the opportunities that volatility and
overreaction in the equity markets may present.

We appreciate your participation in the Mutual European Fund and welcome your
comments and suggestions.

Sincerely,

Franklin Mutual Advisers Senior Portfolio Management Team

TOP 10 INDUSTRIES
12/31/97

% OF TOTAL
INDUSTRY NET ASSETS
----------------------------------------------------------------

Multi-Industry 14.8%

Insurance 6.2%

Machinery & Engineering 6.2%

Business & Public Services 5.7%

Real Estate 5.3%

Industrial Components 4.8%

Broadcasting & Publishing 3.7%

Beverages & Tobacco 3.5%

Banking 3.2%

Transportation 2.8%

<PAGE> 6

Please remember, this discussion reflects our views and opinions as of December
31, 1997, the end of the reporting period. Market and economic conditions are
changing constantly which may affect our strategies and portfolio holdings.
Although historic performance is no guarantee of future results, these insights
may help you understand our investment and management philosophy.

The fund's investments in foreign securities involve special risks, including
political uncertainty or fluctuations in foreign exchange rates in areas where
investments are made. Notably, the fund expects to hedge against currency risk
where feasible and to the extent possible.

The fund may also invest in lower-rated "junk bonds," which entail greater
credit risks than higher-rated bonds. The fund's value-oriented strategy may
include investments in companies involved in mergers, reorganizations,
restructurings, or liquidations. The risks associated with these investments are
described in the fund's prospectus.

TOP 10 HOLDINGS
12/31/97

COMPANY, % OF TOTAL
COUNTRY, INDUSTRY NET ASSETS
--------------------------------------------
Suez Lyonnaise des Eaux SA,
France,
Business & Public Services 3.0%
Societe Elf Aquitane SA,
France,
Energy Sources 1.9%

Actividades de Construcciones Y Servicio,
Spain,
Construction & Housing 1.5%

Triplex Lloyd Plc.,
United Kingdom,
Machinery & Engineering 1.4%

Railtrack Group Plc.,
United Kingdom,
Transportation 1.4%

Assurance Generales
de France (AGF), France,
Insurance 1.3%

Finnveden Invest AB, B,
Sweden,
Industrial Components 1.3%

Custos AB,
Sweden,
Multi-Industry 1.2%

Sampo Insurance Co. Ltd., A,
Finland,
Insurance 1.1%

Pohjola Insurance Co. Ltd.,
Finland,
Insurance 1.1%

<PAGE> 7

PERFORMANCE SUMMARY

CLASS Z

Mutual European Fund - Class Z produced a 23.16% cumulative total return for the
12-month period ended December 31, 1997. Cumulative total return measures the
change in value of an investment, assuming reinvestment of dividends and capital
gains.

The fund's Class Z share price increased $1.21, from $11.39 on December 31,
1996, to $12.60 on December 31, 1997. During the reporting period, Class Z
shareholders received per-share distributions of 84.00 cents ($0.8400) in
dividend income, 45.00 cents ($0.4500) in short-term capital gains, and 11.00
cents ($0.1100) in long-term capital gains. Distributions will vary depending on
income earned by the fund and any profits realized from the sale of securities
in the portfolio, as well as the level of the fund's operating expenses.

The graph on page 6 compares the performance of Mutual European Fund - Class Z
since inception on July 3, 1996, and the Morgan Stanley Capital International
(MSCI) All Countries Europe Index. The index measures the weighted average
performance, in U.S. dollars, of about 60% of the market capitalization listed
on 21 European stock exchanges (approximately 700 securities), and includes all
dividends reinvested.

Past performance is not predictive of future results.

5
<PAGE> 8

Keep in mind that an unmanaged market index has inherent performance
differentials in comparison with any fund. An index does not pay management fees
to cover salaries of security analysts or portfolio managers, or pay commissions
or market spreads to buy and sell securities. Unlike an index, mutual funds are
never 100% invested because they need to have cash on hand to redeem shares. In
addition, the performance shown for the fund includes all fund expenses and
account fees. The index's performance would have been lower if the fund's costs
had been applied to it. Please remember that an index is simply a measure of
performance, and one cannot invest in it directly.

CLASS Z
TOTAL RETURN INDEX COMPARISON
$10,000 INVESTMENT (7/3/96 - 12/31/97)

MUTUAL EUROPEAN MSCI ALL COUNTRIES -
DATE FUND - CLASS Z* EUROPE**
---- --------------- --------
<S> <C> <C>
7/3/96 $10,000 $10,000
7/31/96 $10,060 $9,893
8/31/96 $10,430 $10,192
9/30/96 $10,640 $10,400
10/31/96 $10,840 $10,637
11/30/96 $11,260 $11,172
12/31/96 $11,461 $11,394
1/31/97 $11,984 $11,469
2/28/97 $12,236 $11,626
3/31/97 $12,397 $11,994
4/30/97 $12,376 $11,928
5/31/97 $12,537 $12,444
6/30/97 $12,960 $13,067
7/31/97 $13,525 $13,669
8/31/97 $13,282 $12,901
9/30/97 $14,163 $14,169
10/31/97 $13,627 $13,473
11/30/97 $13,768 $13,674
12/31/97 $14,115 $14,217

</TABLE>

The historical performance shown pertains only to the fund's Class Z shares. The
fund offers other share classes subject to different fees and expenses, which
affect their performance. Please see the prospectus for more details.
*Performance figures represent the change in value of an investment over the
periods shown, assuming reinvestment of dividends and capital gains at net asset
value. This was a period of generally rising security prices.
**Index is unmanaged and includes reinvested dividends. One cannot invest
directly in an index.

Past performance is not predictive of future results.

<PAGE> 9

CLASS Z
Periods ended 12/31/97

<TABLE>
<CAPTION>
SINCE
INCEPTION
1-YEAR (7/3/96)
----------------------------------------------------------------------
<S> <C> <C>
Cumulative Total Return(1) 23.16% 41.15%
Average Annual Total Return(2) 23.16% 25.91%
Value of $10,000 Investment(3) $12,316 $14,115
</TABLE>

1. Cumulative total return represents the change in value of an investment over
the indicated periods.

2. Average annual total return represents the average annual change in value of
an investment over the indicated periods.

3. These figures represent the value of a hypothetical $10,000 investment in the
fund over the indicated periods.

All calculations assume reinvestment of dividends and capital gains at net asset
value. The fund's manager has agreed in advance to waive a portion of its
management fees, which increases total return to shareholders. If the manager
had not taken this action, the fund's total returns would have been lower.
Franklin Mutual Advisers has made a commitment to the fund's Board not to seek
an increase in the rate of investment advisory fees for a three-year period
beginning November 1, 1996.

Investment return and principal value will fluctuate with market conditions,
currency volatility and the economic, social, and political climates of
countries where investments are made. You may have a gain or loss when you sell
your shares.

Past performance is not predictive of future results.

7
<PAGE> 10

CLASS I

Mutual European Fund - Class I produced a 22.61% cumulative total return for the
12-month period ended December 31, 1997. Cumulative total return measures the
change in value of an investment, assuming reinvestment of dividends and capital
gains, and does not include the initial sales charge.

The fund's Class I share price, as measured by net asset value, increased $1.18,
from $11.38 on December 31, 1996, to $12.56 on December 31, 1997. During the
reporting period, Class I shareholders received per-share distributions of 80.70
cents ($0.8070) in dividend income, 45.00 cents ($0.4500) in short-term capital
gains, and 11.00 cents ($0.1100) in long-term capital gains. Distributions will
vary depending on income earned by the fund and any profits realized from the
sale of securities in the portfolio, as well as the level of the fund's
operating expenses.

The graph on page 9 compares the performance of Mutual European Fund - Class I
since inception on November 1, 1996, and the Morgan Stanley Capital
International (MSCI) All Countries Europe Index. The index measures the weighted
average performance, in U.S. dollars, of about 60% of the market capitalization
listed on 21 European stock exchanges (approximately 700 securities), and
includes all dividends reinvested.

