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PROSPECTUS
STATE BOND MINNESOTA TAX-FREE INCOME FUND
100 North Minnesota Street
P.O. Box 69
New Ulm, Minnesota 56073-0069
Phone (507) 354-2144
November 1, 1995
State Bond Minnesota Tax-Free Income Fund (the "Fund") is a mutual fund which
seeks to maximize current income exempt from both federal income tax and
Minnesota personal income tax to the extent consistent with preservation of
capital. The Fund is the only investment portfolio of State Bond Tax-Free Income
Funds, Inc.
This Prospectus concisely sets forth information about the Fund which investors
should know before investing. Please read it carefully before you invest and
keep it for future reference.
Additional information about the Fund is contained in a Statement of Additional
Information filed with the Securities and Exchange Commission and is available
upon request and without charge by calling or writing the Fund at 800-328-4735,
100 North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-0069. The
Statement of Additional Information is dated the same date as this Prospectus
and is incorporated herein by reference in its entirety.
AN INVESTMENT IN THE FUND IS NOT A DEPOSIT OR OBLIGATION OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK AND IS NOT INSURED OR GUARANTEED BY THE U.S. GOVERNMENT,
THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY
OTHER FEDERAL AGENCY. AN INVESTMENT IN THE FUND INVOLVES INVESTMENT RISK,
INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
-----------------------------------------
TABLE OF CONTENTS
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Page
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SHAREHOLDER TRANSACTION AND OPERATING EXPENSE TABLE.................. 2
FINANCIAL HIGHLIGHTS................................................. 3
WHAT ARE THE FUND'S INVESTMENT OBJECTIVES, POLICIES AND RISKS?....... 4
HOW IS THE FUND MANAGED?............................................. 10
WHAT ARE THE FUND'S BROKERAGE COMMISSIONS?........................... 11
HOW CAN YOU INVEST IN THE FUND?...................................... 12
HOW IS THE OFFERING PRICE OF THE FUND'S SHARES DETERMINED?........... 12
HOW ARE THE FUND'S SALES CHARGES DETERMINED?......................... 13
HOW CAN YOU "SELL" YOUR SHARES?...................................... 13
HOW DOES THE FUND'S EXCHANGE PRIVILEGE WORK?......................... 15
HOW DOES THE FUND PAY DIVIDENDS AND DISTRIBUTIONS?................... 16
WHAT IS THE TAX STATUS OF DIVIDENDS AND DISTRIBUTIONS YOU RECEIVE?... 16
WHAT IS THE FUND'S PLAN OF DISTRIBUTION?............................. 18
WHO ARE THE FUND'S ACCOUNTING AGENT AND ITS CUSTODIAN?............... 18
WHAT SERVICES DOES THE FUND OFFER?................................... 18
GENERAL INFORMATION ABOUT STATE BOND MINNESOTA TAX-FREE INCOME FUND.. 19
INVESTMENT PERFORMANCE............................................... 19
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE.......................... 20
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1
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SHAREHOLDER TRANSACTION AND OPERATING EXPENSE TABLE
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load Imposed on Purchases
(as a percentage of offering price) 4.50%
ANNUAL FUND OPERATING EXPENSES
(As a percentage of average daily net assets)
Management Fee (After Expense Reimbursement) .36%
12b-1 Fee (After Expense Reimbursement) .25%
Other Expenses (After Expense Reimbursements) .39%
----
Total Fund Operating Expenses (After Expense Reimbursements) 1.00%
====
A $10 fee will be charged for certain redemptions by wire transfer. See "How Can
You 'Sell' Your Shares?"
EXAMPLE:
You would pay the following aggregate expenses on a $1,000 investment, assuming:
(1) 5% annual return and (2) redemption at the end of each time period:
1 Year 3 Years 5 Years 10 Years
$55 $75 $98 $162
Note: This Example is not a representation of past or future expenses and actual
expenses may be more or less than those shown above.
The Fund's shares have an asset-based sales fee which may result in long-term
shareholders paying more than the economic equivalent of the maximum front-end
sales charge permitted by NASD regulations.
The purpose of the above table is to assist you in understanding the various
costs and expenses that you will bear directly or indirectly as an investor in
the Fund. The expense information in the above table is based upon expenses
incurred by the Fund during its fiscal year ended June 30, 1995. The above
operating expenses are net of expense reimbursements. Without such
reimbursements, the management fee would have been .60%, the 12b-1 fee would
have been .25% and the other expenses would have been .39%, for a total of
1.24%. For more information concerning fees and expenses, see "What Is The
Fund's Plan Of Distribution?" and "How Is The Fund Managed?" See "How Does The
Fund's Exchange Privilege Work?" for information on additional sales charges
that may be payable upon exchange into a mutual fund in the State Bond Group
which has a higher sales charge.
2
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FINANCIAL HIGHLIGHTS
The information presented below for the fiscal year ended June 30, 1995 has been
audited by Ernst & Young LLP, independent auditors for the Fund, and the
financial statements of the Fund, along with the report of Ernst & Young LLP
thereon, are set forth in the Statement of Additional Information. The
information presented below for each fiscal year in the four-year period ended
June 30, 1994 has been audited by Deloitte & Touche LLP, the previous auditors
for the Fund. Further information about the performance of the Fund is contained
in the Fund's most recent annual report to shareholders which may be obtained,
without charge, by calling or writing the Fund at the telephone number or
address on the front cover of this Prospectus.
PER SHARE INVESTMENT INCOME AND CAPITAL CHANGES
(For a share outstanding throughout the year)
YEAR ENDED JUNE 30
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January 6,
l988
(Commencement of
Operations)
through June
30, 1988
1995# 1994 1993 1992 1991 1990 1989
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Net asset value, beginning of year $ 10.45 $ 10.94 $ 10.49 $ 10.18 $10.11 $10.23 $ 9.65 $ 10.00
Income from investment operations:
Net investment income .56 .56 .59 .61 .62 .64 .65 .29
Net realized and unrealized gain (loss)
on investments .16 (.47) .45 .33 .07 (.12) .58 (.35)
------- ------- ------- ------- ------ ------ ------ ----------
Total from investment operations .72 .09 1.04 .94 .69 .52 1.23 (.06)
Less distributions:
From net investment income (.56) (.56) (.59) (.61) (.62) (.64) (.65) (.29)
From net realized gain -- (.02) -- (.02) -- -- -- --
------- -------
Total distributions (.56) (.58) (.59) (.63) (.62) (.64) (.65) (.29)
------- ------- ------- ------- ------ ------ ------ ----------
Net asset value, end of year $ 10.61 $ 10.45 $ 10.94 $ 10.49 $10.18 $10.11 $10.23 $ 9.65
======= ======= ======= ======= ====== ====== ====== ==========
Total Return** 7.10% .79% 10.06% 9.47% 6.87% 5.48% 13.18% (1.03%)*
Ratios and Supplemental Data:
Net assets, end of year $18,178 $16,486 $15,318 $12,244 $9,238 $6,189 $4,997 $ 3,196
(in thousands)
Ratio of expenses to average
net assets*** 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00%*
Ratio of net income to average
net assets 5.37% 5.14% 5.41% 5.86% 6.17% 6.34% 6.56% 6.47%*
Portfolio turnover rate
6% 2% 15% 1% 8% 2% -- --
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# ARM Capital Advisors, Inc. began managing the investment operations of
the Fund on June 14, 1995.
* Annualized
** Total return does not consider the effects of the one time sales charge.
***The Fund's investment adviser voluntarily reimbursed the Fund on a monthly
basis for expenses incurred in excess of 1% of average daily net assets.
Without such voluntary reimbursement, the ratio of expenses to average net
assets in each of the respective fiscal years would have been as follows:
1995 -- 1.24 %; 1994--1.29%; 1993--1.38%; 1992--1.54%; 1991--1.65%; 1990--
1.87%; 1989--2.19%; and 1988--3.10% (annualized).
3
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WHAT ARE THE FUND'S INVESTMENT OBJECTIVES, POLICIES AND RISKS?
The Fund seeks to maximize current income exempt from both Federal income tax
and Minnesota personal income tax to the extent consistent with preservation of
capital. In pursuing these goals, under normal circumstances the Fund invests at
least 80% of the value of its assets in debt obligations issued by or on behalf
of the State of Minnesota and its political subdivisions, the income from which
is exempt from federal income tax and Minnesota personal income tax (referred to
in this prospectus as "Minnesota Tax-Exempt Securities"). The Fund intends to
invest its assets such that at least 95% of its tax-exempt interest income is
derived from Minnesota Tax-Exempt Securities. Generally, the values of the
securities in which the Fund will invest, and accordingly the value of the
Fund's shares, will fall as interest rates rise and rise as interest rates fall.
There is no assurance that the Fund's goals will be achieved.
The Minnesota Tax-Exempt Securities in which the Fund may invest consists of
securities rated within the following grades assigned by Moody's Investors
Service, Inc. ("Moody's"): Aaa, Aa, A, Baa, Ba and B for bonds; MIG-1, MIG-2,
MIG-3 for notes; and Prime-1 and Prime-2 for commercial paper, or within the
following grades assigned by Standard & Poor's Ratings Group ("S&P"): AAA, AA,
A, BBB, BB and B for bonds; SP-1 and SP-2 for notes; and A-1 and A-2 for
commercial paper. Currently the Fund does not invest in bonds rated below A, and
the Fund has no current intention of doing so. The risk of default, including
nonpayment of principal or interest, on bonds and notes rated Baa or MIG-4 or
below by Moody's or BBB or SP-3 or below by S&P is higher than the risk on such
securities rated within the higher grades. Such securities are more speculative
and more sensitive to economic changes than higher rated bonds and notes. A
description of ratings of the Minnesota Tax-Exempt Securities in which the Fund
may invest is included as Appendix A to the Statement of Additional Information.
The Fund may invest in unrated Minnesota Tax-Exempt Securities, if, in the
judgment of ARM Capital Advisors, Inc. (the "Manager"), the financial condition
of the issuer of such securities at the time of purchase is comparable to and
the securities are otherwise similar in quality to those rated securities the
Fund would purchase. As a matter of fundamental policy, the Fund may not invest
more than 25% of its assets in unrated Minnesota Tax-Exempt Securities. Although
securities that are not rated are not necessarily of lower quality, the market
for them may not be as broad as for rated securities, since many investors rely
upon ratings agencies for credit appraisal.
As a matter of fundamental policy, the Fund may not purchase Minnesota Tax-
Exempt Securities that are not rated within the three highest grades by either
Moody's or S&P, or that are unrated, unless such securities are insured as to
the payment of all installments of principal and interest. The Fund does not
currently invest in, and has no current intention to invest in, unrated bonds
that are comparable to and otherwise similar in quality to securities rated
below A.
As a matter of fundamental policy, under normal circumstances at least 80% of
the value of the Fund's assets will be invested in Minnesota Tax-Exempt
Securities. Up to 20% of the net assets of the Fund may generate interest that
is an item of tax preference for purposes of the Federal and Minnesota
alternative minimum tax ("AMT").
In addition, while the Fund attempts, under normal market conditions, to invest
all of its assets in Minnesota Tax-Exempt Securities, the Fund temporarily may
invest up to 20% of the value of its assets in taxable obligations (i) when the
Manager believes abnormal market conditions dictate a temporary defensive
posture in taxable obligations; (ii) pending investment of proceeds of sales of
shares or reinvestment of proceeds of sales of portfolio securities; or (iii) to
meet redemptions of shares by shareholders. Also, on a temporary defensive basis
due to market conditions, the Fund may invest up to 100% of its assets in
taxable obligations or may hold up to 100% of its assets in cash. The taxable
obligations in which the Fund may invest are obligations of the U.S. government,
its agencies or instrumentalities; other debt securities rated within the two
highest grades by either Moody's or S&P (or if unrated, of comparable quality in
the opinion of the Manager); commercial paper rated in the two highest grades by
either of such rating services (or of comparable quality); certificates of
deposit, letters of credit and bankers' acceptances of domestic banks and
savings institutions having total assets over one billion dollars or
certificates of deposit of other domestic banks or savings institutions which
are fully insured by the Federal Deposit Insurance Corporation; and repurchase
agreements with respect to any of the foregoing investments or Minnesota Tax-
Exempt Securities which qualify for investment by the Fund.
4
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Minnesota Tax-Exempt Securities
The Minnesota Tax-Exempt Securities in which the Fund invests consist of bonds,
notes, commercial paper and municipal leases issued by the State of Minnesota,
its political subdivisions (including municipalities), governmental agencies or
instrumen-talities, or Indian tribal governments located in Minnesota.
Bonds are obligations issued to obtain funds for various public purposes, such
as the construction or improvement of public facilities including airports,
highways, hospitals, housing, nursing homes, parks, public buildings,
recreational facilities, school facilities, and sewer and water works. Other
public purposes for which bonds may be issued include the refunding of
outstanding obligations, the anticipation of taxes or state aids, the payment of
judgments, the funding of student loans, community redevelopment, district
heating, the purchase of street maintenance and fire fighting equipment, or any
authorized corporate purpose of the issuer, except the payment of current
expenses. Notes and commercial paper are generally used to provide for short-
term capital needs and ordinarily have a maturity of up to one year. Notes are
frequently issued in anticipation of tax revenue, revenue from other government
sources or revenue from bond offerings. Short-term, unsecured commercial paper
is often used to finance seasonal working capital needs or to provide interim
construction financing.
Municipal leases are obligations of state and local government units incurred to
lease or purchase equipment or other property utilized by such governments. The
Fund will not originate leases as a lessor, but will instead purchase a
participation interest in the regular payment stream of the underlying lease
from a bank, equipment lessor or other third party.
In addition, certain types of securities (generally referred to as "private
activity bonds") may be issued by or on behalf of public authorities to finance
privately operated pollution control facilities, certain local water supply,
gas, electricity or waste disposal facilities, and the construction or
improvement of certain other privately operated facilities.
Minnesota Tax-Exempt Securities may also be classified into two types of
obligations: general obligation and limited obligation (or revenue) securities.
General obligation securities involve the pledge of the full faith and credit of
an issuer possessing taxing power and are payable from the issuer's general
unrestricted revenues and not from any particular fund or revenue source. The
characteristics and methods of enforcement of general obligation securities vary
according to the law applicable to the particular issuer. Limited obligation
(revenue) securities are payable only from the revenues derived from a
particular facility or class of facilities, or a specific revenue source, such
as the user of the facility. Private activity bonds are in most cases limited
obligation bonds payable solely from specific revenues of the project to be
financed. The credit quality of private activity bonds is therefore usually
directly related to the credit standing of the user of the facility (or the
credit standing of a third-party guarantor or other credit enhancement
participant, if any).
Like all debt obligations, Minnesota Tax-Exempt Securities are subject to credit
risk and market risk. Credit risk relates to the issuer's ability to make timely
payments of principal and interest. Market risk relates to the changes in market
values that occur as a result of variations in the level of prevailing interest
rates, yield relationships and other factors in the tax-exempt securities
market. Generally, higher quality tax-exempt securities will provide a lower
yield than lower quality tax-exempt securities of similar maturity and are
subject to lesser credit risk than lower quality tax-exempt securities.
Furthermore, for any given change in the level of interest rates, prices tend to
fluctuate less for higher quality issues than for lower quality issues, and more
for longer maturity issues than for shorter maturity issues. It should be noted
that the creditworthiness of obligations issued by local Minnesota issuers may
be unrelated to the credit worthiness of obligations issued by the State of
Minnesota, and that there is no obligation on the part of the State to make
payment on such local obligations in the event of default.
Risk Factors Regarding Investments in Minnesota
Because the Fund will normally invest at least 80% of its assets in Minnesota
Tax-Exempt Securities and because it seeks to maximize income derived from
Minnesota Tax-Exempt Securities, it is more susceptible to factors adversely
affecting the state of Minnesota and issuers of Minnesota Tax-Exempt Securities
than would be a municipal bond fund that is not concentrated in such
obligations.
The State relies heavily on a progressive individual income tax and a retail
sales tax for revenue, which results in a fiscal system that is sensitive to
economic conditions. Frequently in recent years, legislation has been required
to eliminate projected budget deficits by raising additional revenue, reducing
expenditures, including aids to political subdivisions and higher education,
5
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reducing the State's budget reserve, imposing a sales tax on purchases by local
governmental units, and making other budgetary adjustments. The Minnesota
Department of Finance projects that the current biennium will end June 30, 1997
with a $350 million cash flow account balance plus a $204 million budget
reserve. Total General Fund expenditures and transfers for the biennium are
projected to be $18.2 billion. State expenditures for education finance (K-12),
post-secondary education, and human services in the biennium ending June 30,
1997 are not anticipated to be sufficient to maintain current program levels.
Although it is not possible to anticipate economic performance four years into
the future, planning estimates (extrapolations) for the biennium ending June 30,
1999 show a substantial General Fund deficit of $812 million, after funding a
$350 million cash flow account plus a $204 million budget reserve, if current
law is not changed. This indicates the likelihood of additional revenue
increases or spending cuts relative to current law. The State is party to a
variety of civil actions that could adversely affect the State's General Fund.
In addition, substantial portions of State and local revenues are derived from
federal expenditures, and reductions in federal aid to the State and its
political subdivisions and other federal spending cuts may have substantial
adverse effects on the economic and fiscal condition of the State and its local
governmental units. Risks are inherent in making revenue and expenditure
forecasts. Economic or fiscal conditions less favorable than those reflected in
State budget forecasts and planning estimates may create additional budgetary
pressures.
State grants and aid represent a large percentage of the total revenues of
cities, towns, counties and school districts in Minnesota. Even with respect to
revenue obligations, no assurance can be given that economic or other fiscal
difficulties and the resultant impact on State and local government finances
will not adversely affect the value or marketability of Minnesota Tax-Exempt
Securities held by the Fund or the ability of the respective obligors to make
timely payment of the principal and interest on such obligations.
Diversity and a significant natural resource base are two important
characteristics of the Minnesota economy. Generally, the structure of the
State's economy parallels the structure of the United States economy as a whole.
There are, however, employment concentrations in durable goods and non-durable
goods manufacturing, particularly industrial machinery, instruments and
miscellaneous, food, paper and related industries, and printing and publishing.
During the period from 1980 to 1990, overall employment growth in Minnesota
lagged behind national employment growth, in large part due to declining
agricultural employment. The rate of non-farm employment growth in Minnesota
exceeded the rate of national growth, however, in the period of 1990 to 1994.
Since 1980, Minnesota per capita income generally has remained above the
national average. During 1993, 1994 and 1995, the State's monthly unemployment
rate generally has been less than the national unemployment rate. The Minnesota
Department of Finance February 1995 Forecast projects that the State's economy
will not grow as fast during the biennium ending June 30, 1997 as the national
aggregates, due to continued tightness in local labor markets. Although the
State's national economic forecasting consultant forecast a slowdown but no
recession during 1995, it recognized the substantial possibility of a recession.
Both possible future changes in federal and State income tax laws, including
rate reductions, and recent Minnesota tax legislation could adversely affect the
value and marketability of Minnesota Tax-Exempt Securities held by the Fund. See
"What Is the Tax Status of Dividends and Distributions You Receive?" below.
Diversification
The Fund is a "non-diversified" management investment company and as such is not
required to meet any diversification requirements under the Investment Company
Act of 1940, as amended (the "Act"). The Fund is required to meet certain
standards to qualify as a regulated investment company ("RIC") under the
Internal Revenue Code of 1986, as amended (the "Code"). At the end of each
fiscal quarter with respect to at least 50% of its total assets: (1) the Fund
may not invest more than 5% of its total assets in the securities of any one
issuer (except U.S. government obligations) and (2) the Fund may not own more
than 10% of the outstanding voting securities of any one issuer. (By comparison,
a "diversified" investment company must at all times satisfy those two
conditions with respect to 75% of the value of its total assets). As for the
other 50% of the Fund's total assets not subject to the limitations described
above, the sole limitation on concentration of these assets is that at the end
of each fiscal quarter not more than 25% of such assets may be invested in the
securities of any one issuer. Investment in a non-diversified investment company
such as the Fund may entail greater risks than investment in a "diversified"
fund. Because of the relatively small number of issuers of investment grade
Minnesota Tax-Exempt Securities, the Fund's non-diversified status permits it
from time to time to concentrate its assets in the securities of a few issuers
which the Fund's Manager deems to be attractive investments, rather than invest
in securities of a large number of issuers merely to satisfy the Act's
diversification requirements. Although the Fund's Manager believes that the
ability to concentrate the investments of the Fund in particular
6
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issuers is advantageous when investing in Minnesota Tax-Exempt Securities, such
concentration involves an increased risk of loss to the Fund should any
particular issuer be unable to make interest or principal payments or should the
market value of particular securities decline.
The Fund reserves the right to invest more than 25% of its assets in private
activity revenue bonds. As a matter of fundamental policy, the Fund may not
concentrate in any one industry. In addition, as a matter of fundamental policy,
the Fund may not invest more than 25% of its assets in private activity bonds
which are based, directly or indirectly, on the credit of private entities in
any one industry or in securities of private issuers in any one industry
(governmental issuers are not considered part of any "industry"). See
"Investment Restrictions" in the Statement of Additional Information.
