PRINCIPAL TAX EXEMPT CASH MANAGEMENT FUND INC, 485APOS, 1998-12-30

PRINCIPAL TAX EXEMPT CASH MANAGEMENT FUND INC
485APOS, 1998-12-30

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Registration No. 33-21710

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
--------

POST-EFFECTIVE AMENDMENT NO. 20 TO

FORM N-1A

REGISTRATION STATEMENT

under

THE SECURITIES ACT OF 1933

and

REGISTRATION STATEMENT

under

THE INVESTMENT COMPANY ACT OF 1940
--------

PRINCIPAL TAX-EXEMPT CASH MANAGEMENT FUND, INC.
(Exact name of Registrant as specified in Charter)

The Principal Financial Group
Des Moines, Iowa 50392
(Address of principal executive offices)
--------

Telephone Number (515) 248-3842
--------

MICHAEL D. ROUGHTON Copy to:
The Principal Financial Group JOHN W. BLOUCH, L.L.P.
Des Moines, Iowa 50392 Suite 405 West
1025 Thomas Jefferson Street, N.W.
Washington, DC 20007-0805

(Name and address of agent for service)
----------

It is proposed that this filing will become effective (check appropriate box)

_____ immediately upon filing pursuant to paragraph (b) of Rule 485
_____ on (date) pursuant to paragraph (b) of Rule 485
__X__ 60 days after filing pursuant to paragraph (a)(1) of Rule 485
_____ on (date) pursuant to paragraph (a)(1) of Rule 485
_____ 75 days after filing pursuant to paragraph (a)(2) of Rule 485
_____ on (date) pursuant to paragraph (a)(2) of Rule 485

If appropriate, check the following box:

This post-effective amendment designates a new effective date for
a previously filed post-effective amendment.
----------

<PAGE>

PRINCIPAL MUTUAL FUNDS

DOMESTIC GROWTH-ORIENTED FUNDS

Principal Balanced Fund, Inc.
Principal Blue Chip Fund, Inc.
Principal Capital Value Fund, Inc.
Principal Growth Fund, Inc.
Principal MidCap Fund, Inc.
Principal Real Estate Fund, Inc.
Principal SmallCap Fund, Inc.
Principal Utilities Fund, Inc.

INTERNATIONAL GROWTH-ORIENTED FUNDS

INCOME-ORIENTED FUNDS

Principal International Emerging Markets Fund, Inc.
Principal International Fund, Inc.
Principal International SmallCap Fund, Inc.

Principal Bond Fund, Inc.
Principal Government Securities Income Fund, Inc.
Principal High Yield Fund, Inc.
Principal Limited Term Bond Fund, Inc.
Principal Tax-Exempt Bond Fund, Inc.

MONEY MARKET FUND

Principal Cash Management Fund, Inc.

This Prospectus describes mutual funds organized by Principal Life
Insurance Company. The Funds provide a choice of investment objectives through
Domestic Growth-Oriented Funds, International Growth-Oriented Funds,
Income-Oriented Funds and the Money Market Fund.

The date of this Prospectus is _______________.

Neither the Securities and Exchange Commission nor any State Securities
Commission has approved or disapproved of these securities or determined if this
prospectus is accurate or complete. Any representation to the contrary is a
criminal offense.

TABLE OF CONTENTS

Domestic Growth-Oriented Funds
Balanced Fund
Blue Chip Fund
Capital Value Fund
Growth Fund
MidCap Fund
Real Estate Fund
SmallCap Fund
Utilities Fund

International Growth-Oriented Funds
International Emerging Markets Fund
International Fund
International SmallCap Fund

Income Funds
Bond Fund
Government Securities Income Fund
High Yield Fund
Limited Term Bond Fund
Tax-Exempt Bond Fund

Money Market Fund
Cash Management Fund

The Costs of Investing

Primary Investment Strategies and Related Risks

Management, Organization and Capital Structure

Pricing of Fund Shares

Dividends and Distributions

To Buy Shares

To Sell Shares

To Exchange Shares

General Information about a Fund Account

Financial Highlights

FUND DESCRIPTIONS

The Principal Mutual Funds has three categories of funds: domestic
growth-oriented funds, international growth-oriented funds and income-oriented
funds. The Funds and investment objectives are:

Domestic Growth-Oriented Funds:

Balanced - seeks to generate a total investment return consisting of current
income and capital appreciation while assuming reasonable risks in furtherance
of the investment objective.

Blue Chip - seeks to achieve growth of capital and growth of income by investing
primarily in common stocks of well capitalized, established companies.

Capital Value - seeks to achieve primarily long-term capital appreciation and
secondarily growth of investment income through the purchase primarily of common
stocks, but the Fund may invest in other securities.

Growth - seeks growth of capital through the purchase primarily of common
stocks, but the Fund may invest in other securities.

MidCap - seeks to achieve capital appreciation by investing primarily in
securities of emerging and other growth-oriented companies.

Real Estate - seeks to generate total return by investing primarily in equity
securities of companies principally engaged in the real estate industry.

SmallCap - seeks to achieve long-term growth of capital by investing primarily
in equity securities of companies with comparatively smaller market
capitalizations.

Utilities - seeks to provide high current income and long-term growth of income
and capital. The Fund seeks to achieve its objective by investing primarily in
equity and fixed income securities of companies in the public utilities
industry.

International Growth-Oriented Funds:

International - seeks long-term growth of capital by investing in a portfolio of
equity securities of companies domiciled in any of the nations of the world.

International Emerging Markets - seeks to achieve long-term growth of capital by
investing primarily in equity securities of issuers in emerging market
countries.

International SmallCap - seeks to achieve long-term growth of capital by
investing primarily in equity securities of non-United States companies with
comparatively smaller market capitalizations.

The Growth-Oriented Funds invest primarily in common stocks. Under normal market
conditions, the Growth-Oriented Funds (except Balanced and Utilities) are fully
invested in equity securities. Under unusual circumstances, each of the
Growth-Oriented Funds may invest without limit in cash for temporary defensive
purposes. See Temporary Defensive Measures. When doing so, the Fund is not
investing to achieve its investment objective. The Funds also maintain a portion
of their assets in cash while they are making long-term investment decisions and
to cover sell orders from shareholders.

Income-Oriented Funds

Bond - seeks to provide as high a level of income as is consistent with
preservation of capital and prudent investment risk.

Government Securities Income - seeks a high level of current income, liquidity
and safety of principal by purchasing obligations issued or guaranteed by the
United States Government or its agencies, with emphasis on Government National
Mortgage Association Certificates ("GNMA Certificates"). The guarantee by the U.
S. Government extends only to principal and interest. There are certain risks
unique to GNMA Certificates.

High Yield - seeks high current income primarily by purchasing high yielding,
lower or non-rated fixed income securities which are believed not to involve
undue risk to income or principal. Capital growth is a secondary objective when
consistent with the objective of high current income.

Limited Term Bond - seeks a high level of current income consistent with a
relatively high level of principal stability by investing in a portfolio of
securities with a dollar weighted average maturity of five years or less.

Tax-Exempt Bond - seeks as high a level of current income exempt from federal
income tax as is consistent with preservation of capital. The Fund seeks to
achieve its objective primarily through the purchase of investment grade
quality, tax-exempt fixed income obligations.

The Income-Oriented Funds each has a rating limitation with regard to the
quality of the bonds that are held in its portfolio. The rating limitation
applies when the Fund purchase a bond. If the rating on a bond changes while the
Fund owns it, the Fund is not required to sell the bond. The SAI contains
additional information about bond ratings by Moody's Investors Service, Inc.
("Moody's") and Standard & Poor's Corporation ("S&P").

Money Market Fund

Cash Management - has the investment objective of high level of income through
investments in short-term securities.

In the description for each Fund, you will find important information about the
Fund's:

Primary investment strategy
This section summarizes how the Fund intends to achieve its investment
objective. It identifies the Fund's primary investment strategy (including the
type or types of securities in which the Fund invests) and any policy to
concentrate in securities of issuers in a particular industry or group of
industries.

Annual operating expenses
The annual operating expenses for each Fund are deducted from Fund assets
(stated as a percentage of Fund assets) and are shown as of the end of the most
recent fiscal year. The examples are intended to help you compare the cost of
investing in a particular fund with the cost of investing in other mutual funds.
The examples assume you invest $10,000 in a Fund for the time periods indicated.
The first three lines of each example assume that you sell all of your shares at
the end of those time periods. The second three assume that you do not sell your
shares at the end of the periods. The examples also assume that your investment
has a 5% return each year and that the Fund's operating expenses are the same as
the most recent fiscal year expenses. Although your actual costs may be higher
or lower, based on these assumptions, your costs would be as shown.

Day-to-day fund management
The investment professionals who manage the assets of each Fund are listed with
each Fund. Backed by their staffs of experienced securities analysts, they
provide the Funds with professional investment management.

Principal Management Corporation serves as the manager for the Principal Mutual
Funds. It has signed contracts with Invista Capital Management, Inc.. Under
those contracts, Invista provides portfolio management for the Growth-Oriented
Funds (except the Real Estate Fund), the Government Securities and Limited Term
Bond Funds. (see Management, Organization and Capital Structure)

Fund Performance
Included in each Fund's description is a set of tables and a bar chart.
Together, these provide an indication of the risks involved when you invest.

The bar chart shows changes in the Fund's performance from year to year. The
performance reflected in the chart does not include a sales charge, which would
make the returns less than those shown. Fund shares are generally sold subject
to a sales charge which can be either a front-end sales charge or a contingent
deferred sales charge (CDSC). One of the tables compares the Fund's average
annual returns for 1, 5 and 10 years with a broad based securities market index
(a broad measure of market performance) and an average of mutual funds with a
similar investment objective and management style. The averages used are
prepared by Lipper, Inc. (an independent statistical service). The table shows
how the Fund's performance compares with the returns of an index and with funds
having similar investment objectives. The other table for each Fund provides the
highest and lowest quarterly return for that Fund's Class A shares during the
last 10 years.

A Fund's past performance is not necessarily an indication of how the Fund will
perform in the future.

You may call Principal Mutual Funds (1-800-247-4123) to get the current 7-day
yield for the Cash Management Fund.

Note: All investors should read the prospectus sections discussing the Funds,
the expenses and management (See Fund Descriptions; The Costs of
Investing, Management, Organization and Capital Structure; Dividends and
Distributions; Pricing of Fund Shares; and Financial Highlights).

Investments in these Funds are not deposits of a bank and are not insured
or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.

DOMESTIC GROWTH-ORIENTED FUND

Principal Balanced Fund, Inc.

The Balanced Fund seeks to generate a total investment return consisting of
current income and capital appreciation while assuming reasonable risks in
furtherance of the investment objective.
------------------------------
Total Returns
High & low quarter
during the last 10 years
Annual Total Returns Graph for Calendar ------------------------------
Year Ended 12-31 for years 89 through 98. Quarter Ended Return
------------------------------
mm/dd/yy %
mm/dd/yy %
------------------------------

S&P 500 Stock Index
Lehman Brothers Government/
Corporate Bond Index
Lipper Balanced Fund Average
-------------------------------------------------------
* period from December 9, 1994, date Class B shares
first offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees..... 0.59% 0.59% You would pay the following expenses
12b-1 Fees.......... 0.25% 0.91% if you did not redeem your shares:
Other Expenses...... 0.44% 0.54% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.28% 2.04%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since April 1993 Co-Manager: Judith A. Vogel, CFA. Vice President
of Invista since 1987.
Since December 1997 Co-Manager: Martin J. Schafer, Vice President of
Invista since 1992.

The Balanced Fund invests primarily in common stocks and corporate bonds. It may
also invest in other equity securities, government bonds and notes (obligations
of the U.S. government or its agencies) and cash. Though the percentages in each
category are not fixed, common stocks generally represent 40% to 70% of the
Fund's assets. The remainder of the Fund's assets are invested in bonds and
cash.

In selecting common stocks, the Sub-Advisor, Invista, looks for companies that
have predictable earnings and which, based on growth prospects, are undervalued
in the marketplace. Invista buys stocks with the objective of long-term capital
appreciation. From time to time, Invista purchases stocks with the expectation
of price appreciation over the short term. In response to changes in economic
conditions, Invista may change the make-up of the portfolio and emphasis
different market sectors by buying and selling the portfolio's stocks.

The value of the stocks owned by the Fund changes on a daily basis. Stock prices
reflect the activities of individual companies and general market and economic
conditions. In the short term, stock prices can fluctuate dramatically in
response to these factors.

The Fund generates interest income by investing in bonds and notes. Bonds and
notes are also purchased for capital appreciation purposes when Invista thinks
that declining interest rates may increase market value. Deep discount bonds
(those which sell at a substantial discount from their face amount) are also
purchased to generate capital appreciation. The Fund may invest in bonds with
speculative characteristics but does not intend to invest more than 5% of its
assets in securities rated below BBB by S&P or Baa by Moody's. See Risks of high
yield securities.

Bond values change daily. Their prices reflect changes in interest rates, market
conditions and announcements of other economic, political or financial
information. Generally, when interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.

Because the values of the Fund's assets may rise or fall, when shares of the
Fund are sold they may be worth more or less than the amount paid for them.

The Balanced Fund is generally a suitable investment for investors seeking
long-term growth but who are uncomfortable accepting the risks of investing
entirely in common stocks.

DOMESTIC GROWTH-ORIENTED FUND

Principal Blue Chip Fund, Inc.

The Blue Chip Fund seeks to achieve growth of capital and growth of income by
investing primarily in common stocks of well capitalized, established companies.

-----------------------------------
Total Returns
Highest and lowest quarterly returns
for the last 8 years
Annual Total Returns Graph for Calendar ------------------------------------
Year Ended 12-31 for years 91* through 98. Quarter Ended Return
------------------------------------
mm/dd/yy %
mm/dd/yy %
------------------------------------

* period from March 1, 1991 (date shares first offered to the public)

S&P 500 Stock Index
Lipper Growth and
Income Fund Average
-------------------------------------------------------
** period from December 9, 1994, date Class B shares
first offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.48% 0.48% You would pay the following expenses if you
12b-1 Fees......... 0.25% 0.91% did not redeem your shares:
Other Expenses..... 0.58% 0.63% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.31% 2.02%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since March 1991 Manager: Mark T. Williams, CFA. Vice President of
Invista since 1995.

The Blue Chip Fund invests primarily in common stocks of large, established
companies. The Sub-Advisor, Invista, selects the companies it believes to have
the potential for growth of capital, earnings and dividends. Under normal market
conditions, the Fund invests at least 65% (and may invest up to 100%) of its
assets in blue chip companies. Blue chip companies are easily identified by:
o size (at least $1 billion) o established history of earnings and dividends
o easy access to credit o good industry position
o superior management structure

In addition, the large market of publicly held shares for these companies and
their generally high trading volume results in a relatively high degree of
liquidity for these stocks.

Invista may invest up to 35% of Fund assets in equity securities, other than
common stocks, issued by blue chip companies and in equity securities of
companies that do not fit the blue chip definition. It may also invest up to 5%
of Fund assets in securities of unseasoned issuers, which are more speculative
than blue chip company securities. See Securities of unseasoned issuers. Up to
20% of Fund assets may be invested in foreign securities. The issuers of the
foreign securities do not have to meet the criteria for blue chip companies. See
Foreign Securities.

The value of the stocks owned by the Fund changes on a daily basis. The current
price reflects the activities of individual companies and general market and
economic conditions. In the short term, stock prices can fluctuate dramatically
in response to these factors. Because of these fluctuations, principal values
and investment returns vary. When shares of the Fund are sold, they may be worth
more or less than the amount paid for them.

The Blue Chip Fund is generally a suitable investment for investors seeking
long-term growth who are willing to accept the risks of investing in common
stocks but who prefer investing in larger, established companies.

DOMESTIC GROWTH-ORIENTED FUND

Principal Capital Value Fund, Inc.

The Capital Value Fund seeks to achieve primarily long-term capital appreciation
and secondarily growth of investment income through the purchase primarily of
common stocks, but the Fund may invest in other securities.

------------------------------
Total Returns
High & low quarter
during the last 10 years
Annual Total Returns Graph for Calendar ------------------------------
Year Ended 12-31 for years 89 through 98. Quarter Ended Return
------------------------------
mm/dd/yy %
mm/dd/yy %
------------------------------

-------------------------------------------------------
Average annua1 total returns
(for the period ending December 31, 1998)
-------------------------------------------------------
Past One Past Five Past Ten
Year Years Years
-------- --------- --------
Class A % % %
Class B * --
S&P 500 Stock Index
Lipper Growth & Income
Fund Average
-------------------------------------------------------
* period from December 9, 1994, date Class B shares
first offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.38% 0.38% You would pay the following expenses if
12b-1 Fees......... 0.14% 0.79% you did not redeem your shares:
Other Expenses..... 0.22% 0.35% Class A
----- ----- Class B
Total Fund
Operating Expenses 0.74% 1.52%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since November 1996 Manager: Catherine A. Zaharis, CFA. Vice President of
Invista since 1987.

The Capital Value Fund invests primarily in common stocks. It may also invest in
other equity securities. To achieve its investment objective, the Sub-Advisor,
Invista, invests primarily in securities that have "value" characteristics. This
process is known as "value investing." Value stocks tend to have higher yields
and lower price to earnings (P/E) ratios than other stocks.

Securities chosen for investment may include those of companies which Invista
believes can be expected to share in the growth of the nation's economy over the
long term. The current price of the Fund's assets reflect the activities of the
individual companies and general market and economic conditions. In the short
term, stock prices can fluctuate dramatically in response to these factors.
Because of these fluctuations, principal values and investment returns vary. In
making selections for the Fund's investment portfolio, Invista uses an approach
described as "fundamental analysis." The basic steps involved in this analysis
are:

o Research. Invista, researches economic prospects over the next one to two
years rather than focusing on near term expectations. This approach is
designed to provide insight into a company's real growth potential.

o Valuation. The research findings allow Invista to identify the prospects for
the major industrial, commercial and financial segments of the economy.
Invista looks at such factors as demand for products, capacity to produce,
operating costs, pricing structure, marketing techniques, adequacy of raw
materials and components, domestic and foreign competition and research
productivity. It then uses this information to judge the prospects for each
industry for the near and intermediate term.

o Ranking. Invista then ranks the companies in each industry group according
to their relative value. The greater a company's estimated worth compared to
the current market price of its stock, the more undervalued the company.
Computer models help to quantify the research findings.

o Stock selection. Invista buys and sells stocks according to the Funds own
policies using the research and valuation rankings as a basis. In general,
Invista buys stocks that are identified as undervalued and considers selling
them when they appear overvalued. Along with attractive valuation, other
factors may be taken into account such as:
events that could cause a stock's price to rise or fall;
anticipation of high potential reward compared to potential risk; and
belief that a stock is temporarily mispriced because of market
overreactions.

The Capital Value Fund is generally a suitable investment for investors seeking
long-term growth, who are willing to accept the risks of investing in common
stocks but also prefer investing in companies that appear to be considered
undervalued company to similar companies. When shares of the Fund are sold, they
may be worth more or less than the amount paid for them.

DOMESTIC GROWTH-ORIENTED FUND

Principal Growth Fund, Inc.

The Growth Fund seeks growth of capital through the purchase primarily of common
stocks, but the Fund may invest in other securities.

------------------------------------
Total Returns
Highest and lowest quarterly returns
during the last 10 years
Annual Total Returns Graph for Calendar ------------------------------------
Year Ended 12-31 for years 89 through 98. Quarter Ended Return
------------------------------------
mm/dd/yy %
mm/dd/yy %
-----------------------------------

S&P 500 Stock Index
Lipper Growth
Fund Average
-------------------------------------------------------
* period from December 9, 1994, date Class B shares
first offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.41% 0.41% You would pay the following expenses if
12b-1 Fees......... 0.21% 0.65% you did not redeem your shares:
Other Expenses..... 0.33% 0.40% Class A
----- ----- Class B
Total Fund
Operating Expenses 0.95% 1.46%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since August 1987 Manager: Michael R. Hamilton, Vice President of Invista
since 1987.

The Growth Fund primarily invests in common stocks. It may also invest in other
equity securities.

In seeking the Fund's objective of capital growth, the Fund's Sub-Advisor,
Invista, uses an approach described as "fundamental analysis." The basic steps
involved in this analysis are:

o Research. Invista researches economic prospects over the next one to two
years rather than focusing on near term expectations. This approach is
designed to provide insight into a company's real growth potential.

o Stock selection. Invista then purchases securities of issuers which appear
to have high growth potential. Common stocks selected for the Fund may
include securities of companies that:
o have a record of sales and earnings growth that exceeds the growth rate
of corporate profits of the S&P 500, or
o offer new products or new services.

These securities present greater opportunities for capital growth because of
high potential earnings growth, but may also involve greater risk than
securities which do not have the same potential. The companies may have limited
product lines, markets or financial resources, or may depend on a limited
management group. Their securities may trade less frequently and in limited
volume. As a result, these securities may change in value more than those of
larger, more established companies.

The Growth Fund is generally a suitable investment for investors who want
long-term growth. Additionally, the investor must be willing to accept the risks
of investing in common stocks that may have greater risks than stocks of
companies with lower potential for earnings growth. As the value of the stocks
owned by the Fund changes, the Fund share price changes. In the short term, the
share price can fluctuate dramatically. When shares of the Fund are sold, they
may be worth more or less than the amount paid for them.

DOMESTIC GROWTH-ORIENTED FUND

Principal MidCap Fund, Inc.

The MidCap Fund seeks to achieve capital appreciation by investing primarily in
securities of emerging and other growth-oriented companies.

S&P 500 Stock Index
Lipper Mid-Cap
Fund Average
-------------------------------------------------------
* period from December 9, 1994, date Class B shares
first offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.56% 0.56% You would pay the following expenses if
12b-1 Fees......... 0.24% 0.70% you did not redeem your shares:
Other Expenses..... 0.42% 0.47% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.22% 1.73%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since December 1987 Manager: Michael R. Hamilton, Vice President of Invista
since 1987.

The MidCap Fund primarily invests in stocks of growth oriented companies. Stocks
that are chosen for the Fund by the Sub-Advisor, Invista, are thought to be
responsive to changes in the marketplace and have the fundamental
characteristics to support growth. The Fund may invest for any period in any
industry, in any kind of growth-oriented company. Companies may range from the
well established and well known to the new and unseasoned (see Unseasoned
Issuers).

Under normal market conditions, the Fund invests at least 65% of its assets in
securities of companies with market capitalizations in the $1 billion to $10
billion range. Market capitalization is defined as total current market value of
a company's outstanding common stock.

The Fund may invest up to 20% of its assets in securities of foreign companies.
See Foreign Securities for a description of the unique risks associated with
foreign securities.

The value of the stocks owned by the Fund changes on a daily basis. The current
share price reflects the activities of individual companies and general market
and economic conditions. In the short term, stock prices can fluctuate
dramatically in response to these factors. Because of these fluctuations,
principal values and investment returns vary. When shares of the Fund are sold,
they may be worth more or less than the amount paid for them.

The MidCap Fund is generally a suitable investment for investors seeking
long-term growth and who are willing to accept short-term, dramatic fluctuations
in the value of their investments. The Fund is an aggressive capital
appreciation fund. It is designed for long term investors for a portion of their
investments and not designed for investors seeking income or conservation of
capital.

DOMESTIC GROWTH-ORIENTED FUND

Principal Real Estate Fund, Inc.

The Real Estate Fund seeks to generate total return by investing primarily in
equity securities of companies principally engaged in the real estate industry.

-------------------------------------
Total Returns
Highest and lowest quarterly returns
for the last 1 year
Annual Total Returns Graph for Calendar -------------------------------------
Year Ended 12-31 for 1998. Quarter Ended Quarterly Return
-------------------------------------
mm/dd/yy %
mm/dd/yy %
-------------------------------------

--------------------------------------------
Average annua1 total returns
(for the period ending December 31, 1998)
--------------------------------------------
Past One
Year
--------
Class A %
Class B

Morgan Stanley REIT Index
Lipper Real Estate
Fund Average
--------------------------------------------

Shares first offered to the public December 31, 1997.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.89% 0.89% You would pay the following expenses if
12b-1 Fees......... 0.31% 0.60% you did not redeem your shares:
Other Expenses..... 1.05% 0.98% Class A
----- ----- Class B
Total Fund
Operating Expenses 2.25% 2.47%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since December 1997 Manager: Kelly D. Rush, CFA. Assistant Director -
Investment - Commercial Real Estate of
Principal Life Insurance Company since 1996.

The Real Estate Fund invests primarily in equity securities of companies engaged
in the real estate industry. For purposes of the Fund's investment policies, a
real estate company has at least 50% of its assets, income or profits derived
from products or services related to the real estate industry. Real estate
companies include real estate investment trusts and companies with substantial
real estate holdings such as paper, lumber, hotel and entertainment companies.
Companies whose products and services relate to the real estate industry include
building supply manufacturers, mortgage lenders and mortgage servicing
companies. The Fund may invest up to 25% of its assets in securities of foreign
real estate companies. See Foreign Securities for a description of the unique
risks associated with foreign securities.

Real estate investment trusts ("REITs") are corporations or business trusts that
are effectively permitted to eliminate corporate level federal income taxes if
they meet certain requirements of the Internal Revenue Code. The Fund focuses on
equity REITs. REITs are characterized as:
o equity REITs which primarily own property and generate revenue from rental
income;
o mortgage REITs which invest in real estate mortgages; and
o hybrid REITs which combine the characteristics of both equity and mortgage
REITs.

Securities of real estate companies are subject to securities market
risks as well as risks similar those of direct ownership of real estate. These
include:
o declines in the value of real estate o risks related to general and local
economic conditions
o dependency on management skills o heavy cash flow dependency
o possible lack of available mortgage o overbuilding
funds
o extended vacancies in properties o increases in property taxes and
operating expenses
o changes in zoning laws o expenses incurred in the cleanup
of environmental problems
o casualty or condemnation losses o changes in interest rates

In addition to the risks listed above, equity REITs are affected by the
changes in the value of the properties owned by the trust. Mortgage REITs are
affected by the quality of the credit extended. Both equity and mortgage REITs:
o are dependent upon management skills and may not be diversified;
o are subject to cash flow dependency and defaults by borrowers; and
o could fail to qualify for tax-free pass through of income under the Code.

Because of these factors, the values of the Fund's assets change on a daily
basis. The current share price reflects the activities of individual companies
and general market and economic conditions. In the short term, share prices can
fluctuate dramatically in response to these factors. Because of these
fluctuations, principal values and investment returns vary. When shares of the
Fund are sold, they may be worth more or less than the amount paid for them.

The Real Estate Fund is generally a suitable investment for investors seeking
long-term growth, who want to invest in companies engaged in the real estate
industry and who are willing to accept fluctuations in the value of their
investment.

DOMESTIC GROWTH-ORIENTED FUND

Principal SmallCap Fund, Inc.

The SmallCap Fund seeks to achieve long-term growth of capital by investing
primarily in equity securities of companies with comparatively smaller market
capitalizations.

S&P 600 Stock Index
Lipper Small-Cap
Fund Average
--------------------------------------------

Shares first offered to the public December 31, 1997.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.75% 0.75% You would pay the following expenses if
12b-1 Fees......... 0.37% 0.63% you did not redeem your shares:
Other Expenses..... 1.46% 1.42% Class A
----- ----- Class B
Total Fund
Operating Expenses 2.58% 2.80%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since December 1997 Co-Manager: Mark T. Williams, CFA. Vice President of
Invista since 1995.
Since December 1997 Co-Manager: John F. McClain, Vice President of Invista
since 1995.

The SmallCap Fund invests in equity securities of companies in the U.S. with
comparatively smaller market capitalizations. Market capitalization is defined
as total current market value of a company's outstanding common stock. Under
normal market conditions, the Fund invests at least 65% of its assets in
securities of companies with market capitalizations of $1 billion or less.