8
<PAGE> 11

Keep in mind that an unmanaged market index has inherent performance
differentials in comparison with any fund. An index does not pay management fees
to cover salaries of security analysts or portfolio managers, or pay commissions
or market spreads to buy and sell securities. Unlike an index, mutual funds are
never 100% invested because they need to have cash on hand to redeem shares. In
addition, the performance shown for the fund includes the maximum initial sales
charge, all fund expenses and account fees. The index's performance would have
been lower if the fund's costs had been applied to it. Please remember that an
index is simply a measure of performance, and one cannot invest in it directly.

CLASS I
TOTAL RETURN INDEX COMPARISON
$10,000 INVESTMENT (11/1/96 - 12/31/97)

<TABLE>
<CAPTION>
MUTUAL EUROPEAN MSCI ALL COUNTRIES -
DATE FUND - CLASS I* EUROPE**
---- --------------- --------
<S> <C> <C>
11/1/96 $9,551 $10,000
11/30/96 $9,894 $10,503
12/31/96 $10,068 $10,712
1/31/97 $10,528 $10,783
2/28/97 $10,741 $10,930
3/31/97 $10,882 $11,276
4/30/97 $10,865 $11,214
5/31/97 $10,997 $11,699
6/30/97 $11,369 $12,284
7/31/97 $11,857 $12,851
8/31/97 $11,644 $12,128
9/30/97 $12,409 $13,321
10/31/97 $11,937 $12,667
11/30/97 $12,053 $12,855
12/31/97 $12,354 $13,366
</TABLE>

The historical performance shown pertains only to the fund's Class I shares. The
fund offers other share classes subject to different fees and expenses, which
affect their performance. Please see the prospectus for more details.

*Performance figures represent the change in value of an investment over the
periods shown, and include the maximum 4.5% initial sales charge, assuming
reinvestment of dividends and capital gains at net asset value. This was a
period of generally rising security prices.

**Index is unmanaged and includes reinvested dividends. One cannot invest
directly in an index.

Past performance is not predictive of future results.

9
<PAGE> 12

CLASS I
Periods ended 12/31/97

<TABLE>
<CAPTION>
SINCE
INCEPTION
1-YEAR (11/1/96)
----------------------------------------------------------------------
<S> <C> <C>
Cumulative Total Return(1) 22.61% 29.49%
Average Annual Total Return(2) 17.09% 20.01%
Value of $10,000 Investment(3) $11,709 $12,366
</TABLE>

1. Cumulative total return represents the change in value of an investment over
the indicated periods and does not include the sales charge.

2. Average annual total return represents the average annual change in value of
an investment over the indicated periods and includes the maximum 4.5% initial
sales charge.

3. These figures represent the value of a hypothetical $10,000 investment in the
fund over the indicated periods and include the sales charge.

Past performance is not predictive of future results.

10
<PAGE> 13

CLASS II

Mutual European Fund - Class II produced a 21.79% cumulative total return for
the 12-month period ended December 31, 1997. Cumulative total return measures
the change in value of an investment, assuming reinvestment of dividends and
capital gains, and does not include sales charges.

The fund's Class II share price, as measured by net asset value, increased
$1.14, from $11.38 on December 31, 1996, to $12.52 on December 31, 1997. During
the reporting period, Class II shareholders received per-share distributions of
75.57 cents ($0.7557) in dividend income, 45.00 cents ($0.4500) in short-term
capital gains, and 11.00 cents ($0.1100) in long-term capital gains.
Distributions will vary depending on income earned by the fund and any profits
realized from the sale of securities in the portfolio, as well as the level of
the fund's operating expenses.

The graph on page 12 compares the performance of Mutual European Fund - Class II
since inception on November 1, 1996, and the Morgan Stanley Capital
International (MSCI) All Countries Europe Index. The index measures the weighted
average performance, in U.S. dollars, of about 60% of the market capitalization
listed on 21 European stock exchanges (approximately 700 securities), and
includes all dividends reinvested.

11
<PAGE> 14

Keep in mind that an unmanaged market index has inherent performance
differentials in comparison with any fund. An index does not pay management fees
to cover salaries of security analysts or portfolio managers, or pay commissions
or market spreads to buy and sell securities. Unlike an index, mutual funds are
never 100% invested because they need to have cash on hand to redeem shares. In
addition, the performance shown for the fund includes sales charges, all fund
expenses and account fees. The index's performance would have been lower if the
fund's costs had been applied to it. Please remember that an index is simply a
measure of performance, and one cannot invest in it directly.

CLASS II
TOTAL RETURN INDEX COMPARISON
$10,000 INVESTMENT (11/1/96 - 12/31/97)

<TABLE>
<CAPTION>
MUTUAL EUROPEAN MSCI ALL COUNTRIES -
DATE FUND - CLASS II* EUROPE**
---- ---------------- --------
<S> <C> <C>
11/1/96 $9,900 $10,000
11/30/96 $10,246 $10,503
12/31/96 $10,427 $10,712
1/31/97 $10,895 $10,783
2/28/97 $11,115 $10,930
3/31/97 $11,243 $11,276
4/30/97 $11,225 $11,214
5/31/97 $11,353 $11,699
6/30/97 $11,728 $12,284
7/31/97 $12,223 $12,851
8/31/97 $11,993 $12,128
9/30/97 $12,776 $13,321
10/31/97 $12,288 $12,667
11/30/97 $12,407 $12,855
12/31/97 $12,611 $13,366
</TABLE>

The historical performance shown pertains only to the fund's Class II shares.
The fund offers other share classes subject to different fees and expenses,
which affect their performance. Please see the prospectus for more details.

*Performance figures represent the change in value of an investment over the
periods shown and include all sales charges, assuming reinvestment of dividends
and capital gains at net asset value. This was a period of generally rising
security prices.
**Index is unmanaged and includes reinvested dividends. One cannot invest
directly in an index.

Past performance is not predictive of future results.

12
<PAGE> 15

CLASS II
Periods ended 12/31/97

<TABLE>
<CAPTION>
SINCE
INCEPTION
1-YEAR (11/1/96)
----------------------------------------------------------------------
<S> <C> <C>
Cumulative Total Return(1) 21.79% 28.51%
Average Annual Total Return(2) 19.59% 10.85%
Value of $10,000 Investment(3) $11,959 $12,723
</TABLE>

1. Cumulative total return represents the change in value of an investment over
the indicated periods and does not include sales charges.

2. Average annual total return represents the change in value of an investment
over the indicated periods and includes the 1.0% initial sales charge and 1.0%
contingent deferred sales charge, applicable to shares redeemed within 18 months
of investment.

3. These figures represent the value of a hypothetical $10,000 in the fund over
the indicated periods and include sales charges.

Past performance is not predictive of future results.

13
<PAGE> 16

MUTUAL EUROPEAN FUND
Financial Highlights

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1997++ 1996+
----------------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE - CLASS Z
(For a share outstanding throughout the year)
Net asset value, beginning of year................................................ $11.39 $10.00
--------------------------
Income from investment operations:
Net investment income............................................................ .33 .06
Net realized and unrealized gain................................................. 2.28 1.40
--------------------------
Total from investment operations.................................................. 2.61 1.46
--------------------------
Less distributions from:
Net investment income............................................................ (.84) (.05)
Net realized gains............................................................... (.56) (.02)
--------------------------
Total distributions............................................................... (1.40) (.07)
--------------------------
Net asset value, end of year...................................................... $12.60 $11.39
--------------------------
Total Return*..................................................................... 23.16% 14.61%

RATIOS/SUPPLEMENTAL DATA
Net assets, end of year (000's)................................................... $546,780 $450,495
Ratios to average net assets:
Expenses......................................................................... 1.02% 1.09%**
Expenses, excluding waiver and payments by affiliate............................. 1.05% 1.15%**
Net investment income............................................................ 2.53% 1.87%**
Portfolio turnover rate........................................................... 98.12% 36.75%
Average commission rate paid***................................................... $.0172 $.0233
</TABLE>

*Total return is not annualized.
**Annualized.
***Relates to purchases and sales of equity securities.
+For the period July 3, 1996 (commencement of operations) to December 31, 1996.
++Based on average weighted shares outstanding.