Insurance
The Fund may purchase Minnesota Tax-Exempt Securities that are not rated within
the three highest grades by Moody's or S&P, or are unrated, only if such
securities are insured as to the payment of all installments of principal and
interest. Insurance is not a substitute for the basic credit of an issuer, but
supplements the credit and provides additional security therefor. While
insurance minimizes the credit risk associated with the default of a particular
security, it does not protect against market risk and therefore does not
guarantee the market value of the securities in the Fund's portfolio or the
value of the shares of the Fund. (The market value of an insured security may
differ from the face value due to fluctuations in interest rates.) In addition,
insurance of principal refers to insuring the payment of the face or par value
of the insured security, and not the purchase price paid for the security by the
Fund. To the extent that the Fund purchases insured securities, the Fund may be
dependent upon the credit of the insurance companies issuing the policies
insuring such securities, and subject to the risk that a particular insurer of
securities the Fund may hold may encounter financial difficulties. Municipal
bond insurance is a relatively new form of insurance, and the issuers of
municipal bond insurance are for the most part relatively new companies without
any long-term historical record of claims under their policies. The Fund cannot
predict the level of risk involved in purchasing insured Minnesota Tax-Exempt
Securities.
Insured Minnesota Tax-Exempt Securities held by the Fund may be insured by (i) a
"New Issue Policy" obtained by the issuer of the security or another party
(generally a dealer) at the time of issuance, for which all premiums are paid in
advance; (ii) a "Secondary Market Policy" which is obtained at a time other
than issuance, generally by a person other than the issuer (such as the Fund),
and provides insurance to the maturity of the security (regardless of whether
the purchaser of the insurance continues to hold the security), and for which
all premiums are paid in advance, or (iii) a mutual fund "Portfolio Insurance
Policy" that the Fund has obtained from Financial Guaranty Insurance Company
(''Financial Guaranty") or may obtain from another insurance company approved by
the Board of Directors. From time to time Financial Guaranty also may be the
issuer of New Issue Policies or Secondary Market Policies insuring securities
purchased by the Fund. If a Minnesota Tax-Exempt Security purchased by the Fund
is covered by a New Issue Policy or a Secondary Market Policy providing
insurance to maturity and issued by an insurer that the Manager believes is
satisfactory, then such a security is not required to be additionally insured by
the Fund under its own Portfolio Insurance Policy.
Coverage under a New Issue Policy or Secondary Market Policy is noncancellable
and will continue in force so long as the security insured thereunder is
outstanding and the insurer remains in business. The existence of such insurance
for securities in the Fund's portfolio may have an effect on the resale value of
such securities. New Issue Policies and Secondary Market Policies may be
considered to represent an element of market values of securities insured
thereunder, but the exact effect, if any, of this insurance on such market
values generally cannot be estimated.
Under the Portfolio Insurance Policy issued by Financial Guaranty, insurance on
any particular security will be effective only so long as the Fund is in
existence and continues to pay the applicable premium, Financial Guaranty
remains in business and that security continues to be held by the Fund.
Financial Guaranty cannot cancel coverage already in force with respect to
securities owned by the Fund and covered by the Portfolio Insurance Policy
except for nonpayment of premiums. Any security for which insurance is canceled
as provided herein will be sold by the Fund as promptly thereafter as reasonably
possible. In the event of a sale by the Fund of any security insured by the
Portfolio Insurance Policy, or payment of the principal of the security prior to
maturity, the insurance purchased from Financial Guaranty will terminate as to
such security.
Premium rates for each issue of Minnesota Tax-Exempt Securities covered by the
Portfolio Insurance Policy from Financial Guaranty will be fixed for the life of
the Fund. The premiums are payable monthly by the Fund and are adjusted for
purchases,
7
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sales and payments prior to maturity of covered securities during the month.
Premiums are paid from the Fund's assets and reduce its current yield by the
amount of such premiums. The Manager estimates that annual premiums for the
Portfolio Insurance Policy will range from approximately .1 of 1% to .2 of 1% of
average daily net assets.
Financial Guaranty may not cancel the Portfolio Insurance Policy except for
failure to pay the premium. Nonpayment of premiums on the Portfolio Insurance
Policy will, under certain circumstances, result in the cancellation of the
Portfolio Insurance Policy and will also permit Financial Guaranty to take
action against the Fund to recover premium payments due it. The Portfolio
Insurance Policy is terminable by the Fund upon sixty days' prior written notice
to Financial Guaranty. If it becomes necessary or desirable to do so, the Fund
may terminate the Portfolio Insurance Policy with Financial Guaranty and obtain
portfolio insurance from another insurer.
Under the provisions of the Portfolio Insurance Policy, Financial Guaranty
unconditionally and irrevocably agrees to pay to an independent agent that
portion of the principal of and interest on a security insured thereunder which
shall become due for payment but shall be unpaid by reason of nonpayment by the
issuer. Financial Guaranty will make such payments to the agent on the date such
principal or interest becomes due for payment or on the business day next
following the day on which Financial Guaranty receives notice of non-payment,
whichever is later. The agent will disburse to the Fund the amount of such
unpaid principal and/or interest upon receipt of evidence of the Fund's right to
receive payment of unpaid principal and/or interest and evidence that all of the
rights to such payment shall, upon disbursement by the agent, vest in Financial
Guaranty. Upon such disbursement, Financial Guaranty shall become the owner of,
as applicable, the security, appurtenant coupon or right to principal thereof,
and shall be fully subrogated to the Fund's rights thereunder.
Under the Portfolio Insurance Policy, Financial Guaranty is not obligated to
insure all Minnesota Tax-Exempt Securities that the Fund may wish to purchase.
In determining whether to insure any Minnesota Tax-Exempt Security, Financial
Guaranty will apply its own standards, which are not necessarily the same as the
criteria used in regard to selection of investments by the Manager. Financial
Guaranty's decision to insure a security is made prior to the purchase of such
security by the Fund. Contracts to purchase Minnesota Tax-Exempt Securities are
not covered by the Portfolio Insurance Policy, although securities underlying
such contracts (once approved by Financial Guaranty) are covered by such
insurance upon delivery to the Fund or its Custodian.
The Fund may at any time purchase from Financial Guaranty or any other approved
insurer a Secondary Market Policy, including on any security purchased by the
Fund which is covered by the Portfolio Insurance Policy. The coverage, and the
obligation to pay monthly premiums, under the Portfolio Insurance Policy with
respect to a security would cease with the purchase by the Fund of a Secondary
Market Policy on such security. The Fund may purchase insurance under a
Secondary Market Policy in lieu of coverage under the Portfolio Insurance Policy
at any time if the Manager believes such insurance would best serve the Fund's
interest in meeting its objectives and policies.
One of the purposes of acquiring such a Secondary Market Policy would be to
enable the Fund to sell the portfolio security to a third party as an "AAA"
rated insured security at a market price higher than what otherwise might be
obtainable if the security were sold without the insurance coverage. (Such
rating is not automatic, however, and must specifically be requested from
Moody's or S&P for each security.) Such Secondary Market Policy would likely be
purchased if, in the opinion of the Manager, the market value or net proceeds of
a sale by the Fund would exceed the current value of the security (without
insurance) plus the cost of the policy. Any difference between the excess of a
security's market value as an "AAA" rated security over its market value without
such rating, including the single premium cost thereof, would inure to the Fund
in determining the net capital gain or loss realized by the Fund upon the sale
of the portfolio security. No assurance can be given that the purchase of a
Secondary Market Policy will enable the Fund to obtain a higher price upon sale
of the security.
If an issuer defaults on a security, the Fund may be required to take one of
several actions. One possibility is that the Fund may purchase a Secondary
Market Policy for the security. In that case, the Fund may have the ability to
sell such security without realizing a significant loss or continuing to hold
the security in its portfolio in order to continue in force the coverage of the
Portfolio Insurance Policy, if the security is covered thereby. However, no
assurance can be given that the purchase of such insurance will enable the Fund
to so sell the security.
Alternatively, if a defaulted security is covered by the Portfolio Insurance
Policy, the Fund might continue to hold it. While a defaulted security subject
to the Portfolio Insurance Policy is held by the Fund, the Fund continues to pay
the insurance premium thereon but also collects interest payments from the
insurer and retains the right to collect the full amount of principal from the
8
<PAGE>
insurer when the security comes due. Because coverage under the Portfolio
Insurance Policy terminates upon sale of a security from the Fund's portfolio,
such insurance does not have an effect on the resale value of the securities. It
is the intention of the Fund to retain any securities insured under a Portfolio
Insurance Policy which are in default or in significant risk of default, and to
place a value on the insurance which will be equal to the difference between the
market value of the defaulted security and the market value of similar
securities which are not in default. (See "How is the Offering Price of the
Fund's Shares Determined?"). To the extent that it holds defaulted securities,
the Fund may be unable under certain circumstances to purchase other Minnesota
Tax-Exempt Securities.
Financial Guaranty Insurance Company. Financial Guaranty is a New York stock
insurance company, with principal offices at 175 Water Street, New York, New
York 10038. As of June 30, 1995, Financial Guaranty's capital base (capital and
surplus plus contingency reserve) was approximately $1,336,300,000 as reported
to the New York State Insurance Department. For further information regarding
Financial Guaranty, see the Statement of Additional Information.
Floating Rate, Variable Rate, and Inverse Floating Rate Securities
The Fund may purchase floating and variable rate Minnesota Tax-Exempt
Securities, which are Minnesota Tax-Exempt Securities having a coupon (stated
interest rate paid by the issuer) that is adjusted or reset from time to time.
Certain of these securities ("floating or variable rate demand notes") have a
stated maturity in excess of one year, but permit the holder to demand payment
of principal plus accrued interest upon a specified number of days' notice. The
issuer of floating or variable rate demand notes normally has a corresponding
right, after a given period, to prepay at its discretion the outstanding
principal amount of the notes plus accrued interest upon a specified number of
days' notice to the noteholders. The interest rate on a floating rate demand
note is based on a known lending rate, such as a bank's prime rate and is
adjusted automatically each time such rate is adjusted. The interest rate on a
variable rate demand note is adjusted at specified intervals, based on a known
lending rate, generally the rate on 90-day U.S. Treasury bills. Frequently,
floating or variable rate demand notes are secured by letters of credit or other
credit support arrangements provided by banks. The Fund will invest in floating
or variable rate demand notes so long as the letters of credit or other credit
support arrangements do not adversely affect the tax exempt status of these
obligations. The Manager will rely upon the opinion of the issuer's bond counsel
to determine whether such obligations are exempt from federal income taxes.
The Fund also may invest in inverse or reverse floating rate Minnesota Tax-
Exempt Securities. Inverse or reverse floating rate Minnesota Tax-Exempt
Securities are securities with a coupon that moves in the reverse direction to
an applicable index, such as the London Interbank Offered Rate ("LIBOR").
Accordingly, the coupon thereon will increase as interest rates decrease.
Inverse or reverse floating rate securities are typically more volatile than
fixed rate or other types of floating rate securities. Investments in inverse or
reverse floating rate securities may be made by the Fund to attempt to protect
against a reduction in the income earned on the Fund's investments due to a
decline in interest rates. The Fund would be adversely affected by the purchase
of such securities in the event of an increase in interest rates since the
coupon thereon will decrease as interest rates increase, and the value of the
securities may decrease more than would other debt securities, in some cases to
zero.
The Manager will monitor the creditworthiness of the issuers of floating rate,
variable rate, and inverse or reverse floating rate Minnesota Tax-Exempt
Securities. Such obligations are not as liquid as many other types of Minnesota
Tax-Exempt Securities.
Repurchase Agreements
The Fund may enter into repurchase agreements with broker-dealers and financial
institutions. A repurchase agreement is an agreement under which the Fund
acquires an instrument subject to resale to the seller at an agreed price and
date. The resale price reflects an agreed-upon return for the period the
instrument is held by the Fund and is unrelated to the coupon provided by the
instrument. Repurchase agreements are usually for periods of one week or less,
but may be for longer periods. As a fundamental policy the Fund will not enter
into repurchase agreements of more than seven days' duration if more than 10% of
its net assets would be invested collectively in such agreements and in other
securities deemed to be illiquid. Repurchase agreements will be fully
collateralized. If, however, the seller defaults on its obligation to repurchase
the underlying security, the Fund may experience delay or difficulty in
exercising its rights to realize upon the security and might incur a loss if the
value of the security has declined. The Fund might also incur disposition costs
in liquidating the security.
9
<PAGE>
When-Issued Securities
The Fund may enter into commitments to purchase new issues of Minnesota Tax-
Exempt Securities on a when-issued basis. Delivery and payment for these
securities normally take place 15 to 45 days after the date of commitment. There
is a risk that due to changes in interest rates between the commitment date and
settlement date the market value of the security on the settlement date may be
less than its purchase price. With regard to each commitment agreement for when-
issued securities, the Fund will maintain in a segregated account with its
custodian commencing on the commitment date, cash or high-grade liquid debt
obligations equal in value to the purchase price due on the settlement date
under such agreement.
The Fund will only make commitments to purchase when-issued Minnesota Tax-Exempt
Securities with the intention of actually acquiring the securities, but if
deemed advisable the Fund may sell these securities before the settlement date
or may meet its payment obligations from proceeds of the sale of the when-issued
securities themselves (which may then have a market value greater or less than
the Fund's payment obligation).
Investment Restrictions
In addition to the policies and limitations set forth above, the Fund is subject
to certain other investment policies and limitations set forth more fully in the
Statement of Additional Information. As a matter of fundamental policy, the Fund
may not: (1) borrow money, except for temporary purposes in emergency situations
and in an aggregate amount not in excess of 20% of the value of the total assets
of the Fund; provided that borrowings in excess of 5% of such value are
permitted from banks only; (2) mortgage or pledge assets, except that up to 10%
of the Fund's assets can be used to secure borrowings; (3) purchase securities
of any issuer if immediately thereafter, with respect to 50% of the Fund's total
assets, more than 5% of such assets would be invested in the securities of any
one issuer, except that this limitation does not apply to obligations issued or
guaranteed as to principal and interest either by the U.S. government or its
agencies or instrumentalities; or (4) purchase private activity bonds if
immediately thereafter more than 25% of the Fund's assets would be invested in
private activity bonds which are based, directly or indirectly, on the credit of
private entities in any one industry or in securities of private issuers in any
one industry.
Except as specifically noted, the investment policies described above are not
fundamental and the Board of Directors of the Fund may change them without the
vote of a majority of the Fund's outstanding voting securities. The Board may
not change the Fund's investment objective, nor any other fundamental policy,
without such a vote. Under the Investment Company Act of 1940, a "vote of a
majority of the outstanding voting securities" of the Fund means the affirmative
vote of the lesser of (1) more than 50% of the outstanding shares of the Fund or
(2) 67% or more of the shares present at a shareholders' meeting if more than
50% of the outstanding shares are represented at the meeting in person or by
proxy.
HOW IS THE FUND MANAGED?
The Board of Directors provides broad supervision over the affairs of the Fund.
Pursuant to an Investment Advisory and Management Agreement approved by the
Board and the shareholders of the Fund, ARM Capital Advisors, Inc. (the
"Manager") manages the investments of the Fund and administers its business and
other affairs. The address of the Manager is 200 Park Avenue, 20th Floor, New
York, New York 10166.
The Manager is a wholly-owned subsidiary of ARM Financial Group, Inc. ("ARM"), a
Delaware corporation. ARM is a financial services company providing retail and
institutional products and services to the long-term savings and retirement
market. The Morgan Stanley Leveraged Equity Fund II, L.P., Morgan Stanley
Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P. and MSCP III
892 Investors, L.P., investment funds sponsored by Morgan Stanley Group, Inc.
("Morgan Stanley"), own approximately 91% of the outstanding shares of voting
stock of ARM. The Manager currently provides investment management services to
institutional and individual clients, including ARM and its subsidiaries, with
combined assets in excess of $4 billion.
The Manager commenced investment advisory operations on January 5, 1995, on
which date it acquired the domestic fixed income unit of Kleinwort Benson
Investment Management Americas Inc. The Manager has managed the Fund since June
14, 1995 and since that date has also managed the other mutual funds in the
State Bond Group of mutual funds: State Bond Cash Management Fund, State Bond
Common Stock Fund, State Bond Diversified Fund, State Bond Tax Exempt Fund, and
State Bond U.S. Government and Agency Securities Fund.
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<PAGE>
Keith O. Martens, Senior Vice President and Portfolio Manager of the Manager and
Vice President of the Fund, is responsible for selection of investments and
management of the Fund. Mr. Martens has managed the Fund since the Fund's
inception in December of 1987. Mr. Martens is also the principal manager of the
State Bond Common Stock Fund, State Bond Diversified Fund, State Bond U.S.
Government and Agency Securities Fund, State Bond Cash Management Fund and State
Bond Tax Exempt Fund.
The Fund pays the Manager a management fee, calculated daily and payable
monthly, equal to an annual fee of .85 of 1% of the first $100,000,000 of
average daily net assets of the Fund and .80 of 1% of the average daily net
assets of the Fund in excess of $100,000,000. A portion of this fee is paid by
the Manager to SBM Financial Services, Inc. (the "Distributor") in connection
with the Fund's Plan of Distribution (the "Plan") (see "What Is The Fund's Plan
of Distribution?") The gross management fee (before payment to the Distributor
of the fee under the Plan) is higher than the management fees paid by most other
investment companies principally because it includes the fee paid by the Manager
under the Plan to the Distributor. The Fund pays all its expenses other than
those assumed by the Manager. Total expenses for the Fund for its fiscal year
ended June 30, 1995 amounted to 1.00% of average daily net assets.
WHAT ARE THE FUND'S BROKERAGE COMMISSIONS?
The Manager places orders for the Fund's portfolio securities transactions. As
the Fund's portfolio is exclusively composed of debt (rather than equity)
securities, most of the Fund's portfolio transactions are effected with dealers
without the payment of brokerage commissions, but at net prices which usually
include a spread or markup. Most Fund transactions are with the issuer, or with
major dealers acting for their own account and not as brokers. In effecting
portfolio transactions the Fund seeks the most favorable net price consistent
with the best execution. However, frequently the Fund selects a dealer to effect
a particular transaction without contacting all dealers who might be able to
effect such transaction, because of the volatility of the market and the desire
of the Fund to accept a particular price for a security because the price
offered by the dealer meets its guidelines for profit, yield, or both. No
brokerage is allocated for the sale of Fund shares. The Fund will not deal with
affiliates of the Manager and Distributor in any transaction in which such
affiliate acts as principal.
While it is not expected that the Fund will effect any transactions on an agency
basis, if it does so the Manager will seek to obtain the best price and
execution of orders. Commission rates, being a component of price, are
considered together with other relevant factors. When consistent with these
criteria, business may be placed with broker-dealers who furnish investment
research services to the Manager. Such research services include advice, both
directly and in writing, as to the value of securities, the advisability of
investing in, purchasing, or selling securities, and the availability of
securities or purchasers or sellers of securities, as well as analyses and
reports concerning issues, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts. This allows the Manager to
supplement its own investment research activities and enables it to obtain the
views and information of individuals and research staffs of many different
securities research firms prior to making investment decisions for the Fund. To
the extent portfolio transactions are effected with broker-dealers who furnish
research services to the Manager, the Manager receives a benefit, not capable of
evaluation in dollar amounts.
The Manager has not entered into any formal or informal agreements with any
broker-dealers, and it does not maintain any "formula" which must be followed in
connection with the placement of Fund portfolio transactions in exchange for
research services provided the Manager, except as noted below. If it is
believed to be in the best interests of the Fund, the Manager may place
portfolio transactions with brokers who provide the types of services described
above, even if it means the Fund will have to pay a higher commission (or, if
the broker's profit is part of the cost of the security, will have to pay a
higher price for the security) than would be the case if no weight were given to
the broker's furnishing of those services. This will be done, however, only if,
in the opinion of the Manager, the amount of additional commission or increased
cost is reasonable in relation to the value of the services. The Manager also
serves as investment adviser for other mutual funds. To the extent that the Fund
may pay a somewhat higher brokerage commission or somewhat higher price on a
trade because such trade is executed by a broker-dealer which also provides
research and statistical services, it is possible that said research and
statistical services may also be of value to one of the other Manager's mutual
funds. However, it is felt that this possibility of mutual benefit is not
capable of measurement.
11
<PAGE>
HOW CAN YOU INVEST IN THE FUND?
SBM Financial Services, Inc. (the "Distributor"), a subsidiary of ARM, acts as
distributor of the Fund's shares. Its address is 100 North Minnesota Street,
P.O. Box 69, New Ulm, Minnesota 56073-0069.