In selecting securities for investment, Invista looks at stocks with both value
and/or growth characteristics. In managing the assets of the Fund, Invista does
not have a policy of preferring one of these categories to the other. The value
orientation emphasizes buying stocks at less than their investment value and
avoiding stocks whose price has been artificially built up. The growth
orientation emphasizes buying stocks of companies whose potential for growth of
capital and earnings is expected to be above average. Selection is based on
fundamental analysis of the company relative to other companies with the focus
being on the Manager's estimation of forward looking rates of return.

Investments in companies with smaller market capitalizations may involve greater
risks and price volatility (wide, rapid fluctuations) than investments in
larger, more mature companies. For a more thorough discussion of the risks of
investing in small companies, please review the sections of this prospectus
which discuss the risks of investing in companies with small market
capitalizations (Securities of Smaller Companies) and the risks of investing in
companies with limited operating history (Unseasoned Issuers)

The value of the stocks owned by the Fund changes on a daily basis. The current
share price reflects the activities of individual companies as well as general
market and economic conditions. In the short term, stock prices can fluctuate
dramatically in response to these factors. Because of these fluctuations,
principal values and investment returns vary. When shares of the Fund are sold,
they may be worth more or less than the amount paid for them.

The SmallCap Fund is generally a suitable investment for investors seeking
long-term growth and who are willing to accept volatile fluctuations in the
value of their investment. This Fund is an aggressive capital appreciation fund
designed for long term investors for a portion of their investments. It is not
designed for investors seeking income or conservation of capital.

DOMESTIC GROWTH-ORIENTED FUND

Principal Utilities Fund, Inc.

The Utilities Fund seeks to provide high current income and long-term growth of
income and capital. The Fund seeks to achieve its objective by investing
primarily in equity and fixed income securities of companies in the public
utilities industry.
------------------------------------
Total Returns
Highest and lowest quarterly returns
for the last 6 years
Annual Total Returns Graph for Calendar ------------------------------------
Year Ended 12-31 for years 92* through 98. Quarter Ended Quarterly Return
------------------------------------
mm/dd/yy %
mm/dd/yy %
------------------------------------

* period from December 16, 1992, date shares first offered to the public.

-------------------------------------------
Average annua1 total returns
(for the period ending December 31, 1998)
-------------------------------------------
Past One Past Five
Year Years
-------- ---------
Class A % %
Class B **

S&P 500 Stock Index
Dow Jones Utilities Index
with Income
-------------------------------------------

** period from December 9, 1994, date
Class B shares first offered to the
public, through December 31, 1998

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.60% 0.61% You would pay the following expenses if
12b-1 Fees......... 0.25% 0.90% you did not redeem your shares:
Other Expenses..... 0.38% 0.49% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.23% 2.00%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since April 1993 Manager: Catherine A. Zaharis, CFA. Vice President of
Invista since 1987.

The Utilities Fund invests in securities issued by companies in the public
utilities industry. These companies include:
o companies engaged in the manufacturer, production, generation, sale or
distribution of electric or gas energy or other types of energy, and
o companies engaged in telecommunications, including telephone, telegraph,
satellite, microwave and other communications media (but not public
broadcasting or cable television).

The Sub-Advisor, Invista, considers a company to be in the public utilities
industry if, at the time of investment, at least 50% of the company's assets,
revenues or profits are derived from one or more of those industries.

Under normal market conditions, at least 65% (and up to 100%) of the assets of
the Fund are invested in equity securities and fixed-income securities in the
public utilities industry. The Fund may invest up to 35% of its assets in common
stocks, corporate bonds, other equity securities, government bonds and notes
(obligations of the U.S. government or its agencies) and cash. The Fund does not
have any policy to concentrate its assets in any segment of the utilities
industry. The portion of Fund assets invested in equity securities and
fixed-income securities varies from time to time. When determining how to invest
the Fund's assets to achieve its investment objective, Invista considers:
o changes in interest rates,
o prevailing market conditions, and
o general economic and financial conditions.

The Fund invests in fixed income securities, which at the time of purchase, are
o rated in one of the top four categories by S&P or Moody's, or
o if not rated, in the Manager's opinion are of comparable quality.

Since the Fund's investments are concentrated in the utilities industry, the
value of its shares changes in response to factors affecting those industries.
Many utility companies have been subject to risks of:
o increase in fuel and other operating costs;
o changes in interests rates on borrowings for capital improvement programs;
o changes in applicable laws and regulations;
o changes in technology which render existing plants, equipment or products
obsolete;
o effects of conservation; and
o increased costs and delays associated with environmental regulations.

Generally, the prices charged by utilities are regulated with the intention of
protecting the public while ensuring that utility companies earn a return
sufficient to attract capital to grow and provide appropriate services. However,
due to political and regulatory factors, rate changes ordinarily occur following
a change in financing costs. This delay tends to favorably affect a utility
companies earnings and dividends when costs are decreasing but also adversely
affects earnings and dividends when costs are rising. In addition, the value of
the utility company bond prices rise when interest rates fall and fall when
interest rates rise.

Certain states are adopting deregulation plans. These plans generally allow for
the utility company to set the amount of their earnings without regulatory
approval.

The Utilities Fund is generally a suitable investment for investors seeking
quarterly dividends for income or to be reinvested for growth. Suitable
investors want to invest in companies in the utilities industry and are willing
to accept fluctuations in the value of their investment. The share price of the
Fund may fluctuate more widely than the value of shares of a fund that invests
in a broader range of industries. Because of these fluctuations, principal
values and investment returns vary. When shares of the Fund are sold, they may
be worth more or less than the amount paid for them.

INTERNATIONAL GROWTH-ORIENTED FUND

Principal International Emerging Markets Fund, Inc.

The International Emerging Markets Fund seeks to achieve long-term growth of
capital by investing primarily in equity securities of issuers in emerging
market countries.

------------------------------------
Total Returns
Highest and lowest quarterly returns
for the last 1 year
Annual Total Returns Graph for Calendar ------------------------------------
Year Ended 12-31 for years 97* and 98. Quarter Ended Quarterly Return
------------------------------------
mm/dd/yy %
mm/dd/yy %
------------------------------------

* period from August 29, 1997, date shares first offered to public.

Lipper Emerging Markets
Fund Average
Morgan Stanley Capital International
EMF ( Emerging Markets Free) Index
-------------------------------------------------------

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 1.25% 1.25% You would pay the following expenses if
12b-1 Fees......... 0.39% 0.64% you did not redeem your shares:
Other Expenses..... 1.67% 1.70% Class A
----- ----- Class B
Total Fund
Operating Expenses 3.31% 3.59%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since May 1997 Manager: Kurtis D. Spieler, CFA. Vice President of
Invista since 1995.

The International Emerging Markets Fund seeks to achieve its objective by
investing in common stocks of companies in emerging market countries. For this
Fund, the term "emerging market country" means any country which is considered
to be an emerging country by the international financial community (including
the International Bank for Reconstruction and Development (also known as the
World Bank) and the International Financial Corporation). These countries
generally include every nation in the world except the United States, Canada,
Japan, Australia, New Zealand and most nations located in Western Europe.
Investing in many emerging market countries is not feasible or may involve
unacceptable political risk. Invista, the Sub-Advisor, focuses on those emerging
market countries that it believes have strongly developing economies and markets
which are becoming more sophisticated.

Under normal conditions, at least 65% of the Fund's assets are invested in
emerging market country equity securities. The Fund invests in securities of:
o companies with their principal place of business or principal office in
emerging market countries;
o companies for which the principal securities trading market is an emerging
market country; or
o companies, regardless of where its securities are traded, that derive 50% or
more of their total revenue from either goods or services produced in
emerging market countries or sales made in emerging market countries.

Investments in emerging market countries involve special risks. Certain emerging
market countries have historically experienced, and may continue to experience,
certain economic problems. These may include: high rates of inflation, high
interest rates, exchange rate fluctuations, large amounts of debt, balance of
payments and trade difficulties, and extreme poverty and unemployment. In
addition, there are risks involved with any investment in foreign securities
(See Foreign Securities).

Under unusual market or economic conditions, the Fund may invest in the same
kinds of securities as the other Growth-Oriented Funds. These include securities
issued by domestic corporations, governments or governmental agencies,
instrumentalities or political subdivisions. The securities may be denominated
in U. S. dollars or other currencies.

The International Emerging Markets Fund is generally a suitable investment for
investors seeking long-term growth who want to invest a portion of their assets
in securities of companies in emerging market countries. Because the values of
the Fund's assets are likely to rise or fall dramatically, when shares of the
Fund are sold they may be worth more or less than the amount paid for them. This
Fund is not an appropriate investment if you are seeking either preservation of
capital or high current income. You must be able to assume the increased risks
of higher price volatility and currency fluctuations associated with investments
in international stocks which trade in non-U.S. currencies.

INTERNATIONAL GROWTH-ORIENTED FUND

Principal International Fund, Inc.

The International Fund seeks long-term growth of capital by investing in a
portfolio of equity securities of companies domiciled in any of the nations of
the world.

------------------------------------
Total Returns
Highest and lowest quarterly returns
for the last 10 years
Annual Total Returns Graph for Calendar ------------------------------------
Year Ended 12-31 for years 89 through 98. Quarter Ended Quarterly Return
------------------------------------
mm/dd/yy 00.00%
mm/dd/yy (00.00%)
------------------------------------

--------------------------------------------------------
Average annua1 total returns
(for the period ending December 31, 1998)
--------------------------------------------------------
Past One Past Five Past Ten
Year Years Years
-------- --------- --------
Class A % % %
Class B * --

Lipper International
Fund Average
Morgan Stanley Capital
International EAFE (Europe,
Australia and Far East)
Index
--------------------------------------------------------
* Period from December 9, 1994, date Class B shares
first offered to the public, through December 31,
1998.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.68% 0.68% You would pay the following expenses if
12b-1 Fees......... 0.19% 0.74% you did not redeem your shares:
Other Expenses..... 0.38% 0.49% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.25% 1.91%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since April 1994 Manager: Scott D. Opsal, CFA. Executive Vice President
and Chief Investment Officer of Invista since
1997.

The International Fund invests in common stocks of companies established outside
of the U. S. The Fund has no limitation on the percentage of assets that are
invested in any one country or denominated in any one currency. However under
normal market conditions, the Fund intends to have at least 65% of its assets
invested in companies in at least three different countries. One of those
countries may be the U. S. though currently the Fund does not intend to invest
in equity securities of U. S. companies.

Investments may be made anywhere in the world. Primary consideration is given to
securities of corporations of Western Europe, North America and Australasia
(Australia, Japan and Far East Asia). Changes in investments are made as
prospects change for particular countries, industries or companies.

In choosing investments for the Fund, Invista pays particular attention to the
long-term earnings prospects of the various companies under consideration.
Invista then weighs those prospects relative to the price of the security.

The values of the stocks owned by the Fund change on a daily basis. Stock prices
reflect the activities of individual companies as well as general market and
economic conditions. In the short term, stock prices and currencies can
fluctuate dramatically in response to these factors. In addition, there are
risks involved with any investment in foreign securities (See Foreign
Securities). Because the values of the Fund's assets may rise or fall, when
shares of the Fund are sold they may be worth more or less than the amount paid
for them.

The International Fund is generally a suitable investment for investors who seek
long-term growth and who want to invest in non-U.S. companies. This Fund is not
an appropriate investment if you are seeking either preservation of capital or
high current income. Suitable investors must be able to assume the increased
risks of higher price volatility and currency fluctuations associated with
investments in international stocks which trade in non-U.S. currencies.

INTERNATIONAL GROWTH-ORIENTED FUND

Principal International SmallCap Fund, Inc.

The International SmallCap Fund seeks to achieve long-term growth of
capital by investing primarily in equity securities of non-United States
companies with comparatively smaller market capitalizations.

* period from August 29, 1997, date shares first offered to public.

Lipper International Small-Cap
Fund Average
Morgan Stanley Capital International
EAFE (Europe and Far East) Index
-------------------------------------------------------

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 1.20% 1.20% You would pay the following expenses if
12b-1 Fees......... 0.33% 0.61% you did not redeem your shares:
Other Expenses..... 1.13% 1.09% Class A
----- ----- Class B
Total Fund
Operating Expenses 2.66% 2.90%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since May 1997 Manager: Darren K. Sleister, CFA. Investment Officer of
Invista since 1995.

The International SmallCap Fund invests in stocks of non-U.S. companies with
comparatively smaller market capitalizations. Market capitalization is defined
as total current market value of a company's outstanding common stock. Under
normal market conditions, the Fund invests at least 65% of its assets in
securities of companies having market capitalizations of $1 billion or less.
Please review the sections of this prospectus which discuss the risks involved
with any investment in foreign securities (see Foreign Securities) and with
investments in companies with small market capitalizations (see Securities of
Smaller Companies).

The Fund diversifies its investments geographically. There is no limitation of
the percentage of assets that may be invested in one country or denominated in
any one currency. However, under normal market circumstances, the Fund intends
to have at least 65% of its assets invested in securities of companies of at
least three countries.

This Fund is not an appropriate investment if you are seeking either
preservation of capital or high current income. You must be able to assume the
increased risks of higher price volatility and currency fluctuations associated
with investments in international stocks which trade in non-U.S. currencies.

The International SmallCap Fund is generally a suitable investment for investors
seeking long-term growth who want to invest a portion of their assets in
smaller, non-U.S. companies. Because the values of the Fund's assets may rise or
fall, when shares of the Fund are sold they may be worth more or less than the
amount paid for them.

INCOME-ORIENTED FUND

Principal Bond Fund, Inc.

The Bond Fund seeks to provide as high a level of income as is consistent with
preservation of capital and prudent investment risk.

Lehman Brothers BAA
Corporate Index
Lipper Corporate Debt BBB
Rated Fund Average
--------------------------------------------------------
* period from December 9, 1994, date Class B shares
first offered to the public, through December 31, 1998

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.48% 0.48% You would pay the following expenses if
12b-1 Fees......... 0.23% 0.89% you did not redeem your shares:
Other Expenses..... 0.33% 0.44% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.04% 1.81%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since November 1996 Manager: Scott A. Bennett, CFA. Assistant Director -
Securities Investment of Principal Life Insurance
Company since 1996.

The Bond Fund invests in fixed-income securities. Generally, the Fund invests on
a long-term basis but may make short-term investments. Longer maturities
typically provide better yields but expose the Fund to the possibility of
changes in the values of its securities as interest rates change. Generally,
when interest rates fall, the price per share rises, and when rates rise, the
price per share declines.

Under normal circumstances, the Fund invests at least 65% of its assets in:
o debt securities and taxable municipal bonds;
o rated, at the time of purchase, in one of the top four categories by S&P
or Moody's, or
o if not rated, in the Manager's opinion are of comparable quality.
o similar Canadian, Provincial or Federal Government securities payable in
U.S. dollars; and
o securities issued or guaranteed by the U.S. Government or its agencies.

The rest of the Fund's assets are invested in securities that may be convertible
(may be exchanged for a fixed number of shares of common stock of the same
issuer) or nonconvertible including:
o domestic and foreign debt securities;
o preferred and common stock;
o foreign government securities; and
o securities rated less than the four highest grades of S&P or Moody's but not
lower BB- (S&P) or Ba3 (Moody's). (See Risks of High Yield Securities)

During the fiscal year ended October 31, 1998, based on the dollar-weighted
average ratings of the Fund's portfolio at the end of each month in the fiscal
year, net assets of the Fund were invested in securities rated as follows (all
ratings are by Moody's):
20.06% in securities rated A
70.49% in securities rated Baa
8.36% in securities rated Ba

Under unusual market or economic conditions, the Fund may invest up to 100% of
its assets in cash and cash equivalents. (See Temporary Defensive Measures)

The Bond Fund is generally a suitable investment for an investor seeking monthly
dividends to produce income or to be reinvested in additional fund shares to
help achieve modest growth objectives without accepting the risks of investing
in common stocks. However, because of fluctuations in value, when sold, shares
of the Fund may be worth more or less than the amount paid for them.

INCOME-ORIENTED FUND

Principal Government Securities Income Fund, Inc.

The Government Securities Income Fund seeks a high level of current income,
liquidity and safety of principal by purchasing obligations issued or guaranteed
by the United States Government or its agencies, with emphasis on Government
National Mortgage Associations Certificates. The guarantees by the United States
Government extends only to principal and interest. There are certain risks
unique to GNMA Certificates.

Lehman Brothers GNMA Index
Lipper GNMA Fund Average
--------------------------------------------------------
* period from December 9, 1994, date Class B shares
first offered to the public, through December 31, 1998

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.45% 0.45% You would pay the following expenses if
12b-1 Fees......... 0.20% 0.81% you did not redeem your shares:
Other Expenses..... 0.21% 0.31% Class A
----- ----- Class B
Total Fund
Operating Expenses 0.86% 1.57%
- --------------------------------------------------------------------------------

Day-to-day Fund Management:
Since May 1985 Manager: Martin J. Schafer, CFA. Vice President of
Invista since 1992.

The Government Securities Income Fund invests in U. S. Government securities,
which include obligations issued or guaranteed by the U. S. Government or its
agencies or instrumentalities. The Fund may invest in securities supported by:
o full faith and credit of the U. S. Government (e.g. GNMA certificates); or
o credit of the instrumentality (e.g. bonds issued by the Federal Home Loan
Bank).

Although some of the securities the Fund purchases are backed by the U.S.
government and its agencies, shares of the Fund are not guaranteed. Generally,
when interest rates fall, the value of the Fund's shares rises, and when rates
rise, the value declines. Because of the fluctuation in values of the Fund's
shares, when sold, shares of the Fund may be worth more or less than the amount
paid for them.

U.S. Government securities do not involve the degree of credit risk associated
with investments in lower quality fixed-income securities. As a result, the
yields available from U.S. Government securities are generally lower than the
yields available from many other fixed-income securities. Like other
fixed-income securities, the values of U.S. Government securities change as
interest rates fluctuate. Fluctuations in the value of the Fund's securities do
not effect interest income on securities already held by the Fund, but are
reflected in the Fund's price per share. Since the magnitude of these
fluctuation generally are greater at times when the Fund's average maturity is
longer, under certain market conditions the Fund may invest in short term
investments yielding lower current income rather than investing in higher
yielding longer term securities.

GNMA Certificates are mortgage backed securities representing an interest in a
pool of mortgage loans. Various lenders make the loans which are then insured
(by the Federal Housing Administration) or loans which are guaranteed (by
Veterans Administration or Farmers Home Administration). The lender or other
security issuer creates a pool of mortgages which it submits to GNMA for
approval.

The Fund invests in modified pass-through GNMA Certificates. Owners of
Certificates receive all interest and principal payments owed on the mortgages
in the pool, regardless of whether or not the mortgagor has made the payment.
Timely payment of interest and principal is guaranteed by the full faith and
credit of the U. S. Government.

Mortgage backed securities are subject to prepayment risk. Prepayments,
unscheduled principal payments, may result from voluntary prepayment,
refinancing or foreclosure of the underlying mortgage. When interest rates
decline, significant unscheduled prepayments may result. These prepayments must
then be reinvested at lower rates. Prepayments may also shorten the effective
maturities of these securities, especially during periods of declining interest
rates. On the other hand, during period of rising interest rates, a reduction in
prepayments may increase the effective maturities of these securities,
subjecting them to the risk of decline in market value in response to rising
interest and potentially increasing the volatility of the fund.

In addition, prepayments may cause losses on securities purchased at a premium
(dollar amount by which the price of the bond exceeds its face value). At times,
mortgage backed securities may have higher than market interest rates and are
purchased at a premium. Unscheduled prepayments are made at par and cause the
Fund to experience a loss of some or all of the premium.

The Government Securities Income Fund is generally a suitable investment for
investors who want monthly dividends to provide income or to be reinvested in
additional Fund shares to produce growth. Such investors prefer to have the
repayment of principal and interest on most of the securities in which the Fund
invests to be back by the U.S. Government or its agencies.

INCOME-ORIENTED FUND

Principal High Yield Fund, Inc.

The High Yield Fund seeks high current income primarily by purchasing high
yielding, lower or non-rated fixed income securities which are believed not to
involve undue risk to income or principal. Capital growth is a secondary
objective when consistent with the objective of high current income.

Lehman Brothers High Yield
Composite Bond Index
Lipper High Current Yield
Fund Average
--------------------------------------------------------
* period from December 9, 1994, date Class B shares
first offered to the public, through December 31, 1998

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.60% 0.60% You would pay the following expenses if
12b-1 Fees......... 0.25% 1.03% you did not redeem your shares:
Other Expenses..... 0.55% 0.71% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.40% 2.34%
- --------------------------------------------------------------------------------

During the fiscal year ended October 31, 1998, based on the dollar-weighted
average ratings of the Fund's portfolio at the end of each month in the fiscal
year, net assets of the Fund were invested in securities rated as follows (all
ratings are by Moody's):
34.62% in securities rated Ba
62.28% in securities rated B
2.93% in securities rated C

Day-to-day Fund management:
Since April 1998 Manager: Mark P. Denkinger, CFA. Assistant Director -
Securities Investment of Principal Life
Insurance Company since 1998.

The High Yield Fund invests in high yield, lower or unrated fixed income
securities commonly known as "junk bonds." (See Risks of High Yield Securities)
The Fund invests its assets in securities rated Ba1 or lower by Moody's or BB+
or lower by S&P. The Fund may also invest in unrated securities which the
Manager believes to be of comparable quality. These securities are considered to
be speculative with respect to the issuer's ability to pay interest and repay
principal. The Fund does not invest in securities rated below Caa (Moody's) or
below CCC (S&P) at the time of purchase. The SAI contains descriptions of the
securities rating categories.

Investors assume special risks when investing in the Fund. Compared to higher
rated securities, lower rated securities may:
o have a more volatile market value, generally reflecting specific events
affecting the issuer;
o be subject to greater risk of loss of income and principal (issuers are
generally not as financially secure);
o have a lower volume of trading, making it more difficult to value or sell
the security; and
o be more susceptible to a change in value or liquidity based on adverse
publicity and investor perception, whether or not based on factual analysis.

The market for higher-yielding, lower rated securities has not been tested by an
economic recession. An economic downturn may severely disrupt the market for
these securities. This could cause financial stress to the issuer negatively
affecting the issuer's ability to pay principal and interest. This may also
negatively affect the value of the Fund's securities. In addition if an issuer
defaults, the Fund may have additional expenses if it tries to recover the
amounts due it.

Some securities the Fund buys have call provisions. A call provision allows the
issuer of the security to redeem it before its maturity date. If a bond is
called in a declining interest rate market, the Fund would have to replace it
with a lower yielding security. This results in a decreased return for
investors. In addition, in a rising interest rate market, a higher yielding
security's value decreases. This is reflected in a lower share price for the
Fund.

The Fund tries to minimize the risks of investing in lower rated securities by
diversification, investment analysis and attention to current developments in
interest rates and economics conditions. Although the Fund's Manager considers
security ratings when making investment decisions, it performs its own
investment analysis. This analysis includes traditional security analysis
considerations such as:
o experience and managerial strength
o changing financial conditio
o borrowing requirements or debt maturity schedules
o responsiveness to changes in business conditions
o relative value based on anticipated cash flow
o earnings prospects

The Manager continuously monitors the issuers of the Fund's securities to
determine if the issuers will have sufficient cash flow and profits to meet
required principal and interest payments. It also monitors each security to
assure the security's liquidity so the Fund can meet requests for sales of Fund
shares.

For defensive purposes, the Fund may invest in other securities. During periods
of adverse market conditions, the Fund may invest in all types of money market
instruments, higher rated fixed income securities or any other fixed income
securities consistent with the temporary defensive strategy. The yield to
maturity on these securities is generally lower than the yield to maturity on
lower rated fixed income securities.

The High Yield Fund is generally a suitable investment for investors seeking
monthly dividends to provide income or to be reinvested in Fund shares for
growth. However, it is suitable only for that portion of the investor's
investments for which the investor is willing to accept potentially great risk.
You should carefully consider your ability to assume the risks of this Fund
before making an investment. You should be prepared to maintain your investment
in the Fund during periods of adverse market conditions. This Fund should not be
relied on to meet short term financial needs. When shares of the Fund are sold,
they may be worth more or less than the amount paid for them.

INCOME-ORIENTED FUND

Principal Limited Term Bond Fund, Inc.

The Limited Term Bond Fund seeks a high level of current income consistent with
a relatively high level of principal stability by investing in a portfolio of
securities with a dollar weighted average maturity of five years or less.

------------------------------------
Total Returns
Highest and lowest quarterly returns
for the last 2 years
Annual Total Returns Graph for Calendar ------------------------------------
Year Ended 12-31 for years 96* through 98. Quarter Ended Quarterly Return
------------------------------------
mm/dd/yy %
mm/dd/yy %
------------------------------------

Lehman Brothers Intermediate
Government/Corporate Index
Lipper Short-Intermediate Investment
Grade Debt Fund Average
-------------------------------------------------------

* period from February 29, 1996, date shares first offered to public.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.50% 0.50% You would pay the following expenses if
12b-1 Fees......... 0.15% 0.50% you did not redeem your shares:
Other Expenses..... 0.48% 1.36% Class A
----- ----- Class B
Total Fund
Operating Expenses 1.13% 2.36%
- --------------------------------------------------------------------------------

During the fiscal year ended October 31, 1998, based on the dollar-weighted
average ratings of the Fund's portfolio at the end of each month in the fiscal
year, net assets of the Fund were invested in securities rated as follows (all
ratings are by Moody's):
7.01% in securities rated Aa
6.60% in securities rated A
73.44% in securities rated Baa
12.95% in securities rated Ba

Day-to-day Fund management:
Since February 1996 Manager: Martin J. Schafer, CFA. Vice President of
Invista since 1992.

The Limited Term Bond Fund invests in high grade, short term debt securities.
Under normal circumstances, it invests at least 80% of its assets in:
o securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities;
o debt securities of U.S. issuers rated in the three highest grades by S&P or
Moody's; or
o if unrated, are of comparable quality in the opinion of the Sub-Advisor,
Invista.

The rest of the Fund's assets are invested in securities in the fourth highest
rating category or their equivalent. Securities in the fourth highest category
are "investment grade." While they are considered to have adequate capacity to
pay interest and repay principal, they do have speculative characteristics.
Changes in economic and other conditions are more likely to impact the ability
of the issuer to make principal and interest payments than is the case with
higher rated securities.

The Fund may invest in corporate debt securities and mortgage backed securities.
For a discussion of mortgage backed securities, see the discussion of the U. S.
Government Securities Income Fund.

Under normal circumstances, the Fund maintains a dollar weighted average
maturity of not more than five years. In determining the average maturity of the
Fund's assets, the maturity date of callable or prepayable securities may be
adjusted to reflect Invista's judgment regarding the likelihood of the security
being called or prepaid.

Under unusual market or economic conditions, for temporary defensive purposes
the Fund may invest up to 100% of its assets in the cash or cash equivalents.

The Limited Term Bond Fund is generally a suitable investment for investors who
want monthly dividends for income or to reinvest for modest growth. Suitable
investors are willing to accept some volatility in the value of their investment
but do not want dramatic volatility.

INCOME-ORIENTED FUND

Principal Tax-Exempt Bond Fund, Inc.

The Tax-Exempt Bond Fund seeks as high a level of current income exempt
from federal income tax as is consistent with preservation of capital. The Fund
seeks to achieve its objective primarily through the purchase of investment
grade quality, tax-exempt fixed income obligations.

------------------------------------
Total Returns
Highest and lowest quarterly returns
for the last 10 years
Annual Total Returns Graph for Calendar ------------------------------------
Year Ended 12-31 for years 89 through 98. Quarter Ended Quarterly Return
mm/dd/yy %
mm/dd/yy %
------------------------------------

--------------------------------------------------
Average annua1 total returns
(for the period ending December 31, 1998)
--------------------------------------------------
Past One Past Five Past Ten
Year Years Years
-------- --------- --------
Class A % % %
Class B * --

Lehman Brothers Municipal
Bond Index
Lipper General Municipal Debt
Fund Average
---------------------------------------------------
* Period from December 9, 1994, date Class B
shares first offered to public, through
December 31, 1998.