14
<PAGE> 17

MUTUAL EUROPEAN FUND
Financial Highlights (continued)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997++ 1996+
--------------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE - CLASS I
(For a share outstanding throughout the year)
Net asset value, beginning of year................................................ $11.38 $10.84
--------------------------
Income from investment operations:
Net investment income............................................................ .24 .03
Net realized and unrealized gain................................................. 2.31 .58
--------------------------
Total from investment operations.................................................. 2.55 .61
--------------------------
Less distributions from:
Net investment income............................................................ (.81) (.05)
Net realized gains............................................................... (.56) (.02)
--------------------------
Total distributions............................................................... (1.37) (.07)
--------------------------
Net asset value, end of year...................................................... $12.56 $11.38
--------------------------
Total Return*..................................................................... 22.61% 5.61%

RATIOS/SUPPLEMENTAL DATA
Net assets, end of year (000's)................................................... $93,231 $9,200
Ratios to average net assets:
Expenses......................................................................... 1.37% 1.32%**
Expenses, excluding waiver and payments by affiliate............................. 1.39% 1.42%**
Net investment income............................................................ 1.84% 1.44%**
Portfolio turnover rate........................................................... 98.12% 36.75%
Average commission rate paid***................................................... $.0172 $.0233
</TABLE>

*Total return does not reflect sales commissions and is not annualized.
**Annualized.
***Relates to purchases and sales of equity securities.
+For the period November 1, 1996 (effective date) to December 31, 1996.
++Based on average weighted shares outstanding.

15
<PAGE> 18

MUTUAL EUROPEAN FUND
Financial Highlights (continued)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1997++ 1996+
-------------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE - CLASS II
(For a share outstanding throughout the year)
Net asset value, beginning of year.................................................. $11.38 $10.84
-------------------------
Income from investment operations:
Net investment income.............................................................. .13 .02
Net realized and unrealized gain................................................... 2.33 .58
-------------------------
Total from investment operations.................................................... 2.46 .60
-------------------------
Less distributions from:
Net investment income.............................................................. (.76) (.04)
Net realized gains................................................................. (.56) (.02)
-------------------------
Total distributions................................................................. (1.32) (.06)
-------------------------
Net asset value, end of year........................................................ $12.52 $11.38
-------------------------
Total Return*....................................................................... 21.79% 5.52%

RATIOS/SUPPLEMENTAL DATA
Net assets, end of year (000's)..................................................... $49,174 $2,754
Ratios to average net assets:
Expenses........................................................................... 2.02% 1.94%**
Expenses, excluding waiver and payments by affiliate............................... 2.05% 2.04%**
Net investment income.............................................................. 1.03% 0.79%**
Portfolio turnover rate............................................................. 98.12% 36.75%
Average commission rate paid***..................................................... $.0172 $.0233
</TABLE>

*Total return does not reflect sales commissions or the contingent deferred
sales charge and is not annualized.
**Annualized.
***Relates to purchases and sales of equity securities.
+For the period November 1, 1996 (effective date) to December 31, 1996.
++Based on average weighted shares outstanding.

See Notes to Financial Statements.

16
<PAGE> 19

MUTUAL EUROPEAN FUND
STATEMENT OF INVESTMENTS, DECEMBER 31, 1997

<TABLE>
<CAPTION>
COUNTRY SHARES VALUE
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMON STOCKS 76.6%
AUTOMOBILES 1.1%
Bertrand Faure SA................................................. France 51,672 $ 3,673,747
*Magneti Marelli SpA.............................................. Italy 2,425,000 4,100,155
-----------
7,773,902
-----------
BANKING 3.2%
*Banca Nazionale del Lavoro SpA, fgn.............................. Italy 250,000 3,886,376
*Banque Cantonale Vaudoise, fgn................................... Switzerland 10,250 3,499,299
BG Bank AS, fgn................................................... Denmark 92,000 6,189,816
*Credit National/Natexis.......................................... France 68,423 3,990,442
Merita Ltd., A.................................................... Finland 374,500 2,048,025
*Nordbanken Holding AB............................................ Sweden 418,000 2,363,783
-----------
21,977,741
-----------
BEVERAGES & TOBACCO 3.5%
B.A.T. Industries Plc............................................. United Kingdom 490,000 4,462,374
Diageo Plc........................................................ United Kingdom 605,000 5,549,410
Heineken Holding NV, A............................................ Netherlands 34,250 5,270,140
*Seita............................................................ France 140,000 5,024,508
Swedish Match AB.................................................. Sweden 1,230,000 4,105,215
-----------
24,411,647
-----------
BROADCASTING & PUBLISHING 3.7%
Aamulehti Yhtymae OY, II.......................................... Finland 118,750 3,966,179
A-Pressen AS, A................................................... Norway 62,000 1,366,102
Mirror Group Plc.................................................. United Kingdom 1,306,966 4,217,889
*Modern Times Group AB, B, fgn.................................... Sweden 468,200 2,800,980
NV Holdingsmij de Telegraaf....................................... Netherlands 281,600 5,305,215
Pearson Plc....................................................... United Kingdom 385,000 4,995,237
United News & Media Plc........................................... United Kingdom 255,580 2,883,712
-----------
25,535,314
-----------
BUILDING MATERIALS & COMPONENTS 2.1%
*+Geveko AB, B.................................................... Sweden 552,134 7,023,455
Scancem AB, B..................................................... Sweden 80,145 2,977,717
Williams Plc...................................................... United Kingdom 850,000 4,659,169
-----------
14,660,341
-----------
BUSINESS & PUBLIC SERVICES 5.7%
Cie Generale Des Eaux............................................. France 20,000 2,791,393
Esselte AB, A..................................................... Sweden 162,000 3,060,492
IFIL Finanziaria Partecipazioni SpA............................... Italy 1,100,000 3,999,548
Suez Lyonnaise des Eaux SA........................................ France 184,058 20,367,638
*+Uniholding Corp., Illiquid...................................... United States 576,584 4,151,405
*+Uniholding Corp................................................. United States 5,000 40,000
Yorkshire Water Plc............................................... United Kingdom 645,000 5,127,119
-----------
39,537,595
-----------
</TABLE>

17
<PAGE> 20

MUTUAL EUROPEAN FUND
STATEMENT OF INVESTMENTS, DECEMBER 31, 1997 (continued)

<TABLE>
<CAPTION>
COUNTRY SHARES VALUE
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMON STOCKS (CONT.)
CHEMICALS 1.6%
*Holliday Chemical Holdings Plc................................... United Kingdom 500,000 $ 1,880,502
Inspec Group Plc.................................................. United Kingdom 800,000 3,094,206
Laporte Plc....................................................... United Kingdom 290,000 3,183,961
Yule Catto & Company Plc.......................................... United Kingdom 650,000 3,069,160
-----------
11,227,829
-----------
CONSTRUCTION & HOUSING 2.2%
Actividades de Construcciones Y Servicio (ACS).................... Spain 432,840 10,483,621
*Actividades de Construcciones Y Servicio (ACS), rts.............. Spain 432,840 11,364
Grupo Acciona SA.................................................. Spain 27,550 4,495,523
-----------
14,990,508
-----------
DATA PROCESSING & REPRODUCTION 0.6%
Tecnost Mael SpA.................................................. Italy 1,860,000 3,774,675
-----------
ELECTRONIC COMPONENTS & INSTRUMENTS 0.6%
Spectra Physics AB, A............................................. Sweden 214,400 4,063,930
-----------
ENERGY EQUIPMENT & SERVICES 2.1%
Bouygues Offshore SA, ADR......................................... France 212,700 4,626,225
*Cie Generale De Geophysique SA, ADR.............................. France 230,000 5,893,750
*ISIS SA.......................................................... France 36,556 4,008,800
-----------
14,528,775
-----------
ENERGY SOURCES 2.5%
Saga Petroleum AS, B.............................................. Norway 233,200 3,541,478
Societe Elf Aquitane SA........................................... France 115,250 13,404,503
-----------
16,945,981
-----------
FINANCIAL SERVICES 2.2%
Axa SA............................................................ France 67,000 5,184,332
*Cityscape Financial Corp......................................... United States 88,000 44,000
Julius Baer Holdings AG........................................... Switzerland 2,000 3,708,138
Mercury Asset Management Group Plc................................ United Kingdom 200,000 5,570,884
*Mercury European Privitization Trust Plc., wts................... United Kingdom 540,000 450,089
-----------
14,957,443
-----------
FOOD & HOUSEHOLD PRODUCTS 2.1%
Berisford Plc..................................................... United Kingdom 1,041,000 3,205,681
Cadbury Schweppes Plc............................................. United Kingdom 465,359 4,623,936
Klene Holding NV.................................................. Netherlands 71,489 1,233,997
Van Melle NV...................................................... Netherlands 76,318 5,457,604
-----------
14,521,218
-----------
INDUSTRIAL COMPONENTS 4.7%
Charter Plc....................................................... United Kingdom 486,161 5,968,423
*Cie Plastic Omnium SpA........................................... France 23,742 3,132,200
Finnveden Invest AB, B............................................ Sweden 479,600 8,909,558
Gunnebo AB........................................................ Sweden 450,100 3,939,842
</TABLE>