Shares of the Fund are offered for sale through the Distributor and through
certain broker-dealers under contract with the Distributor. After you become a
shareholder, you may buy additional shares by sending a check drawn to State
Bond Tax Exempt Fund directly to the Fund's Shareholder Servicing Agent, SBM
Financial Services, Inc. at 100 North Minnesota Street, P.O. Box 69, New Ulm,
Minnesota 56073-0069. Orders for the purchase of shares will be executed at the
offering price based upon the net asset value next determined after receipt and
acceptance of the order by the Distributor or the Shareholder Servicing Agent.
Orders for shares placed through broker-dealers will be executed at the offering
price next determined after the receipt of the order by the broker-dealer,
provided that the broker-dealer promptly transmits the order to the Distributor
the same day. The broker-dealer is responsible for transmitting the purchase
order to the Distributor. Shares will begin to earn dividends on the day when
payment for such shares is received by the Fund or the Distributor. The Fund
reserves the right to reject any order for the purchase of its shares. The
minimum initial investment is $500 and subsequent investments must be in the
amount of at least $50. The Fund reserves the right to change these minimum
investments. The Fund will not be responsible for the consequences of delays in
the banking or Federal Reserve wire systems.
HOW IS THE OFFERING PRICE OF THE FUND'S SHARES DETERMINED?
The price you pay for shares of the Fund is the offering price, that is, the
next determined net asset value of the shares plus the applicable sales charge.
Net asset value per share is determined as of the time of close of the New York
Stock Exchange (generally 3:00 p.m. Central Time) on each day that the New York
Stock Exchange is open for business. Net asset value is determined by dividing
the value of the total assets of the Fund, less liabilities, by the number of
shares outstanding. In determining net asset value, the Fund utilizes the
valuations of its portfolio securities furnished by a pricing service approved
by the Board of Directors. The pricing service values portfolio securities which
have remaining maturities of more than sixty days from the date of valuation at
quoted bid prices or the yield equivalents when quotations are readily
available. Such securities for which quotations are not readily available (which
constitute a majority of the Fund's portfolio securities) are valued at fair
value as determined by the pricing service using methods which include
consideration of yields or prices of municipal bonds of comparable quality, type
of issue, coupon, maturity, and rating, indications as to value from dealers,
and general market conditions. The pricing service may employ electronic data
processing techniques and/or a matrix system to determine valuations. Short-term
holdings maturing in 60 days or less are valued at cost plus accrued interest
which approximates market value.
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<PAGE>
HOW ARE THE FUND'S SALES CHARGES DETERMINED?
Sales charges are determined in accordance with the following schedule:
<TABLE>
<CAPTION>
Regular Dealer
% of Net Amount Discount as % of
% of Offering Price Invested Offering Price
------------------- --------------- -----------------
<S> <C> <C> <C>
Less than $50,000 4.50% 4.71% 4.00%
$50,000 but less than $100,000 4.00% 4.17% 3.50%
$100,000 but less than $250,000 3.00% 3.09% 2.50%
$250,000 but less than $500,000 2.50% 2.56% 2.00%
$500,000 but less than $1,000,000 2.00% 2.04% 1.50%
$1,000,000 but less than $2,000,000 1.00% 1.01% 0.50%
$2,000,000 or more 0.50% 0.50% 0.25%
</TABLE>
The sales charge varies depending on the size of the purchase, the number of
shares of the mutual funds in the State Bond Group you already own, whether you
have entered into a Letter of Intent to purchase additional shares during a 13-
month period, or any special purchase programs in effect. Complete details of
how you may purchase shares at reduced sales charges under Volume Discounts,
Right of Accumulation or Letters of Intent are contained in the Statement of
Additional Information and are available from your investment agent or dealer,
or the Distributor.
Shares may be sold at net asset value without a sales charge to present and
retired directors, present and retired officers, and present and retired
employees (and their spouses and minor children) of the Fund, the other
investment companies in the State Bond Group, and ARM and its subsidiaries. Such
sales also may be made to employee benefit plans for such persons. Also, shares
may be sold at net asset value to sales representatives of the Distributor and
registered representatives of broker-dealers who have signed dealer agreements
with the Distributor for sale of the shares of the Fund (including employee
benefit plans for such persons and their spouses and minor children). Shares may
be sold to any investment advisory, custodial, trust or other fiduciary account
managed or advised by the Manager or any affiliate wherein such entity has
discretionary investment authority at a maximum sales charge of 3% or such
lesser sales charge as such account would otherwise qualify for under the Fund's
sales charge schedule and the Volume Discount, Rights of Accumulation or Letter
of Intent provisions. These sales may be made for investment purposes only, and
shares may be resold only to the Fund.
HOW CAN YOU "SELL" YOUR SHARES?
You may redeem your shares without charge at any time by writing to the
Shareholder Servicing Agent at 100 North Minnesota Street, P.O. Box 69, New Ulm,
Minnesota 56073-0069. You will receive the net asset value per share next
determined after receipt of your request in proper form by the Shareholder
Servicing Agent. The written redemption request should identify the account
number and be signed by the shareholder(s) exactly as the shares are registered.
For share redemptions valued at $20,000 or more, your signature or signatures
must be guaranteed by a national securities exchange, a member firm of a
principal stock exchange, a registered securities association, a clearing
agency, a bank or trust company, a savings association, a credit union, a
broker, a dealer, a municipal securities broker or dealer, a government
securities broker or dealer, or a representative of the Distributor. Further
documentation may be required from corporations, executors, partnerships,
administrators, trustees or custodians. If stock certificates have been issued
for the shares that you wish to redeem, you must surrender the certificates in
proper form, endorsed for transfer or accompanied by an endorsed stock power.
For your protection, any certificates should be sent by registered mail.
Shares may also be redeemed through authorized dealers and through
representatives of the Distributor. Requests for redemption received by the
Shareholder Servicing Agent from authorized dealers or representatives of the
Distributor prior to the close of the New York Stock Exchange will be executed
at the net asset value per share determined at the close of
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<PAGE>
the New York Stock Exchange on that day. Dealers and representatives are
responsible for promptly submitting such redemption requests to the Shareholder
Servicing Agent in order to obtain that day's closing price. Requests for
redemption received by the Shareholder Servicing Agent from dealers or
representatives of the Distributor after the close of the New York Stock
Exchange will be executed at the net asset value determined at the close of the
New York Stock Exchange on the next trading day.
A check for the proceeds of the redemption of your shares ordinarily will be
mailed to you within seven calendar days after a redemption request is received
in proper form. However, where shares purchased by means of an uncertified check
are redeemed before the fifteenth day after purchase, proceeds will not be
mailed until the check clears, which may be up to fifteen days after purchase.
Proceeds of a redemption may be more or less than the cost of the shares when
purchased. You will not receive dividends on shares which are redeemed from your
account for the day that the redemption is effected.
Because of the relatively high cost of handling small accounts, the Fund
reserves the right to redeem, upon not less than 30 days' written notice, the
shares in an account which has a value of less than $500. You will be allowed to
make additional investments prior to the date fixed for such a redemption to
avoid liquidation of your account. Shares will not be involuntarily redeemed if
the value of the shares drops below $500 due to market value changes.
Quick Redemption by Wire Transfer
If you have elected the Quick Redemption service, you may request that the
proceeds of a redemption of shares having a value of $5,000 or more be wired to
your account at a commercial bank in the United States which is a member of the
Federal Reserve System. This service is available only if you have designated
such a bank in your Investment Application and no certificates have been issued
for the shares to be redeemed. Redemption proceeds of less than $5,000 will not
be wired, but instead will be mailed to the shareholder's address of record. A
request for Quick Redemption may be made to the Shareholder Servicing Agent by
mail at 100 North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-0069
or by telephone at (800) 328-4735. Each request must include your name and
account number. There is currently a $10.00 charge for each wire transfer, which
is deducted from the redemption proceeds. The fee is waived for banks for their
fiduciary accounts. The Fund reserves the right to modify the Quick Redemption
service at any time.
Quick Redemption requests received before the close of the New York Stock
Exchange on a business day of the Fund will be effected at the net asset value
determined on that day. Quick Redemption requests received after the close of
the New York Stock Exchange will be effected at the net asset value determined
on the next business day of the Fund. Proceeds sent by wire will be transmitted
on the next business day after the day that the redemption is effected. Proceeds
sent by mail will be transmitted within seven days of receipt of your request.
If your bank is not a member of the Federal Reserve System, Quick Redemption
proceeds may be wired to a member bank which has a correspondent relationship
with your bank, provided you designate such a correspondent bank in the
Investment Application and note that your bank should be immediately advised of
the wire transfer. The failure of a correspondent bank to notify your bank of
the wire transfer immediately could delay the crediting of redemption proceeds
to your bank.
The Fund is not liable for any loss arising from telephone redemptions that the
Fund reasonably believes to be genuine. The Fund will employ reasonable
procedures to confirm that instructions communicated by telephone are genuine;
if it does not, it may be liable for any losses due to unauthorized or
fraudulent instructions. The procedures used by the Fund will include requesting
several items of personal identification information prior to acting upon
telephone instructions and sending a written confirmation on all such
transactions.
If you are already a Fund shareholder you may elect the Quick Redemption service
or change a designation of a bank account for the Quick Redemption service by
writing to the Shareholder Servicing Agent at 100 North Minnesota Street , P.O.
Box 69, New Ulm, Minnesota 56073-0069. The designation must be signed by all of
the registered owners of the Fund account, with signature(s) guaranteed by a
national securities exchange, a member firm of a principal stock exchange, a
registered securities association, a clearing agency, a bank or trust company, a
savings association, a credit union, a broker, a dealer, a municipal securities
broker or dealer, a government securities broker or dealer, or a representative
of the Distributor.
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<PAGE>
Check Redemptions
You may elect to participate in the Fund's free Check Redemption service, which
permits you to write checks payable to any person in amounts of $250 or more
(but not more than $100,000), provided that you have an account balance of
$5,000 or more. You may elect this service on the Investment Application or by
later written request to the Shareholder Servicing Agent at 100 North Minnesota
Street, P.O. Box 69, New Ulm, Minnesota 56073-0069. The Shareholder Servicing
Agent will supply you with blank checks which can be drawn on your account with
the Fund. The checks will be paid from the redemption of shares in your account.
When honoring a check presented for payment, the Shareholder Servicing Agent
will cause the Fund to redeem exactly enough full and fractional shares in your
account to cover the amount of the check. Shares for which certificates have
been issued may not be redeemed by check. Check redemption is subject to bank
rules and regulations governing checking accounts. Checks for less than $250 or
more than $100,000 will be returned and a fee may be charged. If there are
insufficient shares in your account to cover a check written under this service,
the check will be returned marked "insufficient funds" and a return fee may be
charged. Checks should not be used to close a Fund account because when the
check is written you will not know the exact total value of the account on the
day the check clears. Fund dividends and distributions continue to be earned
until a check clears for payment. The Fund reserves the right to terminate or
modify the Check Redemption service at any time upon written notice to the
Fund's shareholders.
How Can You Reinstate Your Investment?
If you redeem shares and then decide you should not have redeemed them, or that
you prefer to shift your investment to one of the other mutual funds in the
State Bond Group, you may, within 30 calendar days of the date of redemption,
use all or any part of the proceeds of the redemption to reinstate, free of
sales charge, your investment in shares of the Fund, or, if you held the shares
redeemed for seven calendar days or longer before redemption, invest in shares
of any of the other mutual funds (except the Cash Management Fund) in the State
Bond Group. To make such an investment free of sales charges in shares of the
State Bond Funds which have a higher sales charge than the Fund, you also must
have held the shares of the Fund for six months or longer before their
redemption. Your investment will be reinstated or made at the net asset value
per share next determined after your request is received. You may use this
privilege to reinstate an investment in the Fund only once.
Exercise of the Reinstatement Privilege does not alter the Federal income tax
status of any capital gain realized on a sale of Fund shares, but to the extent
that any shares are sold at a loss and the proceeds are reinvested in shares of
the same Fund, some or all of the loss will not be allowed as a deduction,
depending upon the percentage of the proceeds reinvested.
HOW DOES THE FUND'S EXCHANGE PRIVILEGE WORK?
If you have been a shareholder for seven calendar days or more, you may exchange
any or all of your investment for shares of the other mutual funds in the State
Bond Group. Any exchange for shares of other mutual funds in the State Bond
Group will be at the next determined respective net asset values after receipt
of the request for exchange. Exchanges generally will be made without any sales
charges; except that if, within six months of your investment in the Fund, you
exchange for shares of any fund in the State Bond Group which has a higher sales
charge, you must pay the difference in the sales charge applicable to the
purchase of shares of the Fund and the higher sales charge applicable to the
purchase of shares of such other fund. Exchanges of Fund shares are sales, and
may result in a gain or loss for Federal income tax purposes. Before making an
exchange, you should obtain and read the prospectus for the fund you are
considering. The Fund reserves the right to terminate or modify the terms of
this exchange privilege upon 60 days' notice to shareholders. The exchange
privilege is only available in states in which the shares of the fund to be
acquired are available for purchase.
Exchange requests may be made in writing, signed by all registered owners, to
the Shareholder Servicing Agent at 100 North Minnesota Street, P.O. Box 69, New
Ulm, Minnesota 56073-0069. Shares also may be exchanged by telephone by calling
(800) 328-4735, provided you have on file an Agreement for Exchange of Shares
by Telephone (included on the Investment Application or available from the
Shareholder Servicing Agent). Shares held by trustees of retirement plans may
not be exchanged by telephone. During times of drastic economic or market
changes the telephone exchange privilege may be difficult to implement. In order
to implement an exchange, you will need to provide the name in which your
account is registered, your account number, such other personal identification
information as the Fund may request, the dollar amount or share amount you wish
to exchange, the name of the fund into which you wish to exchange and, if you
already have an account with the fund into which you wish to exchange, the
account registration and account number of such account.
15
<PAGE>
The Fund is not liable for any loss arising from telephone exchanges that the
Fund reasonably believes to be genuine. The Fund will employ reasonable
procedures to confirm that instructions communicated by telephone are genuine;
if it does not, it may be liable for any losses due to unauthorized or
fraudulent instructions. The procedures used by the Fund will include requesting
several items of personal identification information prior to acting upon
telephone instructions and sending a written confirmation on all such
transactions.
HOW DOES THE FUND PAY DIVIDENDS AND DISTRIBUTIONS?
The Fund declares daily dividends on all outstanding shares (dividends are
declared for the day on which shares are purchased but are not declared for
redeemed shares on the day of redemption). A shareholder who redeems all of his
or her Fund shares receives with the redemption proceeds the amount of all
dividends declared for the month to and including the date of redemption of
shares. Dividends in respect of all other redemptions are paid on the regular
dividend payment date. Distributions from taxable net realized investment gains,
if any, will generally be declared at least once each year.
What Are Your Dividend And Gain Distribution Options?
You may elect to:
1. Receive both dividends and gain distributions in additional shares of the
Fund.
2. Receive dividends in cash and gain distributions in additional shares of
the Fund.
3. Receive both dividends and gain distributions in cash.
If no election is made, dividends from investment income and gain distributions
will be reinvested and credited to your account as additional shares. Dividends
and gain distributions reinvestments are made at net asset value. To change your
election at any time, write to the Shareholder Servicing Agent at 100 North
Minnesota Street , P.O. Box 69, New Ulm, Minnesota 56073-0069.
WHAT IS THE TAX STATUS OF DIVIDENDS AND DISTRIBUTIONS YOU RECEIVE?
The Fund has fulfilled, and intends to continue to fulfill, the requirements of
the Internal Revenue Code of 1986, as amended (the "Code") which will enable it
to designate distributions from interest income generated by its investments in
Minnesota Tax-Exempt Securities as "Exempt Interest Dividends" excludable from
gross income for federal income tax purposes. The Fund also intends to invest
its assets so that at least 95% of its tax-exempt interest income is derived
from Minnesota Tax-Exempt Securities. Therefore, Exempt Interest Dividends paid
by the Fund will not be subject to federal income tax or Minnesota personal
income tax, except as indicated below.
Distributions by the Fund of net interest income received from certain temporary
taxable investments and net short-term capital gains realized by the Fund, if
any, will be taxable to shareholders as ordinary income whether received in cash
or additional shares. Any net long-term capital gains realized by the Fund,
whether received as cash or additional shares, will be taxable to shareholders
as long-term capital gains regardless of the length of time investors have held
their shares. Under federal law, long-term capital gains are currently subject
to a maximum tax rate of 28% while ordinary income is subject to a maximum
marginal rate equal to 39.6%. Under Minnesota law, long-term capital gains are
taxed at the same rates as ordinary income. Distributions to shareholders will
not qualify for the dividends received deduction for corporations. Market
discount recognized on Minnesota Tax-Exempt Securities is taxable as ordinary
income.
Up to 20% of the assets of the Fund may be invested in securities which generate
interest that is an item of tax preference for purposes of the federal and
Minnesota alternative minimum tax ("AMT"). Moreover, all exempt interest
dividends received by corporate shareholders will be a component of "adjusted
current earnings" for purposes of the corporate AMT. Individual and corporate
taxpayers whose taxable income plus certain tax preference items less an
exemption amount multiplied by the applicable alternative minimum tax rate
exceeds regular individual or corporate income tax liability (with certain
adjustments) are subject to AMT. Because AMT liability is dependent upon the
regular tax liability and tax preference items of a specific taxpayer, investors
should consult their tax advisers regarding the AMT consequences of an
investment in the Fund.
16
<PAGE>
In addition, shareholders who are or may become recipients of Social Security
should be aware that exempt-interest dividends are includable in computing
"modified adjusted gross income" for purposes of determining the amount, if any,
of social security benefits required to be included in gross income for federal
and Minnesota personal income tax purposes.
The Tax Reform Act of 1986 imposed new requirements on certain tax-exempt bonds
which, if not satisfied, could result in loss of tax exemption for interest on
such bonds, even retroactively to the date of issuance of the bonds. Proposals
to further restrict or eliminate the federal tax exemption for Minnesota Tax-
Exempt Securities may be introduced before Congress in the future. The Fund
cannot predict what additional legislation may be enacted that may affect
shareholders. If a bond in the Fund's portfolio were to lose its exempt status,
the Fund would make every effort to dispose of such investment on terms not
detrimental to the Fund.
The portion of Exempt Interest Dividends derived from interest income on
Minnesota Tax-Exempt Securities is excluded from the Minnesota gross income of
individuals, estates and trusts, so long as at least 95% of the Exempt Interest
Dividends paid by the Fund are derived from Minnesota Tax-Exempt Securities. The
remaining portion of such dividends and dividends that are not Exempt Interest
Dividends or capital gain dividends (except for dividends, if any, derived from
interest paid on obligations of the U.S. Government, its territories and
possessions) are included in the Minnesota gross income of individuals, estates
and trusts. Exempt Interest Dividends are not excludable from the Minnesota
gross income of corporations and banks.
Upon a sale or exchange of his or her shares, a shareholder will realize a
taxable gain or loss depending on his or her basis in the shares. Such gains or
loss will be treated as a capital gain or loss if the shares are capital assets
in the shareholder's hands and will be a long-term capital gain or loss if the
shares have been held for more than one year. Generally, any loss realized on a
sale or exchange will be disallowed to the extent shares disposed of are
replaced within a period of sixty-one days beginning thirty days before and
ending thirty days after the shares are disposed of. Any loss realized by a
shareholder on the sale of shares of the Fund held by the shareholder for six
months or less will be disallowed to the extent of any Exempt Interest Dividends
received by the shareholder with respect to such shares, and will be treated for
tax purposes as a long-term capital loss to the extent of any distributions of
net capital gains received by the shareholder with respect to such shares.
In certain circumstances (such as the exercise of an exchange privilege), a load
charge may not be taken into account in determining the gain or loss on the sale
on redemption of shares in the Fund within 90 days of their acquisition. In such
case, the load charge is treated as incurred with respect to the shares
subsequently purchased.
Under the Code, interest on indebtedness incurred or continued to purchase or
carry Fund shares which is deemed to relate to exempt-interest dividends is not
deductible.
Entities or persons who are "substantial users" (or related persons) of
facilities financed by "private activity" bonds (some of which were formerly
referred to as "industrial development" bonds) should consult their tax advisers
before purchasing shares of the Fund. "Substantial user" is defined generally as
including a "non-exempt person" who regularly uses in its trade or business a
part of a facility financed from the proceeds of industrial development bonds.
The 1995 Minnesota Legislature has enacted a statement of intent that interest
on obligations of Minnesota governmental units and Indian tribes be included in
net income of individuals, estates and trusts for Minnesota income tax purposes
if a court determines that Minnesota's exemption of such interest unlawfully
discriminates against interstate commerce because interest on obligations of
governmental issuers located in other states is so included. This provision
applies to taxable years that begin during or after the calendar year in which
any such court decision becomes final, irrespective of the date on which the
obligations were issued. The Fund is not aware of any decision in which a court
has held that a state's exemption of interest on its own bonds or those of its
political subdivisions or Indian tribes, but not of interest on the bonds of
other states or their political subdivisions or Indian tribes, unlawfully
discriminates against interstate commerce or otherwise contravenes the United
States Constitution. Nevertheless, the Fund cannot predict the likelihood that
interest on the Minnesota Tax-Exempt Securities held by the Fund would become
taxable under this Minnesota statutory provision.