The year to date return as of December 31, 1998 for Class A shares is __.__% and
for Class B shares is __.__%.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.47% 0.47% You would pay the following expenses if
12b-1 Fees......... 0.23% 0.69% you did not redeem your shares:
Other Expenses..... 0.13% 0.27% Class A
----- ----- Class B
Total Fund
Operating Expenses 0.83% 1.43%
- --------------------------------------------------------------------------------

During the fiscal year ended October 31, 1998, based on the dollar-weighted
average ratings of the Fund's portfolio at the end of each month in the fiscal
year, net assets of the Fund were invested in securities rated as follows (all
ratings are by Moody's):
18.35% in securities rated AA
46.96% in securities rated A
33.27% in securities rated BBB

Day-to-day Fund management:
Since July 1991 Manager: Daniel J. Garrett, CFA. Assistant Director -
Securities Investment of Principal Life
Insurance Company since 1994.

The Tax-Exempt Bond Fund invests in a diversified portfolio of securities issued
by or on behalf of state or local governments and other public authorities. In
the opinion of the issuer's bond counsel, interest on these obligations is
exempt from federal income tax. Investment in the Fund is not appropriate for
IRA or other tax-advantaged accounts.

Under normal market conditions, the Fund invests at least 80% of its assets in
municipal obligations. At the time these securities are purchased, they are:
o municipal bonds which are rated in the four highest grades by Moody's;
o municipal notes rated in the highest grade by Moody's;
o municipal commercial paper rated in the highest grade by Moody's or S&P; or
o if unrated, are of comparable quality in the opinion of the Manager.

During normal market conditions, the Fund will not invest more than 20% of its
assets in:
o securities that do not meet the criteria stated above;
o taxable securities; or
o municipal obligations the interest on which is treated as a tax preference
item for purposes of the federal alternative minimum tax.

Up to 20% of Fund assets may be invested in debt securities rated lower than BBB
by S&P or Baa by Moody's. These are sometimes referred to as "junk bonds" and
are considered speculative (See Risks of High Yield Securities). The Fund will
not purchase municipal bonds rated lower than B by Moody's or S&P. It also will
not buy municipal notes or commercial paper which are unrated or are not
comparable in quality to rated securities.

The Fund may not invest more than 5% of its assets in the securities of any one
issuer (except U. S. Government securities). It may invest without limit in
obligations of issuers located in the same state. It may also invest in debt
obligations which are repayable out of revenue from economically related
projects or facilities. This represents a risk to the Fund since an economic,
business or political development or change affecting one security could also
affect others.

The Fund may purchase industrial development bonds. These securities are issued
by industrial development authorities. They may only be backed by the assets and
revenues of the industrial corporation which uses the facility financed by the
bond.

The Fund may also invest in taxable securities which mature one year or less
from the time of purchase. These taxable investments are generally made for
liquidity purposes or as a temporary investment of cash pending investment in
municipal obligations.

Under unusual market or economic conditions, for temporary defensive purposes
the Fund may invest more than 20% of its assets in taxable securities.

The Tax-Exempt Bond Fund is generally a suitable investment for investors
seeking monthly, federally tax-exempt dividends for income or to be reinvested
for modest growth and who are willing to accept fluctuations in the value of
their investment.

MONEY MARKET FUNDS

Principal Cash Management Fund, Inc.

Principal Cash Management Fund seeks as high a level of income available from
short-term securities as is considered consistent with preservation of principal
and maintenance of liquidity by investing in a portfolio of money market
instruments.

Annual Total Returns Graph for Calendar
Year Ended 12-31 for years 89 through 98.

The 7-day yield ending on December 31, 1998 for Class A shares is __.__% and for
Class B shares is __.__%. To obtain the Fund's current yield information, please
call 1-800-247-4123.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class B Class A $ $ $ $
------- ------- Class B
Management Fees.... 0.38% 0.42% You would pay the following expenses if
12b-1 Fees......... -- 0.32% you did not redeem your shares:
Other Expenses..... 0.18% 0.75% Class A
----- ----- Class B
Total Fund
Operating Expenses 0.56% 1.49%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since March 1983 Manager: Michael R. Johnson. Assistant Director -
Securities Trading of Principal Life Insurance
Company since 1994.

MONEY MARKET FUND

Principal Cash Management Fund, Inc.

The Cash Management Fund seeks as high a level of income available from short
term securities as is considered consistent with preservation of principal and
maintenance of liquidity by investing in a portfolio of money market
instruments.

The Fund invests its assets in a portfolio of money market instruments. The
investments are U. S. dollar denominated securities which the Manager believes
present minimal credit risks. At the time the Fund purchases each security, it
is an "eligible security" as defined in the regulations issued under the
Investment Company Act of 1940.

The Fund maintains a dollar weighted average portfolio maturity of 90 days or
less. It intends to hold its investments until maturity. However, the Fund may
sell a security before it matures:
o to take advantage of market variations;
o to generate cash to cover sales of Fund shares by its shareholders; or
o upon revised credit opinions of the security's issuer.

The sale of a security by the Fund before maturity may not be in the best
interest of the Fund. The Fund does have an ability to borrow money to cover the
sale of Fund shares. The sale of portfolio securities is usually a taxable
event.

It is the policy of the Fund to be as fully invested as possible to maximize
current income. Securities in which the Fund invests include:
o Government securities which are issued or guaranteed by the U. S.
Government, including treasury bills, notes and bonds.
o U.S. Government agency securities which are issued or guaranteed by agencies
or instrumentalities of the U. S. Government. These are backed either by the
full faith and credit of the U. S. Government or by the credit of the
particular agency or instrumentality.
o Bank obligations consisting of:
certificates of deposit which generally are negotiable certificates against
funds deposited in a commercial bank or
bankers acceptances which are time drafts drawn on a commercial bank,
usually in connection with international commercial transactions.
o Commercial paper which is short term promissory notes issued by U. S. or
foreign corporations primarily to finance short term credit needs.
o Short term corporate debt consisting of notes, bonds or debentures which at
the time of purchase by the Fund has 397 days or less remaining to maturity.
o Repurchase agreements under which securities are purchased with an agreement
by the seller to repurchase the security at the same price plus interest at
a specified rate. Generally these have a short duration (less than a week)
but may also have a longer one.
o Taxable municipal obligations which are short term obligations issued or
guaranteed by state and municipal issuers which generate taxable income.

An investment in the Fund is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. Although the Fund seeks to
preserve the value of your investment at $1.00 per share, it is possible to lose
money by investing in the Fund.

The Cash Management Fund is generally a suitable investment for investors
seeking monthly dividends to produce income without incurring much principal
risk or for investors short-term needs.

THE COSTS OF INVESTING

Fees and Expenses of the Funds

This table describes the fees and expenses that you may pay if you buy and hold
shares of a Fund.
<TABLE>
<CAPTION>
Shareholder Fees
(fees paid directly from your investment)

Class A Shares Class B Shares
-------------------- --------------------------------
Maximum Sales Charge Maximum Deferred Sales Charge
on Purchases (as a percentage of the lower of
(as a percentage of the original purchase price
offering price) or current market value)
-------------------- --------------------------------
Redemptions During Year
--------------------------------
1 2 3 4 5 6 7
- - - - - - -
All Funds except Limited Term Bond Fund
<S> <C> <C> <C> <C> <C> <C> <C> <C>
and Money Market Funds 4.75% 4% 4% 3% 3% 2% 1% 0%
Limited Term Bond Fund 1.50% 1.25% 1.25% .75% .75% .50% .25% 0%
Money Market Funds None 4% 4% 3% 3% 2% 1% 0%
<FN>
Notes:
o Class A and Class B shares do not have an exchange or redemption fee.
o A wire charge of $6.00 will be deducted for all wire transfers.
o Class A shares have no deferred sales charge on sales of less than $1
million.
o Class B shares have no frontend sales charge.
</FN>
</TABLE>

Fees and expenses are important because they lower your earnings. However, low
costs do not guarantee higher earnings. For example, a fund with no front-end
sales charge may have higher ongoing expenses than a fund with such a sales
charge. Before investing, you should be sure you understand the nature of
different costs. Your Registered Representative can help you with this process.

One-time fees. You may pay a one-time sales charge for each purchase (Class A
shares) or sale (Class B shares).

o Class A shares may be purchased at a price equal to the share price plus an
initial sales charge.
o Purchases of $1 million or more of Class A shares are sold without an
initial sales charge but may be subject to a contingent deferred sales
charge (CDSC) at the time of redemption.
o Class B shares have no initial sales charge but may be subject to a
contingent deferred sales charge (CDSC). If you sell (redeem) shares and the
CDSC is imposed, it will reduce the amount of sales proceeds. (see
Contingent deferred sales charge: Class B shares)

Front-end sales charge: Class A shares
There is no sales charge on purchases of Class A shares of the Cash Management
Fund or on shares of any of the funds purchased with reinvested dividends or
other distributions. Class A shares of the other Funds are sold with a sales
charge that is a variable percentage based on the amount of the purchase. This
table shows the sales charge for those funds which is based on the amount of
your purchase.
<TABLE>
<CAPTION>
Sales Charge for All Funds (Except Sales Charge for
Limited Term Bond Fund Limited Term Bond Fund) Dealers Allowance as
Sales Charge as % of: Sales Charge as % of: % of Offering Price
------------------------ ----------------------- ---------------------
Offering Net Amount Offering Net Amount All Funds Except Limited Term
Amount invested Price Invested Price Invested Limited Term Bond Bond
--------------- -------- ---------- -------- ---------- ----------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Less than $50,000 4.75% 4.99% 1.50% 1.52% 4.00% 1.25%
$50,000 but less than $100,000 4.25% 4.44% 1.25% 1.27% 3.75% 1.00%
$100,000 but less than $250,000 3.75% 3.90% 1.00% 1.10% 3.25% 0.75%
$250,000 but less than $500,000 2.50% 2.56% 0.75% 0.76% 2.00% 0.50%
$500,000 but less than $1,000,000 1.50% 1.52% 0.50% 0.50% 1.25% 0.25%
$1,000,000 or more 0 0 0 0 0.75% 0.25%
</TABLE>

The front-end sales charge is waived on an investment of $1 million or more in
Class A shares. There may be a CDSC on shares sold within 18 months of the
purchase date. The CDSC does not apply to shares purchased with reinvested
dividends or other distributions. The CDSC is calculated as 0.75% (0.25% for the
Limited Term Bond Fund) of the lesser of the current market value or the initial
purchase price of the shares sold. The CDSC is waived on shares sold to fund a
Principal Mutual Fund 401(a) or Principal Mutual Fund 401(k) retirement plan,
except redemptions which are the result of termination of the plan or transfer
of all plan assets. The CDSC is also waived
o on shares sold to satisfy IRS minimum distribution rules
o using a periodic withdrawal plan. (You may sell up to 10% of the value of
the shares subject to a CDSC without paying the CDSC.)

In the case of selling some but not all of the shares in an account, the shares
not subject to a sales charge are redeemed first. Other shares are redeemed in
the order purchased (first in, first out). Shares subject to the CDSC which are
exchanged into another Principal Mutual Fund continue to be subject to the CDSC
until the CDSC expires.

Broker-dealers that sell Principal Mutual Funds are paid a certain percentage of
the sales charge in exchange for their services. At the option of Princor
Financial Services Corporation, the amount paid to a dealer may be more or less
than that shown in the chart above. The amount paid depends on the services
provided. Amounts paid to dealers on purchases without an front-end sales charge
are determined by and paid for by Princor.

SALES CHARGE WAIVER OR REDUCTION

Class A shares of the Funds may be purchased without a sales charge or at a
reduced sales charge. The Funds reserve the right to change or stop offering
shares in this manner at any time for new accounts and with 60 days notice to
shareholders of existing accounts.

Waiver of sales charge. A Fund's Class A shares may be purchased without a
sales charge:
o by its Directors, Principal Life and its subsidiaries and their employees,
officers, directors (active or retired), brokers or agents. This also
includes their immediate family members and trusts for the benefit of these
individuals;
o by the Principal Employees' Credit Union;
o by non-ERISA clients of Invista;
o by any employee or Registered Representative (and their employees) of an
authorized broker-dealer;
o through broker-dealers, investment advisors and other financial institutions
that have entered into an agreement with Princor which includes a
requirement that such shares be sold for the benefit of clients
participating in a "wrap account" or similar program under which clients pay
a fee to the broker-dealer, investment advisor or financial institution;
o by unit investment trusts sponsored by Principal Life and/or its
subsidiaries or affiliates;
o by certain employee welfare benefit plan customers of Principal Life with
Plan Deposit Accounts;
o by participants who receive distributions from certain annuity contracts
offered by Principal Life (except for shares of Tax-Exempt Bond Fund);
o to the extent the investment represents the proceeds of a total surrender of
certain Principal Life issued unregistered group annuity contract if
Principal Life waives any applicable CDSC or other contract surrender
charge; and
o to the extent the purchase proceeds represent a distribution from a
terminating 401(a) plan if the employer or plan trustee has entered into a
written agreement with Princor permitting the group solicitation of
employees/participants. Such purchases are subject to the CDSC which applies
to purchases of $1 million or more as described above.

Class A shares may also be purchased without a sales charge if your Registered
Representative has recently become affiliated with a broker-dealer authorized to
sell shares of the Principal Mutual Funds. The following conditions must be met;
o your purchase of Class A shares must take place within the first 180 days of
your Registered Representative's affiliation with the authorized
broker-dealer;
o your investment must represent the sales proceeds from other mutual fund
shares (you must have paid a front-end sales charge or a CDSC) and the sale
must occur within the 180 day period; and
o you must indicate on your Principal Mutual Fund application that you are
eligible for waiver of the front-end sales charge.
o you must send us either:
o the check for the sales proceeds (endorsed to Principal Mutual Funds) or
o a copy of the confirmation statement from the other mutual fund showing
the sale transaction. If you place your order to buy Principal Mutual Fund
shares on the telephone, you must send us a copy of the confirmation
within 21 days of placing the order. If we do not receive the confirmation
within 21 days, we will sell enough of your Class A shares to pay the
sales charge that otherwise would have been charged.

NOTE: Please be aware that the sale of your other mutual funds shares may be
subject to federal (and state) income taxes. In addition, you may pay a
surrender charge to the other mutual fund.

Reduction of sales charge.
1) Dollar amount of purchase. The sales charge varies with the size of your
purchase. Reduced charges apply to the total of Principal Mutual Funds'
(excluding the Cash Management Fund) shares purchased at one time by any
"Qualified Purchaser." A Qualified Purchaser includes an individual and his/her
spouse and their children under the age of 25, a trust primarily for such
persons, and a trustee or other fiduciary purchasing for a single trust estate
or single fiduciary account. If the total amount being invested in the Principal
Funds is near a sales charge breakpoint, you should consider increasing amount
invested to take advantage of a lower sales charge. A purchase made by or
through an employer on behalf of an employee or employees (including independent
contractors) is also considered a purchase by a Qualified Purchaser.

2) Statement of intention (SOI). Qualified Purchasers may obtain reduced sales
charges by signing an SOI. The SOI is a nonbinding obligation on the Qualified
Purchaser to purchase the full amount indicated in the SOI. The sales charge is
based on the total amount to be invested in a 13 month period (24 months if the
intended investment is $1 million or more). Upon your request, we will set up a
90 day lookback period to include earlier purchases - the 13 (24) month period
then begins on the date of your first purchase during the 90-day period. If the
intended investment is not made, sufficient shares will be sold to pay the
additional sales charge due. A 401(a) plan trustee must submit the SOI at the
time of the first plan purchase. The 90-day lookback period is not available to
a 401(a) plan trustee.

3) Rights of accumulation. The Class A and Class B shares already owned by a
Qualified Purchaser are added to the amount of the new purchase to determine the
applicable sales charge percentage. Class A shares of the Cash Management Fund
are not included in the calculation unless they were acquired in exchange for
other Principal Mutual Fund shares.

4) Death Benefit proceeds. Death benefit proceeds from a life insurance policy
or certain annuity contracts issued by Principal Life (or its subsidiaries or
affiliates) may be invested in Class A shares at a reduced sales charge. To
qualify for the reduced sales charge, the proceeds must be applied to the
purchase of shares of a Principal Mutual Fund within one year of the insured's
death. The applicable sales charge is determined by the table below.
<TABLE>
<CAPTION>
Sales Charge as a % of:

Net Dealer Allowance
Offering Amount as % of
Amount of Purchase Price Invested Offering Price
------------------ -------- -------- ----------------
<S> <C> <C> <C> <C>
Less than $500,000 2.50% 2.56% 2.10%
$500,000 but less than 1.50% 1.52% 1.25%
$1,000,000 No Sales Charge
$1,000,000 or more
</TABLE>

5) Employer sponsored plans. Retirement plans meeting the requirements of
Section 401 of the Code (401(k), Profit Sharing and Money Purchase Pension
Plans) and other employer sponsored retirement plans (SIMPLE IRAs, SEPs,
SAR-SEPs, non-qualified deferred compensation plans, and Payroll Deduction
Plans). The employer chooses to fund the Plan with either Class A or Class B
shares when the plan is established.

a) Principal Mutual Fund 401 Plans.

o If Class A shares are used:
o all plan investments are treated as made by a single investor to
determine the applicable sales charge,
o the sales charge for investments of less than $250,000 is 3.75% as a
percentage of offering price (3.90% of net amount invested), and
o if the investment is $250,000 or more, the regular sales charge
table is used (see Front-end sales charge: Class A shares).
o If Class B shares are used:
o contributions into the plan after the plan assets are $250,000 or
more are used to buy Class A shares.
o Plan assets are not combined with investments made outside of the plan
to determine the applicable sales charge.
o Investments by plan participants outside the plan are not included
with plan assets to determine the applicable sales charge.

b) Other employer sponsored retirement plans.

o If Class A shares are used:
o all plan investments are treated as made by a single investor to
determine the applicable sales charge,
o the sales charge for investments of less than $250,000 is 3.75% as a
percentage of offering price (3.90% of net amount invested), and
o if the investment is $250,000 or more, the regular sales charge
table is used (see Front-end sales charge: Class A shares).
o If Class B shares are used:
o contributions into the plan for a plan participant, after the plan
assets of that plan participant are $250,000 or more, are used to
buy Class A shares (unless the plan participante elects otherwise).
o Plan assets are not combined with investments made outside of the plan
to determine the applicable sales charge.
o Investments by plan participants outside the plan are not included
with plan assets to determine the applicable sales charge.

c)Participants of Principal Mutual Fund 403(b) plans may buy Fund shares
at the same sales charge levels available to other employer sponsored
plans described above. Contributions by plan participants are not
combined to determine the applicable sales charge.

Contingent deferred sales charge: Class B shares
A CDSC is imposed on sales of Class B shares within six years of purchase (five
years for certain sponsored plans). Princor receives the proceeds of any CDSC.
The CDSC does not apply to shares purchased with reinvested dividends or other
distributions. The amount of the CDSC is a percentage based on the number of
years you own the shares multiplied by the lesser of the current market value or
the initial purchase price of the shares sold.

o In the case of selling some but not all of the shares in an account, the
shares not subject to a sales charge are redeemed first. Other shares are
redeemed in the order purchased (first in, first out).
o Using a periodic withdrawal plan, you may sell up to 10% of the value of the
shares subject to a CDSC without paying the CDSC.
o Shares subject to the CDSC which are exchanged into another Principal Mutual
Fund continue to be subject to the CDSC until the CDSC expires.

<TABLE>
<CAPTION>
Contingent Deferred Sales Charge
as a Percentage of
Dollar Amount Subject to Charge
--------------------------------
For Certain Sponsored Plans
Commenced After 2/1/98
------------------------------------
All Funds All Funds
Years Since Purchase Except Limited Term Limited Term Except Limited Term Limited Term
Payments Made Bond Fund Bond Fund Bond Fund Bond Fund
-------------------- ------------------- ------------ ------------------- ------------
<S> <C> <C> <C> <C> <C>
2 years or less 4.0% 1.25% 3.00% .75%
more than 2 years, up to 4 years 3.0% 0.75% 2.00% .50%
more than 4 years, up to 5 years 2.0% 0.50% 1.00% .25%
more than 5 years, up to 6 years 1.0% 0.25% None None
more than 6 years None None None None
</TABLE>

Class B shares of the Cash Management Fund may be purchased only by exchange
from other Class B share accounts. Class B shares automatically convert into
Class A shares (based on share prices, not numbers of shares) 7 years after
purchase. Class B shares provide you the benefit of putting all your dollars to
work from the time of investment, but (until conversion) have higher ongoing
fees and lower dividends than Class A shares.

WAIVER OF THE SALES CHARGE

The CDSC will be waived on sales of Class B shares which are sold

o due to a shareholder's death;
o due to the shareholder's disability, as defined in the Internal Revenue
Code;
o from retirement plans to satisfy minimum distribution rules under the Code;
o to pay surrender charges;
o to pay retirement plan fees;
o involuntarily from small balance accounts;
o through a systematic withdrawal plan;
o from a retirement plan to assure the plan complies with Sections 401(k),
401(m) 408(k) and 415 of the Code; or
o from retirement plans qualified under Section 401(a) of the Code due to the
plan participant's death, disability, retirement or separation from service
after attaining age 55.

Ongoing fees. Each Fund pays ongoing operating fees to its Manager, Underwriter
and others who provide services to the Fund. They reduce the value of each share
you own. See MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE and Distribution
(12b-1) Fees.

Distribution (12b-1) Fees
Each of the Funds (except the Cash Management Fund for Class A shares) has
adopted a Distribution Plan under Rule 12b-1 of the Investment Company Act of
1940. Under the Plan, the Fund pays a fee to Princor based on the average daily
net asset value of the Fund. These ongoing fees pay expenses relating to
distribution fees for the sale of Fund shares and for services provided by
Princor and other selling dealers to shareholders. Because they are ongoing
fees, over time they may exceed other types of sales charges.

The maximum 12b-1 fees that may be paid by the Funds on an annual basis are:
o Class A shares (except Cash Management and Limited Term Bond Funds) 0.25%
o Class A shares of the Limited Term Bond Fund 0.15%
o Class B shares (except the Limited Term Bond Fund) 1.00%
o Class B shares of the Limited Term Bond Fund 0.50%

PRIMARY INVESTMENT STRATEGIES AND RELATED RISKS

The Statement of Additional Information (SAI) contains additional information
about investment strategies and their related risks.

Securities and Investment Practices
Equity Securities include common stocks, preferred stocks, convertible
securities and warrants. Common stocks, the most familiar type, represent an
equity (ownership) interest in a corporation. Although equity securities have a
history of long term growth in value, their prices fluctuate based on changes in
a company's financial condition and on overall market and economic conditions.
Smaller companies are especially sensitive to these factors.

Debt securities include bonds and other debt instruments that are used by
issuers to borrow money from investors. The issuer generally pays the investor a
fixed, variable or floating rate of interest. The amount borrowed must be repaid
at maturity. Some debt securities, such as zero coupon bonds, do not pay current
interest, but are sold at a discount from their face values.

Debt securities are sensitive to changes in interest rates. In general, bond
prices rise when interest rates fall and fall when interest rates rise. Longer
term bonds and zero coupon bonds are generally more sensitive to interest rate
changes.

Bond prices are also affected by the credit quality of the issuer. Investment
grade debt securities are medium and high quality securities. Some bonds may
have speculative characteristics and be particularly sensitive to economic
conditions and the financial condition of the issuers.

Repurchase Agreements and Loaned Securities
Each of the Principal Mutual Funds may invest a portion of its assets in
repurchase agreements. Repurchase agreements typically involve the purchase of
debt securities from a financial institution such as a bank, savings and loan
association or broker-dealer. A repurchase agreement provides that the Fund
sells back to the seller and that the seller repurchases the underlying
securities at a specified price on a specific date. Repurchase agreements may be
viewed as loans by a Fund collateralized by the underlying securities. This
arrangement results in a fixed rate of return that is not subject to market
fluctuation while the Fund holds the security. In the event of a default or
bankruptcy by a selling financial institution, the affected Fund bears a risk of
loss. To minimize such risks, the Fund enters into repurchase agreements only
with large, well-capitalized and well-established financial institutions. In
addition, the value of the collateral underlying the repurchase agreement is
always at least equal to the repurchase price, including accrued interest.

Each of the Principal Mutual Funds, except the Capital Value, Growth and Cash
Management Funds, may lend its portfolio securities to unaffiliated
broker-dealers and other unaffiliated qualified financial institutions.

Currency Contracts
The International, International Emerging Markets and International SmallCap
Funds may each enter into forward currency contracts, currency futures contracts
and options, and options on currencies for hedging and other non-speculative
purposes. A forward currency contract involves a privately negotiated obligation
to purchase or sell a specific currency at a future date at a price set in the
contract. A Fund will not hedge currency exposure to an extent greater than the
aggregate market value of the securities held or to be purchased by the Fund
(denominated or generally quoted or currently convertible into the currency).

Hedging is a technique used in an attempt to reduce risk. If a Fund's Manager or
Sub-Advisor hedges market conditions incorrectly or employs a strategy that does
not correlate well with the Fund's investment, these techniques could result in
a loss, regardless of whether the intent was to reduce risk or to increase
return. These techniques may increase the volatility of a Fund and may involve a
small investment of cash relative to the magnitude of the risk assumed. In
addition, these techniques could result in a loss if the other party to the
transaction does not perform as promised. Additionally, there is the risk of
government action through exchange controls that would restrict the ability of
the Fund to deliver or receive currency.

Forward Commitments
Each of the Income-Oriented Funds and the Balanced Fund may enter into forward
commitment agreements. These agreements call for the Fund to purchase or sell a
security on a future date at a fixed price. Each of these Funds may also enter
into contracts to sell its investments either on demand or at a specific
interval.

Warrants
Each of the Funds (except Cash Management, Government Securities Income and
Tax-Exempt Bond) may invest up to 5% of its assets in warrants. Up to 2% of a
Fund's assets may be invested in warrants which are not listed on either the New
York or American Stock Exchanges. For the International, International Emerging
Markets and International SmallCap Funds, the 2% limitation also applies to
warrants not listed on the Toronto Stock and Chicago Board Options Exchanges.

Risks of High Yield Securities
The Balanced, Bond, High Yield and Tax-Exempt Bond Funds may, to varying
degrees, invest in debt securities rated lower than BBB by S&P or Baa by Moody's
or, if not rated, determined to be of equivalent quality by the Manager. Such
securities are sometimes referred to as high yield or "junk bonds" and are
considered speculative.

Investment in high yield bonds involves special risks in addition to the risks
associated with investment in high rated debt securities. High yield bonds may
be regarded as predominantly speculative with respect to the issuer's continuing
ability to meet principal and interest payments. Moreover, such securities may,
under certain circumstances, be less liquid than higher rated debt securities.

Analysis of the creditworthiness of issuers of high yield securities may be more
complex than for issuers of higher quality debt securities. The ability of a
Fund to achieve its investment objective may, to the extent of its investment in
high yield bonds, be more dependent on such creditworthiness analysis than would
be the case if the Fund were investing in higher quality bonds.

High yield bonds may be more susceptible to real or perceived adverse economic
and competitive industry conditions than higher grade bonds. The prices of high
yield bonds have been found to be less sensitive to interest rate changes than
more highly rated investments, but more sensitive to adverse economic downturns
or individual corporate developments. If the issuer of high yield bonds
defaults, a Fund may incur additional expenses to seek recovery.

The secondary market on which high yield bonds are traded may be less liquid
than the market for higher grade bonds. Less liquidity in the secondary trading
market could adversely affect the price at which a Fund could sell a high yield
bond and could adversely affect and cause large fluctuations in the daily price
of the Fund's shares. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the value and liquidity of high
yield bonds, especially in a thinly traded market.