18
<PAGE> 21

MUTUAL EUROPEAN FUND
STATEMENT OF INVESTMENTS, DECEMBER 31, 1997 (continued)

<TABLE>
<CAPTION>
COUNTRY SHARES VALUE
<S> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------
COMMON STOCKS (CONT.)
INDUSTRIAL COMPONENTS (CONT.)
Hexagon AB, B..................................................... Sweden 204,457 $ 5,613,626
Lucas Varity Plc.................................................. United Kingdom 1,418,536 5,020,604
-----------
32,584,253
-----------
INSURANCE 6.2%
Assurances Generales de France AGF................................ France 169,801 8,997,182
Istituto Nazionale Delle Assicurazioni SpA........................ Italy 1,131,000 2,293,967
Koelnische Rueckversicherungs AG.................................. Germany 2,906 2,665,314
Pohjola Insurance Co. Ltd......................................... Finland 207,000 7,673,420
Sampo Insurance Co. Ltd., A....................................... Finland 237,460 7,843,867
SCOR SA........................................................... France 115,181 5,507,866
*Topdanmark AS.................................................... Denmark 19,252 3,652,651
*Union Assurances Federales SA.................................... France 32,210 4,227,947
-----------
42,862,214
-----------
MACHINERY & ENGINEERING 6.2%
Cardo AB.......................................................... Sweden 185,000 4,823,109
IMI Plc........................................................... United Kingdom 946,000 6,300,141
Incentive AS, fgn................................................. Denmark 71,582 3,760,931
Mckechnie Group Plc............................................... United Kingdom 625,000 4,726,917
*Munters AB....................................................... Sweden 340,400 2,936,737
Partek AB......................................................... Finland 167,500 2,554,366
Rauma OY.......................................................... Finland 274,300 4,278,701
Triplex Lloyd Plc................................................. United Kingdom 2,193,750 9,817,975
TT Group Plc...................................................... United Kingdom 780,000 3,542,077
-----------
42,740,954
-----------
MERCHANDISING 2.1%
FKI Plc........................................................... United Kingdom 1,675,000 5,281,829
*Provigo Inc...................................................... Canada 400,000 2,435,184
Vendome Luxury Group Plc.......................................... United Kingdom 891,000 6,965,510
-----------
14,682,523
-----------
MULTI-INDUSTRY 14.8%
Aker RGI ASA, B................................................... Norway 332,548 5,410,950
Atle AB........................................................... Sweden 275,000 4,346,717
Bulten AB, B...................................................... Sweden 260,100 2,358,619
CGIP-Compagnie Generale Industrie de Participation................ France 15,170 5,444,413
Cie Financiere Richemont AG, A.................................... Switzerland 4,840 5,265,009
*Corporacion Financiera Reunida SA................................ Spain 293,057 1,567,715
Custos AB, A...................................................... Sweden 59,500 1,281,439
Custos AB, B...................................................... Sweden 341,520 7,226,207
Financiere Et Industrielle Gaz Et Eaux SA......................... France 4,181 1,802,724
Gendis Inc., A.................................................... Canada 420,000 6,245,408
Hogg Robinson Plc................................................. United Kingdom 1,350,000 5,664,909
Investor AB, A.................................................... Sweden 34,000 1,657,200
Investor AB, B.................................................... Sweden 120,850 5,890,370
Invik & Co. AB, B................................................. Sweden 132,512 5,924,730
</TABLE>

19
<PAGE> 22

MUTUAL EUROPEAN FUND
STATEMENT OF INVESTMENTS, DECEMBER 31, 1997 (continued)

<TABLE>
<CAPTION>
COUNTRY SHARES VALUE
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMON STOCKS (CONT.)
MULTI-INDUSTRY (CONT.)
La France SA...................................................... France 13,585 $ 2,783,136
Lagardere S.C.A................................................... France 188,687 6,238,882
Marine Wendel SA.................................................. France 35,687 4,055,813
Montaigne Participations et Gestion SA............................ France 8,307 2,725,982
*Montedison SpA................................................... Italy 2,800,000 2,510,345
Oresund Investment AB............................................. Sweden 137,333 3,632,279
Pilkington Plc.................................................... United Kingdom 1,200,000 2,522,665
Sophus Berendsen AS, B............................................ Denmark 30,000 4,947,533
STE Eurafrance.................................................... France 10,350 4,213,259
STE Generale de Belgique SA....................................... Belgium 61,009 5,582,049
Tomkins Plc....................................................... United Kingdom 575,000 2,681,973
-----------
101,980,326
-----------
REAL ESTATE 4.2%
*Castellum AB..................................................... Sweden 661,400 6,580,763
Fastighets AB Tornet, A........................................... Sweden 207,206 2,948,939
First Union Real Estate Equity & Mtg. Investment, SBI............. United States 352,500 5,728,125
Metropolis Realty Trust Inc....................................... United States 152,000 6,688,000
STE des Immeubles De France....................................... France 63,631 3,816,697
Wallenstam Byggnads AB, B......................................... Sweden 480,000 3,022,708
-----------
28,785,232
-----------
RECREATION & OTHER CONSUMER GOODS 0.6%
EMI Group Plc..................................................... United Kingdom 443,175 3,815,768
TELECOMMUNICATIONS 1.9%
*Cellular Communications International Inc........................ United States 69,500 3,249,125
Koninklijke Ptt Nederland NV...................................... Netherlands 139,000 5,799,522
*Telewest Communications Plc...................................... United Kingdom 3,509,000 4,034,128
-----------
13,082,775
-----------
TRANSPORTATION 2.0%
Florida East Coast Industries Inc................................. United States 15,000 1,441,875
Railtrack Group Plc............................................... United Kingdom 605,000 9,648,124
Smit Internationale NV, fgn....................................... Netherlands 101,100 2,742,337
-----------
13,832,336
-----------
UTILITIES ELECTRICAL GAS & WATER 0.7%
Thames Water Group Plc............................................ United Kingdom 330,000 4,937,426
-----------
TOTAL COMMON STOCKS (COST $470,055,708)..................... 528,210,706
-----------
PREFERRED STOCKS (COST $212,750)
First Union Real Est. Equ. & Mtg. Inv.,
conv., pfd., A.................................................. United States 5,000 267,500
-----------
</TABLE>

20
<PAGE> 23

MUTUAL EUROPEAN FUND
STATEMENT OF INVESTMENTS, DECEMBER 31, 1997 (continued)