Shareholders are sent a quarterly statement of account reflecting all
transactions in the prior quarter, including dividends and gain distributions.
Also, at year-end, all shareholders are sent a statement of account and
information on the aggregate amount and tax status of dividends and gain
distributions for the just-ended calendar year.
17
<PAGE>
The foregoing discussion relates to federal and Minnesota income taxation as of
the date of the prospectus, Distributions from the Fund, including exempt-
interest dividends, may be taxable in states other than Minnesota. Prospective
investors should consult their tax advisers with regard to the tax consequences
of an investment in the Fund.
WHAT IS THE FUND'S PLAN OF DISTRIBUTION?
The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1
under the Act. Under the terms of the Plan and the Investment Advisory and
Management Agreement (the "Agreement"), a portion of the management fee paid to
the Manager is paid to the Distributor. Under the Plan and the Agreement, the
Fund pays the Distributor, indirectly through the Manager, a monthly fee
equivalent on an annual basis to .25 of 1% of the average daily net assets of
the Fund. The fee may be used by the Distributor to (i) provide initial and
ongoing sales compensation to its investment executives and to other broker-
dealers in connection with the sale of Fund shares and to pay for other
advertising and promotional expenses in connection with the sale of Fund
("distribution expenses"), and (ii) to provide compensation to entities
("Service Entities") in connection with the provision of certain personal and
account maintenance services to Fund shareholders including, but not limited to,
responding to shareholder inquiries and providing information on their
investments ("shareholder servicing expenses").
In the future, Service Entities may include banks and other depository
institutions which, under the Glass Steagall Act and other applicable laws and
regulations, are prohibited from engaging in the business of underwriting,
selling or distributing certain types of securities. Such institutions will only
be allowed to provide administration, shareholder service and distribution
assistance if the scope of the assistance is such that, in the opinion of the
Manager, it does not fall within the aforementioned prohibition.
WHO ARE THE FUND'S FUND ACCOUNTING AGENT AND ITS CUSTODIAN?
Investors Fiduciary Trust Company serves as the Fund's fund accounting agent,
and in that capacity, maintains certain books and records pursuant to an
agreement with the Fund. Its address is 127 West 10th Street, Kansas City,
Missouri 64105. Investors Fiduciary Trust Company also serves as custodian for
the Fund's portfolio securities and cash, and in that capacity, maintains
certain financial and accounting books and records pursuant to an agreement with
the Fund.
WHAT SERVICES DOES THE FUND OFFER?
Information about various shareholder services is included above under "How Can
You `Sell' Your Shares?" In addition, the Fund also provides the following
services:
What About Shareholder Information?
For general information about the Fund, call or write SBM Financial Services,
Inc., 100 North Minnesota Street, P.O. Box 69, New Ulm, Minnesota 56073-0069.
Its telephone number is 800-328-4735. For information about your account, call
or write the Shareholder Servicing Agent at 100 North Minnesota Street, P.O. Box
69, New Ulm, Minnesota 56073-0069, telephone number 800-328-4735.
What Reports Will You Receive From the Fund?
As a shareholder, you will receive the Fund's annual and semi-annual reports.
You also will receive quarterly account statements confirming dividends paid by
the Fund, transactions in your account and the current balance of shares you
own.
Are Certificates Issued For Shares?
All shares will be issued as book credits by the Shareholder Servicing Agent.
Certificates will not be issued. Any existing certificates may be sent to the
Shareholder Servicing Agent to be transferred in your account to book credits.
18
<PAGE>
Other Services
Pre-Authorized Payments enable you to purchase Fund shares by authorizing your
bank to make regular payments from your bank account in fixed amounts.
Payments at regular intervals can be made to you from your Fund account under
the Automatic Cash Withdrawal Plan if you own or purchase shares held as book
credits worth $5,000 or more.
Further information on these services and others is available by contacting the
Distributor.
GENERAL INFORMATION ABOUT STATE BOND MINNESOTA TAX-FREE INCOME FUND
State Bond Minnesota Tax-Free Income Fund is an investment portfolio of State
Bond Tax-Free Income Funds, Inc., a non-diversified, open-end management
investment company, or mutual fund, incorporated in Maryland on December 2,
1987. The Fund has only one class of capital stock, common shares, par value
$.00001 per share. Each outstanding share has one vote and an equal right to
dividends and distributions, if any. All shares have noncumulative voting rights
for the election of directors. Each share is fully paid and nonassessable, and
each is freely transferable.
INVESTMENT PERFORMANCE
Advertisements and other sales literature for the Fund may refer to "yield,"
"tax equivalent yield," "average annual total return," "cumulative total return"
or data concerning the Fund's performance since its inception. When the Fund
advertises yield, it also will advertise its average annual total return for the
most recent one year, five year, and ten year periods, or the life of the Fund,
if less.
When the advertised yield of the Fund is characterized as the "SEC 30-day
yield", it will be based upon a 30-day period stated in the advertisement and
calculated in accordance with a standardized method promulgated by regulations
of the Securities and Exchange Commission. Such yield is calculated by dividing
the net investment income per share (as defined in such regulations) earned
during the period by the maximum offering price per share on the last day of the
period. Maximum offering price includes the maximum sales charge and any other
nonrecurring charges. The result is then annualized using a formula that
provides for semi-annual compounding of income. The tax-equivalent yield is
calculated based on the Fund's yield, except that the yield is increased by
using a stated income tax to demonstrate the taxable yield necessary to produce
an after-tax yield equivalent to the Fund's yield.
Average annual total return is calculated by finding the average annual
compounded rate of return over the period that would equate the initial
investment to the ending redeemable value. Cumulative total return is the
percentage change between the public offering price of one Fund share at the
beginning of a period and the net asset value of that share at the end of the
period with dividend and capital gain distributions treated as reinvested. In
calculating the average annual total return and cumulative total return, the
maximum sales charge is deducted from the hypothetical investment and all
dividends and distributions during the period are assumed to be reinvested.
The Fund may from time to time compare its investment results to various
unmanaged indices or other mutual funds in reports to shareholders, sales
literature, and advertisements. This may include comparisons of relative
performance based upon data provided by services such as Lipper Analytical
Services, Incorporated. The results may be calculated on a total return and/or
yield basis for various periods, with or without sales charges. Results without
a sales charge will be higher. Total returns assume the reinvestment of all
dividends and capital gain distributions. The Fund also may refer to
publications which have mentioned the Fund, its Manager, or their personnel.
For additional information regarding the calculation of the Fund's yield, and
total return, see "Calculation of Performance Data" in the Statement of
Additional Information.
Tax-Free vs. Taxable Yields. The following table shows the approximate yields
which taxable securities must earn in various income brackets to equal tax-
exempt yields under combined federal and State of Minnesota individual income
tax rates. The table is based on federal and State of Minnesota income tax rates
for taxable years beginning in 1995. The table reflects the new
19
<PAGE>
federal income tax rates for individuals imposed by the revenue provisions of
the Omnibus Budget Reconciliation Act of 1993, which are applied to bracket
amounts that have been adjusted for inflation in 1995: 36% on the taxable income
of single individuals in excess of $117,950 and of married couples filing joint
returns in excess of $143,600, and a surtax of 10%, equaling an effective rate
of 39.6%, on the taxable income of individuals filing both single and joint
returns in excess of $256,500. Combined tax rates take into account the
deductibility of state income taxes for federal income tax purposes. Tax rate
brackets are subject to annual adjustments based on changes in the Consumer
Price Index. Accordingly, tax rates and taxable equivalent yields for 1996 and
subsequent years may be lower at some income levels than indicated in the table.
The table does not take into consideration any federal or Minnesota alternative
minimum tax. Therefore, to the extent Fund distributions are, and a Fund
shareholder is, subject to the federal or Minnesota alternative minimum tax,
taxable equivalent yields will be less than those set forth in this table.
USE THIS TABLE TO FIND YOUR 1995 COMBINED FEDERAL
AND MINNESOTA TAX BRACKET BASED ON YOUR FEDERAL TAXABLE INCOME (000'S OMITTED)
<TABLE>
21.8% 33.8% 34.1% 36.9% 41.4% 44.7%
<S> <C> <C> <C> <C> <C> <C>
Joint $21-39 $39-84 $84-94 $94-144 $144-256 over $256
Single $15-23 $23-48 $48-57 $57-118 $118-256 over $256
</TABLE>
YOUR TAXABLE EQUIVALENT YIELD WOULD HAVE TO BE:
<TABLE>
<CAPTION>
If your tax exempt yield is: 21.8% 33.8% 34.1% 36.9% 41.4% 44.7%
<S> <C> <C> <C> <C> <C> <C>
3.0% 3.8% 4.5% 4.6% 4.8% 5.1% 5.4%
3.5% 4.5% 5.3% 5.3% 5.5% 6.0% 6.3%
4.0% 5.1% 6.0% 6.1% 6.3% 6.8% 7.2%
4.5% 5.8% 6.8% 6.8% 7.1% 7.7% 8.1%
5.0% 6.4% 7.6% 7.6% 7.9% 8.5% 9.0%
5.5% 7.0% 8.3% 8.3% 8.7% 9.4% 9.9%
6.0% 7.7% 9.1% 9.1% 9.5% 10.2% 10.8%
7.0% 9.0% 10.6% 10.6% 11.1% 11.9% 12.7%
</TABLE>
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE
The total return for the Fund's fiscal year ended June 30, 1995 was 7.10%. This
total return assumes the reinvestment of all distributions and does not include
the effects of the one time sales charge. Taking into account the effects of the
one time sales charge, at its maximum rate, the Fund's total return for the
fiscal year ended June 30, 1995, was 2.30%. The Fund's average annual total
return for its most recent one, five, and ten-year periods is shown in the chart
that follows.
The Fund's investment performance in its most recent fiscal year was primarily
affected by the changes in interest rates and investment decisions related to
these changes. During this fiscal year, the Federal Reserve continued its
efforts to curb future inflationary pressures by increasing short-term interest
rates in August, November, and February by a total of 1.75%. With these
increases, the 30 year Treasury Bond yield, which began the fiscal year at
7.60%, increased to over 8% in November, and held near that level through
December. However, even though the Federal Reserve increased short-term interest
rates by an additional 0.5% in February, the 30 year Treasury Bond yield began
to decrease in January and continued its downward trend, closing the fiscal year
near the 6.60% level as weaker economic data suggested a slowing economy.
20
<PAGE>
In an effort to take advantage of these higher rates, the Fund in December used
cash balances and some sales to purchase quality issues having maturities of 16
to 18 years and yields of 6.50% to 7.10%. This extension of duration aided the
Fund's total return for this reporting period as these bonds appreciated in
value as the interest rates declined, while also producing higher yields.
The Fund continued its practice of maintaining a conservative, high quality
investment portfolio by limiting its investments to A-rated securities or
better, and of selling any securities that receive a downgrade to a rating below
A quality. The Fund also continued its practice of not purchasing or holding
securities that are subject to the Alternative Minimum Tax.
The following chart compares the performance of a hypothetical $10,000
investment in the Fund over the life of the Fund (from January 28, 1988) to the
performance of an investment in the Lehman Brothers Municipal Bond Index (the
"Index"). The information in the chart assumes that the maximum current sales
charge was paid upon acquisition of the Fund shares and reflects all Fund
expenses during the period covered. The information in the chart regarding the
performance of the hypothetical investment in the Index assumes that no sales
charge was paid upon an investment in the Index and that there were no expenses
associated with an investment in the Index. The index that is used for
comparative purposes, the Lehman Brothers Municipal Bond Index is a national
index; consequently, its performance may not be directly comparable to the
performance of the Fund, which is a single-state municipal securities fund.
21
<PAGE>
Fund's average annual total return for the period ending June 30, 1995:
One Year.............................................. 2.30%
Five Years............................................ 5.82%
Life of Fund (since 1/28/88).......................... 6.33%
[CHART APPEARS HERE]
Index Performance Fund Performance
1988 10,182 9,501
1989 11,342 10,753
1990 12,114 11,343
1991 13,206 12,122
1992 14,760 13,271
1993 16,526 14,605
1994 16,554 14,721
1995 18,014 15,767
All performance data and figures are based upon past performance. The investment
return on and principal value of an investment in the Fund will fluctuate, so
that an investor's shares, when redeemed, may be worth more or less than their
original cost.
The above performance data for the Fund assumes the applicability of the current
maximum sales charge and does not include adjustments for expenses which have
changed during the periods reflected. The Manager of the Fund historically has
paid a portion of the Fund's expenses. See "Financial Highlights" above.
NO DEALER, SALES REPRESENTATIVE OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS (AND/OR IN THE STATEMENT OF ADDITIONAL INFORMATION REFERRED TO ON THE
COVER PAGE OF THIS PROSPECTUS), AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND,
THE MANAGER OR SBM FINANCIAL SERVICES, INC. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFER OR SOLICITATION BY ANYONE IN A STATE IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION.
22
<PAGE>
THE STATE BOND GROUP OF MUTUAL FUNDS
GENERAL AUTHORIZATION FORM
TO OPEN A NEW ACCOUNT BY MAIL:
1. Complete the General Authorization Form. Be sure to indicate the Fund in
which your Account should be opened. Also indicate the services you will want
to use. Special attention should be given to Section 9 of the Form. BE SURE
TO SIGN THE CERTIFICATION IN SECTION 9.
2. Send the completed Form and your check, payable to SBM Financial Services,
Inc. to:
SBM Financial Services, Inc. - 100 N. Minnesota St. - P.O. Box 69 -
New Ulm, MN 56073-0069 - (800) 328-4735
PLEASE CHECK:
[_] STATE BOND COMMON STOCK FUND DATE _______________
[_] STATE BOND DIVERSIFIED FUND
THIS FORM MAY NOT BE USED TO ESTABLISH OR REVISE AN ACCOUNT OR SERVICE IN
STATE BOND CASH MANAGEMENT FUND, STATE BOND TAX EXEMPT FUND, STATE BOND
U.S. GOVERNMENT AND AGENCY SECURITIES FUND, OR STATE BOND MINNESOTA-TAX FREE
INCOME FUND. FORMS FOR THOSE FUNDS ARE INCLUDED IN THEIR PROSPECTUSES, COPIES
OF WHICH MAY BE OBTAINED FROM SBM FINANCIAL SERVICES, INC., 100 N. MINNESOTA
ST., P.O. BOX 69, NEW ULM, MN 56073-0069.
- --------------------------------------------------------------------------------
I wish to ESTABLISH [_] or REVISE [_] an Account (No. _______________) [_] check
enclosed for $___________ in the mutual fund checked above in accordance with
these instructions, the terms and conditions of this Form and the current
prospectus of the Fund, a copy of which I have received.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------------
1 REGISTRATION: AGE
-----------------------------------------------------------------------------------------------------------
PLEASE PRINT NAME(S) AGE
IN WHICH SHARES ARE -----------------------------------------------------------------------------------------------------------
TO BE REGISTERED STREET OR P.O. BOX
WITH TRUST NAME -----------------------------------------------------------------------------------------------------------
IF APPLICABLE. CITY State ZIP CODE
-----------------------------------------------------------------------------------------------------------
MAILING ADDRESS: HOME PHONE BUSINESS PHONE
-----------------------------------------------------------------------------------------------------------
BIRTHDATE
- ------------------------------------------------------------------------------------------------------------------------------------
Objective Suitability Information
2 LEGAL FORM OF OWNERSHIP (CHECK ONE)
1. [_] Individual ownership ____________ Conversation of Capital Approx. income $______________
2. [_] Joint tenants with right of survivorship
3. [_] Tenants in common ____________ Income Approx. Net Worth (exclusive
4. [_] Corporate ownership of property, home furnishings
5. [_] Partnership ownership ____________ Long term growth and automobiles) $_____________
6. [_] Uniform Gifts/Transfers to Minors
Act of State of _____________________ ____________ Speculative capital gains
7. [_] IRA/*/ Approx. Tax Bracket ___________%
8. [_] Tax-Qualified Retirement Plan/*/ ____________ Deferral of taxes
9. [_] Trust (date trust
established _____________________) ____________ Tax Exempt Income
/*/ Additional documentation Employer _________________________________________________________________
may be required.
Business Address _________________________________________________________
Occupation _______________________________________________________________
Is client of legal age? ___ Yes ___ No
Is client employed by or registered with another securities firm?
___ No ___ Yes, with ____________________________________________________
__________________________________________________________________________
Prior investment experience ________________ years
Note: if client refuses to provide information have client initial here___
- -----------------------------------------------------------------------------------------------------------------------------------
3 I elect to receive: [_] 1. Dividends in shares, gain distributions in shares.
DIVIDENDS [_] 2. Dividends in cash, gain distributions in shares.
AND GAIN [_] 3. Dividends in cash, gain distributions in cash.
DISTRIBUTIONS NOTE: IF NO ELECTION IS MADE, OPTION NO. 1 AUTOMATICALLY WILL BE PUT INTO EFFECT.
Dividends and gain distributions will be invested at net asset value.
- -----------------------------------------------------------------------------------------------------------------------------------
4 [_] Please arrange with my bank to draw pre-authorized payments and invest $___________________ in my
PRE-AUTHORIZED Account.
PAYMENTS [_] Monthly [_] Twice a Month [_] Every Other Month [_] Quarterly
on the: [_] 1st of Month [_] 16th of Month
I have completed the attached "Bank Authorization to Honor Pre-Authorized Payments."
(Also complete Section 3 above)
- ----------------------------------------------------------------------------------------------------------------------------------
5 [_] Please send a check for $_______________ beginning on the 15th day
AUTOMATIC of __________________ 19__, and thereafter on the 15th day of every:
CASH [_] Month [__] 3rd Month [_] 6th Month [_] 12th Month
WITHDRAWAL
Make payments to: Name _________________________________________________________________________________
Address ______________________________________________________________________________
City _______________________ State ______________________ Zip ______________________
Shares having a current value at offering price of
$5,000 or more must be held in the Account at initiation
of Service, and all shares must be in "book credit" form.
- -----------------------------------------------------------------------------------------------------------------------------------
6 I intend to purchase, although I am not obligated to do so,
LETTER shares of the above-designated Fund, and one or more of the
OF INTENT other mutual funds in the State Bond Group which bear a
sales charge as written in below, within a 13-month period
which, together with the present net total asset value of
shares now owned, by me, will aggregate at least:
[_] $50,000 [_] $100,000 [_] $250,000
[_] $500,000 [_] $1,000,000 [_] $2,000,000
I agree to the escrow provisions contained in this application.
[_] This Letter of Intent may be backdated up to 90 days to include shares previously purchased.
Backdate to___________________________
- -----------------------------------------------------------------------------------------------------------------------------------
7
QUANTITY PURCHASE [_] I own shares of more than one fund in the State Bond Group which may entitle me to a reduced sales
Optional. (Attach charge.
a separate sheet My account numbers are: ______________________________________________________________________________
if necessary.)
[_] The registration of some of my shares differs. Their account numbers are:_________________________
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------
8. DIVIDEND If you wish to have your dividend payments made to
DIRECTION another party please complete the following:
OPTION I hereby authorize and request that my dividend payments
be made to:
Name ____________________________________________________________________
Address _________________________________________________________________
City ___________________ State _________________ Zip ________________
Signature Investor ______________________________________________________
Signature Co-Investor ___________________________________________________
- ---------------------------------------------------------------------------------------------------------------------
9. SIGNATURE Under penalties of perjury I certify that the number shown
AND on this form is my correct taxpayer identification number/
CERTIFICATION social security number and that I am not subject to backup
withholding either because I have not been notified that I
am subject to backup withholding as a result of a failure
to report all interest or dividends, or the Internal Revenue
Service has notified me that I am no longer subject to backup
withholding. I (we) certify that I (we) are of legal age and
that I (we) have legal capacity to purchase or redeem shares
of the Fund for my (our) own Account, or for the Account of
the organization named below. I (we) have received a current
Prospectus of the Fund and appoint SBM Company as my (our)
agent to act in accordance with my (our) instructions herein.
SIGNATURE(x) SIGNATURE(x)
------------------------- ------------------------
SOC. SEC. NO. OR TAXPAYER SOC. SEC. NO. OR TAXPAYER
IDENTIFICATION NO.________ IDENTIFICATION NO.________
- ---------------------------------------------------------------------------------------------------------------------
10. DEALER Please establish the Account specified by the Investor
INFORMATION and purchase through SBM Financial Services., general
ONLY distributor, at the public offering price, shares which
you are authorized to purchase from us for the investor.
The investor is authorized to send any future payments
directly to you for investment. Confirm each transaction
to the investor and to us. We guarantee the genuineness
of the investor's signature. We are a duly registered
and licensed dealer and have a sales agreement with SBM
Financial Services, Inc.