The use of credit ratings for evaluating high yield bonds also involves certain
risks. For example, credit ratings evaluate the safety of principal and interest
payments, not the market value risk of high yield bonds. Also, credit rating
agencies may fail to change credit ratings in a timely manner to reflect
subsequent events. If a credit rating agency changes the rating of a portfolio
security held by a Fund, the Fund may retain the security if the Manager thinks
it is in the best interest of shareholders.

Options
Each of the Funds (except Capital Value, Cash Management, Growth, and Tax-Exempt
Bond) may buy and sell certain types of options. Each type is more fully
discussed in the SAI.

Foreign Securities
Each of the following Funds may invest in foreign securities (securities of
non-U.S. companies) to the indicated percentage of its assets: (Debt securities
issued in the United States pursuant to a registration statement filed with the
Securities and Exchange Commission are not treated as foreign securities for
purposes of these limitations.)
o International, International Emerging Markets and International SmallCap
Funds - 100%; Real Estate Fund - 25%;
o Balanced, Blue Chip, Bond, Capital Value, Growth, High Yield, Limited Term
Bond, MidCap, SmallCap and Utilities Funds - 20%.
o The Cash Management Fund does not invest in foreign securities other than
those that are United States dollar denominated. All principal and interest
payments for the security are payable in U.S. dollars. The interest rate,
the principal amount to be repaid and the timing of payments related to the
security do not vary or float with the value of a foreign currency, the rate
of interest on foreign currency borrowings or with any other interest rate
or index expressed in a currency other than U.S. dollars.

Investment in foreign securities presents certain risks including: fluctuations
in currency exchange rates, revaluation of currencies, the imposition of foreign
taxes, future political and economic developments including war, expropriations,
nationalization, the possible imposition of currency exchange controls and other
foreign governmental laws or restrictions. In addition, there may be reduced
availability of public information concerning issuers compared to domestic
issuers. Foreign issuers are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory practices and
requirements that apply to domestic issuers. Transactions in foreign securities
may be subject to higher costs. Each Fund's investment in foreign securities may
also result in higher custodial costs and the costs associated with currency
conversions.

Securities of many foreign issuers may be less liquid and their prices more
volatile than those of comparable domestic issuers. Foreign securities markets,
particularly those in emerging market countries, are known to experience long
delays between the trade and settlement dates of securities purchased and sold.
Such delays may result in a lack of liquidity and greater volatility in the
price of securities on those markets. As a result of these factors, the Boards
of Directors of the Funds have adopted Daily Pricing and Valuation Procedures
for the Funds. These procedures outline the steps to be followed by the Manager
and Sub-Advisor to establish a reliable market or fair value if a reliable
market value is not available through normal market quotations. The Executive
Committee of the Boards of Directors oversees this process.

Euro Conversion. A new European currency is planned for introduction on January
1, 1999. The new currency will be called the "euro." It is expected to be
utilized by eleven European countries. The eleven countries are members of the
European Economic Monetary Union (EMU). The introduction of this currency may
result in uncertainty for European securities, security markets and
international mutual fund portfolios. Because of the euro's introduction,
European securities will undergo a redenomination period which may result in
otherwise unlikely accounting differences and tax consequences. Further
uncertainty exists because not all EMU members, including the United Kingdom,
will officially implement the euro on January 1, 1999. If the euro's
introduction does not occur as planned, then negative effects, such as severe
currency fluctuations and market disruptions, may result.

The Manager is actively working to address euro-related issues. The Manager has
successfully completed three conversion tests for existing Funds potentially
effected by the euro's introduction. The Manager has paid costs of $31,500 for
preparation of the euro's introduction and subsequent conversions. Additional
costs are not expected. However, the precise impact is unknown. Any negative
effects to a Fund's portfolio holdings could decrease the Fund's performance.

Securities of Smaller Companies
The International SmallCap, MidCap and SmallCap Funds invest in securities of
companies with small- or mid-sized market capitalizations. Market capitalization
is defined as total current market value of a company's outstanding common
stock. Investments in companies with smaller market capitalizations may involve
greater risks and price volatility (wide, rapid fluctuations) than investments
in larger, more mature companies. Smaller companies may be less mature than
older companies. At this earlier stage of development, the companies may have
limited product lines, reduced market liquidity for their shares, limited
financial resources or less depth in management than larger or more established
companies. Small companies also may be less significant within their industries
and may be at a competitive disadvantage relative to their larger competitors.
While smaller companies may be subject to these additional risks, they may also
realize more substantial growth than larger or more established companies.

Unseasoned Issuers
The Funds may invest in the securities of unseasoned issuers. Unseasoned issuers
are companies with a record of less than three years continuous operation,
including the operation of predecessors and parents. Unseasoned issuers by their
nature have only a limited operating history which can be used for evaluating
the companies growth prospects. As a result, investment decisions for these
securities may place a greater emphasis on current or planned product lines and
the reputation and experience of the companies management and less emphasis on
fundamental valuation factors than would be the case for more mature growth
companies. In addition, many unseasoned issuers also may be small companies and
involve the risks and price volatility associated with smaller companies.

Temporary Defensive Measures
For temporary defensive purposes in times of unusual or adverse market
conditions, the Growth-Oriented Funds, the Bond and Limited Term Bond Funds, may
invest without limit in cash and cash equivalents. For this purpose, cash
equivalents include: bank certificates of deposit, bank acceptances, repurchase
agreements, commercial paper, and commercial paper master notes which are
floating rate debt instruments without a fixed maturity. In addition, a Fund may
purchase U.S. Government securities, preferred stocks and debt securities,
whether or not convertible into or carrying rights for common stock.

Portfolio Turnover
"Portfolio Turnover" is the term used in the industry for measuring the amount
of trading that occurs in a Fund's portfolio during the year. For example, a
100% turnover rate means that on average every security in the portfolio has
been replaced once during the year.

Funds with high turnover rates (more than 100%) often have higher transaction
costs (which are paid by the Fund) and may generate short-term capital gains (on
which you pay taxes even if you don't sell any of your shares during the year).
You can find the turnover rate for each Fund, except for the Cash Management
Fund, in the Fund's Financial Highlights table.

Please consider all the factors when you compare the turnover rates of different
funds. A fund with consistently higher total returns and higher turnover rates
than another fund may actually be achieving better performance precisely because
the managers are active traders. You should also be aware that the "total
return" line in the Financial Highlights already includes portfolio turnover
costs.

MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE

The Manager

Principal Management Corporation (the "Manager") serves as the manager for the
Principal Mutual Funds. In its handling of the business affairs of each Fund,
the Manager provides clerical, recordkeeping and bookkeeping services, and keeps
the financial and accounting records required for the Funds. The Manager has
signed sub-advisory agreements with Invista for portfolio management functions
for the Growth-Oriented Funds (except the Real Estate Fund), the Government
Securities Income Fund and the Limited Term Bond Fund. The Manager pays Invista
for the costs of these services.

The Manager is a subsidiary of Principal Life Insurance Company. It has managed
mutual funds since 1969. As of December 31, 1998, the Funds it managed had
assets of approximately $__ billion. The Manager's address is Principal
Financial Group, Des Moines, Iowa 50392-0200.

Invista is also a subsidiary of Principal Life Insurance Company and is an
affiliate of the Manager. Invista has managed investments for institutional
investors, including Principal Life, since 1985. As of December 31, 1998, it
managed assets of approximately $_____ billion. Invista's address is 1800 Hub
Tower, 699 Walnut, Des Moines, Iowa 50309.

The Manager or Invista provides the Board of Directors of each Fund a
recommended investment program. Each program must be consistent with the Fund's
investment objective and policies. Within the scope of the approved investment
program, the Manager or Invista advises each Fund on its investment policies and
determines which securities are bought and sold, and in what amounts.

The Manager is paid a fee by each Fund for its services, which includes any fee
paid to Invista. The fee paid by each Fund (as a percentage of the average daily
net assets) for the fiscal year ended October 31, 1998 was:

Balanced % International Emerging Markets %
Blue Chip % International SmallCap %
Bond % Limited Term Bond %
Capital Value % MidCap %
Cash Management % Real Estate %
Government Securities Income % SmallCap %
Growth % Tax-Exempt Bond %
High Yield % Utilities %
International %

PRICING OF FUND SHARES

Each Fund's shares are bought and sold at the current share price. The share
price of each class of each Fund is calculated every day the New York Stock
Exchange is open. The share price is determined at the close of business of the
Exchange (normally at 3:00 p.m. Central Time). When we receive your order to buy
or sell shares, the share price used to fill the order is the next price
calculated after the order is placed.

For all Funds, except the Cash Management Fund, the share price is calculated
by:
o taking the current market value of the total assets of the Fund
o subtracting liabilities of the Fund
o dividing the remainder proportionately into the Classes of the Fund
o subtracting the liabilities of each Class
o dividing the remainder by the total number of shares owned by that Class.

The securities of the Cash Management Fund are valued at amortized cost. The
calculation procedure is described in the Statement of Additional Information.
The Cash Management Fund reserves the right to determine a share price more than
once a day.

NOTES:

o If current market values are not readily available for a security, its fair
value is determined using a policy adopted by the Fund's Board of Directors.
o A Fund's securities may be traded on foreign securities markets which
generally complete trading at various times during the day prior to the
close of the New York Stock Exchange. The values of foreign securities used
in computing share price are determined at the time the foreign market
closes. Occasionally, events affecting the value of foreign securities occur
when the foreign market is closed and the New York Stock Exchange is open.
If the Manager believes the market value is materially affected, the share
price will be calculated using the policy adopted by the Fund.
o Foreign securities markets may trade on days when the New York Stock
Exchange is closed (such as customary U.S. holidays) and a Fund's share
price is not calculated. As a result, the value of a Fund's assets may be
significantly affected by such trading on days when you cannot purchase or
sell shares of the Fund.
o Certain Funds may acquire a portion of portfolio securities in foreign OTC
transactions involving premium prices in excess of the Korean Stock Exchange
(KSE) price. There can be no assurance that a Fund will be able to realize
such premiums if it sells the shares to another foreign investor. Such
premiums may be affected by changes in regulations and otherwise, including
changes in the percentage of foreign ownership permitted in KSE-listed
companies. Shares listed on the KSE which are traded by foreign investors in
foreign OTC transactions generally are valued at prices at which it is
expected such shares may be sold, as determined by or under the direction of
a committee appointed by the Board of Directors, provided that the committee
determines that such valuations are accurate; otherwise such KSE shares will
be valued using the procedures for listed securities.

DIVIDENDS AND DISTRIBUTIONS

The Growth-Oriented and Income-Oriented Funds pay most of their net dividend
income to you every year. The payment schedule is:
<TABLE>
<CAPTION>
Funds Record Date Payable Date
----- ----------- ------------
<S> <C> <C> <C>
Balanced, Blue Chip, three business days before March 24, June 24,
Real Estate and each payable date September 24 and December 24
Utilities (or previous business day)

Capital Value and Growth three business days before June 24 and December 24
each payable date (or previous business day)

International, International three business days before December 24
Emerging Markets, each payable date (or previous business day)
International SmallCap,
MidCap and SmallCap

Bond, Government Securities three business days before monthly on the 24th
Income, High Yield, Limited each payable date (or previous business day)
Term Bond and Tax-Exempt Bond
</TABLE>

Net realized capital gains, if any, are distributed annually. Generally the
distribution is made on the fourth business day of December. Payments are made
to shareholders of record on the third business day prior to the payable date.
Capital gains may be taxable at different rates, depending on the length of time
that the Fund holds it assets.

You can authorize income dividend and capital gain distributions to be:
o invested in additional shares of the Fund you own without a sales charge;
o invested in shares of another Principal Mutual Fund (Dividend Relay) without
a sales charge (distributions of a Fund may be directed only to one
receiving Fund); or
o paid in cash.

NOTE: Payment of income dividends and capital gains shortly after you buy shares
has the effect of reducing the share price by the amount of the payment.

Distributions from a Fund, whether received in cash or reinvested in
additional shares, may be subject to federal (and state) income tax.

Money Market Fund
The Cash Management Fund declares dividends of all its daily net investment
income each day its shares are priced. The dividends are paid daily and are
automatically reinvested back into additional shares of the Fund. You may ask to
have your dividends paid to you monthly in cash. These cash payments are made on
the 20th (or preceding business day if the 20th is not a business day) of each
month.

Under normal circumstances, the Fund intends to hold portfolio securities until
maturity and value them at amortized cost. Therefore, the Fund does not expect
any capital gains or losses. Should there be any gain, it could result in an
increase in dividends. A capital loss could result in a dividend decrease.

TO BUY SHARES

To open an account and buy fund shares, rely on your Registered Representative.
Principal Mutual Funds are "load" funds which means you pay a sales charge for
the ongoing assistance of your Registered Representative.

Fill out the Principal Mutual Fund application* completely. You must include:
o the name(s) you want to appear on the account;
o the Principal Mutual Fund(s) you want to invest in and your choice of Class
A or Class B shares;
o the amount of the investment;
o your Social Security number or Taxpayer I.D. number;
o investor information (used to help your Registered Representative confirm
that your investment selection is consistent with your goals and
circumstances);
o employer information; and
o other required information (may include corporate resolutions, trust
agreements, etc.).

* An application is included with this prospectus. A different application
is needed for an IRA, 403(b), SEP, SIMPLE, SAR-SEP or certain employee
benefit plans. Call Principal Mutual Funds (1-800-247-4123) for more
information.

Each Fund requires a minimum initial investment:
o Regular Accounts $1,000
o Uniform Transfer to Minor Accounts $500
o IRA Accounts $500

Subsequent investment minimums are $100 per Fund. However, if your subsequent
investment are made using an Automatic Investment Plan, the investment minimum
is $50 per Fund. (see Establish an Automatic Investment Plan).

Note: The minimum investment applies on a fund level, not on the total
investment being made. Minimums may be waived on accounts set up for:
certain employee benefit plans; Principal Mutual Fund asset allocation
programs; Automatic Investment Plans; and Cash Management Accounts (with
Delaware Charter Guarantee and Trust Company as trustee).

Invest by mail:

o Send a check and completed application to:

Principal Mutual Funds
P. O. Box 10423
Des Moines Iowa 50306-9780

o Make your check payable to Principal Mutual Funds.
o Your purchase will be priced at the next share price calculated after
Principal Mutual Funds receives your completed paperwork.

Order by telephone:
o Call us at 1-800-247-4123 between 7:00 a.m. and 7:00 p.m. Central Time on
any day that the New York Stock Exchange is open.
o To buy shares the same day, you need to call before 3:00 p.m. Central Time.
o We must receive your payment for the order within three business days (or
the order will be canceled and you may be liable for any loss).
o For new accounts, you also need to send a completed application.

Wire money from your bank:
o Have your Registered Representative call Principal Mutual Funds
(1-800-247-4123) for an account number and wiring nstructions.
o For both initial and subsequent purchases, federal funds should be wired to:

Norwest Bank Iowa, N.A.
Des Moines, Iowa 50309
ABA No.: 073000228
For credit to: Principal Mutual Funds
Account No.: 3000499968
For credit: Principal ________ Fund, Class ____
Shareholder Account No. __________________
Shareholder Registration __________________

o Give the number and instructions to your bank (which may charge a wire fee).
o To buy shares the same day, the wire must be received before 3:00 p.m.
Central Time.
o No wires are accepted on days when the New York Stock Exchange is closed or
when the Federal Reserve is closed(because the bank that would receive your
wire is closed).

Establish an Automatic Investment Plan
o Make regular monthly investments with automatic deductions from your bank or
other financial institution account.
o Minimum investment amounts are waived if you set up an Automatic Investment
Plan when you open your account.
o Minimum monthly purchase $50 per Fund (except Cash Management Fund).
o Cash Management Fund minimum monthly purchase is $100. However, if the Cash
Management account is greater than $1,000 when the plan is set up, the
monthly minimum is $50.
o Send completed application, check authorization form and voided check (or
voided deposit slip) to:

Principal Mutual Funds
P. O. Box 10423
Des Moines Iowa 50306-9780

Set up a Dividend Relay

o Invest your dividends and capital gains from one Principal Mutual Fund in
shares of another Principal Mutual Fund.
o Distributions from a Fund may be directed only to one receiving Fund.
o The Fund receiving the investment must be the same class as the originating
Fund.
o There is no sales charge or administrative charge for the Dividend Relay.
o You can set up Dividend Relay:
o on the application for a new account; or
o by calling Principal Mutual Funds (1-800-247-4123) if telephone services
apply to the originating account; or
o in writing (a signature guarantee may be required).
o You may discontinue your Dividend Relay election with a written notice to
Principal Mutual Funds.
o There may be a delay of up to 10 days before the Dividend Relay plan is
discontinued.
o The receiving Fund must meet fund minimums. If it does not, the Fund
reserves the right to close the account if it is not brought up to the
minimum investment amount within 90 days of sending you a deficiency notice.

TO SELL SHARES

After you place a sell order in proper form, shares are sold using the next
share price calculated. The amount you receive will be reduced by any applicable
CDSC. There is no additional charge for a sale. However, you will be charged a
$6 wire fee if you have the sale proceeds wired to your bank. Generally, the
sale proceeds are sent out on the next business day after the sell order has
been placed. At your request, the check will be sent overnight (a $15 overnight
fee will be deducted from your account unless other arrangements are made). The
Fund can only sell shares after your check making the Fund investment has
cleared your bank. To avoid the inconvenience of a delay in obtaining sale
proceeds, shares may be purchased with a cashier's check, money order or
certified check. A sell order from one owner is binding on all joint owners.

Selling shares may create a gain or a loss for federal (and state) income tax
purposes. You should maintain accurate records for use in preparing your income
tax returns.

Generally, sales proceeds checks are:
o payable to all owners on the account (as shown in the account registration)
and
o mailed to address on the account (if not changed within last month) or
previously authorized bank account.

For other payment arrangements, please call Principal Mutual Funds
(1-800-247-4123).

You should also call Principal Mutual Funds (1-800-247-4123) for special
instructions that may apply to sales from accounts:
o when an owner has died;
o for certain employee benefit plans, or
o owned by corporations, partnerships, agents or fiduciaries.

Within 60 days after the sale of shares, the amount of the sale proceeds can be
reinvested in any Principal Mutual Funds' Class A shares without a sales charge
if the shares that were sold were:
o Class A shares on which a sales charge was paid;
o Class A shares acquired by conversion of Class B shares; or
o Class B shares on which a CDSC was paid.

The transaction is considered a sale for federal (and state) income tax purposes
even if the proceeds are reinvested. If a loss is realized on the sale, the
reinvestment may be subject to the "wash sale" rules resulting in the
postponement of the recognition of the loss for tax purposes.

Sell shares by mail
o Send a letter (signed by the owner of the account) to

Principal Mutual Funds
P. O. Box 10423
Des Moines Iowa 50306-9780

o Specify the Fund and account number.
o Specify the number of shares or the dollar amount to be sold.
o A signature guarantee* will be required if the:
o sell order is for more than $100,000;
o account address has been changed within one months of the sell order; or
o check is payable to a party other than the account shareholder(s) or
Principal Life Insurance Company.
* If required, the signature(s) must be guaranteed by a commercial bank,
trust company, credit union, savings and loan, national securities
exchange member or brokerage firm. A signature guaranteed by a notary
public or savings bank is not acceptable.

Sell shares in amounts of $100,000 or less by telephone* (1-800-247-4123)
o Address on account must not have been changed within the last month and
telephone privileges must apply to the account from which the shares are
being sold.
o If our phone lines are busy, you may need to send in a written sell order.
o To sell shares the same day, the order must be received before 3:00 p.m.
Central Time.
o Telephone privileges are not available for Principal Mutual Funds IRAs,
403(b)s, certain employee benefit plans, or on shares for which certificates
have been issued.
o If previously authorized, checks can be sent to a shareholder's U.S. bank
account.
* The Fund and transfer agent reserve the right to refuse telephone orders
to sell shares. The shareholder is liable for a loss resulting from a
fraudulent telephone order that the Fund reasonably believes is genuine.
Each Fund will use reasonable procedures to assure instructions are
genuine. If the procedures are not followed, the Fund may be liable for
loss due to unauthorized or fraudulent transactions. The procedures
include: recording all telephone instructions, requesting personal
identification information (name, phone number, social security number,
birth date, etc.) and sending written confirmation to the address on the
account.

Sell shares by checkwriting (Class A shares of Cash Management Fund only)
o Checkwriting must be elected on initial application or by written request to
Principal Mutual Funds.
o The Fund can only sell shares after your check making the Fund investment
has cleared your bank.
o Checks must be written for at least $100.
o Checks are drawn on Norwest Bank Iowa, N.A. and its rules concerning
checking accounts apply.
o If the account does not have sufficient funds to cover the check, it is
marked "Insufficient Funds" and returned (the Fund may revoke checkwriting
on accounts on which "Insufficient Funds" checks are drawn).
o Accounts may not be closed by withdrawal check (accounts continue to earn
dividends until checks clear and the exact value of the account is not known
until the check is received by Norwest).
o Not available for Principal Mutual Funds IRAs, 403(b)s, SEPs, SIMPLES,
SAR-SEPs or certain employee benefit plans or shares subject to a CDSC or on
shares for which a certificate has been issued.

Periodic withdrawal plans
You may set up a periodic withdrawal plan
o on a monthly, quarterly, semiannual or annual basis to:
o sell a fixed number of sales ($25 initial minimum amount),
o sell enough shares to provide a fixed amount of money ($25 initial minimum
amount).
o pay insurance or annuity premiums or deposits to Principal Life Insurance
Company (call us at 1-800-247-4123 for details), and
o to provide an easy method of making monthly installment payments (if the
service is available from your creditor who must supply the necessary
forms).

You can set up a periodic withdrawal plan by:
o completing the applicable section of the application; or
o sending us your written instructions (and share certificate, if any, issued
for the account).

Your periodic withdrawal plan continues until:
o you instruct us to stop, or
o your Fund account is exhausted.

When you set up the withdrawal plan, you select which day you want the sale made
(if none selected, the sale will be made on the 15th of the month). If the
selected date is not a trading day, the sale will take place on the next trading
day (if that day falls in the month after your selected date, the transaction
will take place on the trading day before your selected date. If telephone
privileges apply to the account, you may change the date or amount by
telephoning us at 1-800-247-4123.

Sales may be subject to CDSC. Up to 10% of the value of a Class B share account
may be withdrawn annually free of CDSC. If the plan is set up when the Class B
share account is opened, 10% of the value of additional purchases made within 60
days may also be withdrawn free of CDSC. The amount of the 10% withdrawal
privilege is reset as of the last business day of December of each year based on
the account's value as of that day.

Withdrawal payments are sent on or before the third business day after the date
of the sale. Sales made under your periodic withdrawal plan will reduce and may
eventually exhaust your account. The Funds do not normally accept purchase
payments for shares of any Fund except the Cash Management Fund while a periodic
withdrawal planpaln is in effect (unless the purchase represents a substantial
addition to your account).

The Fund from which the periodic withdrawal is made makes no recommendation as
to either the number of shares or the fixed amount that you withdraw. The
portion of sales proceeds from the Tax-Exempt Bond Fund which represents
tax-exempt income which has been accrued by not declared a dividend by the Fund
may be taxed at capital gains rates (see DIVIDENDS AND DISTRIBUTIONS).

TO EXCHANGE SHARES

Your shares in the Funds (except Class A shares of the Cash Management and
Limited Term Bond Funds) may be exchanged without a sales charge for the same
class of any other Fund. After 90 days of their purchase, Class A shares of the
Limited Term Bond Fund may be exchanged for Class A shares of the other Funds.

ClassA shares of the Cash Management Fund may be exchanged into

o Class A shares of other Principal Mutual Funds.

o If the Cash Management shares were acquired by direct purchase, a sales
charge will be imposed on the exchange into other Class A shares.

o If the Cash Management shares were acquired by exchange from other Funds,
conversion of Class B shares or shares purchased by reinvestment of
dividends earned on Class A shares, no sales charge will be imposed on the
exchange into other Class A shares.

o Class B shares of other Principal Mutual Funds - subject to the CDSC

The CDSC is not charged on exchanges. However, the purchase date of the
exchanged shares and the CSDC table are used to determine if the newly acquired
shares are subject to the CDSC (and the amount of the CDSC if any) when they are
sold.

You may exchange shares by:

o calling us (1-800-247-4123), if you have telephone privileges on the account
and if
o the amount of the exchange is $500,000 or less, and
o no share certificate has been issued.
o sending a written request to

Principal Mutual Funds
P. O. Box 10423
Des Moines, Iowa 50306-9780

o completing an Exchange Authorization Form (call us at 1-800-247-4123 to
obtain the form).

Automatic exchange election.
This election authorizes an exchange from one Principal Mutual Fund to another
on a monthly, quarterly, semiannual or annual basis. You can set up an automatic
exchange by:

o completing the Automatic Exchange Election section of the application;
o by calling us (1-800-247-4123) if telephone privileges apply to the account
from which the exchange is to be made, or
o sending us your written instructions.

Your automatic exchange continues until:
o you instruct us to stop, or
o your Fund account is exhausted.

You may specify the day of the exchange. If the selected day is not a trading
day, the sale will take place on the next trading day (if that day falls in the
month after your selected date, the transaction will take place on the trading
day before your selected date). If telephone privileges apply to the account,
you may change the date or amount by telephoning us at 1-800-247-4123

General
o An exchange by any joint owner is binding on all joint owners.
o If you do not have an existing account in the Fund to which the exchange is
being made, a new account is established. The new account has the same
owner(s), dividend and capital gain options and dealer of record as the
account from which the shares are being exchanged
o All exchanges are subject to the minimum investment and eligibility
requirement of the Fund being acquired.
o You may acquire shares of a Fund only if its shares are legally offered in
your state of residence.
o If a certificate has been issued, it must be returned to the Fund before the
exchange can take place.

The exchange privilege is not intended for short-term trading. Excessive
exchange activity may interfere with portfolio management and have an adverse
impact on all shareholders. In order to limit excessive exchange activity, and
under other circumstances where the Board of Directors of the Fund or the
Manager believes it is in the best interest of the Fund, the Fund reserves the
right to revise or terminate the exchange privilege, limit the amount or number
of exchanges, reject any exchange or close the account. You would be notified of
any such action to the extent required by law.

Fund shares used to fund an employee benefit plan may be exchanged only for
shares of other Principal Mutual Funds available to employee benefit plans. Such
an exchange must be made by following the procedures provided in the employee
benefit plan and the written service agreement. The exchange is treated as a
sale of shares for federal income tax purposes and may result in a capital gain
or loss. Income tax rules regarding the calculation of cost basis may make it
undesirable in certain circumstances to exchange shares within 90 days of their
purchase.

GENERAL INFORMATION ABOUT A FUND ACCOUNT

Statements
You will receive quarterly statements (monthly statements for the Cash
Management Fund) for the Funds you own The statements provide the number and
value of shares you own, transactions during the quarter, dividends declared or
paid and other information. The year end statement includes information for all
transactions that took place during the year. Please review your statement as
soon as your receive it. Keep your statements as you may need them for tax
reporting purposes.

Generally, each time you buy, sell or exchange shares between Principal Mutual
Funds, you will receive a confirmation in the mail shortly thereafter. It
summarizes all the key information; what you bought or sold, the amount of the
transaction, and other vital data. The Cash Management Fund mails confirmations
only once a month detailing dividend and account activity.

Certain purchases and sales are only included on your quarterly statement. These
include accounts
o when the only activity during the quarter
o is purchase of shares from reinvested dividends and/or capital gains;
o is a result of Dividend Relay;
o purchases under a Automatic Investment Plan;
o sales under a periodic withdrawal plan; and
o purchases or sales under an automatic exchange election.
o used to fund certain individual retirement or individual pension plans.
o established under a payroll deduction plan.