<TABLE>
<CAPTION>
PRINCIPAL
COUNTRY AMOUNT** VALUE
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BONDS (COST $2,173,471) 0.4%
Olivetti International NV,
3.75%, conv., 12/31/99.......................................... Italy 4,000,000,000ITL $ 2,509,892
------------
BONDS IN REORGANIZATION 2.7%
Anchor Glass Container Corp.,
9.91%, 7/15/99.................................................. United States 121,259 118,834
Zero coupon, 7/15/98............................................ United States 149,611 146,619
Eurotunnel Finance Ltd., tranche B................................ United Kingdom 2,754,803 GBP 2,397,920
Eurotunnel Finance Ltd., tranche B1............................... United Kingdom 1,245,197 GBP 1,083,883
Eurotunnel Finance Ltd., tranche EO............................... United Kingdom 25,000,000 FRF 2,160,007
Fokker NV
7.50%, 6/29/96.................................................. Netherlands 4,500,000 DEM 825,459
6.50%, 8/26/96.................................................. Netherlands 4,000,000 DEM 733,741
6.25%, 11/04/97................................................. Netherlands 14,750,000 DEM 2,705,670
10.00%, 11/22/97................................................ Netherlands 6,600,000 NLG 1,074,150
Northampton Business Parks, bank claim............................ United Kingdom 11,147,443 GBP 7,414,785
------------
TOTAL BONDS IN REORGANIZATION (COST $14,091,781)............ 18,661,068
------------
SHORT TERM INVESTMENTS 12.9%
Federal National Mortgage Assn., 5.35% to 5.62%
with maturities to 11/12/98..................................... United States 39,900,000 38,669,795
Federal Home Loan Bank, 5.30% to 5.67%
with maturities to 12/24/98..................................... United States 49,275,000 48,176,594
Federal Home Loan Mortgage Corp., 5.40% to 5.48%
with maturities to 6/05/98...................................... United States 1,800,000 1,771,795
------------
TOTAL SHORT TERM INVESTMENTS
(COST $88,606,199)........................................ 88,618,184
------------
TOTAL INVESTMENTS
(COST $575,139,909) 92.6%................................ 638,267,350
NET EQUITY IN FORWARD CONTRACTS 0.8%....................... 5,586,255
OTHER ASSETS, LESS LIABILITIES 6.6%........................ 45,331,932
------------
TOTAL NET ASSETS 100.0%.................................... $689,185,537
============
</TABLE>

*Non-income producing.
**Securities traded in U.S. dollars unless otherwise indicated.
+The Investment Company Act of 1940 defines "affiliated companies" as
investments in portfolio companies in which the Fund owns 5% or more of the
outstanding voting securities. Investments in non-controlled "affiliated
companies" at 12/31/97 were $11,214,860.

CURRENCY ABBREVIATIONS:
- -------------------

<TABLE>
<S> <C>
DEM -- German Mark
FRF -- French Franc
GBP -- British Pound
ITL -- Italian Lira
NLG -- Dutch Guilder
</TABLE>

See Notes to Financial Statements.

21
<PAGE> 24

MUTUAL EUROPEAN FUND
Financial Statements

STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 1997

<TABLE>
<S> <C> <C>
Assets:
Investments in securities, at value:
Unaffiliated issuers (cost $563,751,711)............................. $627,052,490
Non controlled affiliates (cost $11,388,198)......................... 11,214,860 $638,267,350
------------
Cash.................................................................. 38,969,171
Receivables:
Investment securities sold........................................... 3,177,784
Capital shares sold.................................................. 3,420,673
Dividends and interest............................................... 2,813,518
From affiliates...................................................... 97,443
Unrealized gain on forward exchange contracts (Note 7)................ 10,000,705
------------
Total assets...................................................... 696,746,644
------------
Liabilities:
Payables:
Investment securities purchased...................................... 1,531,921
Capital shares redeemed.............................................. 658,661
To affiliates........................................................ 694,675
Unrealized loss on forward exchange contracts (Note 7)................ 4,414,450
Other liabilities..................................................... 261,400
------------
Total liabilities................................................. 7,561,107
------------
Net assets, at value................................................... $689,185,537
============
Net assets consist of:
Undistributed net investment income................................... $ 119,297
Net unrealized appreciation........................................... 68,496,869
Accumulated net realized gain......................................... 24,408,641
Capital shares........................................................ 596,160,730
------------
Net assets, at value................................................... $689,185,537
============
CLASS Z
Net asset value per share ($546,780,453 / 43,411,737 shares outstanding).................. $12.60
======
CLASS I
Net asset value per share ($93,231,160 / 7,420,423 shares outstanding).................... $12.56
======
Maximum offering price per share ($12.56 / 95.50%)........................................ $13.15
======
CLASS II
Net asset value per share ($49,173,924 / 3,926,964 shares outstanding)*................... $12.52
======
Maximum offering price per share ($12.52 / 99.00%)........................................ $12.65
======
*Redemption price per share is equal to net asset value less any applicable sales charge.
</TABLE>

See Notes to Financial Statements.

22
<PAGE> 25

MUTUAL EUROPEAN FUND
Financial Statements (continued)

STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997

<TABLE>
<S> <C> <C>
Investment Income:
(net of foreign taxes of $1,900,363)
Dividends............................................................ $16,767,672
Interest............................................................. 6,654,436
-----------
Total investment income.......................................... $ 23,422,108
-----------
Expenses:
Management fees (Note 4)............................................. 5,372,334
Administrative fees (Note 4)......................................... 519,493
Distribution fees (Note 4)
Class I........................................................ 199,072
Class II....................................................... 269,431
Transfer agent fees (Note 4)......................................... 458,281
Custodian fees....................................................... 325,899
Reports to shareholders.............................................. 120,157
Registration and filing fees......................................... 172,741
Professional fees.................................................... 35,578
Directors' fees and expenses......................................... 7,670
Other................................................................ 15,735
-----------
Total expenses................................................... 7,496,391
Expenses waived/paid by affiliate (Note 4)....................... (204,659)
-----------
Net expenses................................................ 7,291,732
-----------
Net investment income..................................... 16,130,376
-----------
Realized and unrealized gains:
Net realized gain from:
Investments......................................................... 33,461,444
Foreign currency transactions....................................... 41,099,689
-----------
Net realized gain................................................ 74,561,133
Net unrealized appreciation on:
Investments......................................................... 34,595,926
Translation of assets and liabilities denominated in foreign
currencies........................................................ 5,464,891
-----------
Net unrealized appreciation...................................... 40,060,817
-----------
Net realized and unrealized gain...................................... 114,621,950
-----------
Net increase in net assets resulting from operations.................. $130,752,326
===========
</TABLE>

See Notes to Financial Statements.

23
<PAGE> 26

MUTUAL EUROPEAN FUND
Financial Statements (continued)

STATEMENTS OF CHANGES IN NET ASSETS
FOR THE PERIODS ENDED DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
1997 1996+
-------------------------------
<S> <C> <C>
Increase (decrease) in net assets:
Operations:
Net investment income.............................................. $ 16,130,376 $ 2,205,789
Net realized gain from investments and foreign currency
transactions..................................................... 74,561,133 4,514,505
Net unrealized appreciation on investments and translation of
assets and liabilities denominated in foreign currencies......... 40,060,817 28,436,052
-------------------------------
Net increase in net assets resulting from operations............. 130,752,326 35,156,346
Distributions to shareholders from:
Net investment income:
Class Z............................................................ (34,010,794) (1,947,610)
Class I............................................................ (5,190,859) (25,784)
Class II........................................................... (2,628,833) (7,669)
Net realized gains:
Class Z............................................................ (22,774,808) (779,044)
Class I............................................................ (3,590,901) (10,995)
Class II........................................................... (1,912,553) (4,015)
Capital share transactions (Note 3):
Class Z............................................................ 36,143,016 418,343,037
Class I............................................................ 83,196,564 9,032,503
Class II........................................................... 46,753,423 2,692,187
-------------------------------
Net increase in net assets....................................... 226,736,581 462,448,956
Net assets:
Beginning of year................................................... 462,448,956 --
-------------------------------
End of year......................................................... $689,185,537 $462,448,956
===============================
Undistributed net investment income included in net assets:
End of year......................................................... $ 119,297 $ 580,686
===============================
</TABLE>

+For the period July 3, 1996 (commencement of operations) to December 31, 1996.