_____________________________________________ _____________________________________________
Dealer Name Representative's Name Number
_____________________________________________ _____________________________________________
Address Address
_____________________________________________ _____________________________________________
City State Zip Code City State Zip Code
X____________________________________________ Representative's Phone Number (___)__________
Authorized Signature of Broker/Dealer
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
FOR INTERNAL USE ONLY Accepted By:
- ---------------------------------------------------------
| # OF SHARES | NET ASSET VALUE | VALUE AS OF | SBM Financial Services, Inc.
| OWNED | AS OF DATE OF LOI | DATE OF LOI |
- --------------------------------------------------------- By ____________________________________
| | | | Authorized Signature
| | | |
| | | |
- ---------------------------------------------------------
Accounts eligible for the Rights of Accumulation or to be used toward completion of a Letter of Intent.
Name________________________________ Fund______________________________ Account No. _________________________________
Name________________________________ Fund______________________________ Account No. _________________________________
Name________________________________ Fund______________________________ Account No. _________________________________
Name________________________________ Fund______________________________ Account No. _________________________________
Name________________________________ Fund______________________________ Account No. _________________________________
TO: SBM COMPANY THE STATE BOND GROUP OF MUTUAL FUNDS
100 N. MINNESOTA ST. REQUEST AND AUTHORIZATION FOR PRE-AUTHORIZED PAYMENTS
P.O. BOX 69
NEW ULM, MN 58073-0069
To start your Pre-Authorized Payment Service, fill out Section A and the "Bank Authorization to Honor Pre-Authorized
Payments" below, and forward it with an unsigned blank check from your regular checking account (marked "void").
- --------------------------------------------------------------------------------------------------------------------------
A. Pre-Authorized Payments
[_] Please arrange with my bank to draw pre-authorized payments and invest $________________ in my Account:
[_] Monthly [_] Twice a Month [_] Every Other Month [_] Quarterly
On The [_] 1st of Month [_] 16th of Month I have completed the "Bank Authorization To Honor
Pre-Authorized Payments" below.
If not completed, the 1st will be assumed.
Starting Month ________________________ ____________________________________________________________________
Signature(s) of Investor(s)
____________________________________________________________________
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
BANK AUTHORIZATION TO HONOR PRE-AUTHORIZED PAYMENTS
AUTHORIZATION TO HONOR DEBITS (INCLUDING CHECKS, DRAFTS, AND OTHER ORDERS
WHETHER BY ELECTRONIC OR PAPER MEANS) BY SBM COMPANY.
Depositor's Name:_______________________________________________________________
(Print name(s) exactly as shown on my bank, or other
Financial Institution, Account)
Depository Name:________________________________________________________________
(Print name of Bank or Financial Institution and Branch, if any)
________________________________________________________________________________
(Print address of Bank, Financial Institution or Branch where Account is
maintained)
I hereby authorize SBM Company to initiate debt entries to my account as
listed below and the depository named above to debit the same to such
account. This authorization will remain in full force and effect until SBM
Company and depository receive written notification from either of us to
the other and in such time and in such manner so as to afford SBM Company
and depository a reasonable opportunity to act on it.
Signature of Depositor X ______________________________________________________
If required by the Financial Institution,
Signature of Joint Depositor X ________________________________________________
My Account Number at said Financial Institution is ______________ Date ________
SBM COMPANY
100 N. MINNESOTA ST.
P.O. BOX 69
NEW ULM, MINNESOTA 56073-0069
25
<PAGE>
TERMS AND CONDITIONS
Open Account
Investments will be made in as many shares of the Fund, including fractions to
the third decimal place, as can be purchased at the public offering price at the
close of business on the day the order is accepted. Shareholders will receive
dividends from investment income and any distributions from long-term gain
realized on investments in shares or in cash according to the option elected.
Dividend and gain options may be changed at any time by notifying the Fund in
writing. Stock certificates will not be issued.
Pre-Authorized Payment Service
The Pre-Authorized Payment Service is available to all shareholders. Your
application is subject to acceptance by your bank and the Fund. Payments in the
amount specified will be drawn automatically on your bank on the day of each
month in which an investment is scheduled and invested at the public offering
price at the close of business on the same date. If a payment is not honored by
your bank, the Service will be suspended. It will be reinstated upon written
request indicating that the cause of interruption has been corrected. This
Service may be terminated by you or the Fund at any time by written notice. You
agree to hold the Fund and its agents free from all liability which may result
from acts done in good faith and pursuant to these terms. Instructions for
establishing Pre-Authorized Payment Service are given on the following page.
Automatic Cash Withdrawal Service
All income and gain distributions on shares held in your account subject to this
withdrawal service will be reinvested in additional shares. A sufficient number
of full and fractional shares will be redeemed to provide the amount requested.
You may change the amount of scheduled payments or you may suspend payments for
not more than one year by written notice to the Fund at least ten days prior to
the effective date of such a change or suspension. Your service may be
terminated by you or the Fund at any time by written notice. It will be
terminated upon proper notification of the death or legal incapacity of the
shareholder. The Service may be considered terminated in the event a withdrawal
of shares, other than to make scheduled withdrawal payments, reduces the value
of shares remaining on deposit to less than $5,000. Redeeming shares to make
these payments represents a return of capital and will result in tax
consequences. Withdrawals, concurrently with purchases of shares of this or any
other investment company will be disadvantageous to you because of the payment
of duplicative sales charges. For this reason, additional purchases of Fund
shares when the Withdrawal Service is in effect are discouraged.
Letter Of Intent
SBM Financial Services, Inc. will hold in escrow shares equal to 5% of the
minimum purchase amount specified. Dividends and distributions on the escrowed
shares will be paid to you or credited to your Account. Upon completion of the
specified minimum purchase within the thirteen-month period, all shares held in
escrow will be deposited in your account or delivered to you. You may include
the total asset value of shares of the State Bond Funds (except State Bond Cash
Management Fund shares) owned as of the date of a Letter of Intent toward the
completion of the Letter. If the total amount invested within the thirteen-
month period does not equal or exceed the specified minimum purchase, you will
be requested to pay the difference between the amount of the sales charge paid
and the amount of the sales charge applicable to the total purchase made. If,
within 20 days following the mailing of a written request, you have not paid
this additional sales charge to SBM Financial Services, Inc., sufficient
escrowed shares will be redeemed for payment of the additional sales charge.
Shares remaining in escrow after this payment will be released to your Account.
The Letter of Intent may be backdated by as much as 90 days to change the
purchase price for previous purchases. The thirteen-month period begins on the
date to which you have backdated.
Shares of the State Bond Cash Management Fund, which have been acquired by an
exchange may be taken into account in completing a Letter of Intent or for
Rights of Accumulation. However, shares of that Fund which have been purchased
directly may not be used for purposes of determining reduced sales charges on
additional purchases of the other Mutual Funds in the State Bond Group.
26
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
November 1, 1995
STATE BOND MINNESOTA TAX-FREE INCOME FUND
100 North Minnesota Street
P.O. Box 69
New Ulm, Minnesota 56073-0069
Telephone No. (507) 354-2144
This Statement of Additional Information supplements the information
contained in the current Prospectus of State Bond Minnesota Tax-Free Income Fund
(the "Fund") dated November 1, 1995. This Statement of Additional Information is
not a Prospectus, but should be read in conjunction with the Fund's Prospectus,
which may be obtained by contacting the Fund at the address or telephone number
noted above.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
What Are The Fund's Investment Objectives, Policies, and
Risks?..................................................... 2
(See "What Are The Fund's Investment Objectives And
Policies?" in the Prospectus)
Calculation of Performance Data............................. 4
What Are The Fund's Investment Limitations?................. 7
Who Manages The Fund?....................................... 8
(See "How Is The Fund Managed?" in the Prospectus)
The Manager................................................. 13
Management Agreement And Expenses........................... 13
(See "How Is The Fund Managed?" in the Prospectus)
Transfer Agent.............................................. 15
Plan of Distribution........................................ 15
(See "What Is the Fund's Plan of Distribution?" in the
Prospectus)
Custodian................................................... 16
Independent Auditors........................................ 16
Portfolio Transactions And Brokerage........................ 16
(See "What Are the Fund's Brokerage Commissions?" in the
Prospectus)
Purchase Of Shares.......................................... 17
Offering Price.............................................. 19
How Are Shares Distributed?................................. 19
How Can You "Sell" Your Shares?............................. 19
How Is Net Asset Value Per Share Determined?................ 19
Tax Status Of The Fund...................................... 20
Additional Tax Information.................................. 20
Will The Fund Withhold Taxes On Distributions?.............. 21
General Information......................................... 21
Financial Statements........................................ 22
Appendix A - Description of Tax-Exempt Securities Ratings... A-1
</TABLE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS STATEMENT OF ADDITIONAL
INFORMATION OR THE PROSPECTUS DATED NOVEMBER 1, 1995, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MAY NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE FUND. THIS STATEMENT OF ADDITIONAL INFORMATION DOES NOT
CONSTITUTE AN OFFER TO SELL SECURITIES IN ANY STATE OR JURISDICTION IN WHICH
SUCH OFFERING MAY NOT LAWFULLY BE MADE. THE DELIVERY OF THIS STATEMENT OF
ADDITIONAL INFORMATION AT ANY TIME SHALL NOT IMPLY THAT THERE HAS BEEN NO CHANGE
IN THE AFFAIRS OF THE FUND SINCE THE DATE HEREOF.
1
<PAGE>
WHAT ARE THE FUND'S INVESTMENT OBJECTIVES, POLICIES, AND RISKS?
The Fund's investment objective is to maximize current income exempt from
both federal income tax and Minnesota personal income tax to the extent
consistent with preservation of capital. In addition, as more fully described in
the Prospectus, the Fund may invest up to 20% of its net assets in taxable
fixed-income securities, may invest up to 25% of its net assets in unrated
Minnesota Tax-Exempt Securities (as defined in the Prospectus), may enter into
repurchase agreements and may purchase securities on a when-issued basis. The
Fund may only purchase Minnesota Tax-Exempt Securities that are not rated within
the three highest grades by either Moody's or Standard & Poor's or are unrated
if such securities are at all times fully insured as to the scheduled payment of
all installments of principal and interest. See "Insurance" in the Prospectus.
Portfolio Turnover
- ------------------
Portfolio turnover rate for a fiscal year is the ratio of the lesser of
annual purchases or sales of portfolio securities to the average monthly value
of portfolio securities, excluding securities whose maturities at acquisition
were one year or less. The Fund cannot accurately predict its annual portfolio
turnover rate, but anticipates that it will not exceed 100%. The Fund's
portfolio turnover rate will not be a limiting factor when the Manager deems it
desirable to sell or purchase securities. The Fund's portfolio turnover rate was
6% for the fiscal year ended June 30, 1995.
Fixed-Income Securities
- -----------------------
Although the Manager seeks to manage the Fund with a view toward reducing
the price volatility of its portfolio, the net asset value of the Fund will
change with changes in the value of its portfolio securities. When interest
rates decline, the value of a fixed-income portfolio can be expected to rise.
Conversely, when interest rates rise, the value of a fixed-income portfolio can
be expected to decline.
Interest rate fluctuations may affect payment expectations on fixed-income
securities. For example, certain municipal obligations may contain redemption or
call provisions. If an issuer exercises these provisions in a declining interest
rate market, the Fund would likely have to replace the security with a lower
yielding security, resulting in a decreased return for investors. In addition, a
municipal obligation's value will decrease in a rising interest rate market,
resulting in a decrease in the value of the Fund's assets. If the Fund
experiences unexpected net redemptions, this may force it to sell its portfolio
securities without regard to their investment merits, thereby decreasing the
asset base upon which the Fund's expenses can be spread and possibly reducing
the Fund's rate of return.
For a discussion of the risks associated with investing in fixed-income
securities of issuers located in the State of Minnesota, see the Prospectus.
High-Yield Securities
- ---------------------
The Fund currently does not invest in securities rated below A by Standard
& Poor's Ratings Group ("S&P") or Moody's Investors Service, Inc. ("Moody's"),
and has no current intention of investing in such securities. In addition, as is
discussed in the next section, it is a fundamental policy of the Fund that the
Fund will not acquire securities that are not rated in the three highest grades
by S&P or Moody's unless those securities are covered by insurance guaranteeing
the scheduled payment of principal and interest thereon.
Securities rated BB or B by S&P or Ba or B by Moody's (or equivalently
rated by another nationally recognized statistical rating organization) are
below investment grade and generally will involve more credit
2
<PAGE>
risk than securities in the higher rating categories. Such securities are
commonly known as "junk" bonds. In some cases such securities are subordinated
to the prior payment of senior indebtedness, thus potentially limiting the
holder's ability to receive payments or to recover full principal when senior
securities are in default. Also, during an economic downturn or substantial
period of rising interest rates, highly leveraged issuers may experience
financial stress which would adversely affect their ability to service their
principal and interest payment obligations, to meet projected business goals,
and to obtain additional financing. If the Fund did acquire any lower-rated
securities, upon any default, the Fund could incur additional expenses to the
extent it is required to seek recovery of the payment of principal or interest
on the relevant portfolio holding. The credit risks associated with lower-rated
securities may be reduced by the Fund's policy of not acquiring securities that
are not rated in one of the top three grades by S&P or Moody's unless those
securities are covered by insurance guaranteeing scheduled payments of principal
and interest. See "Insurance" in the Prospectus.
In addition, lower-rated securities may be thinly traded, which may have an
adverse impact on market price and the ability of the holder to dispose of
particular issues when necessary to meet its liquidity needs or in response to a
specific economic event such as a deterioration in the creditworthiness of the
issuer. A thinly traded market also may interfere with the ability of the holder
to accurately value high-yield securities and, consequently, value the Fund's
assets. Furthermore, adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the value and liquidity of high-
yield securities, especially in a thinly traded market.
Yields on high-yield securities will fluctuate over time. The prices of
high-yielding securities have been found to be less sensitive to interest rate
changes than higher-rated investments, but more sensitive to adverse economic
changes or developments affecting the issuer. In addition, periods of economic
uncertainty and changes can be expected to result in increased volatility of
market prices of high-yielding securities and, to the extent the Fund acquires
such securities, the Fund's asset value.
For more information covering the rating categories of debt securities and
commercial paper, see Appendix A to this Statement of Additional Information.
Insurance
- ---------
Minnesota Tax-Exempt Securities that are not rated within the three highest
grades by either Moody's or S&P or are unrated will be purchased by the Fund
only if such securities are covered by insurance guaranteeing the scheduled
payment of principal and interest thereon.
As described in the Prospectus, the Fund will receive payments of insurance
for any installment of interest or principal due for payment but which shall be
unpaid by reason of nonpayment by the issuer. The term "due for payment" means,
when referring to the principal of a security, its stated maturity date or the
date on which it shall have been called for mandatory sinking fund redemption
and does not refer to any earlier date on which payment is due by reason of call
for redemption (other than by mandatory sinking fund redemption), acceleration
or other advancement of maturity, and means, when referring to interest on a
security, the stated date for payment of interest. However, when the interest
on the security shall have been determined, as provided in the underlying
documentation relating to such security, to be subject to federal income
taxation, "due for payment" also means, when referring to the principal of such
security, the date on which it has been called for mandatory redemption as a
result of such determination of taxability, and when referring to interest on
such security, the accrued interest at the rate provided in such documentation
to the date on which it has been called for such mandatory redemption, together
with any applicable redemption premium.
3
<PAGE>
The insurance feature insures the scheduled payment of interest and
principal and does not guarantee the market value of the insured municipal
securities nor the value of the shares of the Fund.
Financial Guaranty Insurance Company. Financial Guaranty, domiciled in the
State of New York, commenced its business of providing insurance and financial
guarantees for a variety of investment instruments in January, 1984. Since 1989,
Financial Guaranty has been a wholly owned subsidiary of GE Capital Corporation.
Financial Guaranty, in addition to providing insurance for the payment of
interest on and principal of municipal bonds and notes held in unit investment
trust and mutual fund portfolios, provides insurance for new and secondary
market issues of municipal bonds and notes and for portfolios of new and
secondary market issues of municipal bonds and notes. Financial Guaranty expects
to provide other forms of financial guarantees in the future. It is also
authorized to write fire, property damage liability and fidelity and surety
insurance. As of June 30, 1995, the total capital and surplus of Financial
Guaranty was approximately $1.136 billion.
Financial Guaranty is currently licensed to provide insurance in 50 states
and the District of Columbia, files reports with state insurance regulatory
agencies and is subject to audit and review by such authorities. Financial
Guaranty is also subject to regulation by the New York State Insurance
Department. Such regulation, however, is no guarantee that Financial Guaranty
will be able to perform on its contracts of insurance in the event a claim
should be made thereunder at some time in the future.
The information relating to Financial Guaranty contained above and in the
Prospectus has been furnished by such corporation. The financial information
about Financial Guaranty contained in the Registration Statement and Prospectus
is unaudited but appears in reports or other materials filed with and subject to
audit and review by state insurance regulatory authorities. No representation is
made as to the accuracy or adequacy of such or as to the absence of subsequent
material adverse changes in such information.
The policies of insurance obtained by the Fund from Financial Guaranty and
the agreements and negotiations in respect thereof represent the only
relationship between Financial Guaranty and the Fund. Otherwise, neither
Financial Guaranty nor any affiliate has any significant relationship, direct or
indirect, with the Fund or its Manager. The Portfolio Insurance Policy is
terminable by the Fund upon sixty days' prior written notice to Financial
Guaranty. If it becomes necessary or desirable to do so, the Fund may terminate
the Portfolio Insurance Policy with Financial Guaranty and obtain portfolio
insurance from a comparable carrier.
CALCULATION OF PERFORMANCE DATA
SEC 30-Day Yield
- ----------------
Advertisements and other sales literature for the Fund may quote "SEC 30-
day yield," "tax equivalent yield,"and "total return" data. Such performance
data is computed on a standardized basis pursuant to formulas established by the
rules and regulations of the Securities and Exchange Commission.
4
<PAGE>
The Fund's SEC 30-day yield for the 30-day period ended June 30, 1995 was
4.20%. Such yield is computed by dividing the net investment income per share
(as defined under Securities and Exchange Commission rules and regulations)
earned during the computation period by the maximum offering price per share on
the last day of the period, according to the following formula:
a-b
YIELD = 2[( +1)/6/-1]
----
cd
WHERE: a = dividends and interest earned
during the period;
b = expenses accrued for the period
(net of reimbursements);
c = the average daily number of
shares outstanding during the
period that were entitled to
receive dividends; and
d = the maximum offering price per
share on the last day of the period.
Tax Equivalent Yield
- --------------------
The Fund's tax equivalent yield for the 30-day period ended June 30, 1995
was 6.73%. The Fund calculates its tax equivalent yield over a 30-day period.
The tax equivalent yield will be determined by first computing the yield as
discussed above. The Fund will then determine what portion of the yield is
attributable to securities, the income of which is exempt for federal tax
purposes. This portion of the yield will then be divided by one minus 39.6% (the
assumed maximum tax rate for individual taxpayers not subject to the Alternative
Minimum Tax) and then added to the portion of the yield that is attributable to
other securities.
Tax Fund's tax equivalent yield is calculated according to the following
formula:
Tax Equivalent Yield = Yield
--------
1-.396
Average Annual Total Return
- ---------------------------
The Fund's average annual total return over the one and five year periods
ended June 30, 1995 and the life of the Fund was as follows:
Life of Fund
One Year Five Years (From January 28, 1988)
-------- ---------- -----------------------
Average Annual
Total Return: 2.30% 5.82% 6.33%
5
<PAGE>
The average annual total return figures are computed by finding the average
annual compounded rates of return over the periods indicated that would equate
the initial amount invested to the ending redeemable value, according to the
following formula:
P(1+T)/n/ = ERV
WHERE: P = a hypothetical initial
payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value
at the end of the period
of a hypothetical $1,000
payment made at the
beginning of such period.
This calculation deducts the maximum sales charge from the initial
hypothetical $1,000 investment, assumes all dividends and capital gains
distributions are reinvested at net asset value on the appropriate reinvestment
dates as described in the Prospectus, and includes all recurring fees, such as
investment advisory and management fees, charged to all shareholder accounts.
Cumulative Total Return
- -----------------------
Cumulative total return is computed by finding the cumulative compound rate
of return over the period indicated that would equate the initial amount
invested to the ending redeemable value, according to the following formula:
CTR = ERV - P
------- X 100
P
WHERE:
CTR = cumulative total return
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of
period.
P = initial payment of $1,000
This calculation assumes all dividends and capital gains distributions are
reinvested at net assets value on the appropriate reinvestment dates as
described in the prospectus and includes all recurring fees, such as investment
advisory and management fees, charged to all shareholder accounts.
Other Yields
- ------------
Current and effective yields of the Fund, not calculated in accordance with
the guidelines of the SEC as explained above, may be quoted in reports and sales
literature. Non-SEC current yield is computed based
6
<PAGE>
upon a recent seven-calendar-day period by determining the net change, exclusive
of capital changes, in the value of a hypothetical pre-existing account having a
balance of one share at the beginning of the period, dividing the net change in
account value by the value of the account at the beginning of the period to
obtain a base period return, and multiplying the base period return by 365/7.