Signature Guarantees
Certain transactions require that your signature be guaranteed. If required, the
signature(s) must be guaranteed by a commercial bank, trust company, credit
union, savings and loan, national securities exchange member or brokerage firm.
A signature guaranteed by a notary public or savings bank is not acceptable.
Signature guarantees are required:
o if you sell more than $100,000 from any one Fund;
o if a sales proceeds check is payable to other than the account
shareholder(s), Principal Life Insurance Company or one of its affiliates;
o to make a Dividend Relay election from an account with joint owners to an
account with only one owner or different joint owners;
o to change ownership of an account;
o to add telephone transaction services to an existing account;
o to change bank account information designated under an existing telephone
withdrawal plan;
o to have a sales proceeds check mailed to an address other than the address
on the account or to the address on the account if it has been changed
within the preceding month; and
o to add wire privileges to an existing account.

Minimum Account Balance
Generally, the Funds do not have a minimum required balance. Because of the
disproportional high cost of maintaining small accounts, the Funds reserve the
right to set a minimum and sell all shares in an account with a value of less
than $300. The sales proceeds would then be mailed to you. These involuntary
sales will not be triggered just by market conditions. If a Fund exercises this
right, you will be notified that the redemption is going to be made. You will
have 30 days to make an additional investment and bring your account up to the
required minimum. The Funds reserve the right to increase the required minimum.

Special Plans
The Funds reserve the right to amend or terminate the special plans described in
this prospectus. Such plans include automatic investment, dividend relay,
periodic withdrawal, and waiver or reduction of sales charges for certain
purchasers. You would be notified of any such action to the extent required by
law.

Telephone Orders
The Principal Mutual Funds reserve the right to refuse telephone orders to sell
shares. You are liable for a loss resulting from a fraudulent telephone order
that we reasonably believe is genuine. We will use reasonable procedures to
assure instructions are genuine. If the procedures are not followed, we may be
liable for loss due to unauthorized or fraudulent transactions. The procedures
include: recording all telephone instructions, requesting personal
identification information (name, phone number, social security number, birth
date, etc.) and sending written confirmation to the policy owner's address of
record.

Year 2000 Problem
The business operations of the Funds depend on computer systems that contain
date fields. These systems include securities transfer agent operations and
securities pricing systems. Many of these systems were constructed using a two
digit date field to represent the date. Unless these systems are changed or
modified, they may not be able to distinguish the Year 1900 from the Year 2000
(commonly referred to as the Year 2000 Problem).

When the Year 2000 arrives, the Funds' operations could be adversely affected if
the computer systems used by the Manager, the service providers and other third
parties it does business with are not Year 2000 compliant. For example, the
Funds' portfolios and operational areas could be impacted, included securities
pricing, dividend and interest payments, shareholder account servicing and
reporting functions. In addition, a Fund could experience difficulties in
transactions if foreign broker-dealers or foreign markets are not Year 2000
compliant.

The Manager relies on public filings and other statements made by companies
about their Year 2000 readiness. Issuers in countries outside of the U.S.,
particularly in emerging countries, may not be required to make the same
disclosures about their readiness as are required in the U.S. It is likely that
if a company a Fund invests in is adversely affected by Year 2000 problems, the
price of its securities will also be negatively impacted. A decrease in value of
one or more of a Fund's securities will decrease that Fund's share price.

In addition, the Manager and affiliated service providers are working to
identify their Year 2000 problems and taking steps they reasonably believe will
address these issues. This process began in 1996 with the identification of
product vendors and service providers as well as the internal systems that might
be impacted.

At this time, testing of internal systems has been completed. The Manager is now
participating in a corporate-wide initiative lead by senior management
representatives of Principal Life. Currently they are engaged in regression
testing of internal programs. They are also participating in development of
contingency plans in the event that Year 2000 problems develop and/or persist on
or after January 1, 2000. This plan is scheduled to be completed in March 1999.
The contingency plan calls for:
o identification of business risks;
o consideration of alternative approaches to critical business risks; and
o development of action plans to address problems.

Other important Year 2000 initiatives include:
o the service provider for our transfer agent system has renovated its code.
Client testing will occur in the first and second quarters of 1999. The
service provider is also participating in a securities industry wide testing
program that is scheduled to be completed by the end of April 1999;
o the securities pricing system we use has renovated its code and conducted
client testing in June 1998;
o Facilities Management of Principal Life has identified non-systems issues
(heat, lights, water, phone, etc.) and is working with these service
providers to ensure continuity of service; and
o the Manager and other areas of Principal Life have contacted all vendors
with which we do business to receive assurances that they are able to deal
with any Year 2000 problems. We continue to work with the vendors to
identify any areas of risk.

In its budget for 1999 and 2000, the Manager has estimated expenses of between
$100,000 and $500,000 to deal with Year 2000 issues.

Financial Statements
You will receive an annual financial statement for the Funds, examined by the
Funds' independent auditors, Ernst & Young LLP. That report is a part of this
prospectus. You will also receive a semiannual financial statement which is
unaudited. The following financial highlights are based on financial statements
which were audited by Ernst & Young LLP.

FINANCIAL HIGHLIGHTS
Domestic Growth-Oriented Funds

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
PRINCIPAL BALANCED FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $15.11 $14.61 $13.74 $12.43 $13.26
Income from Investment Operations:
Net Investment Income............................... .42 .35 .38 .41 .32
Net Realized and Unrealized Gain (Loss) on Investments 1.15 1.81 1.59 1.31 (.20)

Total from Investment Operations 1.57 2.16 1.97 1.72 .12
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.37) (.36) (.43) (.36) (.40)
Distributions from Capital Gains.................... (1.03) (1.30) (.67) (.05) (.55)

Total Dividends and Distributions (1.40) (1.66) (1.10) (.41) (.95)

Net Asset Value, End of Period......................... $15.28 $15.11 $14.61 $13.74 $12.43

Total Return(b)........................................ 11.00% 15.88% 15.10% 14.18% .94%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $104,414 $85,436 $70,820 $57,125 $53,366
Ratio of Expenses to Average Net Assets............. 1.28% 1.33% 1.28% 1.37% 1.51%
Ratio of Net Investment Income to Average Net Assets 2.86% 2.42% 2.82% 3.21% 2.70%
Portfolio Turnover Rate............................. 57.0% 27.6% 32.6% 35.8% 14.4%

PRINCIPAL BALANCED FUND, INC.(a)
Class B shares 1998 1997 1996 1995(e)
Net Asset Value, Beginning of Period................... $15.05 $14.56 $13.71 $11.80
Income from Investment Operations:
Net Investment Income............................... .31 .25 .29 .31
Net Realized and Unrealized Gain (Loss) on Investments 1.14 1.79 1.55 1.90

Total from Investment Operations 1.45 2.04 1.84 2.21
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.25) (.25) (.32) (.30)
Distributions from Capital Gains.................... (1.03) (1.30) (.67) --

Total Dividends and Distributions (1.28) (1.55) (.99) (.30)

Net Asset Value, End of Period......................... $15.22 $15.05 $14.56 $13.71

Total Return(b)........................................ 10.18% 14.96% 14.10% 18.72%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $18,930 $11,885 $5,964 $1,263
Ratio of Expenses to Average Net Assets............. 2.04% 2.14% 2.13% 1.91%(d)
Ratio of Net Investment Income to Average Net Assets 2.08% 1.58% 1.93% 2.53%(d)
Portfolio Turnover Rate............................. 57.0% 27.6% 32.6% 35.8%(d)

PRINCIPAL BLUE CHIP FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $20.22 $17.10 $15.03 $12.45 $11.94
Income from Investment Operations:
Net Investment Income............................... .12 .21 .23 .24 .20
Net Realized and Unrealized Gain (Loss) on Investments 3.57 3.58 2.45 2.55 .57

Total from Investment Operations 3.69 3.79 2.68 2.79 .77
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.12) (.21) (.26) (.21) (.26)
Distributions from Capital Gains.................... (2.08) (.46) (.35) -- --

Total Dividends and Distributions (2.20) (.67) (.61) (.21) (.26)

Net Asset Value, End of Period......................... $21.71 $20.22 $17.10 $15.03 $12.45

Total Return(b)........................................ 19.48% 22.57% 18.20% 22.65% 6.58%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $126,740 $79,985 $44,389 $35,212 $27,246
Ratio of Expenses to Average Net Assets............. 1.31% 1.30% 1.33% 1.38% 1.46%
Ratio of Net Investment Income to Average Net Assets .57% 1.10% 1.41% 1.83% 1.72%
Portfolio Turnover Rate............................. .5% 55.4% 13.3% 26.1% 5.5%

PRINCIPAL BLUE CHIP FUND, INC.(a)
Class B shares 1998 1997 1996 1995(e)
Net Asset Value, Beginning of Period................... $20.14 $17.03 $14.99 $11.89
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.02) .07 .11 .15
Net Realized and Unrealized Gain (Loss) on Investments 3.53 3.54 2.41 3.10

Total from Investment Operations 3.51 3.61 2.52 3.25
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.02) (.04) (.13) (.15)
Distributions from Capital Gains.................... (2.08) (.46) (.35) --

Total Dividends and Distributions (2.10) (.50) (.48) (.15)

Net Asset Value, End of Period......................... $21.55 $20.14 $17.03 $14.99

Total Return(b)........................................ 18.59% 21.59% 17.18% 26.20%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $34,223 $18,265 $6,527 $1,732
Ratio of Expenses to Average Net Assets............. 2.02% 2.06% 2.19% 1.90%(d)
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (.14)% .32% .49% .97%(d)
Portfolio Turnover Rate............................. .5% 55.4% 13.3% 26.1%(d)

PRINCIPAL CAPITAL VALUE FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $29.69 $27.72 $23.69 $20.83 $21.41
Income from Investment Operations:
Net Investment Income............................... .50 .50 .45 .45 .39
Net Realized and Unrealized Gain (Loss) on Investments 3.88 5.80 5.48 3.15 .93

Total from Investment Operations 4.38 6.30 5.93 3.60 1.32
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.53) (.48) (.43) (.39) (.41)
Distributions from Capital Gains.................... (2.47) (3.85) (1.47) (.35) (1.49)

Total Dividends and Distributions (3.00) (4.33) (1.90) (.74) (1.90)

Net Asset Value, End of Period......................... $31.07 $29.69 $27.72 $23.69 $20.83

Total Return(b)........................................ 15.59% 25.36% 26.41% 17.94% 6.67%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $565,052 $494,444 $435,617 $339,656 $285,965
Ratio of Expenses to Average Net Assets............. .74% .70% .69% .75% .83%
Ratio of Net Investment Income to Average Net Assets 1.67% 1.85% 1.82% 2.08% 2.02%
Portfolio Turnover Rate............................. 23.2% 30.8% 50.2% 46.0% 31.7%

PRINCIPAL CAPITAL VALUE FUND, INC.(a)
Class B shares 1998 1997 1996 1995(e)
Net Asset Value, Beginning of Period................... $29.51 $27.58 $23.61 $19.12
Income from Investment Operations:
Net Investment Income............................... .26 .23 .21 .33
Net Realized and Unrealized Gain (Loss) on Investments 3.86 5.77 5.45 4.46

Total from Investment Operations 4.12 6.00 5.66 4.79
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.26) (.22) (.22) (.30)
Distributions from Capital Gains.................... (2.47) (3.85) (1.47) --

Total Dividends and Distributions (2.73) (4.07) (1.69) (.30)

Net Asset Value, End of Period......................... $30.90 $29.51 $27.58 $23.61

Total Return(b)........................................ 14.71% 24.13% 25.19% 25.06%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $44,765 $27,240 $9,832 $2,248
Ratio of Expenses to Average Net Assets............. 1.52% 1.65% 1.70% 1.50%(d)
Ratio of Net Investment Income to Average Net Assets .88% .84% .80% 1.07%(d)
Portfolio Turnover Rate............................. 23.2% 30.8% 50.2% 46.0%(d)

PRINCIPAL GROWTH FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $50.43 $39.54 $37.22 $31.14 $30.41
Income from Investment Operations:
Net Investment Income............................... .35 .31 .35 .35 .26
Net Realized and Unrealized Gain (Loss) on Investments 7.14 11.26 3.50 6.67 2.56

Total from Investment Operations 7.49 11.57 3.85 7.02 2.82
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.34) (.31) (.35) (.31) (.28)
Distributions from Capital Gains.................... (1.49) (.37) (1.18) (.63) (1.81)

Total Dividends and Distributions (1.83) (.68) (1.53) (.94) (2.09)

Net Asset Value, End of Period......................... $56.09 $50.43 $39.54 $37.22 $31.14

Total Return(b)........................................ 15.17% 29.55% 10.60% 23.29% 9.82%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $395,954 $317,386 $228,361 $174,328 $116,363
Ratio of Expenses to Average Net Assets............. .95% 1.03% 1.08% 1.16% 1.30%
Ratio of Net Investment Income to Average Net Assets .66% .68% .95% 1.12% .95%
Portfolio Turnover Rate............................. 21.9% 16.5% 1.8% 12.2% 13.6%

PRINCIPAL GROWTH FUND, INC.(a)
Class B shares 1998 1997 1996 1995(e)
Net Asset Value, Beginning of Period................... $50.36 $39.43 $37.10 $28.33
Income from Investment Operations:
Net Investment Income............................... .06 .09 .08 .21
Net Realized and Unrealized Gain (Loss) on Investments 7.14 11.23 3.48 8.76

Total from Investment Operations 7.20 11.32 3.56 8.97
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.09) (.02) (.05) (.20)
Distributions from Capital Gains.................... (1.49) (.37) (1.18) --

Total Dividends and Distributions (1.58) (.39) (1.23) (.20)

Net Asset Value, End of Period......................... $55.98 $50.36 $39.43 $37.10

Total Return(b)........................................ 14.58% 28.92% 9.80% 31.48%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $64,809 $42,241 $24,019 $8,279
Ratio of Expenses to Average Net Assets............. 1.46% 1.48% 1.79% 1.80%(d)
Ratio of Net Investment Income to Average Net Assets .15% .23% .22% .31%(d)
Portfolio Turnover Rate............................. 21.9% 16.5% 1.8% 12.2%(d)

PRINCIPAL MIDCAP FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $45.33 $35.75 $31.45 $25.08 $23.56
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.07) .07 .14 .12 --
Net Realized and Unrealized Gain (Loss) on Investments (4.26) 10.80 5.05 6.45 1.61

Total from Investment Operations (4.33) 10.87 5.19 6.57 1.61
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- (.11) (.14) (.06) --
Distributions from Capital Gains.................... (1.10) (1.18) (.75) (.14) (.09)

Total Dividends and Distributions (1.10) (1.29) (.89) (.20) (.09)

Net Asset Value, End of Period......................... $39.90 $45.33 $35.75 $31.45 $25.08

Total Return(b)........................................ (9.78)% 31.26% 16.89% 26.89% 6.86%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $332,942 $346,666 $229,465 $150,611 $92,965
Ratio of Expenses to Average Net Assets............. 1.22% 1.26% 1.32% 1.47% 1.74%
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (.14)% .20% .46% .47% .02%
Portfolio Turnover Rate............................. 25.1% 9.5% 12.3% 13.5% 8.1%

PRINCIPAL MIDCAP FUND, INC.(a)
Class B shares 1998 1997 1996 1995(e)
Net Asset Value, Beginning of Period................... $44.88 $35.48 $31.31 $23.15
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.23) (.05) (.04) --
Net Realized and Unrealized Gain (Loss) on Investments (4.26) 10.64 4.97 8.18

Total from Investment Operations (4.49) 10.59 4.93 8.18
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- (.01) (.01) (.02)
Distributions from Capital Gains.................... (1.10) (1.18) (.75) --

Total Dividends and Distributions (1.10) (1.19) (.76) (.02)

Net Asset Value, End of Period......................... $39.29 $44.88 $35.48 $31.31

Total Return(b)........................................ (10.24)% 30.64% 16.07% 35.65%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $68,358 $59,554 $28,480 $8,997
Ratio of Expenses to Average Net Assets............. 1.73% 1.69% 2.01% 2.04%(d)
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (.66)% (.24)% (.24)% (.17)%(d)
Portfolio Turnover Rate............................. 25.1% 9.5% 12.3% 13.5%(d)

PRINCIPAL REAL ESTATE FUND, INC.
Class A shares 1998(f)
Net Asset Value, Beginning of Period................... 10.15
Income from Investment Operations:
Net Investment Income............................... .20
Net Realized and Unrealized Gain (Loss) on Investments (1.76)

Total from Investment Operations (1.56)
Less Dividends:
Dividends from Net Investment Income................ (.20)

Total Dividends (.20)

Net Asset Value, End of Period......................... $8.39

Total Return(b)........................................ (15.45)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ 5,490
Ratio of Expenses to Average Net Assets............. 2.25%(d)
Ratio of Net Investment Income to Average Net Assets 2.89%(d)
Portfolio Turnover Rate............................. 60.4%(d)

PRINCIPAL REAL ESTATE FUND, INC.
Class B shares 1998(f)
Net Asset Value, Beginning of Period................... 10.15
Income from Investment Operations:
Net Investment Income............................... .20
Net Realized and Unrealized Gain (Loss) on Investments (1.78)

Total from Investment Operations (1.58)
Less Dividends:
Dividends from Net Investment Income................ (.19)

Total Dividends (.19)

Net Asset Value, End of Period......................... 8.38

Total Return(b)........................................ (15.67)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ 3,120
Ratio of Expenses to Average Net Assets............. 2.47%(d)
Ratio of Net Investment Income to Average Net Assets 2.67%(d)
Portfolio Turnover Rate............................. 60.4%(d)

PRINCIPAL SMALLCAP FUND, INC.
Class A shares 1998(f)
Net Asset Value, Beginning of Period................... 9.92
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.08)
Net Realized and Unrealized Gain (Loss) on Investments (1.41)

Total from Investment Operations (1.49)
Less Dividends:
Dividends from Net Investment Income................ --

Total Dividends --

Net Asset Value, End of Period......................... $8.43

Total Return(b)........................................ (15.95)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ 18,438
Ratio of Expenses to Average Net Assets............. 2.58%(d)
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (1.65)%(d)
Portfolio Turnover Rate............................. 20.5%(d)

PRINCIPAL SMALLCAP FUND, INC.
Class B shares 1998(f)
Net Asset Value, Beginning of Period................... 9.91
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.11)
Net Realized and Unrealized Gain (Loss) on Investments (1.39)

Total from Investment Operations (1.50)
Less Dividends:
Dividends from Net Investment Income................ --

Total Dividends --

Net Asset Value, End of Period......................... $8.41

Total Return(b)........................................ (16.15)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ 6,550
Ratio of Expenses to Average Net Assets............. 2.80%(d)
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (1.85)%(d)
Portfolio Turnover Rate............................. 20.5%(d)

PRINCIPAL UTILITIES FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $12.55 $11.40 $10.94 $9.25 $11.45
Income from Investment Operations:
Net Investment Income(g)............................ .41 .48 .44 .48 .46
Net Realized and Unrealized Gain (Loss) on Investments 3.59 1.12 .45 1.70 (2.19)

Total from Investment Operations 4.00 1.60 .89 2.18 (1.73)
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.44) (.45) (.43) (.49) (.45)
Distributions from Capital Gains.................... -- -- -- -- (.02)

Total Dividends and Distributions (.44) (.45) (.43) (.49) (.47)

Net Asset Value, End of Period......................... $16.11 $12.55 $11.40 $10.94 $9.25

Total Return(b)........................................ 32.10% 14.26% 8.13% 24.36% (15.20)%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $83,533 $64,366 $66,322 $65,873 $56,747
Ratio of Expenses to Average Net Assets(g).......... 1.15% 1.15% 1.17% 1.04% 1.00%
Ratio of Net Investment Income to Average Net Assets 2.73% 3.90% 3.85% 4.95% 4.89%
Portfolio Turnover Rate............................. 11.9% 22.5% 34.2% 13.0% 13.8%

PRINCIPAL UTILITIES FUND, INC.(a)
Class B shares 1998 1997 1996 1995(e)
Net Asset Value, Beginning of Period................... $12.53 $11.38 $10.93 $9.20
Income from Investment Operations:
Net Investment Income(g)............................ .30 .38 .36 .40
Net Realized and Unrealized Gain (Loss) on Investments 3.59 1.13 .43 1.77

Total from Investment Operations 3.89 1.51 .79 2.17
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.33) (.36) (.34) (.44)
Distributions from Capital Gains.................... -- -- -- --

Total Dividends and Distributions (.33) (.36) (.34) (.44)

Net Asset Value, End of Period......................... $16.09 $12.53 $11.38 $10.93

Total Return(b)........................................ 31.23% 13.41% 7.23% 24.18%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $11,391 $6,937 $5,579 $3,952
Ratio of Expenses to Average Net Assets(g).......... 1.90% 1.90% 1.93% 1.72%(d)
Ratio of Net Investment Income to Average Net Assets 2.04% 3.14% 3.07% 3.84%(d)
Portfolio Turnover Rate............................. 11.9% 22.5% 34.2% 13.0%(d)
</TABLE>

Notes to Financial Highlights

(a) Effective January 1, 1998, the following changes were made to the names of
the Domestic Growth Funds:

Former Fund Name New Fund Name
--------------------------------------------------------------------------
Princor Balanced Fund, Inc. Principal Balanced Fund, Inc.
Princor Blue Chip Fund, Inc. Principal Blue Chip Fund, Inc.
Princor Capital Accumulation Fund, Inc. Principal Capital Value Fund, Inc.
Princor Growth Fund, Inc. Principal Growth Fund, Inc.
Princor Emerging Growth Fund, Inc. Principal MidCap Fund, Inc.
Princor Utilities Fund, Inc. Principal Utilities Fund, Inc.

(b) Total return is calculated without the front-end sales charge or contingent
deferred sales charge.

(d) Computed on an annualized basis.

(e) Period from December 9, 1994, date Class B shares first offered to the
public, through October 31, 1995. The Domestic Growth Funds' Class B shares
recognized net investment income as follows for the period from the initial
purchase of Class B shares on December 5, 1994 through December 8, 1994,
none of which was distributed to the sole shareholder, Principal Management
Corporation. The Domestic Growth Funds' Class B shares incurred unrealized
losses on investments during the initial interim period as follows. This
represents Class B share activities of each fund prior to the initial
public offering of Class B shares:
Per Share
Net Investment Per Share
Income Unrealized (Loss)

Principal Balanced Fund, Inc. $-- $(.19)
Principal Blue Chip Fund, Inc. -- (.15)
Principal Capital Value Fund, Inc. -- (.46)
Principal Growth Fund, Inc. -- (.86)
Principal MidCap Fund, Inc. -- (.77)
Principal Utilities Fund, Inc. .01 (.01)

(f) Period from December 31, 1997, date Class A and Class B shares first
offered to the public, through October 31, 1998. With respect to Principal
Real Estate Fund, Inc. Class A and Class B shares, net investment income
aggregating $.03 per share for the period from the initial purchase of
shares on December 11, 1997 through December 30, 1997 was recognized, of
which $.01 per share was distributed to its sole shareholder, Principal
Life Insurance Company, during the period. With respect to Principal
SmallCap Fund, Inc. Class A and Class B shares, net investment income
aggregating $.01 per share from the initial purchase of shares on December
11, 1997 through December 30, 1997 was recognized. Principal SmallCap Fund,
Inc. Class A and Class B distributed a tax return of capital of $.01 per
share to the sole shareholder Principal Life Insurance Company, during the
period. Principal Real Estate Fund, Inc. and Principal SmallCap Fund, Inc.
Class A, Class B and Class R shares incurred unrealized gains (losses) on
investments during the initial interim period as follows. This represents
Class A and Class B share activities of each fund prior to the initial
public offering of each class of shares.

Per Share Unrealized
Gain (Loss)
--------------------
Class Class
A B
------- -------
Principal Real Estate Fund, Inc. $ .13 $ .13
Principal SmallCap Fund, Inc. (.08) (.09)

(g) Without the Manager's voluntary waiver of a portion of certain of its
expenses (see Note 3 to the financial statements) for the periods
indicated, Principal Utilities Fund, Inc. would have had per share net
investment income and the ratios of expenses to average net assets as
shown:

Year Ended
October 31, Per Share Ratio of Expenses
Except Net Investment to Average Net Amount
as Noted Income Assets Waived
Class A 1998 $.39 1.23% $ 60,477
1997 .46 1.25% 65,940
1996 .43 1.25% 54,932
1995 .46 1.30% 151,145
1994 .41 1.50% 284,836

Class B 1998 .29 2.00% 9,557
1997 .37 1.95% 3,753
1996 .34 2.06% 6,690
1995(e) .40 1.81%(d) 1,338

International Growth-Oriented Funds

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

PRINCIPAL INTERNATIONAL EMERGING MARKETS FUND, INC.
Class A shares 1998 1997(a)
- --------------------------------------------------------------------------------
Net Asset Value, Beginning of Period................... $8.29 $9.51
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.02) (.01)
Net Realized and Unrealized Gain (Loss) on Investments (1.73) (1.21)

Total from Investment Operations (1.75) (1.22)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $6.54 $8.29

Total Return(b)........................................ (21.11)% (10.18)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $7,312 $5,039
Ratio of Expenses to Average Net Assets............. 3.31% 2.03%(d)
Ratio of Net Investment Income (Operating Loss) to
Average Net Assets................................ (.36)% (.32)%(d)
Portfolio Turnover Rate............................. 45.2% 21.4%(d)

PRINCIPAL INTERNATIONAL EMERGING MARKETS FUND, INC.
Class B shares 1998 1997(a)
- --------------------------------------------------------------------------------
Net Asset Value, Beginning of Period................... $8.28 $9.51
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.05) (.01)
Net Realized and Unrealized Gain (Loss) on Investments (1.71) (1.22)

Total from Investment Operations (1.76) (1.23)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $6.52 $8.28

Total Return(b)........................................ (21.26)% (10.29)%(c)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $3,275 $3,116
Ratio of Expenses to Average Net Assets............. 3.59% 2.16%(d)
Ratio of Net Investment Income (Operating Loss) to
Average Net Assets................................ (.69)% (.46)%(d)
Portfolio Turnover Rate............................. 45.2% 21.4%(d)

<TABLE>
<CAPTION>
PRINCIPAL INTERNATIONAL FUND, INC.(e)
Class A shares 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period................... $9.33 $8.14 $7.28 $7.44 $6.85
Income from Investment Operations:
Net Investment Income............................... .13 .09 .10 .08 .01
Net Realized and Unrealized Gain (Loss) on Investments .04 1.52 1.17 (.02) .64

Total from Investment Operations .17 1.61 1.27 .06 .65

Less Dividends and Distributions:
Dividends from Net Investment Income................ (.10) (.11) (.08) (.03) (.02)
Distributions from Capital Gains.................... (.20) (.31) (.33) (.19) (.04)

Total Dividends and Distributions (.30) (.42) (.41) (.22) (.06)

Net Asset Value, End of Period......................... $9.20 $9.33 $8.14 $7.28 $7.44

Total Return(b)........................................ 1.93% 20.46% 18.36% 1.03% 9.60%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $302,757 $281,158 $172,276 $126,554 $115,812
Ratio of Expenses to Average Net Assets............. 1.25% 1.39% 1.45% 1.63% 1.74%
Ratio of Net Investment Income to Average Net Assets 1.45% 1.25% 1.43% 1.10% .10%
Portfolio Turnover Rate............................. 38.7% 26.6% 23.8% 35.4% 13.2%
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL INTERNATIONAL FUND, INC.(e)
Class B shares 1998 1997 1996 1995(f)
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period................... $9.26 $8.07 $7.24 $6.71
Income from Investment Operations:
Net Investment Income............................... .07 .03 .03 .05
Net Realized and Unrealized Gain (Loss) on Investments .04 1.51 1.15 .51

Total from Investment Operations .11 1.54 1.18 .56

Less Dividends and Distributions:
Dividends from Net Investment Income................ (.03) (.04) (.02) (.03)
Distributions from Capital Gains.................... (.20) (.31) (.33) --

Total Dividends and Distributions (.23) (.35) (.35) (.03)

Net Asset Value, End of Period......................... $9.14 $9.26 $8.07 $7.24

Total Return(b)........................................ 1.27% 19.62% 17.16% 9.77%(c)

<TABLE>
<CAPTION>
PRINCIPAL INTERNATIONAL SMALLCAP FUND, INC.
Class A shares 1998 1997(a)
- --------------------------------------------------------------------------------
<S> <C> <C>
Net Asset Value, Beginning of Period................... $9.96 $10.04
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.07) (.01)
Net Realized and Unrealized Gain (Loss) on Investments .10 (.07)

Total from Investment Operations .03 (.08)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $9.99 $9.96

Total Return(b)........................................ .30% .50%(c)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $11,765 $6,210
Ratio of Expenses to Average Net Assets............. 2.66% 1.99%(d)
Ratio of Net Investment Income (Operating Loss) to
Average Net Assets................................ (.81)% (.40)%(d)
Portfolio Turnover Rate............................. 99.8% 10.4%(d)
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL INTERNATIONAL SMALLCAP FUND, INC.
Class B shares 1998 1997(a)
- --------------------------------------------------------------------------------
<S> <C> <C>
Net Asset Value, Beginning of Period................... $9.96 $10.04
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.10) (.01)
Net Realized and Unrealized Gain (Loss) on Investments .11 (.07)

Total from Investment Operations .01 (.08)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $9.97 $9.96

Total Return(b)........................................ .10% .50%(c)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $6,585 $4,774
Ratio of Expenses to Average Net Assets............. 2.90% 2.07%(d)
Ratio of Net Investment Income (Operating Loss) to
Average Net Assets................................ (1.05)% (.47)%(d)
Portfolio Turnover Rate............................. 99.8% 10.4%(d)
</TABLE>

Notes to Financial Highlights

(a) Period from August 29, 1997, date Class A and Class B shares first offered
to the public, through October 31, 1997. Principal International Emerging
Markets Fund, Inc. and Principal International SmallCap Fund, Inc. classes
of shares recognized net investment income as follows for the period from
the initial purchase of shares on August 14, 1997, through August 28, 1997,
none of which was distributed to the sole shareholder, Principal Life
Insurance Company. Principal International Emerging Markets Fund, Inc. and
Principal International SmallCap Fund, Inc. incurred unrealized gains
(losses) on investments during the initial interim period as follows. This
represents Class A and Class B share activities prior to the initial public
offering of all classes of shares of each fund.