See Notes to Financial Statements.

24
<PAGE> 27

MUTUAL EUROPEAN FUND
Notes to Financial Statements

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Mutual European Fund (the Fund) is a separate, diversified series of Franklin
Mutual Series Fund, Inc. (the Series Fund), which is an open-end investment
company registered under the Investment Company Act of 1940. The Fund seeks
long-term capital appreciation and income through a flexible policy of investing
in stocks and corporate debt securities. The following summarizes the Fund's
significant accounting policies.

a. SECURITY VALUATION:

Securities listed or traded on a recognized national exchange or NASDAQ are
valued at the latest reported sales price. Over-the-counter securities and
listed securities for which no sale is reported are valued within the range of
the latest quoted bid and asked prices. Restricted securities and securities for
which market quotations are not readily available are valued at fair value as
determined by management in accordance with procedures established by the Board
of Directors.

b. FOREIGN CURRENCY TRANSLATION:

Portfolio securities and other assets and liabilities denominated in foreign
currencies are translated into U.S. dollars based on the exchange rate of such
currencies against U.S. dollars on the date of valuation. Purchases and sales of
securities and income items denominated in foreign currencies are translated
into U.S. dollars at the exchange rate in effect on the transaction date.

The Fund does not separately report the effect of changes in foreign exchange
rates from changes in market prices on securities held. Such changes are
included in net realized and unrealized gain or loss from investments.

Realized foreign exchange gains or losses arise from sales of foreign
currencies, currency gains or losses realized between the trade and settlement
dates on securities transactions and the difference between the recorded amounts
of dividends, interest, and foreign withholding taxes, and the U.S. dollar
equivalent of the amounts actually received or paid. Net unrealized foreign
exchange gains and losses arise from changes in foreign exchange rates on
foreign currency denominated assets and liabilities other than investments in
securities held at the end of the reporting period.

c. INCOME TAXES:

No provision has been made for income taxes because the Fund's policy is to
qualify as a regulated investment company under the Internal Revenue Code and to
distribute all of its taxable income.

d. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS:

Security transactions are accounted for on trade date. Realized gains and losses
on security transactions are determined on a specific identification basis.
Certain income from foreign securities is recorded as soon as information is
available to the Fund. Interest income and estimated expenses are accrued daily.
Dividend income and distributions to shareholders are recorded on the
ex-dividend date.

Realized and unrealized gains and losses and net investment income, other than
class specific expenses, are allocated daily to each class of shares based upon
the relative proportion of net assets of each class.

25
<PAGE> 28

MUTUAL EUROPEAN FUND
Notes to Financial Statements (continued)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

d. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS:
(CONTINUED)
Common expenses incurred by the Series Fund are allocated among the funds
comprising the Series Fund based on the ratio of net assets of each fund to the
combined net assets. Other expenses are charged to each fund on a specific
identification basis.

e. FORWARD EXCHANGE CONTRACTS:

The Fund may enter into forward exchange contracts to hedge against foreign
exchange risks. These contracts are valued daily and the Fund's equity therein
is included in the Statement of Assets and Liabilities. Realized and unrealized
gains and losses are included in the Statement of Operations.

f. OPTION CONTRACTS:

Options purchased are recorded as investments; options written (sold) are
recorded as liabilities. When an option expires, the premium (original option
value) is realized as a gain if the option was written or as a loss if the
option was purchased. When the exercise of an option results in a cash
settlement, the difference between the premium and the settlement proceeds is
realized as a gain or loss. When securities are acquired or delivered upon
exercise of an option, the acquisition cost or sale proceeds are adjusted by the
amount of the premium. When an option is closed, the difference between the
premium and the cost to close the position is realized as a gain or loss.

g. SECURITIES SOLD SHORT:

The Fund is engaged in selling securities short, which obligates the Fund to
replace a security borrowed by purchasing the same security at the current
market value. The Fund would incur a loss if the price of the security increases
between the date of the short sale and the date on which the Fund replaces the
borrowed security. The Fund would realize a gain if the price of the security
declines between those dates.

The Fund is required to establish a margin account with the broker lending the
security sold short. While the short sale is outstanding, the broker retains the
proceeds of the short sale. The Fund must maintain a deposit with the broker
consisting of cash and securities having a value equal to a specified percentage
of the value of the securities sold short.

h. ACCOUNTING ESTIMATES:

The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the amounts of income and expense during the reporting
period. Actual results could differ from those estimates.

2. MERGER OF HEINE SECURITIES AND FRANKLIN RESOURCES

On October 31, 1996, pursuant to an agreement between Franklin Resources, Inc.
(FRI) and Heine Securities Corporation (Heine), the investment adviser, the
assets of Heine were acquired by Franklin Mutual Advisers, Inc.

26
<PAGE> 29

MUTUAL EUROPEAN FUND
Notes to Financial Statements (continued)

2. MERGER OF HEINE SECURITIES AND FRANKLIN RESOURCES (CONTINUED)
(Franklin Mutual), a subsidiary of FRI (the Merger). Franklin Mutual became the
investment adviser to the Series Fund and the Series Fund name changed from
Mutual Series Fund Inc. to Franklin Mutual Series Fund Inc.

3. CAPITAL STOCK

The Fund offers three classes of shares: Class Z, Class I and Class II. The
shares differ by their initial sales load, distribution fees, voting rights on
matters affecting a single class and the exchange privilege of each class.

At December 31, 1997, there were 400 million Fund shares authorized ($0.001 par
value) of which 200 million, 100 million, and 100 million were designated as
Class Z, Class I, and Class II shares, respectively. Transactions in the Fund's
shares were as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1997 1996*
----------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT
----------------------------------------------------------------
<S> <C> <C> <C> <C>
CLASS Z SHARES:
Shares sold............................................ 19,930,968 $ 248,766,946 42,171,939 $446,968,711
Shares issued on reinvestment of distributions......... 3,501,875 43,592,209 229,503 2,586,502
Shares redeemed........................................ (19,568,039) (256,216,139) (2,854,509) (31,212,176)
----------------------------------------------------------------
Net increase........................................... 3,864,804 $ 36,143,016 39,546,933 $418,343,037
================================================================
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1997 1996**
----------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT
----------------------------------------------------------------
<S> <C> <C> <C> <C>
CLASS I SHARES:
Shares sold............................................ 9,533,956 $ 121,476,325 813,014 $ 9,085,283
Shares issued on reinvestment of distributions......... 620,677 7,685,745 2,838 31,814
Shares redeemed........................................ (3,542,483) (45,965,506) (7,579) (84,594)
----------------------------------------------------------------
Net increase........................................... 6,612,150 $ 83,196,564 808,273 $ 9,032,503
================================================================
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1997 1996**
----------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT
----------------------------------------------------------------
<S> <C> <C> <C> <C>
CLASS II SHARES:
Shares sold............................................ 3,726,239 $ 47,508,558 242,959 $ 2,703,061
Shares issued on reinvestment of distributions......... 346,987 4,280,950 860 9,680
Shares redeemed........................................ (388,267) (5,036,085) (1,814) (20,554)
----------------------------------------------------------------
Net increase........................................... 3,684,959 $ 46,753,423 242,005 $ 2,692,187
================================================================
</TABLE>

*Commencement of operations of Class Z shares was July 3, 1996.
**Effective date of Class I and II shares was November 1, 1996.

27
<PAGE> 30

MUTUAL EUROPEAN FUND
Notes to Financial Statements (continued)

4. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES

Certain officers of the Series Fund are also officers and/or directors of
Franklin Mutual and Franklin Templeton Services, Inc. (FT Services), the Fund's
investment manager and administrative manager, respectively. Franklin/ Templeton
Investor Services, Inc. (Investor Services) and Franklin/Templeton Distributors,
Inc. (Distributors) are the Fund's transfer agent and principal underwriter,
respectively.