Non-SEC effective yield is computed by annualizing the seven-day return with all
dividends reinvested in additional Fund shares. The Fund's non-SEC yield
quotation may be inclusive or exclusive of taxable income, if any, as indicated
in such quotation. The Fund's non-SEC yield may fluctuate daily depending upon
such factors as market conditions, the composition of the Fund's portfolio and
operating expenses. Therefore, the Fund's non-SEC yield in the future may be
higher or lower than its past non-SEC yields and there can be no assurance that
historical yields will continue. That the Fund's non-SEC current yield will
fluctuate and that shareholders' principal is not guaranteed or insured should
be taken into account when comparing the yield on an investment in Fund shares
with yields on fixed-yield investments, such as insured savings accounts. These
factors and possible differences in the methods used in calculating non-SEC
yield should be considered when comparing the Fund's non-SEC current yield to
non-SEC yields published for other investment companies and other investment
vehicles. Yield should also be considered relative to changes in the value of
the Fund's shares and the Fund's investment goals and policies.
WHAT ARE THE FUND'S INVESTMENT LIMITATIONS?
Under the Fund's fundamental policies, which cannot be changed except by
vote of a majority of its outstanding voting securities, the Fund may not:
1. Borrow money, except for temporary purposes in emergency situations in an
aggregate amount not to exceed 20% of the value of the total assets of the
Fund; provided, that borrowings in excess of 5% of such value will be only
from banks, and the Fund will not purchase additional portfolio securities
while its borrowings exceed 5%;
2. Underwrite the securities of other issuers, except insofar as it may
technically be deemed an underwriter under the Securities Act of 1933 in
selling a portfolio security;
3. Purchase securities of any issuer if immediately thereafter, with respect
to 50% of the Fund's total assets, more than 5% of such assets would be
invested in the securities of any one issuer, except that this limitation
does not apply to obligations issued or guaranteed as to principal and
interest either by the U.S. government or its agencies or
instrumentalities;
4. Purchase industrial development revenue bonds (which shall be interpreted
to include private activity bonds) if immediately thereafter more than 25%
of the Fund's assets would be invested in revenue bonds which are based,
directly or indirectly, on the credit of private entities in any one
industry or in securities of private issuers in any one industry;
5. Issue any senior securities (as defined in the Investment Company Act of
1940, as amended);
6. Buy or hold any real estate or real estate investment trust securities;
7. Buy or hold any commodity or commodity futures contracts, or any oil,
gas or other mineral exploration or development program;
8. Make loans, except to the extent that the purchase of bills, notes, bonds
or other debt obligations or the entry into repurchase agreements may be
considered loans;
7
<PAGE>
9. Mortgage or pledge any of its assets, except to the extent that up to a
maximum of 10% of the value of its total assets may be mortgaged or pledged
if necessary to secure borrowings permitted by paragraph 1;
10. Buy securities on "margin," except that it may obtain such short-term
credits as may be necessary for the clearance of purchases or sales of
securities;
11. Make "short" sales of securities;
12. Write or purchase put or call options;
13. Buy securities which have legal or contractual restrictions on resale,
except in connection with repurchase agreements;
14. Buy securities of any issuer for the purpose of exercising control or
management; or buy securities issued by any other investment company,
except in connection with a merger, consolidation, acquisition or
reorganization;
15. Invest more than 10% of the Fund's net assets in any combination of
repurchase agreements maturing in more than seven days and other illiquid
securities;
16. Purchase Minnesota Tax-Exempt Securities (as defined in the Prospectus)
that are either not rated within the three highest grades by either Moody's
or S&P or are unrated unless such securities are insured as to the payment
of all installments of principal and interest;
17. Invest more than 25% of its assets in Minnesota Tax-Exempt Securities
that are unrated;
18. Invest more than 20% of the value of the Fund's net assets in securities
other than Minnesota Tax-Exempt Securities, except that, on a temporary
defensive basis due to market conditions, the Fund may invest up to 100% of
its assets in cash or in taxable fixed-income securities.
If a percentage restriction described above is complied with at the time an
investment is made, a later increase or decrease in percentage resulting from a
change in values of portfolio securities or in the amount of net assets of the
Fund will not be considered a violation of the restriction.
Under the Investment Company Act of 1940, a "vote of a majority of the
outstanding voting securities" of the Fund means the affirmative vote of the
lesser of (1) more than 50% of the outstanding shares of the Fund or (2) 67% or
more of the shares present at a shareholders' meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy.
WHO MANAGES THE FUND?
Directors and officers of the Fund, together with information as to their
principal business occupations during the past five years, are shown below. Each
Director who is an "interested person" of the Fund, as defined in the Investment
Company Act of 1940, is indicated by an asterisk. Unless otherwise indicated,
their addresses are 239 S. Fifth Street, Louisville, Kentucky.
8
<PAGE>
<TABLE>
<CAPTION>
Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
- --------------------- ---------------------- -----------------------------------------
<S> <C> <C>
William B. Faulkner (68) Director President, William Faulkner &
825 Goodrich Avenue Associates, business and institutional
St. Paul, MN 55105 adviser since 1986; Consultant to
American Hoist & Derrick Company,
construction equipment manufacturer,
from 1986 to 1989; prior thereto, Vice
President and Assistant to the President,
American Hoist & Derrick Company.
Director of the other mutual funds in
the State Bond Group
Patrick M. Finley (57) Director President, Universal Cooperatives, Inc.,
5603 Bernard Place a farmers' cooperative. Director of the
Edina, MN 55436 other mutual funds in the State Bond
Group
Chris L. Mahai (39) Director Senior Vice President, Strategic
425 Portland Avenue Integration Unit, Star Tribune/Cowles
Minneapolis, MN 55488 Media Company, since August 1995;
Vice President, Marketing Director,
Star Tribune, since September 1992;
from 1990 to 1992, self-employed
consultant, marketing services; prior
thereto, Senior Vice President of
Corporate Relations and marketing,
First Bank System, Inc. Director of the
other mutual funds in the State Bond
Group
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
- ---------------------- ---------------------- -----------------------------------------
<S> <C> <C>
John R. Lindholm (46)* Director President of Integrity Life Insurance
Company ("Integrity") and Vice
President-Chief Marketing Officer of
National Integrity Life Insurance
Company ("National Integrity") since
November 26, 1993; Executive Vice
President-Chief Marketing Officer of
ARM Financial Group, Inc. since July
27, 1993; since March 1992 Chief
Marketing Officer of Analytical Risk
Management, L.P.; from June 1990 to
February 1992, Chief Marketing
Officer and a Managing Director of the
ICH Capital Management Group, ICH
Corporation, Louisville, Kentucky;
prior thereto, Chief Marketing Officer
and Managing Director for Capital
Holding Corporation's Accumulation
and Investment Group. Director of the
other mutual funds in the State Bond
Group and of The Legends Fund, Inc.
Arthur J. Gartland, Jr. (48) Director President and a founder of Benedetto,
1330 Avenue of the Americas Gartland & Greene, Inc. (an investment
New York, NY banking firm). Director of the other
mutual funds in the State Bond Group
and of The Legends Fund, Inc.
John Katz (56) Director Investment banker since January 1991;
10 Hemlock Road Chairman and Chief Executive Officer,
Hartsdale, NY Sam's Restaurant Group, Inc. (a
restaurant holding company), from June
1991 to August 1992; Executive Vice
President (from January 1989 to January
1991) and Senior Vice President (from
December 1985 to January 1989),
Equitable Investment Corporation (an
indirect wholly-owned subsidiary of The
Equitable Life Assurance Society of the
United States, through which it owns and
manages its investment operations).
Director of the other mutual funds in the
State Bond Group and of The Legends
Fund, Inc.
10
</TABLE>
<PAGE>
<TABLE>
Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
- ---------------------- ---------------------- -----------------------------------------
<S> <C> <C>
Theodore S. Rosky (57) Director Retired since April 1992; Executive Vice
2304 Speed Avenue President, Capital Holding Corporation
Louisville, KY (from December 1991 to April 1992);
prior thereto, Executive Vice President
and Chief Financial Officer, Capital
Holding Corporation. Director of the
other mutual funds in the State Bond
Group and of The Legends Fund, Inc.
Dale C. Bauman (58) President Vice President and Sales Manager, SBM
Financial Services, Inc., since June 1992;
prior thereto, Vice President and
Division Manager, SBM Financial
Services, Inc., 1980 to June 1992.
President of the other mutual funds in the
State Bond Group
Keith O. Martens (56) Vice President Senior Portfolio Manager, ARM Capital
Advisors, Inc. since June 14, 1995;
Executive Vice President - Investments,
SBM Company; Vice President State
Bond and Mortgage Life Insurance
Company and SBM Certificate
Company. Vice President of the other
mutual funds in the State Bond Group.
Don W. Cummings (32) Controller Controller of ARM Financial Group, Inc.
since July 15, 1993, and Integrity and
National Integrity since November 26,
1993. Prior to November 26, 1993 he
served as Controller of ARM, Ltd., a
position he held from July 1992. From
1985 to June 1992, Mr. Cummings
served in various positions within Ernst
& Young's Insurance Industry
Accounting and Auditing Practice, the
last of which was Manager. Controller of
the other mutual funds in the State Bond
Group and of The Legends Fund, Inc.
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
Name, Age and Address Position with the Fund Other Business Activities in Past 5 Years
- --------------------- ---------------------- -----------------------------------------
<S> <C> <C>
Kevin L. Howard (31) Vice President and Assistant General Counsel of ARM
Secretary Financial Group, Inc. since January 31,
1994; Assistant General Counsel of
Capital Holding Corporation from April
1992 to January 1994; Attorney,
Greenebaum Doll & McDonald, 1989 to
April 1992. Vice President and Secretary
of the other mutual funds in the State
Bond Group and Secretary of The
Legends Fund, Inc.
Peter S. Resnik (34) Treasurer Treasurer of ARM Financial Group, Inc.,
Integrity and National Integrity since
December 1993; employed in various
financial and operational capacities by
Analytical Risk Management Ltd. since
December 14, 1992; Assistant Vice
President of the Commonwealth Life
Insurance Company subsidiary of Capital
Holding Corporation from 1986 to
December 1992. Treasurer of the other
mutual funds in the State Bond Group
and of The Legends Fund, Inc.
Pam Freeman (28) Assistant Secretary Financial Analyst with ARM Financial
Group, Inc. since October 1993; Senior
Accountant and various other capacities
with Ernst & Young LLP from 1989 to
September 1993.
- ----------
* Mr. Lindholm is an interested person, as defined in the 1940 Act, by virtue of his positions
with ARM Financial Group, Inc.
</TABLE>
Directors of the Fund (including former Directors) received aggregate
remuneration of $4,044 during the Fund's fiscal year ended June 30, 1995.
Directors and officers of the Fund as a group owned directly or indirectly 936
shares, or 0.055% of the Fund's capital stock at June 30, 1995.
The following table sets forth, for the fiscal year ended June 30, 1995,
compensation paid by the Fund to the non-interested Directors and, for the 1994
calendar year, the aggregate compensation paid by the six funds in the State
Bond Group of mutual funds to the non-interested Directors. Directors who are
interested persons, as defined in the 1940 Act, received no compensation from
the Fund.
12
<PAGE>
<TABLE>
<CAPTION>
Aggregate Total Compensation
Compensation from State Bond Group
from Fund (a) of Mutual Funds (b)
------------- ---------------------
Name of Director
- ----------------
<S> <C> <C>
William B. Faulkner $588.00 $3,528.00
Patrick M. Finley $516.00 $2,232.00
Chris L. Mahai $588.00 $3,528.00
- -------------------
</TABLE>
(a) There were no pension or retirement benefits accrued for any of the named
persons by any of the funds.
(b) This includes the aggregate compensation paid to the named persons by all
of the funds and also the amounts paid to such persons in calendar year
1994 by the State Bond Progress Fund ("Progress Fund"). The Progress Fund
formerly was a member of the State Bond Group of Funds. All of the assets
of Progress Fund were acquired by State Bond Common Stock Fund on June 24,
1994.
THE MANAGER
ARM Capital Advisors, Inc. (the "Manager") manages the investments of the
Fund and administers its business and other affairs. The address of the Manager
is 200 Park Avenue, 20th Floor, New York, New York 10166. The predecessor to the
Manager was SBM Company, which served as manager of the Fund from the Fund's
inception until June 13, 1995. The Manager assumed management of the Fund on
June 14, 1995, effective for accounting purposes as of June 1, 1995, following
the acquisition of substantially all of the business operations of SBM Company
by ARM.
The Manager is a wholly-owned subsidiary of ARM Financial Group, Inc.
("ARM"), a Delaware corporation. ARM is a financial services company providing
retail and institutional products and services to the long-term savings and
retirement market. The Morgan Stanley Leveraged Equity Fund II, L.P., Morgan
Stanley Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P. and
MSCP III 892 Investors, L.P., investment funds sponsored by Morgan Stanley
Group, Inc. ("Morgan Stanley"), own approximately 91% of the outstanding shares
of voting stock of ARM. The Manager currently provides investment management
services to institutional and individual clients, including ARM and its
subsidiaries, with combined assets in excess of $4 billion.
The Manager is also manager of the other mutual funds in the State Bond
Group of mutual funds: State Bond Cash Management Fund, State Bond Common Stock
Fund, State Bond Diversified Fund, State Bond Tax Exempt Fund, and State Bond
U.S. Government and Agency Securities Fund.
MANAGEMENT AGREEMENT AND EXPENSES
Under the Investment Advisory and Management Agreement (the "Agreement"),
dated June 14, 1995, subject to the control of the Board of Directors, the
Manager manages the investment of the assets of the Fund, including making
purchases and sales of portfolio securities consistent with the Fund's
investment objectives and policies and administers its business and other
affairs. The Manager provides the Fund with
13
<PAGE>
such office space, administrative services and executive personnel as are
necessary for Fund operations. The Manager also pays all the compensation of the
directors of the Fund who are employees of the Manager and of the officers and
employees of the Fund. In addition, the Manager pays distribution expenses
pursuant to the Fund's 12b-1 Plan.
The Fund pays the Manager a management fee for its services, calculated
daily and payable monthly, equal to an annual fee of .85 of 1% of the first
$100,000,000 of average daily net assets of the Fund and .80% of 1% of the
average daily net assets of the Fund in excess of $100,000,000. A portion of
this fee is paid to SBM Financial Services, Inc. (the "Distributor") in
connection with the Fund's 12b-1 Plan (see Plan of Distribution). SBM Company,
the previous investment manager of the Fund received the following amounts from
the Fund as a management fee (excluding 12b-1 plan fees) during the periods
ended June 30, 1995, 1994, and 1993, respectively: $96,640; $96,758; and
$83,012. For the period from June 1, 1995, the effective date for accounting
purposes on which the Manager assumed its duties with respect to the Fund
through, June 30, 1995, the Manager received a management fee (excluding 12b-1
plan fees) of $9,606. The Manager has voluntary undertaken, and SBM Company
previously voluntarily undertook, to reimburse the Fund for any expenses
incurred by the Fund to the extent the Fund's total expenses exceeded 1% of
average daily net assets, despite the fact that higher expenses may be permitted
by state law. For the period June 1, 1995 to June 30, 1995, the Manager
reimbursed the Fund in the amount of $2,378. SBM Company reimbursed the Fund
during the periods ended June 30, 1995, 1994, and 1993 in the following amounts:
$40,101; $46,311; and $53,504.
The Fund pays all its expenses other than those assumed by the Manager,
including the investment advisory and management fee; outside legal,
auditing and accounting expenses; bookkeeping, record keeping, and Fund
portfolio and Fund shares pricing expenses; interest, taxes and governmental
fees; expenses incurred in connection with membership in investment company
organizations; brokerage commissions or charges, if any; fees of custodians,
transfer agents, registrars, accounting services agents, or other agents;
expense of preparing share certificates; expenses relating to the redemption or
repurchase of the Fund's shares; investor services expenses; expenses of
registering and qualifying Fund shares for sale under applicable federal and
state law; expenses of preparing, setting in print, printing and distributing
prospectuses, statements of additional information, reports, notices and
dividends to Fund shareholders; cost of stationery; costs of stockholder and
other meetings of the Fund; traveling expenses of officers, directors, and
employees of the Fund, if any; fees of the Fund's independent directors and
salaries of any officers or employees who are not affiliated with the Manager;
the Fund's pro rata portion of premiums on any fidelity bond and insurance
covering the Fund; and general corporate fees and expenses.
Under the regulations of various states in which the Fund's shares are
qualified for sale, the amount of annual expenses which the Fund may pay are
limited to certain percentages of its average net assets. The most stringent of
such requirements limits such expenses, with certain limited categories of
expenses excepted, to 2 1/2% of the first $30 million of average net assets, 2%
of the next $70 million, and 1 1/2% of the remaining average net assets.
The Agreement was approved by the directors of the Fund, including a
majority of the disinterested directors, at a meeting held March 24, 1995, and
by the shareholders of the Fund at a meeting held May 15, 1995. The Agreement
may be terminated at any time on 60 days' written notice by the Board of
Directors, or by vote of a majority of the outstanding shares or by the Manager.
The Agreement will terminate automatically upon assignment. The Agreement will
continue in effect from year to year so long as continuance is approved annually
by either the Board of Directors of the Fund or by a vote of a majority of the
outstanding voting shares, provided that in either event such continuance is
also approved by the vote of a majority of the directors who are not parties to
such Agreement, or interested persons of such parties, cast in person at a
meeting called for the purpose of voting on such approval.
14
<PAGE>
Accounting Services Agreement. Prior to June 1, 1995, SBM Company also
acted as the accounting services agent for the Fund pursuant to a separate
agreement. Under this agreement, SBM Company was paid a fee for keeping the
books, accounts, records, journals and other records of original entry relating
to the business of the Fund current. It also performed certain daily functions
in connection with the Fund's accounts and records. The Manager received $625
from the Fund for accounting services provided by the Manager during the period
June 1, 1995 through June 14, 1995. SBM Company, as the previous accounting
services agent, received the following amounts from the Fund for the periods
ended June 30, 1995, 1994, and 1993, respectively: $13,750; $15,000; and
$15,000.
TRANSFER AGENT
SBM Financial Services, Inc. acts as the transfer and dividend disbursing
agent for the Fund pursuant to an agreement with the Fund and is compensated on
a transactional basis under a schedule approved by the Fund's Board of
Directors. The transfer agent maintains shareholders lists, processes requested
account registration changes and stock certificate issuance and redemption
requests, administers withdrawal plans, administers mailing and tabulation of
Fund proxy solicitations, and administers payment of distributions declared by
the Fund. SBM Financial Services, Inc. received $610 in transfer agency fees
from the Fund for the period June 1, 1995 to June 30, 1995. SBM Company, the
Fund's previous transfer and dividend disbursing agent, received the following
amounts from the Fund for the periods ended June 30, 1995, 1994, and 1993,
respectively: $6,890; $6,200; and $5,600.
PLAN OF DISTRIBUTION
The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule
12b-1 under the Investment Company Act of 1940 pursuant to which a portion of
the fees paid to the Manager is paid by the Manager to the Distributor, as
described below.
SBM Financial Services, Inc. (the "Distributor"), a subsidiary of ARM, acts
as distributor of the shares of the Fund and of the other mutual funds in the
State Bond Group. Under the Investment Advisory and Management Agreement (the
"Agreement"), a portion of the advisory fee the Fund pays the Manager is paid by
the Manager to the Distributor to be used to pay for account servicing, to
compensate those who provide administration, shareholder service and
distribution assistance (the Service Entities), and to pay certain other
expenses of selling Fund shares. As noted above, the Manager will receive a
monthly fee equivalent on an annual basis to .85 of 1% of the first $100,000,000
of average daily net assets of the Fund and .80 of 1% of the average daily net
assets in excess of $100,000,000. From this amount, .25 of 1% of the average
daily net assets of the Fund will be paid to the Distributor under the Plan. A
portion of the fee may be used for advertising and promotional expenses
including, by way of example but not by way of limitation, costs of printing and
mailing prospectuses, statements of additional information and shareholder
reports to prospective investors; preparation and distribution of sales
literature; advertising of any type; an allocation of overhead and other
expenses of the Distributor related to the distribution of Fund shares; and
payments to, and expenses of, officers, employees or representatives of the
Distributor, of other broker-dealers, banks or other financial institutions, and
of any other person who provides support services in connection with the
distribution of Fund shares, including travel, entertainment, and telephone
expenses.
The Prospectus outlines the general uses to which the Distributor is
authorized to apply the fees received by it. During the fiscal year ended June
30, 1995, the Distributor received $44,269 in such fees. The Distributor used
these fees to cover the following expenses: compensation of sales personnel -
$32,404; compensation of sales administration personnel - $16,587; sales
meetings and training - $112; marketing
15
<PAGE>
materials $5,241; promotion and travel - $3,276; telephone and postage $159;
and branch office expenses -$72.