Per Share
Net Investment
Income

Principal International Emerging Markets Fund, Inc.:
Class A $.01 $(.50)
Class B .01 (.50)

Principal International SmallCap Fund, Inc.:
Class A .01 .03
Class B .01 .03

(b) Total return is calculated without the front-end sales charge or contingent
deferred sales charge.

(d) Computed on an annualized basis.

(e) Effective January 1, 1998, Princor World Fund, Inc. changed its name to
Principal International Fund, Inc.

(f) Period from December 9, 1994, date Class B shares first offered to the
public, through October 31, 1995. Principal International Fund, Inc. Class
B shares recognized no net investment income for the period from the
initial purchase by Principal Management Corporation of Class B shares on
December 5, 1994, through December 8, 1994. Additionally, Class B shares
incurred unrealized losses on investments of $.07 per share during the
initial interim period. This represents Class B share activities of the
fund prior to the initial public offering of Class B shares.

Income-Oriented Funds

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

<TABLE>
<CAPTION>
PRINCIPAL BOND FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $11.44 $11.17 $11.42 $10.27 $11.75
Income from Investment Operations:
Net Investment Income(b).............................. .71 .75 .76 .78 .78
Net Realized and Unrealized Gain (Loss) on Investments .16 .33 (.25) 1.16 (1.47)
------ ------ ------ ------ ------
Total from Investment Operations .87 1.08 .51 1.94 (.69)
Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.72) (.81) (.76) (.78) (.78)

<TABLE>
<CAPTION>
PRINCIPAL HIGH YIELD FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $8.52 $8.27 $8.06 $7.83 $8.36
Income from Investment Operations:
Net Investment Income................................. .64 .67 .68 .68 .63
Net Realized and Unrealized Gain (Loss) on Investments (.88) .31 .23 .20 (.51)
------ ------ ------ ------ ------
Total from Investment Operations (.24) .98 .91 .88 .12

Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.64) (.73) (.70) (.65) (.65)
Excess Distribution of Net Investment Income(h)....... (.01) -- -- -- --
------ ------ ------ ------ ------
Total Dividends and Distributions (.65) (.73) (.70) (.65) (.65)
------ ------ ------ ------ ------
Net Asset Value, End of Period........................... $7.63 $8.52 $8.27 $8.06 $7.83
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total Return(c).......................................... (3.18)% 12.33% 11.88% 11.73% 1.45%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $33,474 $38,239 $28,432 $23,396 $19,802
Ratio of Expenses to Average Net Assets............... 1.40% 1.22% 1.26% 1.45% 1.46%
Ratio of Net Investment Income to Average Net Assets.. 7.71% 7.99% 8.49% 8.71% 7.82%
Portfolio Turnover Rate............................... 65.9% 39.2% 18.8% 40.3% 27.2%
</TABLE>

<TABLE>
<CAPTION>
PRINCIPAL HIGH YIELD FUND, INC.(a)
Class B shares 1998 1997 1996 1995(f)
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $8.47 $8.22 $8.05 $7.64
Income from Investment Operations:
Net Investment Income................................. .57 .62 .60 .53
Net Realized and Unrealized Gain (Loss) on Investments (.87) .28 .20 .38
---- ---- ---- ----
Total from Investment Operations (.30) .90 .80 .91

Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.57) (.65) (.63) (.50)
Excess Distribution of Net Investment Income(h)....... (.01) -- -- --
---- ---- ---- ----
Total Dividends and Distributions (.58) (.65) (.63) (.50)
---- ---- ---- ----
Net Asset Value, End of Period........................... $7.59 $8.47 $8.22 $8.05
---- ---- ---- ----
---- ---- ---- ----
Total Return(c).......................................... (3.93)% 11.31% 10.46% 12.20%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $8,527 $6,558 $2,113 $633
Ratio of Expenses to Average Net Assets............... 2.34% 2.13% 2.38% 2.10%(e)
Ratio of Net Investment Income to Average Net Assets.. 6.78% 7.03% 7.39% 7.78%(e)
Portfolio Turnover Rate............................... 65.9% 39.2% 18.8% 40.3%(e)
</TABLE>

<TABLE>
<CAPTION>
PRINCIPAL LIMITED TERM BOND FUND, INC.(a)
Class A shares 1998 1997 1996(g)
---- ---- ----
<S> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $9.88 $9.89 $9.90
Income from Investment Operations:
Net Investment Income(b).............................. .57 .61 .38
Net Realized and Unrealized Gain (Loss) on Investments .06 .03 (.04)
------ ------ ------
Total from Investment Operations .63 .64 .34

Less Dividends from Net Investment Income................ (.58) (.65) (.35)
------ ------ ------
Net Asset Value, End of Period........................... $9.93 $9.88 $9.89
------ ------ ------
------ ------ ------
Total Return(c).......................................... 6.57% 6.75% 3.62%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $27,632 $20,567 $17,249
Ratio of Expenses to Average Net Assets(b)............ .82% .90% .89%(e)
Ratio of Net Investment Income to Average Net Assets.. 5.86% 6.20% 6.01%(e)
Portfolio Turnover Rate............................... 23.8% 17.4% 16.5%(e)

PRINCIPAL LIMITED TERM BOND FUND, INC.(a)
Class B shares 1998 1997 1996(g)
---- ---- ----
Net Asset Value, Beginning of Period..................... $9.90 $9.89 $9.90
Income from Investment Operations:
Net Investment Income(b).............................. .54 .56 .36
Net Realized and Unrealized Gain (Loss) on Investments .06 .04 (.05)
------ ------ ------
Total from Investment Operations .60 .60 .31

Less Dividends from Net Investment Income................ (.52) (.59) (.32)
------ ------ ------
Net Asset Value, End of Period........................... $9.98 $9.90 $9.89
------ ------ ------
------ ------ ------
Total Return(c).......................................... 6.24% 6.31% 3.32%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $1,705 $625 $112
Ratio of Expenses to Average Net Assets(b)............ 1.22% 1.24% 1.15%(e)
Ratio of Net Investment Income to Average Net Assets.. 5.44% 5.84% 5.75%(e)
Portfolio Turnover Rate............................... 23.8% 17.4% 16.5%(e)
</TABLE>

<TABLE>
<CAPTION>
PRINCIPAL TAX-EXEMPT BOND FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $12.38 $12.04 $11.98 $10.93 $12.62
Income from Investment Operations:
Net Investment Income................................. .60 .63 .64 .65 .64
Net Realized and Unrealized Gain (Loss) on Investments .22 .39 .07 1.05 (1.54)
------ ------ ------ ------ ------
Total from Investment Operations .82 1.02 .71 1.70 (.90)

<TABLE>
<CAPTION>
PRINCIPAL TAX-EXEMPT BOND FUND, INC.(a)
Class B shares 1998 1997 1996 1995(f)
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $12.39 $12.02 $11.96 $10.56
Income from Investment Operations:
Net Investment Income................................. .53 .55 .55 .50
Net Realized and Unrealized Gain (Loss) on Investments .20 .40 .06 1.38
------ ------ ------ ------
Total from Investment Operations .73 .95 .61 1.88
Less Dividends and Distributions:
Dividends from Net Investment Income................. (.53) (.58) (.55) (.48)
Distributions from Capital Gains..................... -- -- -- --
------ ------ ------ ------
Total Dividends and Distributions (.53) (.58) (.55) (.48)
------ ------ ------ ------
Net Asset Value, End of Period........................... $12.59 $12.39 $12.02 $11.96
------ ------ ------ ------
------ ------ ------ ------

Total Return(c).......................................... 6.01% 8.08% 5.23% 17.97%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $11,419 $7,783 $5,794 $3,486
Ratio of Expenses to Average Net Assets............... 1.43% 1.45% 1.52% 1.51%(e)
Ratio of Net Investment Income to Average Net Assets.. 4.22% 4.46% 4.59% 4.78%(e)
Portfolio Turnover Rate............................... 6.6% 8.9% 9.8% 17.6%(e)
</TABLE>

Notes to Financial Highlights

(a) Effective January 1, 1998, the following changes were made to the names of
the Income Funds:

<TABLE>
<CAPTION>
Former Fund Name New Fund Name
---------------- -------------
<S> <C>
Princor Bond Fund, Inc. Principal Bond Fund, Inc.
Princor Government Securites Income Fund, Inc. Principal Government Securities Income Fund, Inc.
Princor High Yield Fund, Inc. Principal High Yield Fund, Inc.
Princor Limited Term Bond Fund, Inc. Principal Limited Term Bond Fund, Inc.
Princor Tax-Exempt Bond Fund, Inc. Principal Tax-Exempt Bond Fund, Inc.
</TABLE>

(b) Without the Manager's voluntary waiver of a portion of certain of its
expenses (see Note 3 to the financial statements) for the periods indicated,
the following funds would have had per share net investment income and the
ratios of expenses to average net assets as shown:
<TABLE>
<CAPTION>
Year Ended
October 31, Per Share Ratio of Expenses
Except Net Investment to Average Net Amount
as Noted Income Assets Waived
------------ -------------- ----------------- --------

Principal Bond Fund, Inc.:
<S> <C> <C> <C> <C>
Class A 1998 $.70 1.04% $121,092
1997 .74 .98 41,256
1996 .76 .97 22,536
1995 .77 1.02 86,018
1994 .77 1.09 120,999

Class B 1998 .62 1.81 26,130
1997 .66 1.79 8,982
1996 .67 1.79 5,874
1995(f) .62 1.62(e) 300

Principal Limited Term Bond Fund, Inc.:
Class A 1998 .55 1.13 76,952
1997 .59 1.15 46,271
1996(h) .37 1.16(e) 22,716

Class B 1998 .47 2.36 11,537
1997 .46 3.82 6,528
1996(h) .34 1.94(e) 259

</TABLE>

(d) Total return amounts have not been annualized.

(e) Computed on an annualized basis.

(f) Period from December 9, 1994, date Class B shares first offered to the
public, through October 31, 1995. Certain of the Income Funds' Class B
shares recognized net investment income as follows, for the period from the
initial purchase of Class B shares on December 5, 1994 through December 8,
1994, none of which was distributed to the sole shareholder, Principal
Management Corporation. Additionally, the Income Funds' Class B shares
incurred unrealized losses on investments during the initial interim period
as follows. This represents Class B share activities of each fund prior to
the initial public offering of Class B shares:

Per Share Per Share
Net Investment Unrealized
Income (Loss)
-------------- ----------
Principal Bond Fund, Inc. $.01 $ --
Principal Government Securities Income Fund, Inc. .01 (.02)
Principal High Yield Fund, Inc. .01 (.03)
Principal Tax-Exempt Bond Fund, Inc. -- (.05)

(g) Period from February 29, 1996, date shares first offered to the public,
through October 31, 1996. With respect to Class A shares, net investment
income, aggregating $.02 per share for the period from the initial purchase
of shares on February 13, 1996 through February 28, 1996, was recognized,
none of which was distributed to its sole shareholder, Principal Life
Insurance Company during the period. Additionally, Class A shares incurred
unrealized losses on investments of $.12 per share during the initial
interim period. With respect to Class B shares, no net investment income was
recognized for the period from initial purchase of shares on February 27,
1996 through February 28, 1996. Additionally, Class B shares incurred
unrealized losses on investments of $.02 per share during the initial
interim period. This represents Class A share and Class B share activities
of the fund prior to the initial public offering of both classes of shares.

(h) Dividends and distributions which exceed investment income and net realized
gains for financial reporting purposes but not for tax purposes are reported
as dividends in excess of net investment income or distributions in excess
of net realized gains on investments. To the extent distributions exceed
current and accumulated earnings and profits for federal income tax
purposes, they are reported as tax return of capital distributions.

Money Market Fund

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

<TABLE>
<CAPTION>
PRINCIPAL CASH MANAGEMENT FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
- -------------------------------------------------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.................... $1.000 $1.000 $1.000 $1.000 $1.000
Income from Investment Operations:
Net Investment Income(b)............................. .051 .050 .049 .052 .033
Net Realized and Unrealized Gain (Loss) on Investments -- -- -- -- --

Total from Investment Operations .051 .050 .049 .052 .033

Less Dividends From Net Investment Income............... (.051) (.050) (.049) (.052) (.033)

Net Asset Value, End of Period.......................... $1.000 $1.000 $1.000 $1.000 $1.000

Total Return(c)......................................... 5.10% 4.96% 5.00% 5.36% 2.67%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............. $294,918 $836,072 $694,962 $623,864 $332,346
Ratio of Expenses to Average Net Assets(b)........... .56%(e) .63% .66% .72% .70%
Ratio of Net Investment Income to Average Net Assets. 5.12% 4.98% 4.88% 5.24% 3.27%

PRINCIPAL CASH MANAGEMENT FUND, INC.(a)
Class B shares 1998 1997 1996 1995(g)
- -------------------------------------------------------- ---- ---- ---- ----
Net Asset Value, Beginning of Period.................... $1.000 $1.000 $1.000 $1.000
Income from Investment Operations:
Net Investment Income(b)............................. .042 .041 .041 .041
Net Realized and Unrealized Gain (Loss) on Investments -- -- -- --

Total from Investment Operations .042 .041 .041 .041

Less Dividends from Net Investment Income............... (.042) (.041) (.041) (.041)

Net Asset Value, End of Period.......................... $1.000 $1.000 $1.000 $1.000

Total Return(c)......................................... 4.25% 4.05% 4.13% 4.19%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............. $3,602 $992 $520 $208
Ratio of Expenses to Average Net Assets(b)........... 1.41%(e) 1.47% 1.50% 1.42%(f)
Ratio of Net Investment Income to Average Net Assets. 4.23% 4.08% 4.08% 4.50%(f)
</TABLE>

Notes to Financial Highlights

(a) Effective January 1, 1998, the following change was made to the name of
the Money Market Fund:

<TABLE>
<CAPTION>
Former Fund Name New Fund Name
<S> <C>
Princor Cash Management Fund, Inc. Principal Cash Management Fund, Inc.
</TABLE>

(b) Without the Manager's voluntary waiver of a portion of certain of its
expenses (see Note 3 to the financial statements) for the periods
indicated, the Money Market Funds would have had per share net investment
income and the ratios of expenses to average net assets as shown:

<TABLE>
<CAPTION>
Year Ended Ratio of
October 31, Per Share Expenses
Except Net Investment to Average Amount
as Noted Income Net Assets Waived
<S> <C> <C> <C> <C>
Principal Cash Management Fund, Inc.:
Class A 1998(e) $.051 .56% $ --
1997 .050 .63 --
1996 .049 .67 7,102
1995 .052 .78 296,255
1994 .031 .90 595,343

Class B 1998(e) .041 1.49 1,343
1997 .036 2.14 5,492
1996 .029 3.94 6,140
1995(g) .041(f) 1.63(f) 104

</TABLE>

(d) Total return amounts have not been annualized.

(e) Management fee waivers apply to November 1, 1997 through February 28, 1998.

(f) Computed on an annualized basis.

(g) Period from December 9, 1994, date Class B shares first offered to the
public, through October 31, 1995.

Additional information about the Funds is available in the Statement of
Additional Information dated ____________ and which is part of this prospectus.
Information about the Funds' investments is also available in the Funds' annual
and semi-annual reports to shareholders. In the Funds' annual report, you will
find a discussion of the market conditions and investment strategies that
significantly affected the Funds' performance during its last fiscal year. The
Statement of Additional Information and annual and semi-annual reports can be
obtained free of charge by writing or telephoning Princor Financial Services
Corporation, P.O. Box 10423, Des Moines, IA 50306. Telephone 1-800-247-4123.

Information about the Funds can be reviewed and copied at the Securities and
Exchange Commission's Public Reference Room in Washington, D.C. Information on
the operation of the public reference room may be obtained by calling the
Commission at 800-SEC-0330. Reports and other information about the Funds are
available on the Commission's internet site at http://www.sec.gov. Copies of
this information may be obtained, upon payment of a duplicating fee, by writing
the Public Reference Section of the Commission, Washington, D.C. 20549-6009.

The U.S. Government does not insure or guarantee an investment in any of the
Funds. There can be no assurance the Money Market Fund will be able to maintain
a stable share price of $1.00 per share.

Shares of the Funds are not deposits or obligations of, or guaranteed or
endorsed by, any financial institution, nor are shares of the Funds federally
insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board,
or any other agency.
SEC FILE DOMESTIC GROWTH-ORIENTED FUNDS

811-05072 Principal Balanced Fund, Inc.
811-06263 Principal Blue Chip Fund, Inc.
811-01874 Principal Capital Value Fund, Inc.
811-01873 Principal Growth Fund, Inc.
811-05171 Principal MidCap Fund, Inc.
811-08379 Principal Real Estate Fund, Inc.
811-08381 Principal SmallCap Fund, Inc.
811-07266 Principal Utilities Fund, Inc.

INTERNATIONAL GROWTH-ORIENTED FUNDS

811-08249 Principal International Emerging Markets Fund, Inc.
811-03183 Principal International Fund, Inc.
811-08251 Principal International SmallCap Fund, Inc.

INCOME-ORIENTED FUNDS

811-05172 Principal Bond Fund, Inc.
811-04226 Principal Government Securities Income Fund, Inc.
811-05174 Principal High Yield Fund, Inc.
811-07453 Principal Limited Term Bond Fund, Inc.
811-04449 Principal Tax-Exempt Bond Fund, Inc.

MONEY MARKET FUND

811-03585 Principal Cash Management Fund, Inc.

Principal Balanced Fund, Inc.
Principal Blue Chip Fund, Inc.
Principal Bond Fund, Inc.
Principal Capital Value Fund, Inc.
Principal Cash Management Fund, Inc.
Principal Government Securities Fund, Inc.
Principal Growth Fund, Inc.
Principal High Yield Fund, Inc.
Principal International Emerging Markets Fund, Inc.
Principal International Fund, Inc.
Principal International SmallCap Fund, Inc.
Principal Limited Term Bond Fund Inc.
Principal MidCap Fund, Inc.
Principal Real Estate Fund, Inc.
Principal SmallCap Fund, Inc.
Principal Tax-Exempt Bond Fund, Inc.
Principal Tax-Exempt Cash Management Fund, Inc.
Principal Utilities Fund, Inc.

Statement of Additional Information

dated ______________

This Statement of Additional Information is not a prospectus but is a part of
the prospectuses for the Funds listed above. The most recent prospectuses dated
_____________ and shareholder report is available without charge. Please call
1-800-247-4123 to request a copy.

TABLE OF CONTENTS

Investment Policies and Restrictions of the Funds...................... 3
Growth-Oriented Funds............................................... 3
Income-Oriented Funds .............................................. 7
Money Market Funds.................................................. 10
Funds' Investments..................................................... 13
Directors and Officers of the Funds.................................... 25
Manager and Sub-Advisor................................................ 27
Cost of Manager's Services............................................. 28
Brokerage on Purchases and Sales of Securities......................... 30
How to Purchase Shares................................................. 33
Offering Price of Funds' Shares........................................ 35
Distribution Plan...................................................... 41
Determination of Net Asset Value of Funds' Shares ..................... 44
Performance Calculation................................................ 45
Tax Treatment of Funds, Dividends and Distributions .................. 50
General Information and History........................................ 52
Financial Statements .................................................. 52
Appendix A............................................................. 52

INVESTMENT POLICIES AND RESTRICTIONS OF THE FUNDS

The following information about the Principal Funds, a family of separately
incorporated, diversified, open-end management investment companies, commonly
called mutual funds, supplements the information provided in the Prospectuses
under the caption "PRIMARY INVESTMENT STRATEGIES AND RELATED RISKS".

There are three categories of Principal Funds:

Growth-Oriented Funds which include:
o seven Funds which seek primarily capital appreciation through
investments in equity securities (Capital Value Fund, Growth Fund,
International Emerging Markets Fund, International Fund,
International SmallCap Fund, MidCap Fund and SmallCap Fund);
o one Fund which seeks a total investment return including both
capital appreciation and income through investments in equity and
debt securities (Balanced Fund);
o one Fund which seeks growth of capital and growth of income
primarily through investments in common stocks of
well-capitalized, established companies (Blue Chip Fund);
o one Fund which seeks to generate total return by investing
primarily in equity securities of companies principally engaged in
the real estate industry (Real Estate Fund); and
o one Fund which seeks current income and long-term growth of income
and capital by investing primarily in equity and fixed-income
securities of companies in the public utilities industry
(Utilities Fund).

Income-Oriented Funds which include five funds which seek primarily a high
level of income through investments in debt securities (Bond Fund,
Government Securities Income Fund, High Yield Fund, Limited Term Bond Fund
and Tax-Exempt Bond Fund).

Money Market Funds which include two funds which seek primarily a high
level of income through investments in short-term debt securities (Cash
Management Fund and Tax-Exempt Cash Management Fund).

In seeking to achieve its investment objective, each Fund has adopted as matters
of fundamental policy certain investment restrictions which cannot be changed
without approval by the holders of the lesser of: (i) 67% of the Fund's shares
present or represented at a shareholders' meeting at which the holders of more
than 50% of such shares are present or represented by proxy; or (ii) more than
50% of the outstanding shares of the Fund. Similar shareholder approval is
required to change the investment objective of each of the Funds. The following
discussion provides for each Fund a statement of its investment objective, a
description of its investment restrictions that are matters of fundamental
policy and a description of any investment restrictions it may have adopted that
are not matters of fundamental policy and may be changed without shareholder
approval. For purposes of the investment restrictions, all percentage and rating
limitations apply at the time of acquisition of a security, and any subsequent
change in any applicable percentage resulting from market fluctuations or in a
rating by a rating service will not require elimination of any security from the
portfolio. Unless specifically identified as a matter of fundamental policy,
each investment policy discussed in the Prospectuses or the Statement of
Additional Information is not fundamental and may be changed by the respective
Fund's Board of Directors.

The Table on the next page graphically illustrates each Fund's emphasis on
producing current income and capital growth and the stability of the market
value of the Fund's portfolio. These illustrations represent comparative
relationships only with regard to the investment objectives sought by the Funds.
Relative income, stability and growth may vary among the Funds with certain
market conditions. The illustrations are not intended and should not be
construed as projected relative performances of the Principal Funds.

GROWTH-ORIENTED FUNDS

Investment Objectives

Principal Balanced Fund, Inc. ("Balanced Fund") seeks to generate a total
investment return consisting of current income and capital appreciation while
assuming reasonable risks in furtherance of the investment objective.

Principal Blue Chip Fund, Inc. ("Blue Chip Fund") seeks to achieve growth of
capital and growth of income by investing primarily in common stocks of well
capitalized, established companies.

Principal Capital Value Fund, Inc. ("Capital Value Fund") seeks to achieve
primarily long-term capital appreciation and secondarily growth of
investment income through the purchase primarily of common stocks, but the
Fund may invest in other securities.

Principal Growth Fund, Inc. ("Growth Fund") seeks growth of capital through the
purchase primarily of common stocks, but the Fund may invest in other
securities.

Principal International Emerging Markets Fund, Inc. ("International Emerging
Markets Fund") seeks to achieve long-term growth of capital by investing
primarily in equity securities of issuers in emerging market countries.

Principal International Fund, Inc. ("International Fund") seeks long-term growth
of capital by investing in a portfolio of equity securities of companies
domiciled in any of the nations of the world.

Principal International SmallCap Fund, Inc. ("International SmallCap Fund")
seeks to achieve long-term growth of capital by investing primarily in
equity securities of non-United States companies with comparatively smaller
market capitalizations.

Principal MidCap Fund, Inc. ("MidCap Fund") seeks to achieve capital
appreciation by investing primarily in securities of emerging and other
growth-oriented companies.

Principal Real Estate Fund, Inc. ("Real Estate Fund") seeks to generate total
return by investing primarily in equity securities of companies principally
engaged in the real estate industry.

Principal SmallCap Fund, Inc. ("SmallCap Fund") seeks to achieve long-term
growth of capital by investing primarily in equity securities of companies with
comparatively smaller market capitalizations.

Principal Utilities Fund, Inc. ("Utilities Fund") seeks to provide high
current income and long-term growth of income and capital. The Fund seeks
to achieve its objective by investing primarily in equity and fixed income
securities of companies in the public utilities industry.

Investment Restrictions

Balanced Fund, Blue Chip Fund, International Emerging Markets Fund,
International Fund, International SmallCap Fund, MidCap Fund, Real Estate Fund,
SmallCap Fund and Utilities Fund

Each of the following numbered restrictions is a matter of fundamental
policy and may not be changed without shareholder approval. The Balanced
Fund, Blue Chip Fund, International Fund, International Emerging Markets
Fund, International SmallCap Fund, MidCap Fund, Real Estate Fund, SmallCap
Fund and Utilities Fund each may not:

(1) Issue any senior securities as defined in the Investment Company
Act of 1940. Purchasing and selling securities and futures
contracts and options thereon and borrowing money in accordance
with restrictions described below do not involve the issuance of a
senior security.

(2) Purchase or retain in its portfolio securities of any issuer if
those officers or directors of the Fund or its Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.

(3) Invest in commodities or commodity contracts, but it may purchase
and sell financial futures contracts and options on such
contracts.

(4) Invest in real estate, although it may invest in securities which
are secured by real estate and securities of issuers which invest
or deal in real estate.

(5) Borrow money, except for temporary or emergency purposes, in an amount
not to exceed 5% of the value of the Fund's total assets at the time of
the borrowing.

(6) Make loans, except that the Fund may (i) purchase and hold debt
obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities without limitation against collateral
(consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities)
equal at all times to not less than 100% of the value of the
securities loaned.

(7) Invest more than 5% of its total assets in the securities of any
one issuer (other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities)
except that this limitation shall apply only with respect to 75%
of the total assets of the International Emerging Markets Fund and
the International SmallCap Fund; or purchase more than 10% of the
outstanding voting securities of any one issuer.