The Fund pays an investment management fee to Franklin Mutual of 0.80% per year
of the average daily net assets of the Fund. In connection with the Merger, FRI
and FMA agreed, through October 31, 1999 to limit the expense ratio of the Fund
to be no higher than expected for the Fund's 1996 fiscal year, except that
increases in expenses will be permitted if the Series Fund's Board of Directors
determines that such expenses would have been higher had the merger not taken
place. This expense limitation does not include items such as litigation
expenses, interest, taxes, insurance, brokerage commissions, and expenses of an
extraordinary nature. The expense reduction is set forth in the Statement of
Operations.

The Fund pays its allocated share of an administrative fee to FT Services based
on the Series Fund's aggregate average daily net assets as follows:

<TABLE>
<CAPTION>
ANNUALIZED
FEE RATE AVERAGE DAILY NET ASSETS
---------------------------------------------------------------------
<S> <C>
0.15% First $200 million
0.135% Over $200 million, up to and including $700 million
0.10% Over $700 million, up to and including $1.2 billion
0.075% Over $1.2 billion
</TABLE>

The Fund reimburses Distributors up to 0.35% and 1.00% per year of the average
daily net assets of Class I and Class II shares, respectively, for costs
incurred in marketing the Fund's Class I and Class II shares. Distributors
received net commissions on sales of those Fund shares and received contingent
deferred sales charges for the year of $58,337 and $18,694, respectively.

5. INCOME TAXES

At December 31, 1997, the net unrealized appreciation based on the cost of
investments for income tax purposes of $575,526,426 was as follows:

<TABLE>
<S> <C>
Unrealized appreciation....................................... $ 80,188,445
Unrealized depreciation....................................... (17,447,521)
-----------
Net unrealized appreciation................................... $ 62,740,924
===========
</TABLE>

Net investment income and net realized capital gains differ for financial
statement and tax purposes primarily due to differing treatments of passive
foreign investment companies and foreign currency transactions.

28
<PAGE> 31

MUTUAL EUROPEAN FUND
Notes to Financial Statements (continued)

6. INVESTMENT TRANSACTIONS

Purchases and sales of securities (excluding short-term securities) for the year
ended December 31, 1997 aggregated $726,208,073 and $518,139,609, respectively.

7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Fund has been a party to financial instruments with off-balance-sheet risk,
primarily forward exchange contracts, in order to minimize the impact on the
Fund from adverse changes in the relationship between the functional currency
and foreign currencies and interest rates. These instruments involve market risk
in excess of the amount recognized on the Statement of Assets and Liabilities.
Some of these risks have been minimized by offsetting contracts. Risks arise
from the possible inability of counterparties to meet the terms of their
contracts, future movement in currency values and interest rates and contract
positions that are not exact offsets. The contract amount indicates the extent
of the Fund's involvement in such contracts.

A forward exchange contract is an agreement between two parties to exchange
different currencies at a specific rate at an agreed future date. The contracts
are reported in the financial statements at the Fund's net equity, as measured
by the difference between the forward exchange rates at the reporting date and
the forward exchange rates at the day of entry into the contract.

As of December 31, 1997, the Mutual European Fund had the following forward
exchange contracts outstanding:
<TABLE>
<CAPTION>
IN SETTLEMENT UNREALIZED
CONTRACTS TO BUY: EXCHANGE FOR DATE GAIN/(LOSS)
- --------------- --------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
2,621,428 British Pounds...................................... U.S. $ 4,169,575 1/20/98 U.S. $ 131,420
1,963,665 British Pounds...................................... 3,156,591 3/18/98 56,259
580,695 French Francs....................................... 97,269 6/11/98 87
41,011,635 Spanish Peseta...................................... 268,471 2/18/98 1,063
----------- ----------
U.S. $ 7,691,906 188,829
=========== ----------
</TABLE>

<TABLE>
<CAPTION>
CONTRACTS TO SELL:
- ------------------
<S> <C> <C> <C> <C> <C> <C>
393,082,168 Belgium Francs...................................... U.S. $11,104,016 2/9/98 492,319
15,562,200 British Pounds...................................... 25,848,939 1/20/98 315,928
7,534,978 British Pounds...................................... 12,741,648 2/17/98 395,256
12,859,835 British Pounds...................................... 21,153,121 4/15/98 141,921
7,000,000 British Pounds...................................... 11,801,300 5/18/98 381,777
7,207,800 Canadian Dollars.................................... 5,255,208 2/27/98 202,150
118,467,696 Danish Krone........................................ 17,578,702 1/26/98 264,854
9,581,476 German Mark......................................... 5,404,957 3/18/98 55,122
32,960,441 Dutch Guilders...................................... 16,773,124 3/17/98 441,797
21,327,007 Dutch Guilders...................................... 10,706,329 6/10/98 88,507
161,209,196 Finnish Markka...................................... 30,173,665 3/3/98 475,877
179,144,800 French Francs....................................... 29,884,456 1/20/98 83,115
92,322,948 French Francs....................................... 15,931,054 2/17/98 548,177
49,556,810 French Francs....................................... 8,451,505 2/27/98 189,724
</TABLE>

29
<PAGE> 32

MUTUAL EUROPEAN FUND
Notes to Financial Statements (continued)

<TABLE>
<CAPTION>
7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED)
IN SETTLEMENT UNREALIZED
CONTRACTS TO SELL (CONT.) EXCHANGE FOR DATE GAIN/(LOSS)
- ------------------------- --------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
168,557,844 French Francs....................................... U.S. $29,014,197 4/17/98 U.S. $ 837,706
10,691,730 French Francs....................................... 1,800,000 6/11/98 7,382
38,612,699,095 Italian Lira........................................ 21,958,996 7/2/98 109,461
54,327,222 Norwegian Krone..................................... 7,565,833 3/9/98 170,296
157,955,359 Spanish Peseta...................................... 1,074,662 2/18/98 36,559
55,552,421 Swedish Krona....................................... 7,184,277 1/21/98 183,373
269,119,023 Swedish Krona....................................... 35,407,107 2/17/98 1,466,729
235,497,573 Swedish Krona....................................... 31,390,887 3/18/98 1,669,073
16,753,330 Swedish Krona....................................... 2,203,516 4/21/98 87,533
56,408,266 Swedish Krona....................................... 7,491,614 5/15/98 363,643
21,179,326 Swiss Francs........................................ 15,278,130 6/10/98 171,119
------------ ----------
U.S. $383,177,243 9,179,398
============
Net unrealized gain on offsetting forward exchange
contracts................................................... 632,478
----------
Unrealized gain on forward exchange contracts............... 10,000,705
----------
CONTRACTS TO BUY:
- -----------------
206,075,094 Belgium Francs...................................... U.S. $ 5,796,651 2/9/98 (233,421)
5,828,388 British Pounds...................................... 9,744,982 3/18/98 (208,867)
3,000,000 Dutch Guilders...................................... 1,495,215 3/9/98 (9,509)
17,547,200 Finnish Markka...................................... 3,283,533 3/3/98 (51,006)
7,511,181 French Francs....................................... 1,306,997 1/20/98 (57,487)
3,087,690 Norwegian Krone..................................... 426,063 3/9/98 (5,738)
10,077,239 Norwegian Krone..................................... 1,439,024 3/10/98 (67,143)
42,624,240 Spanish Peseta...................................... 280,940 2/18/98 (808)
10,333,802 Swedish Krona....................................... 1,348,281 1/12/98 (46,322)
54,943,802 Swedish Krona....................................... 7,075,136 1/21/98 (150,932)
12,206,238 Swedish Krona....................................... 1,573,313 2/17/98 (33,904)
10,313,775 Swedish Krona....................................... 1,303,891 5/15/98 (628)
4,203,486 Swiss Francs........................................ 2,976,973 6/10/98 (47,818)
----------- --------
U.S. $38,050,999 (913,583)
=========== --------
CONTRACTS TO SELL:
- ------------------
25,036,525 British Pounds...................................... U.S. $40,392,217 1/20/98 (685,386)
18,942,572 British Pounds...................................... 30,003,140 3/18/98 (989,745)
15,654,931 British Pounds...................................... 25,360,988 6/18/98 (141,162)
13,544,127 French Francs....................................... 2,207,298 1/20/98 (45,813)
174,751,292 French Francs....................................... 29,040,899 2/27/98 (92,473)
30,803,384 Norwegian Krone..................................... 4,177,296 3/10/98 (16,170)
2,055,721,170 Spanish Peseta...................................... 13,208,605 2/18/98 (301,863)
</TABLE>

30
<PAGE> 33

MUTUAL EUROPEAN FUND
Notes to Financial Statements (continued)

31
<PAGE> 34

REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
Franklin Mutual Series Fund Inc.