The arrangements under which the Fund compensates, indirectly, those who
provide administration, shareholder service, and distribution assistance, as
described above, are set forth in the Plan. The Plan provides:
(i) That it shall continue in effect for a period of more than one year
from the date of its execution or adoption only so long as such
continuance is specifically approved at least annually by the Board of
Directors and by the Directors who are not interested persons of the
Fund and have no direct or indirect financial interest in the operation
of the Plan or in any agreement related to the Plan;
(ii) That any person authorized to direct the disposition of monies paid or
payable by the Fund pursuant to the Plan or any related agreement shall
provide to the Fund's Board of Directors, and the Directors shall
review, at least quarterly, a written report of the amounts so expended
and the purposes for which such expenditures were made; and
(iii) That it may be terminated at any time by vote of a majority of the
members of the Board of Directors of the Fund who are not interested
persons of the Fund and have no direct or indirect financial interest
in the operation of the Plan or in any agreements related to the Plan
or by vote of a majority of the outstanding voting shares of the Fund.
The Plan provides that it may not be amended to increase materially the
amount to be spent for distribution without shareholder approval and that all
material amendments of the Plan must be approved by the Fund's Board of
Directors, including a majority of the Directors who are not interested persons
of the Fund and have no financial interest in the operation of the Plan or
any related agreements. The Fund may implement the Plan only if the selection
and nomination of the Fund's disinterested Directors are committed to the
discretion of the Fund's existing disinterested Directors. Under the terms of
Rule 12b-1, the Fund must preserve copies of any plan, agreement or report made
pursuant to the Rule for a period of not less than six years in an easily
accessible place.
CUSTODIAN
First Bank National Association, Minneapolis, Minnesota 55440 serves as the
custodian for the Fund.
INDEPENDENT AUDITORS
Ernst & Young LLP, One Kansas City Place, 1200 Main Street, Kansas City,
Missouri 64105-2143, independent certified public accountants, have been
selected as auditors of the Fund and issue a report on the Fund's financial
statements.
PORTFOLIO TRANSACTIONS AND BROKERAGE
As the Fund's portfolio is exclusively composed of debt (rather than
equity) securities, most of the Fund's portfolio transactions are effected with
dealers without the payment of brokerage commissions, but at net prices which
usually include a spread or markup. Most Fund transactions are with the issuer,
or with major dealers acting for their own account and not as brokers. In
effecting portfolio transactions the Fund seeks the most favorable net price
consistent with the best execution. However, frequently the Fund selects
16
<PAGE>
a dealer to effect a particular transaction without contacting all dealers who
might be able to effect such transaction, because of the volatility of the
market and the desire of the Fund to accept a particular price for a security
because the price offered by the dealer meets its guidelines for profit, yield,
or both. No brokerage is allocated for the sale of Fund shares.
While it is not expected that the Fund will effect any transactions on an
agency basis, if it does so the Manager will seek to obtain the best price and
execution of orders. Commission rates, being a component of price, are
considered together with other relevant factors. When consistent with these
criteria, business may be placed with broker-dealers who furnish investment
research services to the Manager. Such research services include advice, both
directly and in writing, as to the value of securities, the advisability of
investing in, purchasing, or selling securities, and the availability of
securities or purchasers or sellers of securities, as well as analyses and
reports concerning issues, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts. This allows the Manager to
supplement its own investment research activities and enables it to obtain the
views and information of individuals and research staffs of many different
securities research firms prior to making investment decisions for the Fund. To
the extent portfolio transactions are effected with broker-dealers who furnish
research services to the Manager, the Manager receives a benefit, not capable of
evaluation in dollar amounts.
The Manager has not entered into any formal or informal agreements with any
broker-dealers, and it does not maintain any "formula" which must be followed in
connection with the placement of Fund portfolio transactions in exchange for
research services provided the Manager, except as noted below. If it is
believed to be in the best interests of the Fund, the Manager may place
portfolio transactions with brokers who provide the types of services described
above, even if it means the Fund will have to pay a higher commission (or, if
the broker's profit is part of the cost of the security, will have to pay a
higher price for the security) than would be the case if no weight were given
to the broker's furnishing of those services. This will be done, however, only
if, in the opinion of the Manager, the amount of additional commission or
increased cost is reasonable in relation to the value of the services. The
Manager also serves as investment adviser for other mutual funds. To the extent
that the Fund may pay a somewhat higher brokerage commission or somewhat higher
price on a trade because such trade is executed by a broker-dealer which also
provides research and statistical services, it is possible that said
research and statistical services may also be of value to one of the other
Manager's mutual funds. However, it is felt that this possibility of mutual
benefit is not capable of measurement.
No brokerage commissions were paid by the Fund in any of the fiscal years
ended June 30, 1995, 1994 and 1993.
PURCHASE OF SHARES
What Reductions are Provided?
- -----------------------------
Volume Discounts are provided if the total amount being invested in shares
of the Fund alone, or in any combination of shares of the Fund and the other
funds in the State Bond Group having a sales charge, reaches levels indicated in
the sales charge schedule set forth in the Prospectus.
The Right of Accumulation allows you to combine the amount being invested
in shares of the Fund and the other mutual funds in the State Bond Group having
a sales charge with the total net asset value of shares of those mutual funds
already owned and the total net asset value of shares you own of State Bond Cash
Management Fund which were acquired through an exchange of shares of another
mutual fund in the State Bond Group, to determine reduced sales charges in
accordance with the schedule in the Prospectus. The value of the shares owned,
including the value of shares of State Bond Cash Management Fund acquired
17
<PAGE>
in an exchange, will be taken into account in orders placed, however, only if
the Distributor is notified by you or your dealer of the amount owned at the
time your purchase is made and is furnished sufficient information to permit
confirmation.
The schedule of sales charges is also applicable to the aggregate amount of
purchases made by a single person within a period of 13 months pursuant to a
written Purchase Intention and Price Agreement (the "Letter of Intent"), a form
of which is available from the Distributor. The Letter of Intent provides for
a price adjustment applicable to the amount of intended purchases specified in
the Letter of Intent based upon the amount of purchases specified plus the total
net asset value of the shares of the other mutual funds in the State Bond Group
already owned that have a sales charge and the total net asset value of the
shares owned of State Bond Cash Management Fund which were acquired through an
exchange of shares. The investor considering the possibility of signing a Letter
of Intent should read it carefully. The schedule of sales charges applicable to
all amounts invested under the Letter of Intent is computed as if the aggregate
amount had been invested immediately. Reduced sales charges also may apply to
purchases made within a 13-month period starting up to 90 days before the date
of execution of the Letter of Intent. Shares with a net asset value equal to 5%
of the minimum purchase amount specified are held in escrow to be applied toward
any sales charge deficiency that might result if the Letter of Intent is not
completed. The shares so held may be redeemed and proceeds thereof used as
required to pay additional sales charges which may be due if the amount of
purchases by such person during the 13 month period aggregates less than the
amount specified in the Letter of Intent. Escrow shares not redeemed will be
delivered to the investor upon completion of purchases under the Letter of
Intent.
If the gross amount invested within the 13 month period covered by the
Letter of Intent exceeds the specified purchase amount and reaches a level
allowing a smaller sales charge, a price adjustment will be made on the day it
reaches the new level. The Letter of Intent is not a binding agreement upon the
investor to purchase, or the Fund to sell, the full indicated amount.
Who Is Entitled To Reductions?
- ------------------------------
Reductions in sales charges apply to purchases by a "single person,"
including an individual; members of a family unit comprising husband, wife and
minor children; or a trustee or other fiduciary purchasing for a single
fiduciary account, including employee benefit plans qualified under Section 401
of the Internal Revenue Code.
18
<PAGE>
OFFERING PRICE
The public offering price is determined by adding to the Fund's current net
asset value per share (as described under "How is Net Asset Value Per Share
Determined?") the sales charge percentage applicable to the transaction. The
portfolio securities in which the Fund invests fluctuate in value, and hence the
net asset value per share of the Fund also fluctuates. The following sample
calculation is based upon the total net assets of the Fund on June 30, 1995 of
$18,177,953 and the total shares of the Fund outstanding as of that date of
1,713,138 and a transaction with an applicable sales charge of the maximum 4.5%:
Net Asset Value Per Share $10.61
======
($18,177,953 divided by 1,713,138
shares outstanding)
Maximum Offering Price Per Share $11.11
=======
($10.61 divided by .955)
HOW ARE SHARES DISTRIBUTED?
SBM Financial Services, Inc., a subsidiary of ARM, acts as distributor of
the shares of the Fund and of the other mutual funds in the State Bond Group. As
distributor of the Fund's capital stock, SBM Financial Services, Inc. allows
concessions to all dealers of up to 4.0% on purchases to which the 4.5% sales
charge applies. In the event that the dealer concession is 90% or more of the
sales charge, dealers taking advantage of such concession may be deemed to be
underwriters under the Securities Act of 1933. The Distributor also pays sales
commissions to its own agents who sell Fund shares. The Distributor retains the
balance of sales charges paid by investors. The sales charges paid by investors
and received by the Distributor amounted to the following amounts during the
periods ended June 30, 1995, 1994, and 1993, respectively: $90,322; $84,012; and
$92,978. The Distributor retained these entire amounts.
The agreement between the Fund and the Distributor provides that the
Distributor will pay certain expenses such as printing costs of prospectuses and
Statements of Additional Information used in offering shares to prospective
investors, applications and confirmations, and all other expenses in connection
with the issuance and sale of the Fund's shares. The Fund will pay the costs of
registering and qualifying shares for sale and of preparing, setting in print,
and printing and distributing prospectuses to existing shareholders.
HOW CAN YOU "SELL" YOUR SHARES?
The procedure for redemption of Fund shares under ordinary circumstances is
set forth in the Prospectus.
In unusual circumstances, payment may be postponed if the orderly
liquidation of portfolio securities is prevented by the closing of, or
restricted trading on, the New York Stock Exchange during periods of emergency,
or such other periods as ordered by the Securities and Exchange Commission.
HOW IS NET ASSET VALUE PER SHARE DETERMINED?
Net asset value per Fund share is determined as of the close of the New
York Stock Exchange on each day that the New York Stock Exchange is open for
business. The New York Stock Exchange is closed on Saturdays and Sundays and is
also closed in observance of the following holidays: New Year's Day,
President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and
19
<PAGE>
Christmas Day. Net asset value is determined by dividing the value of the total
assets of the Fund, less liabilities, by the number of shares outstanding.
In determining net asset value, the Fund utilizes the valuations of its
portfolio securities furnished by a pricing service approved by the Board of
Directors. The pricing service values portfolio securities which have remaining
maturities of more than 60 days from the date of valuation at quoted bid prices
or the yield equivalents when quotations are readily available. Such securities
for which quotations are not readily available (which constitute a majority of
the Fund's portfolio securities) are valued at fair value as determined by the
pricing service using methods which include consideration of yields or prices of
municipal securities and other securities in the Fund's portfolio of comparable
quality, type of issue, coupon, maturity and rating; indications as to value
from dealers; and general market conditions. The pricing service may employ
electronic data processing techniques and/or a matrix system to determine
valuations. Short-term holdings maturing in 60 days or less are valued at cost
plus accrued interest, which approximates market value.
TAX STATUS OF THE FUND
The Fund has fulfilled during its most recent fiscal year, and intends to
continue to fulfill, the requirements of subchapter M of the Internal Revenue
Code of 1986, as amended (the "Code"), to qualify as a regulated investment
company, and so long as it remains so qualified, it will not be liable for
Federal income tax to the extent that it distributes all of its net taxable and
non-taxable income to shareholders.
ADDITIONAL TAX INFORMATION
Under the Code, interest on indebtedness incurred or continued to purchase
or carry shares of an investment company paying exempt-interest dividends, such
as the Fund, will not be deductible by a shareholder in proportion to the ratio
of exempt-interest dividends to all dividends other than those treated as long-
term capital gains. Minnesota law also restricts the deductibility of interest
on indebtedness incurred or continued to purchase or carry shares of the Fund.
Indebtedness may be allocated to shares of the Fund even though not directly
traceable to the purchase of such shares.
Any loss on the sale or exchange of shares held for six months or less
(although regulations may reduce this time period to 31 days) will be disallowed
for federal income tax purposes to the extent of the amount of any exempt-
interest dividend received with respect to such shares. Except to the extent
disallowed pursuant to the preceding sentence, any loss on the sale or exchange
of shares held for six months or less will be treated as a long-term capital
loss to the extent of the amount of any dividend received from long-term
capital gains with respect to such shares. Similar rules apply in the case of
individuals, estates and trusts under Minnesota law.
For federal tax purposes, if a shareholder exchanges shares of the Fund for
shares of any other fund in the State Bond Fund Group pursuant to the exchange
privilege (see "How does the Fund's Exchange Privilege Work?" in the
Prospectus), such exchange will be considered a taxable sale of the shares in
the Fund. Furthermore, if a shareholder carries out the exchange within 90 days
of purchasing the shares in the Fund, the sales charge incurred on the purchase
of those shares cannot be taken into account for determining the shareholder's
gain or loss on the sale of those shares to the extent that the sales charge on
the purchase of the later-acquired shares is reduced because of the exchange
privilege. However, the amount of the sales charge that may not be taken into
account in determining the shareholder's gain or loss on the sale of the shares
in the Fund may be taken into account in determining his gain or loss on the
eventual sale or exchange of the later-acquired shares.
20
<PAGE>
Pursuant to the Code, the Fund is subject to a non-deductible excise tax
equal to 4 percent of the excess, if any, of the amount required to be
distributed pursuant to the Code for each calendar year over the amount actually
distributed. In order to avoid the imposition of this excise tax, the Fund
generally must declare dividends by the end of a calendar year representing 98
percent of the Fund's ordinary income for the calendar year and 98 percent of
its capital gain net income (both long-term and short-term capital gains) for
the twelve-month period ending October 31 of the calendar year.
Certain deductions otherwise allowable to financial institutions and
property and casualty insurance companies will be eliminated or reduced by
reason of the receipt of certain exempt-interest dividends.
Information regarding the tax status of payments you receive is set forth
in the Prospectus.
WILL THE FUND WITHHOLD TAXES ON DISTRIBUTIONS?
Under Federal law, the Fund is required, subject to certain exceptions, to
withhold and remit to the U.S. Treasury 31% of distributions and redemption
proceeds paid on an account if the holder of the account provides the Fund with
either an incorrect tax identification number or no number at all, or fails to
certify to the Fund that he is not subject to such withholding.
GENERAL INFORMATION
As previously indicated, the Fund was incorporated in Maryland on December
12, 1987. In March 1993, the Fund was reorganized as an individual investment
portfolio of a series fund, "State Bond Tax-Free Income Funds, Inc."
Under Maryland law, each director of State Bond Tax-Free Income Funds, Inc.
owes certain duties to the Fund and its shareholders. Maryland law provides that
a director shall "perform his duties as a director in good faith, in a manner he
reasonably believes to be in the best interests of the corporation and with the
care that an ordinarily prudent person in a like position would use under
similar circumstances." Fiduciary duties of a director of a Maryland
corporation include, therefore, both a duty of "loyalty" (to act in good faith
and in a manner reasonably believed to be in the best interests of the
corporation) and a duty of "care" (to act with the care an ordinarily prudent
person in a like position would use under similar circumstances). Maryland law
allows Maryland corporations to eliminate or limit the personal liability of a
director or an officer to the corporation or its shareholders for monetary
damages for breach of the fiduciary duty of "care."
The Amended and Restated Articles of Incorporation of State Bond Tax-
Free Income Funds, Inc. contain a provision eliminating liability of directors
and officers to the corporation or its shareholders to the fullest extent
permitted by Maryland law. Therefore, directors and officers of State Bond Tax-
Free Income Funds, Inc. will not be liable for monetary damages to the Fund or
its shareholders for breach of the duty of care. However, such elimination of
liability is subject to several significant limitations. Applicable Maryland law
regarding a director's duty of care does not permit the elimination or
limitation of liability (1) to the extent that it is proved that the person
actually received an improper benefit or profit in money, property or services
for the amount of the benefit or profit in money, property or services actually
received; (2) to the extent that a judgment or other final adjudication adverse
to the person is entered in a proceeding based on a finding in the proceeding
that the person's action, or failure to act, was the result of active and
deliberate dishonesty and was material to the cause of action adjudicated in the
proceeding; or (3) for any action or failure to act occurring prior to February
18, 1988. In addition, due to the provisions of the Investment Company Act of
1940, shareholders would still have a right to pursue monetary claims against
directors or officers for acts involving willful malfeasance, bad faith, gross
negligence or reckless disregard of their duties as directors or officers.
21
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Schedule of Investments
June 30, 1995
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (93.5%)
Albany, MN Independent School District #745, G.O. Bonds,
6.000%, due 2009 Aa/NR $235,000 $ 240,840
Blaine Minnesota Economic Development Authority Bonds, Anoka and
Ramsey County, 7.250%, due 2006 A1/NR 150,000 162,299
Bloomington Port Authority, Series 1994 A, 5.250%, due 2003 Aaa/AAA 200,000 201,232
Burnsville, MN Multi-Family Housing Rev. Ref. Bonds, Coventry
Court Apartments Project, Series 1989, 7.500%, due 2027 NR/AAA 100,000 105,591
Centennial Minnesota Independent School District #12, G.O. Bonds,
Series 1991 A, 7.150%, due 2011 NR/AAA 250,000 276,075
City of Mora, MN, G.O. Refunding Revenue Bonds, 5.000%, due 2008 Aaa/AAA 200,000 195,786
Coon Rapids, MN, G.O. Tax Increment Bonds, Series 1986 B2,
7.750%, due 2006 A/NR 150,000 154,068
Dakota County, MN, G.O. Ref. Bonds, 6.450%, due 2010 Aaa/AAA 300,000 312,630
Dakota County, MN Housing and Rev. Authority, SFM Rev. Bonds,
7.200%, due 2009 NR/AAA 205,000 219,100
Duluth, MN, G.O. Water Rev., Series 1992 A, 6.250%, due 2007 A/NR 285,000 295,280
Eden Prairie, MN Multi-Family Housing Preserve Place Apartments,
7.875%, due 2017 NR/AAA 100,000 106,895
Farmington Independent School District #192, G.O., 4.900%, due 2004 NR/AA 200,000 191,466
Foley, MN Independent School District #51 MBIA, 7.500%, due 2008 Aaa/AAA 100,000 106,367
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
Hennepin County, MN Lease Rev. Certificate of Participation,
Series 1991, 6.800%, due 2017 Aa/AA $165,000 $ 175,662
Housing and Redevelopment Authority, St. Paul Parking,
6.450%, due 2007 NR/A- 300,000 328,512
Housing and Redevelopment Authority, Eden Prairie, 6.200%, due 2008 A/NR 300,000 308,373
Kandiyohi County, MN, G.O. Ref. Bonds, Series 1993, 5.650%, due 2011 A/NR 225,000 219,976
Minnesota Higher Education Fac. Auth. Rev. Bonds, Series Three J
(Macalaster College), 6.300%, due 2014 NR/AA- 300,000 305,187
Minnesota Higher Education Fac. Auth. Rev. Bonds, Series Two-O
(College of St. Thomas), 7.600%, due 2007 A/NR 100,000 109,460
Minnesota Higher Education Fac. Auth. Rev. Ref. Bonds, Series 3-R2,
5.600%, due 2014 A1/NR 315,000 297,984
Minnesota Higher Education Fac. Auth. Rev. Bonds, Series 3M1,
6.000%, due 2010 NR/AAA 200,000 201,514
Minnesota Housing Finance Agency, SFM Rev. Bonds, Series 1991 C,
7.100%, due 2011 NR/AA 195,000 206,601
Minnesota Housing Finance Agency, SFM Rev. Bonds, Series C,
7.650%, due 2008 Aa/AA 100,000 107,854
Minnesota Housing Finance Agency, SFM Rev. Bonds, Series 1989 B,
7.300%, due 2017 Aa/AA 315,000 333,087
Minnesota Housing Finance Authority, Series 1993, E,
6.000%, due 2014 NR/A+ 160,000 159,101
</TABLE>
3
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Schedule of Investments (continued)
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
Minnesota Public Facilities Authority, Water Pollution Control,
Rev. Bonds, Series 1991 A, 6.950%, due 2013 NR/AA+ $250,000 $ 270,345
Minnesota Public Facilities Authority, Water Pollution Control,
Rev. Bonds, Series 1990 A, 7.100%, due 2012 NR/AA+ 300,000 325,068
Minnesota Public Facilities Authority, Water Pollution Control,
Rev. Bonds, Series 1992 A, 6.500%, due 2014 NR/AA+ 250,000 264,210
Minnesota State Housing Finance Agency, Rental Housing,
Series C Ref. Bonds, 6.150%, due 2014 NR/A+ 175,000 176,027
Minnesota State Housing Finance Agency, Single Family Mortgage,
5.850%, due 2011 Aa/AA 350,000 348,555
Minnesota State Housing Development Single Family Mortgage,
Series B, 7.250%, due 2016 Aa/AA 55,000 56,860
Minnetonka, MN Multi-Family Housing Rev. Bonds (Cedar Hills East
Project), 7.500%, due 2017 NR/AA 100,000 106,361
State of Minnesota, G.O. State Bonds, State Infrastructure
Development Bonds, 7.000%, due 2007 Aa/AA+ 150,000 166,152
Minnesota State University Board Rev. Bonds, Series 1993 A,
6.000%, due 2013 A/NR 300,000 295,458
Minneapolis-St. Paul Metro Area Council G.O. Bonds, 7.000%, due 2006 Aaa/AAA 100,000 101,328
Minneapolis Community Development Agency, Multi-Family Housing
Rev., Laurel #9, 7.500%, due 2031 NR/AAA 100,000 102,190
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
Minneapolis, MN Hospital Facility Refunding Revenue Bonds,
7.875%, due 2014 A1/A+ $450,000 $ 497,655
Minneapolis, MN Multi-Family Housing Rev. Ref. Bonds, Series 1991,
7.050%, due 2022 NR/AAA 300,000 312,798
Minneapolis, MN Multi-Family Rev. Bonds, 7.125%, due 2010 NR/AAA 200,000 211,660
Minneapolis, MN Refunding Laurel Village G.O. Bonds, 5.75%, due 2010 Aaa/AAA 275,000 274,420
Minneapolis-St. Paul, MN Metro Council Sewer Bonds, Series 1990 D,
7.250%, due 2007 Aaa/AAA 150,000 166,239
Minneapolis, MN Sales Tax Ref. G.O., 6.250%, due 2012 Aaa/AAA 250,000 258,650
Moorhead, MN Public Utility Rev. Bonds, Series 1992,
6.050%, due 2006 Aaa/AAA 300,000 315,549
Northern Municipal Power Agency, MN Electric Rev. Ref. Bonds,
Series A, 7.250%, due 2017 Aaa/AAA 285,000 315,897
Northern Municipal Power Agency, MN Electric Rev. Ref. Bonds,
6.000%, due 2020 A/A 530,000 512,844
Owatonna, MN Public Utility Ref. Bonds, Series 1990,
7.400%, due 2007 A1/NR 300,000 333,297
Ramsey & Washington Counties Resource Recovery Rev. Bonds, NSP
Project, 6.750%, due 2006 Aa2/AA- 100,000 106,899
Red Wing Independent School District #256, G.O. School Building,
Series 1998 A, 7.300%, due 2004 Aa/NR 150,000 159,657
Robbinsdale Hospital Ref. Rev. NMMCP, 1989, 7.200%, due 2005 Aaa/AAA 100,000 110,680
</TABLE>
5
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Schedule of Investments (continued)
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
Robbinsdale Hospital Ref. Rev. NMMCP, Series A, 5.450%, due 2013 Aaa/AAA $370,000 $ 349,780
Rochester, MN Health Care Facility Rev. Bonds, Mayo Medical Center,
6.250%, due 2021 NR/AA+ 500,000 507,385
Scott County, MN, G.O. Capital Improvement Plan, Series 1988 A,
7.250%, due 2008 Aaa/AAA 100,000 107,347
Southern Minnesota Municipal Power Authority, Series A,
8.125%, due 2018 NR/A+ 300,000 332,952
St. Anthony-New Brighton Independent School District #282, G.O.