(8) Act as an underwriter of securities, except to the extent the Fund
may be deemed to be an underwriter in connection with the sale of
securities held in its portfolio.

(9) Concentrate its investments in any particular industry or industries,
except that:

(a) the Utilities Fund may not invest less than 25% of its total
assets in securities of companies in the public utilities
industry,
(b) the Balanced Fund, Blue Chip Fund, International Emerging
Markets Fund, International Fund, International SmallCap Fund,
MidCap Fund and SmallCap Fund each may invest not more than
25% of the value of its total assets in a single industry, and
(c) the Real Estate Fund may not invest less than 25% of its total
assets in securities of companies in the real estate industry.

(10) Sell securities short (except where the Fund holds or has the
right to obtain at no added cost a long position in the securities
sold that equals or exceeds the securities sold short) or purchase
any securities on margin, except it may obtain such short-term
credits as are necessary for the clearance of transactions. The
deposit or payment of margin in connection with transactions in
options and financial futures contracts is not considered the
purchase of securities on margin.

(11) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Fund may invest in securities
of issuers which invest in or sponsor such programs.

Each of these Funds has also adopted the following restrictions which are
not fundamental policies and may be changed without shareholder approval.
It is contrary to each Fund's present policy to:

(1) Invest more than 15% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than
seven days. The value of any options purchased in the
Over-the-Counter market are included as part of this 15%
limitation.

(2) Purchase warrants in excess of 5% of its total assets, of which 2%
may be invested in warrants that are not listed on the New York or
American Stock Exchange. The 2% limitation for the International
Fund also includes warrants not listed on the Toronto Stock
Exchange. The 2% limitation for the International Emerging Markets
Fund and International SmallCap Fund also includes warrants not
listed on the Toronto Stock Exchange and the Chicago Board Options
Exchange.

(3) Purchase securities of any issuer having less than three years'
continuous operation (including operations of any predecessors) if
such purchase would cause the value of the Fund's investments in
all such issuers to exceed 5% of the value of its total assets.

(4) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.

(5) Invest in companies for the purpose of exercising control or
management.

(6) Invest more than 5% of its total assets in the purchase of covered
spread options and the purchase of put and call options on
securities, securities indices and financial futures contracts.
Options on financial futures contracts and options on securities
indices will be used solely for hedging purposes; not for
speculation.

(7) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.

(8) Invest in arbitrage transactions.

(9) Invest in real estate limited partnership interests except that
this restriction shall not apply to the Real Estate Fund.

(10) Invest in mineral leases.

The Balanced Fund, Blue Chip Fund, MidCap Fund, SmallCap Fund and Utilities
Fund have also adopted a restriction, which is not a fundamental policy and
may be changed without shareholder approval, that each such Fund may not
invest more than 20% of its total assets in securities of foreign issuers.

The Real Estate Fund has adopted a restriction, which is not a fundamental
policy and may be changed without shareholder approval, that the Fund may
not invest more than 25% of its total assets in securities of foreign
issuers.

The Balanced Fund, Blue Chip Fund, International Emerging Markets Fund,
International Fund, International SmallCap Fund, MidCap Fund, SmallCap Fund
and Utilities Fund have also adopted a restriction, which is not a
fundamental policy and may be changed without shareholder approval, that
each Fund may not invest more than 10% of its assets in securities of other
investment companies, invest more than 5% of its total assets in the
securities of any one investment company or acquire more than 3% of the
outstanding voting securities of any one investment company except in
connection with a merger, consolidation or plan of reorganization and the
Funds may purchase securities of closed-end companies in the open market
where no underwriter or dealer's commission or profit, other than a
customary broker's commission, is involved.

The Utilities Fund has also adopted a restriction, which is not a
fundamental policy and may be changed without shareholder approval, that
the Fund may not own more than 5% of the outstanding voting securities of
more than one public utility company as defined by the Public Utility
Holding Company Act of 1935.

Capital Value Fund and Growth Fund

Each of the following numbered restrictions is a matter of fundamental
policy and may not be changed without shareholder approval. The Capital
Value Fund and Growth Fund each may not:

(1) Concentrate its investments in any one industry. No more than 25% of
the value of its total assets will be invested in any one industry.

(2) Purchase the securities of any issuer if the purchase will
cause more than 5% of the value of its total assets to be
invested in the securities of any one issuer (except U. S.
Government securities).

(3) Purchase the securities of any issuer if the purchase will
cause more than 10% of the voting securities, or any other
class of securities of the issuer, to be held by the Fund.

(4) Underwrite securities of other issuers, except that the Fund
may acquire portfolio securities under circumstances where if
sold the Fund might be deemed an underwriter for purposes of
the Securities Act of 1933.

(5) Purchase securities of any company with a record of less than
three years' continuous operation (including that of
predecessors) if the purchase would cause the value of the
Fund's aggregate investments in all such companies to exceed
5% of the Fund's total assets.

(6) Engage in the purchase and sale of illiquid interests in real
estate. For this purpose, readily marketable interests in real
estate investment trusts are not interests in real estate.

(7) Engage in the purchase and sale of commodities or commodity
contracts.

(8) Purchase or retain in its portfolio securities of any issuer
if those officers and directors of the Fund or its Manager
owning beneficially more than one-half of one percent (0.5%)
of the securities of the issuer together own beneficially more
than 5% of such securities.

(9) Purchase securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions. The Fund will not effect a short sale of a
security. The Fund will not issue or acquire put and call
options.

(10) Invest more than 5% of its assets at the time of purchase in
rights and warrants (other than those that have been acquired
in units or attached to other securities).

(11) Invest more than 20% of its total assets in securities of foreign
issuers.

In addition:

(12) The Fund may not make loans except that the Fund may (i)
purchase and hold debt obligations in accordance with its
investment objective and policies, and (ii) enter into
repurchase agreements.

(13) The Fund does not propose to borrow money except for temporary
or emergency purposes from banks in an amount not to exceed
the lesser of (i) 5% of the value of the Fund's assets, less
liabilities other than such borrowings, or (ii) 10% of the
Fund's assets taken at cost at the time such borrowing is
made. The Fund may not pledge, mortgage, or hypothecate its
assets (at value) to an extent greater than 15% of the gross
assets taken at cost.

Each of these Funds has also adopted the following restrictions which
are not fundamental policies and may be changed without shareholder
approval, each Fund may not:

(1) Invest in companies for the purpose of exercising control or
management.

(2) Purchase warrants in excess of 5% of its total assets, of which 2% may
be invested in warrants that are not listed on the New York or American
Stock Exchange.

(3) Invest more than 15% of its total assets in securities not
readily marketable and in repurchase agreements maturing in
more than seven days.

(4) Invest in real estate limited partnership interests.

(5) Invest in interests in oil, gas, or other mineral exploration
or development programs, but the Fund may purchase and sell
securities of companies which invest or deal in such
interests.

(6) Invest more than 10% of its assets in securities of other
investment companies, invest more than 5% of its total assets
in the securities of any one investment company, or acquire
more than 3% of the outstanding voting securities of any one
investment company except in connect with a merger,
consolidation or plan of reorganization.

INCOME-ORIENTED FUNDS

Investment Objectives

Principal Bond Fund, Inc. ("Bond Fund") seeks to provide as high a level of
income as is consistent with
preservation of capital and prudent investment risk.

Principal Government Securities Income Fund, Inc. ("Government Securities
Income Fund") seeks a high level of current income, liquidity and safety of
principal by purchasing obligations issued or guaranteed by the United
States Government or its agencies, with emphasis on Government National
Mortgage Association Certificates ("GNMA Certificates"). The guarantee by
the United States Government extends only to principal and interest. There
are certain risks unique to GNMA Certificates.

Principal High Yield Fund, Inc. ("High Yield Fund") seeks high current
income primarily by purchasing high yielding, lower or non-rated fixed
income securities which are believed to not involve undue risk to income or
principal. Capital growth is a secondary objective when consistent with the
objective of high current income.

Principal Limited Term Bond Fund, Inc. ("Limited Term Bond Fund") seeks a
high level of current income consistent with a relatively high level of
principal stability by investing in a portfolio of securities with a dollar
weighted average maturity of five years or less.

Principal Tax-Exempt Bond Fund, Inc. ("Tax-Exempt Bond Fund") seeks as high
a level of current income exempt from federal income tax as is consistent
with preservation of capital. The Fund seeks to achieve its objective
primarily through the purchase of investment grade quality, tax-exempt
fixed income obligations.

Investment Restrictions

Bond Fund, High Yield Fund and Limited Term Bond Fund

Each of the following numbered restrictions is a matter of fundamental
policy and may not be changed without shareholder approval. The Bond Fund,
High Yield Fund and Limited Term Bond Fund each may not:

(2) Purchase or retain in its portfolio securities of any issuer if
those officers or directors of the fund or its Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.

(3) Invest in commodities or commodity contracts, but it may purchase
and sell financial futures contracts and options on such
contracts.

(4) Invest in real estate, although it may invest in securities which
are secured by real estate and securities of issuers which invest
or deal in real estate.

(5) Borrow money, except for temporary or emergency purposes, in an
amount not to exceed 5% of the value of the Fund's total assets at
the time of the borrowing.

(8) Act as an underwriter of securities, except to the extent the Fund
may be deemed to be an underwriter in connection with the sale of
securities held in its portfolio.

(9) Concentrate its investments in any particular industry or
industries, except that the Fund may invest not more than 25% of
the value of its total assets in a single industry.

(11) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Fund may invest in securities
of issuers which invest in or sponsor such programs.

Each of these Funds has also adopted the following restrictions which are
not fundamental policies and may be changed without shareholder approval.
It is contrary to each Fund's present policy to:

(2) Purchase warrants in excess of 5% of its total assets, of which 2%
may be invested in warrants that are not listed on the New York or
American Stock Exchange.

(4) Purchase securities of other investment companies except in
connection with a merger, consolidation, or plan of reorganization
or by purchase in the open market of securities of closed-end
companies where no underwriter or dealer's commission or profit,
other than a customary broker's commission, is involved, and if
immediately thereafter not more than 10% of the value of the
Fund's total assets would be invested in such securities.

(5) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.

(6) Invest in companies for the purpose of exercising control
or management.

(7) Invest more than 20% of its total assets in securities of foreign
issuers.

(8) Invest more than 5% of its total assets in the purchase of covered
spread options and the purchase of put and call options on
securities, securities indices and financial futures contracts.
Options on financial futures contracts and options on securities
indices will be used solely for hedging purposes; not for
speculation.

(9) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.

(10) Invest in arbitrage transactions.

(11) Invest in real estate limited partnership interests.

Government Securities Income Fund

Each of the following numbered restrictions is a matter of fundamental
policy and may not be changed without shareholder approval. The Government
Securities Income Fund may not:

(1) Issue any senior securities.

(2) Purchase any securities other than obligations issued or
guaranteed by the United States Government
or its agencies or instrumentalities, except that the Fund may
maintain reasonable amounts in cash or commercial paper or
purchase short-term debt securities not issued or guaranteed by
the United States Government or its agencies or instrumentalities
for daily cash management purposes or pending selection of
particular long-term investments. There is no limit on the amount
of its assets which may be invested in the securities of any one
issuer of obligations issued by the United States Government or
its agencies or instrumentalities.

(3) Act as an underwriter of securities, except to the extent the Fund
may be deemed to be an underwriter in connection with the sale of
GNMA certificates held in its portfolio.

(4) Engage in the purchase and sale of interests in real estate,
including interests in real estate investment trusts (although it
will invest in securities secured by real estate or interests
therein, such as mortgage-backed securities) or invest in
commodities or commodity contracts, oil and gas interests, or
mineral exploration or development programs.

(5) Purchase or retain in its portfolio securities of any issuer if
those officers and directors of the Fund or its Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.

(6) Sell securities short or purchase any securities on margin, except
it may obtain such short-term credits as are necessary for the
clearance of transactions. The deposit or payment of margin in
connection with transactions in options and financial futures
contracts is not considered the purchase of securities on margin.

(7) Invest in companies for the purpose of exercising control
or management.

(8) Make loans, except that the Fund may purchase or hold debt
obligations in accordance with the investment restrictions set
forth in paragraph (2) and may enter into repurchase agreements
for such securities, and may lend its portfolio securities without
limitation against collateral consisting of cash, or securities
issued or guaranteed by the United States Government or its
agencies or instrumentalities, which is equal at all times to 100%
of the value of the securities loaned.

(9) Borrow money, except for temporary or emergency purposes, in an
amount not to exceed 5% of the value of the Fund's total assets.

(10) Enter into repurchase agreements maturing in more than seven days
if, as a result, thereof, more than 10% of the Fund's total assets
would be invested in such repurchase agreements and other assets
without readily available market quotations.

(11) Invest more than 5% of its total assets in the purchase of covered
spread options and the purchase of put and call options on
securities, securities indices and financial futures contracts.

(12) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.

The Fund has also adopted the following restrictions which are not
fundamental policies and may be changed without shareholder approval. It is
contrary to the Fund's current policy to:

(2) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.

(3) Invest in real estate limited partnership interests.

(4) Invest more than 10% of its assets in securities of other
investment companies, invest more than 5% of its total assets in
the securities of any one investment company, or acquire more than
3% of the outstanding voting securities of any one investment
company except in connection with a merger, consolidation or plan
of reorganization.

Tax-Exempt Bond Fund

Each of the following numbered restrictions is a matter of fundamental
policy and may not be changed without shareholder approval. The Tax-Exempt
Bond Fund may not:

(1) Issue any senior securities as defined in the Act except insofar
as the Fund may be deemed to have issued a senior security by
reason of: (a) purchasing any securities on a when-issued or
delayed delivery basis; or (b) borrowing money in accordance with
restrictions described below.

(2) Purchase any securities other than Municipal Obligations and
Taxable Investments as defined in the Prospectus and Statement of
Additional Information.

(3) Act as an underwriter of securities, except to the extent the Fund
may be deemed to be an underwriter in connection with the sale of
securities held in its portfolio.

(5) Purchase or retain in its portfolio securities of any issuer if
those officers and directors of the Fund or its Manager owning
more than one-half of 1% (0.5%) of the securities of the issuer
together own beneficially more than 5% of such securities.

(6) Invest in companies for the purpose of exercising control
or management.

(7) Invest more than:
(a) 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the United States
Government or its agencies or instrumentalities). (b) 15% of its
total assets in securities that are not readily marketable and in
repurchase agreements maturing in more than seven days.

(8) Invest in real estate, although it may invest in securities which
are secured by real estate and securities of issuers which invest
or deal in real estate.

(9) Invest in commodities or commodity futures contracts.

(10) Write, purchase or sell puts, calls or combinations thereof.

(11) Invest in interests in oil, gas or other mineral exploration or
development programs, although it may invest in securities of
issuers which invest in or sponsor such programs.

(12) Make short sales of securities.

(13) Purchase any securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions.

(14) Make loans, except that the Fund may purchase and hold debt
obligations in accordance with its investment objective and
policies, enter into repurchase agreements, and may lend its
portfolio securities without limitation against collateral,
consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities,
which is equal at all times to 100% of the value of the securities
loaned.

(15) Borrow money, except for temporary or emergency purposes from
banks in an amount not to exceed 5% of the value of the Fund's
total assets at the time the loan is made.

(16) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings.

The Fund has also adopted the following restriction which is not
fundamental and may be changed without shareholder approval. It is contrary
to the Fund's current policy to invest in real estate limited partnership
interests.

The identification of the issuer of a Municipal Obligation depends on the
terms and conditions of the security. When the assets and revenues of an
agency, authority, instrumentality or other political subdivision are
separate from those of the government creating the subdivision and the
security is backed only by the assets and revenues of the subdivision, the
subdivision is deemed the sole issuer. Similarly, in the case of an
industrial development bond, if that bond is backed only by the assets and
revenues of the non-governmental user, then such non-governmental user is
deemed the sole issuer. If, in either case, the creating government or some
other entity guarantees a security, the guarantee is considered a separate
security and is treated as an issue of such government or other entity.
However, that guarantee is not deemed a security issued by the guarantor if
the value of all securities issued or guaranteed by the guarantor and owned
by the Fund does not exceed 10% of the value of the Fund's total assets.

The Fund may invest without limit in debt obligations of issuers located in
the same state and in debt obligations which are repayable out of revenue
sources generated from economically related projects or facilities. Sizable
investments in such obligations could increase the risk to the Fund since
an economic, business or political development or change affecting one
security could also affect others. The Fund may also invest without limit
in industrial development bonds, but it will not invest more than 20% of
its total assets in any Municipal Obligation the interest on which is
treated as a tax preference item for purposes of the federal alternative
minimum tax.

MONEY MARKET FUNDS

Investment Objectives

Principal Cash Management Fund, Inc. ("Cash Management Fund") seeks as high
a level of income available from short-term securities as is considered
consistent with preservation of principal and maintenance of liquidity by
investing in a portfolio of money market instruments.

Principal Tax-Exempt Cash Management Fund, Inc. ("Tax-Exempt Cash
Management Fund") seeks, through investment in a professionally managed
portfolio of high quality short-term Municipal Obligations, as high a level
of interest income exempt from federal income tax as is consistent with
stability of principal and maintenance of liquidity.

Investment Restrictions

Cash Management Fund

Each of the following numbered restrictions is a matter of fundamental
policy and may not be changed without shareholder approval. The Cash
Management Fund may not:

(1) Concentrate its investments in any one industry. No more than 25%
of the value of its total assets will be invested in securities of
issuers having their principal activities in any one industry,
other than securities issued or guaranteed by the U.S. Government
or its agencies or instrumentalities, or obligations of domestic
branches of U.S. banks and savings institutions. (See "Bank
Obligations").

(2) Purchase the securities of any issuer if the purchase will cause
more than 5% of the value of its total assets to be invested in
the securities of any one issuer (except securities issued or
guaranteed by the U.S. Government, its agencies or
instrumentalities).

(3) Purchase the securities of any issuer if the purchase will cause
more than 10% of the outstanding voting securities of the issuer
to be held by the Fund (other than securities issued or guaranteed
by the U.S. Government, its agencies or instrumentalities).

(4) Act as an underwriter except to the extent that, in connection
with the disposition of portfolio securities, it may be deemed to
be an underwriter under the federal securities laws.

(5) Purchase securities of any company with a record of less than 3
years continuous operation (including that of predecessors) if the
purchase would cause the value of the Fund's aggregate investments
in all such companies to exceed 5% of the value of the Fund's
total assets.

(6) Engage in the purchase and sale of illiquid interests in real
estate, including interests in real estate investment trusts
(although it may invest in securities secured by real estate or
interests therein) or invest in commodities or commodity
contracts, oil and gas interests, or mineral exploration or
development programs.

(7) Purchase securities of other investment companies except in
connection with a merger, consolidation, or plan of
reorganization.

(8) Purchase or retain in its portfolio securities of any issuer if
those officers and directors of the Fund or its Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.

(9) Purchase securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions. The Fund will not effect a short sale of any
security. The Fund will not issue or acquire put and call options,
straddles or spreads or any combination thereof.

(10) Invest in companies for the purpose of exercising control
or management.

(11) Make loans to others except through the purchase of debt
obligations in which the Fund is authorized to invest and by
entering into repurchase agreements (see "Fund Investments").

(12) Borrow money except from banks for temporary or emergency
purposes, including the meeting of redemption requests which might
otherwise require the untimely disposition of securities, in an
amount not to exceed the lesser of (i) 5% of the value of the
Fund's assets, or (ii) 10% of the value of the Fund's net assets
taken at cost at the time such borrowing is made. The Fund will
not issue senior securities except in connection with such
borrowings. The Fund may not pledge, mortgage, or hypothecate its
assets (at value) to an extent greater than 10% of the net assets.

(13) Invest in time deposits maturing in more than seven days; time
deposits maturing from two business days through seven calendar
days may not exceed 10% of the value of the Fund's total assets.

(14) Invest more than 10% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than
seven days.

The Fund has also adopted the following restriction which is not
fundamental and may be changed without shareholder approval. It is contrary
to the Fund's current policy to:

(1) Invest in real estate limited partnership interests.

Tax-Exempt Cash Management Fund

Each of the following numbered restrictions is a matter of fundamental
policy and may not be changed without shareholder approval. The Tax-Exempt
Cash Management Fund may not:

(1) Invest in securities other than Municipal Obligations and
Temporary Investments as those terms are defined in the Prospectus
and the Statement of Additional Information.

(2) Issue any senior securities as defined in the Investment Company
Act of 1940. Purchasing and selling securities and borrowing money
in accordance with restrictions described below do not involve the
issuance of a senior security.

(3) Purchase or retain in its portfolio securities of any issuer if
those officers or directors of the Fund or its Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.

(4) Invest in commodities or commodity contracts.

(5) Invest in real estate, although it may invest in securities which
are secured by real estate and securities of issuers which invest
or deal in real estate.

(6) Borrow money, except from banks for temporary or emergency
purposes, including the purpose of meeting redemption requests
which might otherwise require the untimely disposition of
securities, in an amount not to exceed one-third of the sum of
(a) the value of the Fund's net assets at the time of the borrowing
and (b) the amount borrowed. While any such borrowings exceed 5%
of total assets, no additional purchases of investment securities
will be made by the Fund. If due to market fluctuations or other
reasons the Fund's asset coverage falls below 300% of its
borrowings, the Fund will reduce its borrowings within 3 business
days.

(7) Make loans, except that the Fund may (i) purchase and hold debt
obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities without limitation against collateral
(consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities)
equal at all times to not less than 100% of the value of the
securities loaned.

(8) Invest more than 5% of its total assets in the securities of any
one issuer (other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities); or
purchase more than 10% of the outstanding voting securities of any
one issuer.

(9) Act as an underwriter of securities, except to the extent the Fund
may be deemed to be an underwriter in connection with the sale of
securities held in its portfolio.

(10) Concentrate its investments in any particular industry or
industries, except that the Fund may invest not more than 25% of
the value of its total assets in a single industry; provided,
however, that this limitation shall not be applicable to the
purchase of Municipal Obligations issued by governments or
political subdivisions of governments, obligations issued or
guaranteed by the United States Government or its agencies or
instrumentalities, or obligations of domestic banks (excluding
foreign branches of domestic banks).

(11) Sell securities short (except where the Fund holds or has the
right to obtain at no added cost a long position in the securities
sold that equals or exceeds the securities sold short) or purchase
any securities on margin, except it may obtain such short-term
credits as are necessary for the clearance of transactions.

(12) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Fund may invest in securities
of issuers which invest in or sponsor such programs.

The Fund has also adopted the following restrictions which are not
fundamental policies and may be changed without shareholder approval. It is
contrary to the Fund's present policy to:

(1) Invest more than 10% of its total assets in securities not readily
marketable, in repurchase agreements maturing in more than seven
days, and in other illiquid securities.

(2) Purchase securities of any issuer having less than three years'
continuous operation (including operations of any predecessors) if
such purchase would cause the value of the Fund's investments in
all such issuers to exceed 5% of the value of its total assets;
provided that this limitation shall not apply to obligations
issued or guaranteed by the United States Government or its
agencies or instrumentalities or to Municipal Obligations other
than industrial development bonds issued by non-governmental
issuers.

(3) Invest more than 10% of its assets in securities of other
investment companies, invest more than 5% of its total assets in
the securities of any one investment company, or acquire more than
3% of the outstanding voting securities of any one investment
company except in connection with a merger, consolidation or plan
of reorganization.

(4) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings.

(5) Invest in companies for the purpose of exercising control
or management.

(6) Write or purchase put or call options.

(7) Invest more than 20% of its total assets in industrial development
bonds the interest on which is treated as a tax preference item
for purposes of the federal alternative minimum tax.

(8) Purchase warrants in excess of 5% of its total assets, of which 2%
may be invested in warrants that are not listed on the New York or
American Stock Exchange.

(9) Invest in real estate limited partnership interests.

The identification of the issuer of a Municipal Obligation depends on the
terms and conditions of the security. When the assets and revenues of an
agency, authority, instrumentality or other political subdivision are
separate from those of the government creating the subdivision and the
security is backed only by the assets and revenues of the subdivision, such
subdivision is deemed to be the sole issuer. Similarly, in the case of an
industrial development bond, if that bond is backed only by the assets and
revenues of the non-governmental user, then such non-governmental user is
deemed to be the sole issuer. In either case, if the creating government or
some other entity guarantees a security, the guarantee is considered a
separate security and is treated as an issue of such government or other
entity.

The Fund may invest without limit in debt obligations of issuers located in
the same state and in debt obligations which are repayable out of revenue
sources generated from economically related projects or facilities. Sizable
investments in such obligations could increase the risk to the Fund since
an economic, business or political development or change affecting one
security could also affect others. The Fund may also invest without limit
in industrial development bonds, but it will not invest more than 20% of
its total assets in any municipal obligations the interest on which is
treated as a tax preference item for purposes of the federal alternative
minimum tax.

The Fund's Manager waives its management fee on the Fund's assets invested
in securities of other investment companies. The Fund generally invests in
other investment companies only for short-term cash management purposes
when the advisor anticipates the net return from the investment to be
superior to alternatives then available. The Fund generally invests only in
those investment companies that have investment policies requiring
investment in securities comparable in quality to those in which the Fund
invests.

Funds' Investments

The following information supplements the discussion of the Funds'
investment objectives and policies in the Prospectuses under the caption
"PRIMARY INVESTMENT STRATEGIES AND RELATED RISKS."

In making selections of equity securities for the Funds, the Manager uses
an approach described broadly as fundamental analysis. Three basic steps
are involved in this analysis.

o First is the continuing study of basic economic factors in an effort to
conclude what the future general economic climate is likely to be over
the next one to two years.
o Second, given some conviction as to the likely economic climate, the
Manager attempts to identify the prospects for the major industrial,
commercial and financial segments of the economy. By looking at such
factors as demand for products, capacity to produce, operating costs,
pricing structure, marketing techniques, adequacy of raw materials and
components, domestic and foreign competition, and research
productivity, the Manager evaluates the prospects for each industry for
the near and intermediate term.
o Finally, determinations are made regarding earnings prospects for
individual companies within each industry by considering the same types
of factors described above. These earnings prospects are evaluated in
relation to the current price of the securities of each company.

Although the Funds may pursue the investment practices described below,
none of the funds either committed during the last fiscal year or
currently intends to commit during the present fiscal year more than 5%
of its net assets to any of the practices, with the following
exceptions: (1) the High Yield Fund's investments in restricted
securities are expected to exceed 5% of the Fund's net assets; and (2)
the International, International Emerging Markets and International
SmallCap Funds' investments in foreign securities are expected to
continue to exceed 5% of each Fund's net assets.

Restricted Securities

Each of the Funds has adopted investment restrictions that limit its
investments in restricted securities or other illiquid securities to 15%
(10% for the Government Securities Income Fund and the Money Market Funds
and not more than 5% in equity securities) of its assets. The Board of
Directors of each of the Growth-Oriented and Income-Oriented Funds has
adopted procedures to determine the liquidity of Rule 4(2) short-term paper
and of restricted securities under Rule 144A. Securities determined to be
liquid under these procedures are excluded from other restricted securities
when applying the preceding investment restrictions.

Generally, restricted securities are not readily marketable because they
are subject to legal or contractual restrictions upon resale. They are sold
only in a public offering with an effective registration statement or in a
transaction which is exempt from the registration requirements of the
Securities Act of 1933. When registration is required, a Fund may be
obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and
the time the Fund may be permitted to sell a security. If, during such a
period, adverse market conditions were to develop, the Fund might obtain a
less favorable price than existed when it decided to sell. Restricted
securities and other securities not readily marketable are priced at fair
value as determined in good faith by or under the direction of the Board of
Directors.