We have audited the accompanying statement of assets and liabilities of Mutual
European Fund, a portfolio of Franklin Mutual Series Fund Inc. ("Fund"),
including the schedule of investments, as of December 31, 1997, the related
statement of operations for the year then ended, and the statement of change in
net assets and the financial highlights for the year then ended and for the
period from July 3, 1996 (commencement of operations) to December 31, 1996.
These financial statements and financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights. Our procedures included confirmation of
securities owned as of December 31, 1997, by correspondence with the custodian
and brokers, or other appropriate auditing procedures when replies from brokers
were not received. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Mutual
European Fund, a portfolio of Franklin Mutual Series Fund Inc., at December 31,
1997, the results of its operations for the year then ended, and the changes in
its net assets and the financial highlights for the year then ended and for the
period from July 3, 1996 (commencement of operations) to December 31, 1996, in
conformity with generally accepted accounting principles.

[ERNST & YOUNG LLP SIGNATURE]

Boston, Massachusetts
January 30, 1998

32
<PAGE> 35

MUTUAL EUROPEAN FUND
Tax Designation

Under Section 854(b)(2) of the Internal Revenue Code, the Fund hereby designates
0.09% of the ordinary income dividends as income qualifying for the dividends
received deduction for the fiscal year ended December 31, 1997.

33
<PAGE> 36

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<PAGE> 37

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<PAGE> 38

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<PAGE> 39

LITERATURE REQUEST

For a free brochure and prospectus, which contain more complete information,
including charges and expenses, call Franklin Fund Information, toll free, at
1-800/DIAL BEN (1-800/342-5236). Please read the prospectus carefully before you
invest or send money. To ensure the highest quality of service, telephone calls
to or from our service departments may be monitored, recorded and accessed.
These calls can be determined by the presence of a regular beeping tone.

FRANKLIN TEMPLETON GROUP

GLOBAL GROWTH
Franklin Global Health Care Fund
Franklin Templeton Japan Fund
Templeton Developing
Markets Trust
Templeton Foreign Fund
Templeton Foreign Smaller
Companies Fund
Templeton Global
Infrastructure Fund
Templeton Global
Opportunities Trust
Templeton Global
Real Estate Fund
Templeton Global
Smaller Companies Fund
Templeton Greater European Fund
Templeton Growth Fund
Templeton Latin America Fund
Templeton Pacific Growth Fund
Templeton World Fund

GLOBAL GROWTH AND INCOME
Franklin Global Utilities Fund
Franklin Templeton German
Government Bond Fund
Franklin Templeton Global
Currency Fund
Mutual European Fund
Templeton Global Bond Fund
Templeton Growth and
Income Fund

GLOBAL INCOME
Franklin Global Government
Income Fund
Franklin Templeton Hard
Currency Fund
Franklin Templeton High Income
Currency Fund
Templeton Americas Government
Securities Fund

GROWTH
Franklin Biotechnology
Discovery Fund
Franklin Blue Chip Fund
Franklin California Growth Fund
Franklin DynaTech Fund
Franklin Equity Fund
Franklin Gold Fund
Franklin Growth Fund
Franklin MidCap Growth Fund
Franklin Small Cap
Growth Fund
Mutual Discovery Fund

GROWTH AND INCOME
Franklin Asset Allocation Fund
Franklin Balance Sheet
Investment Fund*
Franklin Convertible
Securities Fund
Franklin Equity Income Fund
Franklin Income Fund
Franklin MicroCap Value Fund*
Franklin Natural Resources Fund
Franklin Real Estate
Securities Fund
Franklin Rising Dividends Fund
Franklin Strategic Income Fund
Franklin Utilities Fund
Franklin Value Fund
Mutual Beacon Fund
Mutual Financial Services Fund
Mutual Qualified Fund
Mutual Shares Fund
Templeton American Trust, Inc.

Fund Allocator Series
Franklin Templeton Conservative
Target Fund
Franklin Templeton Moderate
Target Fund
Franklin Templeton Growth
Target Fund

INCOME
Franklin Adjustable Rate
Securities Fund
Franklin Adjustable U.S.
Government Securities Fund
Franklin's AGE High Income Fund
Franklin Investment Grade
Income Fund
Franklin Short-Intermediate
U.S. Government Securities Fund
Franklin U.S. Government
Securities Fund
Franklin Money Fund
Franklin Federal Money Fund

For Corporations
Franklin Corporate Qualified
Dividend Fund

FRANKLIN FUNDS SEEKING
TAX-FREE INCOME
Federal Intermediate-Term
Tax-Free Income Fund
Federal Tax-Free Income Fund
High Yield Tax-Free Income Fund
Insured Tax-Free Income Fund
Puerto Rico Tax-Free
Income Fund
Tax-Exempt Money Fund

FRANKLIN STATE-SPECIFIC
FUNDS SEEKING
TAX-FREE INCOME
Alabama
Arizona**
Arkansas***
California**
Colorado
Connecticut
Florida**
Georgia
Hawaii***
Indiana
Kentucky
Louisiana
Maryland
Massachusetts+
Michigan**
Minnesota+
Missouri
New Jersey
New York**
North Carolina
Ohio+
Oregon
Pennsylvania
Tennessee***
Texas
Virginia
Washington***

VARIABLE ANNUITIES++
Franklin Valuemark(R)
Franklin Templeton
Valuemark Income Plus
(an immediate annuity)

*These funds are now closed to new accounts, with the exception of retirement
accounts.

**Two or more fund options available: long-term portfolio, intermediate-term
portfolio, a portfolio of insured municipal securities, and/or a high yield
portfolio (CA) and a money market portfolio (CA and NY).

***The fund may invest up to 100% of its assets in bonds that pay interest
subject to the federal alternative minimum tax.

+Portfolio of insured municipal securities.

++Franklin Valuemark and Franklin Templeton Valuemark Income Plus are issued by
Allianz Life Insurance Company of North America or by its wholly owned
subsidiary, Preferred Life Insurance Company of New York, and distributed by
NALAC Financial Plans, LLC.

10/97.1
<PAGE> 40
BOARD OF DIRECTORS
Michael F. Price (Chairman)
Peter A. Langerman
Edward I. Altman
Ann Torre Grant
Andrew H. Hines, Jr.
William J. Lippman
Bruce A. MacPherson
Fred R. Millsaps
Leonard Rubin
Barry F. Schwartz
Vaughn R. Sturtevant, M.D.
Robert E. Wade

INVESTMENT MANAGER
Franklin Mutual Advisers, Inc.
51 John F. Kennedy Parkway
Short Hills, NJ 07078

SHAREHOLDER SERVICES
1-800-632-2301 - (Class I & II)
1-800-448-FUND - (Class Z)

FUND INFORMATION
1-800-342-5236

This report must be preceded or accompanied by the current prospectus of the
Mutual European Fund, which contains more complete information including risk
factors, charges and expenses. Like any investment in securities, the Fund's
portfolio will be subject to the risk of loss from market, currency, economic,
political and other factors, as well as investment decisions by the Investment
Manager, which will not always be profitable or wise. The Fund and its investors
are not protected from such losses by the Investment Manager. Therefore,
investors who cannot accept the risk of such losses should not invest in shares
of the Fund.

To ensure the highest quality of service, telephone calls to or from our service
departments may be monitored, recorded and accessed. These calls can be
determined by the presence of a regular beeping tone.

478 A97 12/97 [LOGO] Printed on recycled paper