Bonds, 5.700%, due 2012 Aa/AA 300,000 297,447
St. Cloud, MN Hydro Electric Generator Facility Gross Rev. Bonds,
7.375%, due 2018 NR/A- 250,000 262,055
St. Louis County, MN, G.O. Revenue Bonds, 4.750%, due 2004 Aaa/AAA 300,000 288,519
St. Paul, MN, G.O. Street Improvement, Special Assessment Bonds,
Series 1988 D, 7.200%, due 2008 Aa/AA+ 100,000 102,072
St. Paul, MN Housing & Redevelopment Authority, Tax Increment Bonds,
7.400%, due 2005 Aaa/AAA 100,000 107,610
St. Paul, MN Housing and Redevelopment Authority Revenue Bonds,
5.400%, due 2008 Aaa/AAA 300,000 293,889
St. Paul, MN, Independent School District #625, Series C,
5.550%, due 2012 Aa/AA 300,000 292,059
St. Paul, MN, Independent School District #625, Series 1994 C,
6.050%, due 2012 Aa/AA 400,000 406,932
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
MOODY'S/S&P PRINCIPAL
RATING AMOUNT VALUE
-----------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS (CONTINUED)
St. Paul, MN, Independent School District #625 School Building
Bonds, Series 1990 D, 7.250%, due 2009 Aa/AA $150,000 $ 163,623
Stearns County, MN, G.O. Ref. Bonds, Series B, 6.000%, due 2007 A/NR 325,000 334,773
University of Minnesota, Ref. Series A, 7.750%, due 2010 A1/AA 200,000 208,390
Vadnais Heights, MN Housing Development Rev. Bonds, Riverwood
Housing Foundation, 7.500%, due 2009 NR/A+ 115,000 116,006
Wayzata, MN Tax Increment Bonds, 7.000%, due 2010 Aa/NR 200,000 220,538
Wayzata, MN Independent School District #284, G.O. Bonds,
Series 1994 B, 5.800%, due 2009 Aa/NR 250,000 251,325
Western Minnesota Municipal Power Agency, Power Supply Revenue Ref.
Bonds, 6.875%, due 2007 A/A 300,000 313,539
Western Minnesota Municipal Power, Series A, 6.125%, due 2016 A/A 250,000 250,518
Western Minnesota Municipal Power Agency, Transmission Project Rev.
Ref. Bonds, Series 1991, 6.750%, due 2016 Aaa/AAA 200,000 215,196
Worthington, MN, G.O., Water Rev. Bonds, Series 1990 A,
7.000%, due 2010 A/NR 100,000 108,231
Wright County, MN, G.O. Jail Ref. Bonds, Series 1992 B,
6.000%, due 2007 A/NR 350,000 360,059
-----------
TOTAL MUNICIPAL BONDS (Cost $16,386,816) 16,999,984
</TABLE>
7
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Schedule of Investments (continued)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
-------------------------
<S> <C> <C>
SHORT-TERM SECURITIES (6.5%)
Ford Motor Credit Corp., 5.930%, due 07/03/95 $650,000 $ 649,250
Sears Roebuck Acceptance Corp., 6.000%, due 07/07/95 525,000 524,388
-----------
TOTAL SHORT-TERM SECURITIES
(Cost $1,173,638) 1,173,638
-----------
TOTAL INVESTMENTS (100.0%)
(Cost $17,560,454*) $18,173,622
===========
</TABLE>
* Also represents cost for federal income tax purposes.
Ratings were provided by Moody's Investors Service, Inc. and Standard & Poor's
Corporation and are not covered by the report of Ernst & Young LLP.
See accompanying notes.
8
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Statement of Assets and Liabilities
June 30, 1995
<TABLE>
<S> <C>
ASSETS
Investment in securities, at value (cost $17,560,454)
(Note 1)--See accompanying schedule $18,173,622
Cash 47,344
Receivable for capital shares sold 4,501
Receivable for reimbursable expenses (Note 2) 2,738
Interest receivable 364,344
Prepaid expenses 1,740
-----------
TOTAL ASSETS 18,594,289
LIABILITIES
Payable for securities purchased 300,000
Dividends payable 82,200
Payable to affiliates 14,357
Accrued expenses 19,779
-----------
TOTAL LIABILITIES 416,336
-----------
NET ASSETS $18,177,953
===========
Net Assets consist of:
Paid-in capital $17,537,193
Undistributed net realized gain on investments 27,592
Net unrealized appreciation on investment securities 613,168
-----------
NET ASSETS, for 1,713,138 shares outstanding $18,177,953
===========
NET ASSET VALUE and redemption price per share $ 10.61
===========
Maximum offering price per share (includes maximum sales
charge of 4.5%--reduced on purchases of $50,000 or more) $ 11.11
===========
</TABLE>
See accompanying notes.
9
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Statement of Operations
Year Ended June 30, 1995
<TABLE>
<S> <C>
INVESTMENT INCOME
Interest $1,122,971
EXPENSES (NOTE 2)
Investment advisory and management fees, net of 12b-1 plan fees 106,246
12b-1 plan fees 44,269
Accounting and pricing service fees 23,600
Professional fees 12,300
Shareholders' reports 5,900
Transfer agent fees 7,500
Custodian fees 7,200
Directors' fees and expenses 5,000
Other expenses 7,900
----------
Total expenses before reimbursement 219,915
Less: expense reimbursement (42,839)
----------
Net expenses 177,076
----------
Net investment income 945,895
REALIZED AND UNREALIZED GAIN ON INVESTMENTS (Note 1)
Net realized gain on investments 27,592
Change in unrealized appreciation on investment securities 268,408
----------
Net realized and unrealized gain on investments 296,000
----------
Net increase in net assets resulting from operations $1,241,895
==========
</TABLE>
See accompanying notes.
10
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Statements of Changes in Net Assets
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
1995 1994
---------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net investment income $ 945,895 $ 831,864
Net realized gain on investments 27,592 400
Net unrealized appreciation (depreciation) 268,408 (730,910)
---------------------------
Net increase in net assets resulting
from operations 1,241,895 101,354
Distributions to shareholders from:
Net investment income (945,895) (831,864)
Net realized gain -- (29,684)
---------------------------
Total distributions to shareholders (945,895) (861,548)
Capital share transactions:
Proceeds from sales of shares 3,233,318 2,730,892
Proceeds from reinvested dividends 675,610 624,970
Cost of shares redeemed (2,512,546) (1,428,523)
---------------------------
Net increase in net assets resulting from
share transactions 1,396,382 1,927,339
---------------------------
Total increase in net assets 1,692,382 1,167,145
NET ASSETS
Beginning of year 16,485,571 15,318,426
---------------------------
End of year $18,177,953 $16,485,571
===========================
OTHER INFORMATION
Shares:
Sold 311,971 251,856
Issued through reinvestment of dividends 65,014 57,461
Redeemed (241,814) (131,433)
---------------------------
Net increase 135,171 177,884
===========================
</TABLE>
See accompanying notes.
11
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Financial Highlights
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------------------------------------
1995 1994 1993 1992 1991
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SELECTED PER-SHARE DATA
Net asset value, beginning of year $ 10.45 $ 10.94 $ 10.49 $ 10.18 $10.11
Income from investment operations:
Net investment income .56 .56 .59 .61 .62
Net realized and unrealized gain (loss) on investments .16 (.47) .45 .33 .07
-------------------------------------------------------------
Total from investment operations .72 .09 1.04 .94 .69
Less distributions:
From net investment income (.56) (.56) (.59) (.61) (.62)
From net realized gain -- (.02) -- (.02) --
-------------------------------------------------------------
Total distributions (.56) (.58) (.59) (.63) (.62)
-------------------------------------------------------------
Net asset value, end of year $ 10.61 $ 10.45 $ 10.94 $ 10.49 $10.18
=============================================================
TOTAL RETURN(A) 7.10% 0.79% 10.06% 9.47% 6.87%
RATIOS AND SUPPLEMENTAL DATA
Net assets, end of year (in thousands) $18,178 $16,486 $15,318 $12,244 $9,238
Ratio of expenses to average net assets(B) 1.00% 1.00% 1.00% 1.00% 1.00%
Ratio of net investment income to average net assets 5.37%(C) 5.14% 5.41% 5.86% 6.17%
Portfolio turnover rate 6% 2% 15% 1% 8%
</TABLE>
(A) Total returns do not consider the effects of the one time sales charge.
(B) The ratio of expenses to average net assets before voluntary expense
reimbursements from the investment adviser for the years ended June 30,
1995, 1994, 1993, 1992, and 1991 were 1.24%, 1.29%, 1.38%, 1.54%, and
1.65%, respectively.
(C) The ratio of net investment income to average net assets before voluntary
expense reimbursements from the investment adviser for the year ended
June 30, 1995 was 5.10%.
12
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Notes to Financial Statements
June 30, 1995
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
The State Bond Minnesota Tax-Free Income Fund (the "Fund") is the only
investment portfolio of State Bond Tax-Free Income Funds, Inc., which is
registered under the Investment Company Act of 1940, as amended, as an open-end
management investment company. The primary investment objective of the Fund is
to maximize current income exempt from both Federal income tax and Minnesota
personal income tax to the extent consistent with the preservation of capital,
with consideration given to the opportunity for capital gains by investing in
tax-exempt securities. The ability of the issuers of the securities held by the
Fund to meet their obligations may be affected by economic developments in
Minnesota or a specific industry or region.
On June 14, 1995, ARM Financial Group, Inc. ("ARM") completed the acquisition of
substantially all of the assets and business operations of SBM Company ("SBM").
As part of the acquisition, ARM Capital Advisors, Inc. ("ARM Capital Advisors"),
a subsidiary of ARM, assumed the responsibilities of SBM as manager of the Fund.
The Investment Advisory and Management Agreement between the Fund and ARM
Capital Advisors contains the same material terms and conditions (including the
fees payable to ARM Capital Advisors) as were contained in the Fund's prior
Investment Advisory and Management Agreement with SBM.
As part of the acquisition, ARM acquired all of the issued and outstanding
common stock of SBM Financial Services, Inc. ("SBM Financial Services"), the
Fund's distributor. Effective June 14, 1995, SBM Financial Services also became
the transfer agent for the Fund. Prior to the acquisition SBM functioned as the
transfer agent for the Fund.
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles for investment companies.
INVESTMENTS IN SECURITIES
Investment securities are stated at aggregate market values. Market valuations
are furnished by a pricing service approved by the Board of Directors. The
pricing service values portfolio securities which have remaining maturities of
more than sixty days from the date of valuation at quoted bid prices. Such
securities for which quotations are not readily available (which constitute a
majority of the Fund's portfolio securities) are valued at fair value as
determined by the pricing service. Securities which have remaining maturities
of sixty days or less and short-term securities are valued at amortized cost
which approximates market value. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general
supervision of the Board of Directors.
Security transactions are accounted for on trade date and interest income is
recorded on the accrual basis. Realized gains or losses from investment
transactions are determined on the basis of specific identification.
At June 30, 1995, unrealized appreciation of investments aggregated $735,435 and
unrealized depreciation of investments aggregated $122,267 for tax purposes.
13
<PAGE>
State Bond Minnesota Tax-Free Income Fund
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAX STATUS AND RELATED MATTERS
The Fund complied with the requirements of the Internal Revenue Code applicable
to regulated investment companies and distributed its taxable net investment
income and net realized gains. Therefore, no provision for federal or state
income tax is required.
The Fund hereby designates $27,592 as capital gain dividends attributable to the
year ended June 30, 1995 for the purpose of the dividend paid deduction in the
Fund's federal income tax returns.
DISTRIBUTIONS TO SHAREHOLDERS
Exempt interest dividends from net investment income are declared daily and
distributed monthly. Distributions from net realized investment gains, if any,
are declared at least once a year. Dividends and distributions are recorded on
the ex-dividend date.
2. INVESTMENT ADVISORY AGREEMENT AND PAYMENTS TO RELATED PARTIES
ARM Capital Advisors is the Fund's investment adviser. The investment advisory
fee is computed at the annual rate of .85% on the first $100,000,000 of average
daily net assets of the Fund and .80% on the average daily net assets in excess
of $100,000,000. Included in the investment advisory fee is .25% of the average
daily net assets which ARM Capital Advisors pays to SBM Financial Services under
a Rule 12b-1 plan of share distribution. ARM Capital Advisors has voluntarily
undertaken to reimburse the Fund for any expenses in excess of 1% of the average
daily net assets despite the fact that higher expenses may be permitted by state
law.
Fees paid to SBM Financial Services for underwriting services in connection with
sales of the Fund's capital shares aggregated $90,322 for the fiscal year ended
June 30, 1995. Such fees are not an expense of the Fund and are excluded from
the proceeds received by the Fund for sales of its capital shares as shown in
the accompanying statements of changes in net assets. Fees paid to SBM for
accounting services for the fiscal year ended June 30, 1995 were $13,750.
Certain officers and directors of the Fund are also officers of ARM, ARM Capital
Advisors, and SBM Financial Services.
3. PURCHASES AND SALES OF SECURITIES
Aggregate purchases and proceeds from sales of securities, excluding short-term
investments, during the fiscal year ended June 30, 1995, amounted to $1,771,797
and $932,167, respectively.
4. CAPITAL SHARES
At June 30, 1995, the Fund had authority to issue ten billion shares of common
stock, each with a par value of $.00001.
14
<PAGE>
Report of Independent Auditors
Board of Directors and Shareholders
State Bond Minnesota Tax-Free Income Fund
We have audited the accompanying statement of assets and liabilities including
the schedule of investments of the State Bond Minnesota Tax-Free Income Fund
(the "Fund") as of June 30, 1995 and the related statements of operations and
changes in net assets and financial highlights for the year then ended. These
financial statements 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 audit. The statement of changes in net assets
for the year ended June 30, 1994 and financial highlights for the four years
ended June 30, 1994 of the State Bond Minnesota Tax-Free Income Fund were
audited by other auditors whose report dated July 29, 1994 expressed an
unqualified opinion.
We conducted our audit 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.
Our procedures included confirmation of securities owned at June 30, 1995, by
correspondence with the custodian. As to uncompleted securities transactions,
we performed other auditing procedures. 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
audit provides 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 the
State Bond Minnesota Tax-Free Income Fund at June 30, 1995, and the results of
its operations, changes in its net assets and financial highlights for the year
then ended in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Kansas City, Missouri
August 4, 1995
15
<PAGE>
APPENDIX A
Description of Tax-Exempt Securities Ratings
Tax-Exempt Bonds
----------------
Moody's Investors Service, Inc.
- -------------------------------
Aaa: Tax-exempt bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Tax-exempt bonds which are rated Aa are judged to be a 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 or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A: Tax-exempt 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: Tax-exempt bonds which are rated Baa are considered as medium grade
obligations; i.e., they are neither highly protected nor poorly secured.
Interest payments 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: Tax-exempt 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: Tax-exempt 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.
NOTE: Moody's applies numerical modifiers 1,2, and 3 in each generic rating
classification from Aa through B in its bond ratings. The modifier 1 indicates
that the security ranks in the higher end of its generic rating category. The
modifier 2 indicates a mid-range ranking; and modifier 3 indicates that the
issue ranks in the lower end of its generic rating category.
Standard & Poor's Corporation
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A-1
<PAGE>
AAA: Tax-exempt bonds rated AAA are highest grade obligations. They possess
the ultimate degree of protection as to principal and interest. In the market
they move with interest rates, and hence provide the maximum safety on all
counts.
AA: Tax-exempt bonds rated AA also qualify as high-grade obligations, and
in the majority of instances differ from AAA issues only in small degree. Here,
too, prices move with the long-term money market.
A: Tax-exempt bonds rated A are regarded as upper medium grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are regarded
as safe. They predominantly reflect money rates in their market behavior, but
also to some extent, economic conditions.
BBB: Tax-exempt bonds rated BBB are regarded as having adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
BB or B: Tax-exempt bonds rated BB or B are regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and B a higher degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
NOTE: The S&P ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within the major rating categories.
Tax-Exempt Notes
----------------
Moody's
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Moody's ratings for state, municipal and other short-term obligations are
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in short-
term borrowing, while various factors of primary importance in long-term
borrowing risk are of lesser importance in the short run. Symbols used are as
follows:
MIG-1: Notes are of the best quality enjoying strong protection from
established cash flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both.
MIG-2: Notes are of high quality, with margins of protection ample,
although not so large as in the preceding group.
MIG-3: Notes are of favorable quality, with all security elements accounted
for, but lacking the undeniable strength of the preceding grades. Market access
for refinancing, in particular, is likely to be less well established.
A-2
<PAGE>
Standard & Poor's
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Until June 29, 1984, Standard & Poor's used the same rating symbols for
notes and bonds. After June 29, 1984, for new municipal note issues due in three
years or less the ratings below usually will be assigned. Notes maturing beyond
three years will most likely receive a bond rating of the type recited above.
SP-1: Issues carrying this designation have a very strong or strong
capacity to pay principal and interest. Issues determined to possess
overwhelming safety characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
Commercial Paper
----------------
Moody's
- -------
Moody's Commercial Paper ratings, which are also applicable to municipal
paper investments permitted to be made by the Fund, are opinions of the ability
of issuers to repay punctually their promissory obligations not having an
original maturity in excess of nine months. Moody's employs the following
designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated Issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
Standard & Poor's
- -----------------
S&P's ratings are a current assessment of the likelihood of timely payment
of debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues with the "A" category are delineated with the numbers
1,2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely
payment is very strong. A "plus" (+) designation indicates an even stronger
likelihood of timely payment.
A-2: Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as overwhelming as for
issues designated A-1.
A-3