Foreign Securities

Each of the following Principal Funds may invest in foreign securities to
the indicated percentage of its assets:
o International, International Emerging Markets and International
SmallCap Funds - 100%;
o Real Estate Fund - 25%;
o Balanced, Blue Chip, Bond, Capital Value, Growth, High Yield, Limited
Term Bond, MidCap, SmallCap and Utilities Funds - 20%.
o The Cash Management and Tax-Exempt Cash Management Funds do not invest
in foreign securities other than those that are United States dollar
denominated. All principal and interest payments for the security are
payable in U.S. dollars. The interest rate, the principal amount to be
repaid and the timing of payments related to the securities do not vary
or float with the value of a foreign currency, the rate of interest on
foreign currency borrowings or with any other interest rate or index
expressed in a currency other than U.S. dollars.

Debt securities issued in the United States pursuant to a registration
statement filed with the Securities and Exchange Commission are not treated
as foreign securities for purposes of these limitations.

Investment in foreign securities presents certain risks including:
fluctuations in currency exchange rates, revaluation of currencies, the
imposition of foreign taxes, future political and economic developments
including war, expropriations, nationalization, the possible imposition of
currency exchange controls and other foreign governmental laws or
restrictions. In addition, there may be reduced availability of public
information concerning issuers compared to domestic issuers. Foreign
issuers are not generally subject to uniform accounting, auditing and
financial reporting standards or to other regulatory practices and
requirements that apply to domestic issuers. Transactions in foreign
securities may be subject to higher costs. Each Fund's investment in
foreign securities may also result in higher custodial costs and the costs
associated with currency conversions.

Securities of many foreign issuers may be less liquid and their prices more
volatile than those of comparable domestic issuers. Foreign securities
markets, particularly those in emerging market countries, are known to
experience long delays between the trade and settlement dates of securities
purchased and sold. Such delays may result in a lack of liquidity and
greater volatility in the price of securities on those markets. As a result
of these factors, the Boards of Directors of the Funds have adopted Daily
Pricing and Valuation Procedures for the Funds which set forth the steps to
be followed by the Manager and Sub-Advisor to establish a reliable market
or fair value if a reliable market value is not available through normal
market quotations. Oversight of this process is provided by the Executive
Committee of the Boards of Directors.

Certain Funds may acquire a portion of portfolio securities in
foreign OTC transactions involving premium prices in excess of the
Korean Stock Exchange (KSE) price. There is no assurance that a
Fund will be able to realize such premiums if it sells the shares to
another foreign investor. Such premiums may be affected by changes in
regulations and otherwise, including changes in the percentage of
foreign ownership permitted in KSE-listed companies.

Shares listed on the KSE which are traded by foreign investors in
foreign OTC transactions generally are valued at prices at which it is
expected such shares may be sold, as determined by or under the
direction of a committee appointed by the Board of Directors, provided
that the committee determines that such valuations are accurate;
otherwiae such KSE shares will be valued using the procedures for
listed securities.

Securities of Smaller Companies

The International SmallCap, MidCap and SmallCap Funds invest in securities
of companies with small- or mid-sized market capitalizations. Market
capitalization is defined as total current market value of a company's
outstanding common stock. Investments in companies with smaller market
capitalizations may involve greater risks and price volatility (wide, rapid
fluctuations) than investments in larger, more mature companies. Smaller
companies may be less mature than older companies. At this earlier stage of
development, the companies may have limited product lines, reduced market
liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Small companies also
may be less significant factors within their industries and may be at a
competitive disadvantage relative to their larger competitors. While
smaller companies may be subject to these additional risks, they may also
realize more substantial growth than larger or more established companies.

Unseasoned Issuers

The Funds may invest in the securities of unseasoned issuers. Unseasoned
issuers are companies with a record of less than three years continuous
operation, including the operation of predecessors and parents. Unseasoned
issuers by their nature have only a limited operating history which can be
used for evaluating the companies growth prospects. As a result, investment
decisions for these securities may place a greater emphasis on current or
planned product lines and the reputation and experience of the companies
management and less emphasis on fundamental valuation factors than would be
the case for more mature growth companies. In addition, many unseasoned
issuers also may be small companies and involve the risks and price
volatility associated with smaller companies.

Spread Transactions, Options on Securities and Securities Indices, and Futures
Contracts and Options on Futures Contracts

The Balanced, Blue Chip, Bond, Government Securities Income, High Yield,
International, International Emerging Markets, International SmallCap,
Limited Term Bond, MidCap, Real Estate, SmallCap and Utilities Funds may
each engage in the practices described under this heading. The Tax-Exempt
Bond Fund may invest in financial futures contracts as described under this
heading. In the following discussion, the terms "the Fund," "each Fund" or
"the Funds" refer to each of these Funds.

Spread Transactions

Each Fund may purchase covered spread options. Such covered spread
options are not presently exchange listed or traded. The purchase of a
spread option gives the Fund the right to put, or sell, a security that
it owns at a fixed dollar spread or fixed yield spread in relationship
to another security that the Fund does not own, but which is used as a
benchmark. The risk to the Fund in purchasing covered spread options is
the cost of the premium paid for the spread option and any transaction
costs. In addition, there is no assurance that closing transactions
will be available. The purchase of spread options can be used to
protect each Fund against adverse changes in prevailing credit quality
spreads, i.e., the yield spread between high quality and lower quality
securities. The security covering the spread option is maintained in a
segregated account by each Fund's custodian. The Funds do not consider
a security covered by a spread option to be "pledged" as that term is
used in the Funds' policy limiting the pledging or mortgaging of
assets.

Options on Securities and Securities Indices

Each Fund's Manager has the discretion (but is under no requirement) to
write (sell) and purchase call and put options on securities in which
it invests and on securities indices based on securities in which the
Fund invests. The International Fund would only write covered call
options on its portfolio securities; it does not write or purchase put
options. The Funds may write call and put options to generate
additional revenue, and may write and purchase call and put options in
seeking to hedge against a decline in the value of securities owned or
an increase in the price of securities which the Fund plans to
purchase.

Writing Covered Call and Put Options. When a Fund writes a call option,
it gives the purchaser of the option the right to buy a specific
security at a specified price at any time before the option expires.
When a Fund writes a put option, it gives the purchaser of the option
the right to sell to the Fund a specific security at a specified price
at any time before the option expires. In both situations, the Fund
receives a premium from the purchaser of the option.

The premium received by a Fund reflects, among other factors, the
current market price of the underlying security, the relationship of
the exercise price to the market price, the time period until the
expiration of the option and interest rates. The premium generates
additional income for the Fund if the option expires unexercised or is
closed out at a profit. By writing a call, a Fund limits its
opportunity to profit from any increase in the market value of the
underlying security above the exercise price of the option, but it
retains the risk of loss if the price of the security should decline.
By writing a put, a Fund assumes the risk that it may have to purchase
the underlying security at a price that may be higher than its market
value at time of exercise.

The Funds write only covered options and comply with applicable
regulatory and exchange cover requirements. The Funds usually (and the
International Fund must) own the underlying security covered by any
outstanding call option. With respect to an outstanding put option,
each Fund deposits and maintains with its custodian cash, U.S.
Government securities or other liquid securities with a value at least
equal to the exercise price of the option.

Once a Fund has written an option, it may terminate its obligation,
before the option is exercised. The Fund executes a closing transaction
by purchasing an option of the same series as the option previously
written. The Fund has a gain or loss depending on whether the premium
received when the option was written exceeds the closing purchase price
plus related transaction costs. Purchasing Call and Put Options. When a
Fund purchases a call option, it receives, in return for the premium it
pays, the right to buy from the writer of the option the underlying
security at a specified price at any time before the option expires. A
Fund purchases call options in anticipation of an increase in the
market value of securities that it intends ultimately to buy. During
the life of the call option, the Fund is able to buy the underlying
security at the exercise price regardless of any increase in the market
price of the underlying security. In order for a call option to result
in a gain, the market price of the underlying security must exceed the
sum of the exercise price, the premium paid and transaction costs.

When a Fund purchases a put option, it receives, in return for the
premium it pays, the right to sell to the writer of the option the
underlying security at a specified price at any time before the option
expires. A Fund purchases put options in anticipation of a decline in
the market value of the underlying security. During the life of the put
option, the Fund is able to sell the underlying security at the
exercise price regardless of any decline in the market price of the
underlying security. In order for a put option to result in a gain, the
market price of the underlying security must decline, during the option
period, below the exercise price enough to cover the premium and
transaction costs.

Once a Fund purchases an option, it may close out its position by
selling an option of the same series as the option previously
purchased. The Fund has a gain or loss depending on whether the closing
sale price exceeds the initial purchase price plus related transaction
costs.

None of the Funds will invest more than 5% of its assets in the
purchase of call and put options on individual securities, securities
indices and futures contracts.

Options on Securities Indices. Each Fund may purchase and sell put and
call options on any securities index based on securities in which the
Fund may invest. Securities index options are designed to reflect price
fluctuations in a group of securities or segment of the securities
market rather than price fluctuations in a single security. Options on
securities indices are similar to options on securities, except that
the exercise of securities index options requires cash payments and
does not involve the actual purchase or sale of securities. The Funds
engage in transactions in put and call options on securities indices
for the same purposes as they engage in transactions in options on
securities. When a Fund writes call options on securities indices, it
holds in its portfolio underlying securities which, in the judgment of
the Manager, correlate closely with the securities index and which have
a value at least equal to the aggregate amount of the securities index
options.

Risks Associated with Options Transactions. An options position may be
closed out only on an exchange which provides a secondary market for an
option of the same series. The Funds generally purchase or write only
those options for which there appears to be an active secondary market.
However, there is no assurance that a liquid secondary market on an
exchange exists for any particular option, or at any particular time.
If a Fund is unable to effect closing sale transactions in options it
has purchased, it has to exercise its options in order to realize any
profit and may incur transaction costs upon the purchase or sale of
underlying securities. If a Fund is unable to effect a closing purchase
transaction for a covered option that it has written, it is not able to
sell the underlying securities, or dispose of the assets held in a
segregated account, until the option expires or is exercised. A Fund's
ability to terminate option positions established in the
over-the-counter market may be more limited than for exchange-traded
options and may also involve the risk that broker-dealers participating
in such transactions might fail to meet their obligations.

Futures Contracts and Options on Futures

Each Fund may purchase and sell financial futures contracts and options
on those contracts. Financial futures contracts are commodities
contracts based on financial instruments such as U.S. Treasury bonds or
bills or on securities indices such as the S&P 500 Index. Futures
contracts, options on futures contracts and the commodity exchanges on
which they are traded are regulated by the Commodity Futures Trading
Commission ("CFTC"). Through the purchase and sale of futures contracts
and related options, a Fund seeks to hedge against a decline in
securities owned by the Fund or an increase in the price of securities
which the Fund plans to purchase.

Futures Contracts. When a Fund sells a futures contract based on a
financial instrument, the Fund is obligated to deliver that kind of
instrument at a specified future time for a specified price. When a
Fund purchases that kind of contract, it is obligated to take delivery
of the instrument at a specified time and to pay the specified price.
In most instances, these contracts are closed out by entering into an
offsetting transaction before the settlement date. The Fund realizes a
gain or loss depending on whether the price of an offsetting purchase
plus transaction costs are less or more than the price of the initial
sale or on whether the price of an offsetting sale is more or less than
the price of the initial purchase plus transaction costs. Although the
Funds usually liquidate futures contracts on financial instruments in
this manner, they may make or take delivery of the underlying
securities when it appears economically advantageous to do so.

A futures contract based on a securities index provides for the
purchase or sale of a group of securities at a specified future time
for a specified price. These contracts do not require actual delivery
of securities but result in a cash settlement. The amount of the
settlement is based on the difference in value of the index between the
time the contract was entered into and the time it is liquidated (at
its expiration or earlier if it is closed out by entering into an
offsetting transaction). When a futures contract is purchased or sold a
brokerage commission is paid. Unlike the purchase or sale of a security
or option, no price or premium is paid or received. Instead, an amount
of cash or U.S. Government securities (generally about 5% of the
contract amount) is deposited by the Fund with its custodian for the
benefit of the futures commission merchant through which the Fund
engages in the transaction. This amount is known as "initial margin."
It does not involve the borrowing of funds by the Fund to finance the
transaction. It instead represents a "good faith" deposit assuring the
performance of both the purchaser and the seller under the futures
contract. It is returned to the Fund upon termination of the futures
contract if all the Fund's contractual obligations have been satisfied.

Subsequent payments to and from the broker, known as "variation
margin," are required to be made on a daily basis as the price of the
futures contract fluctuates, a process known as "marking to market."
The fluctuations make the long or short positions in the futures
contract more or less valuable. If the position is closed out by taking
an opposite position prior to the settlement date of the futures
contract, a final determination of variation margin is made. Any
additional cash is required to be paid to or released by the broker and
the Fund realizes a loss or gain.

In using futures contracts, the Fund seeks to establish more certainly
than would otherwise be possible the effective price of or rate of
return on portfolio securities or securities that the Fund proposes to
acquire. A Fund, for example, sells futures contracts in anticipation
of a rise in interest rates which would cause a decline in the value of
its debt investments. When this kind of hedging is successful, the
futures contract increases in value when the Fund's debt securities
decline in value and thereby keep the Fund's net asset value from
declining as much as it otherwise would. A Fund also sells futures
contracts on securities indices in anticipation of or during a stock
market decline in an endeavor to offset a decrease in the market value
of its equity investments. When a Fund is not fully invested and
anticipates an increase in the cost of securities it intends to
purchase, it may purchase financial futures contracts. When increases
in the prices of equities are expected, a Fund purchases futures
contracts on securities indices in order to gain rapid market exposure
that may partially or entirely offset increases in the cost of the
equity securities it intends to purchase.

Options on Futures. The Funds may also purchase and write call and put
options on futures contracts. A call option on a futures contract gives
the purchaser the right, in return for the premium paid, to purchase a
futures contract (assume a long position) at a specified exercise price
at any time before the option expires. A put option gives the purchaser
the right, in return for the premium paid, to sell a futures contract
(assume a short position), for a specified exercise price, at any time
before the option expires.

Upon the exercise of a call, the writer of the option is obligated to
sell the futures contract (to deliver a long position to the option
holder) at the option exercise price, which will presumably be lower
than the current market price of the contract in the futures market.
Upon exercise of a put, the writer of the option is obligated to
purchase the futures contract (deliver a short position to the option
holder) at the option exercise price, which will presumably be higher
than the current market price of the contract in the futures market.
However, as with the trading of futures, most options are closed out
prior to their expiration by the purchase or sale of an offsetting
option at a market price that reflects an increase or a decrease from
the premium originally paid. Options on futures can be used to hedge
substantially the same risks addressed by the direct purchase or sale
of the underlying futures contracts. For example, if a Fund anticipates
a rise in interest rates and a decline in the market value of the debt
securities in its portfolio, it might purchase put options or write
call options on futures contracts instead of selling futures contracts.

If a Fund purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures
position itself. But in contrast to a futures transaction, the purchase
of an option involves the payment of a premium in addition to
transaction costs. In the event of an adverse market movement, however,
the Fund is not subject to a risk of loss on the option transaction
beyond the price of the premium it paid plus its transaction costs.

When a Fund writes an option on a futures contract, the premium paid by
the purchaser is deposited with the Fund's custodian. The Fund must
maintain with its custodian all or a portion of the initial margin
requirement on the underlying futures contract. It assumes a risk of
adverse movement in the price of the underlying futures contract
comparable to that involved in holding a futures position. Subsequent
payments to and from the broker, similar to variation margin payments,
are made as the premium and the initial margin requirement are marked
to market daily. The premium may partially offset an unfavorable change
in the value of portfolio securities, if the option is not exercised,
or it may reduce the amount of any loss incurred by the Fund if the
option is exercised.

Risks Associated with Futures Transactions. There are a number of risks
associated with transactions in futures contracts and related options.
A Fund's successful use of futures contracts is subject to the
Manager's ability to predict correctly the factors affecting the market
values of the Fund's portfolio securities. For example, if a Fund is
hedged against the possibility of an increase in interest rates which
would adversely affect debt securities held by the Fund and the prices
of those debt securities instead increases, the Fund loses part or all
of the benefit of the increased value of its securities it hedged
because it has offsetting losses in its futures positions. Other risks
include imperfect correlation between price movements in the financial
instrument or securities index underlying the futures contract, on the
one hand, and the price movements of either the futures contract itself
or the securities held by the Fund, on the other hand. If the prices do
not move in the same direction or to the same extent, the transaction
may result in trading losses.

Prior to exercise or expiration, a position in futures may be
terminated only by entering into a closing purchase or sale
transaction. This requires a secondary market on the relevant contract
market. The Fund enters into a futures contract or related option only
if there appears to be a liquid secondary market. There can be no
assurance, however, that such a liquid secondary market exists for any
particular futures contract or related option at any specific time.
Thus, it may not be possible to close out a futures position once it
has been established. Under such circumstances, the Fund continues to
be required to make daily cash payments of variation margin in the
event of adverse price movements. In such situations, if the Fund has
insufficient cash, it may be required to sell portfolio securities to
meet daily variation margin requirements at a time when it may be
disadvantageous to do so. In addition, the Fund may be required to
perform under the terms of the futures contracts it holds. The
inability to close out futures positions also could have an adverse
impact on the Fund's ability effectively to hedge its portfolio.

Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. This
daily limit establishes the maximum amount that the price of a futures
contract may vary either up or down from the previous day's settlement
price at the end of a trading session. Once the daily limit has been
reached in a particular type of contract, no more trades may be made on
that day at a price beyond that limit. The daily limit governs only
price movements during a particular trading day and therefore does not
limit potential losses because the limit may prevent the liquidation of
unfavorable positions. Futures contract prices have occasionally moved
to the daily limit for several consecutive trading days with little or
no trading, thereby preventing prompt liquidation of futures positions
and subjecting some futures traders to substantial losses.

Limitations on the Use of Futures and Options on Futures. Each Fund
intends to come within an exclusion from the definition of "commodity
pool operator" provided by CFTC regulations by complying with certain
limitations on the use of futures and related options prescribed by
those regulations.

None of the Funds will purchase or sell futures contracts or options
thereon if immediately thereafter the aggregate initial margin and
premiums exceed 5% of the fair market value of the Fund's assets, after
taking into account unrealized profits and unrealized losses on any
such contracts it has entered into (except that in the case of an
option that is in-the-money at the time of purchase, the in-the-money
amount generally may be excluded in computing the 5%).

The Funds enter into futures contracts and related options transactions
only for bona fide hedging purposes as permitted by the CFTC and for
other appropriate risk management purposes, if any, which the CFTC
deems appropriate for mutual funds excluded from the regulations
governing commodity pool operators. The Funds are not permitted to
engage in speculative futures trading. Each Fund determines that the
price fluctuations in the futures contracts and options on futures used
for hedging or risk management purposes are substantially related to
price fluctuations in securities held by the Fund or which it expects
to purchase. In pursuing traditional hedging activities, each Fund
sells futures contracts or acquires puts to protect against a decline
in the price of securities that the Fund owns. Each Fund purchases
futures contracts or calls on futures contracts to protect the Fund
against an increase in the price of securities the Fund intends to
purchase before it is in a position to do so.

When a Fund purchases a futures contract, or purchases a call option on
a futures contract, it places any asset, including equity securities
and non-investment grade debt in a segregated account, so long as the
asset is liquid and marked to the market daily. The amount so
segregated plus the amount of initial margin held for the account of
its broker equals the market value of the futures contract.

The Funds do not maintain open short positions in futures contracts,
call options written on futures contracts, and call options written on
securities indices if, in the aggregate, the value of the open
positions (marked to market) exceeds the current market value of that
portion of its securities portfolio being hedged by those futures and
options plus or minus the unrealized gain or loss on those open
positions, adjusted for the historical volatility relationship between
that portion of the portfolio and the contracts (i.e., the Beta
volatility factor). To the extent a Fund writes call options on
specific securities in that portion of its portfolio, the value of
those securities is deducted from the current market value of that
portion of the securities portfolio. If this limitation is exceeded at
any time, the Fund takes prompt action to close out the appropriate
number of open short positions to bring its open futures and options
positions within this limitation.

Forward Foreign Currency Exchange Contracts

The International, International Emerging Markets and International
SmallCap Funds may, but are not obligated to, enter into forward
foreign currency exchange contracts only under two circumstances.
First, when a Fund is entering into a contract for the purchase or sale
of a security denominated in a foreign currency and wants to "lock-in"
the U.S. dollar price of the security. Second, when the Manager
believes that the currency of a particular foreign country in which a
portion of a Fund's securities are denominated may suffer a substantial
decline against the U.S. dollar. A Fund generally does not enter into a
forward contract with a term of greater than one year.

The International, International Emerging Markets and International
SmallCap Funds enter into forward foreign currency exchange contracts
only for the purpose of "hedging," that is limiting the risks
associated with changes in the relative rates of exchange between the
U.S. dollar and foreign currencies in which securities owned by a Fund
are denominated. They do not enter into such forward contracts for
speculative purposes. A Fund sets up a separate account with the
Custodian to place foreign securities denominated in the currency for
which the Fund has entered into forward contracts under the second
circumstance, as set forth above, for the term of the forward contract.
It should be noted that the use of forward foreign currency exchange
contracts does not eliminate fluctuations in the underlying prices of
the securities. It simply establishes a rate of exchange between the
currencies which can be achieved at some future point in time.
Additionally, although such contracts tend to minimize the risk of loss
due to a decline in the value of the hedged currency, they also tend to
limit any potential gain which might result if the value of the
currency increases.

Repurchase Agreements

All Principal Funds may invest in repurchase agreements. None of the
Growth-Oriented or Income-Oriented Funds enter into repurchase
agreements that do not mature within seven days if any such investment,
together with other illiquid securities held by the Fund, amount to
more than 15% of its assets. Neither of the Money Market Funds enter
into repurchase agreements that do not mature within seven days of such
investment together with other illiquid securities held by the Fund,
amount to more than 10% of its assets. Repurchase agreements typically
involve the acquisition by the Fund of debt securities from a selling
financial institution such as a bank, savings and loan association or
broker-dealer. A repurchase agreement provides that the Fund sells back
to the seller and that the seller repurchases the underlying securities
at a specified price and at a fixed time in the future. Repurchase
agreements may be viewed as loans by a Fund collateralized by the
underlying securities. This arrangement results in a fixed rate of
return that is not subject to market fluctuation during the Fund's
holding period. Although repurchase agreements involve certain risks
not associated with direct investments in debt securities, each of the
Funds follows procedures established by its Board of Directors which
are designed to minimize such risks. These procedures include entering
into repurchase agreements only with large, well-capitalized and
well-established financial institutions which the Fund's Manager, or
Sub-Advisor, believes present minimum credit risks. In addition, the
value of the collateral underlying the repurchase agreement is always
at least equal to the repurchase price, including accrued interest. In
the event of a default or bankruptcy by a selling financial
institution, the affected Fund bears a risk of loss. In seeking to
liquidate the collateral, a Fund may be delayed in or prevented from
exercising its rights and may incur certain costs. Further to the
extent that proceeds from any sale upon a default of the obligation to
repurchase are less than the repurchase price, the Fund could suffer a
loss.

Lending of Portfolio Securities

All Principal Funds, except the Capital Value, Growth and Cash
Management Funds, may lend their portfolio securities. None of the
Principal Funds intends to lend its portfolio securities if as a result
the aggregate of such loans made by the Fund would exceed 30% of its
total assets. Portfolio securities may be lent to unaffiliated
broker-dealers and other unaffiliated qualified financial institutions
provided that such loans are callable at any time on not more than five
business days' notice and that cash or government securities equal to
at least 100% of the market value of the securities loaned, determined
daily, is deposited by the borrower with the Fund and is maintained
each business day in a segregated account. While such securities are on
loan, the borrower pays the Fund any income accruing thereon. The Fund
may invest any cash collateral, thereby earning additional income, or
may receive an agreed-upon fee from the borrower. Borrowed securities
must be returned when the loan is terminated. Any gain or loss in the
market price of the borrowed securities which occurs during the term of
the loan belongs to the Fund and its shareholders. A Fund pays
reasonable administrative, custodial and other fees in connection with
such loans and may pay a negotiated portion of the interest earned on
the cash or government securities pledged as collateral to the borrower
or placing broker. A Fund does not vote securities that have been
loaned, but it will call a loan of securities in anticipation of an
important vote.

When-Issued and Delayed Delivery Securities

Each of the Principal Funds may from time to time purchase securities
on a when-issued basis and may purchase or sell securities on a delayed
delivery basis. The price of such a transaction is fixed at the time of
the commitment, but delivery and payment take place on a later
settlement date, which may be a month or more after the date of the
commitment. No interest accrues to the purchaser during this period.
The securities are subject to market fluctuation which involve the risk
for the purchaser that yields available in the market at the time of
delivery are higher than those obtained in the transaction. Each Fund
only purchases securities on a when-issued or delayed delivery basis
with the intention of acquiring the securities. However, a Fund may
sell the securities before the settlement date, if such action is
deemed advisable. At the time a Fund commits to purchase securities on
a when-issued or delayed delivery basis, it records the transaction and
reflects the value of the securities in determining its net asset
value. Each Fund also establishes a segregated account with its
custodian bank in which it maintains cash or cash equivalents, United
States Government securities, other high grade debt obligations and
equity securities equal in value to the Fund's commitments for
when-issued or delayed delivery securities. The availability of liquid
assets for this purpose and the effect of asset segregation on a Fund's
ability to meet its current obligations, to honor requests for
redemption and to have its investment portfolio managed properly limit
the extent to which the Fund may engage in forward commitment
agreements. Except as may be imposed by these factors, there is no
limit on the percent of a Fund's total assets that may be committed to
transactions in such agreements.

Money Market Instruments

The Cash Management Fund invests all of its available assets in money
market instruments maturing in 397 days or less. The types of
instruments which this Fund purchases are described below.

(1) U.S. Government Securities -- Securities issued or guaranteed by
the U.S. Government, including treasury bills, notes and bonds.

(2) U.S. Government Agency Securities -- Obligations issued or
guaranteed by agencies or instrumentalities of the U.S.
Government.
o U.S. agency obligations include, but are not limited to,
the Bank for Co-operatives, Federal Home Loan Banks, Federal
Intermediate Credit Banks, and the Federal National Mortgage
Association.
o U.S. instrumentality obligations include, but are not limited
to, the Export-Import Bank and Farmers Home Administration.

Some obligations issued or guaranteed by U.S. Government agencies
and instrumentalities are supported by the full faith and credit
of the U.S. Treasury. Others, such as those issued by the Federal
National Mortgage Association, are supported by discretionary
authority of the U.S. Government to purchase certain obligations
of the agency or instrumentality. Still others, such as those
issued by the Student Loan Marketing Association, are supported
only by the credit of the agency or instrumentality.

(3) Bank Obligations -- Certificates of deposit, time deposits and
bankers' acceptances of U.S.commercial banks having total assets
of at least one billion dollars and overseas branches of U.S.
commercial banks and foreign banks, which in the Manager's
opinion, are of comparable quality. However, each such bank with
its branches has total assets of at least five billion dollars,
and certificates, including time deposits of domestic savings and
loan associations having at least one billion dollars in assets
which are insured by the Federal Savings and Loan Insurance
Corporation. The Fund may acquire obligations of U.S. banks which
are not members of the Federal Reserve System or of the Federal
Deposit Insurance Corporation.

Any obligations of foreign banks must be denominated in U.S.
dollars. Obligations of foreign banks and obligations of overseas
branches of U.S. banks are subject to somewhat different
regulations and risks than those of U.S. domestic banks. For
example, an issuing bank may be able to maintain that the
liability for an investment is solely that of the overseas branch
which could expose the Fund to a greater risk of loss. In
addition, obligations of foreign banks or of overseas branches of
U.S. banks may be affected by governmental action in the country
of domicile of the branch or parent bank. Examples of adverse
foreign governmental actions include the imposition of currency
controls, the imposition of withholding taxes on interest income
payable on such obligations, interest limitations, seizure or
nationalization of assets, or the declaration of a moratorium.
Deposits in foreign banks or foreign branches of U.S. banks are
not covered by the Federal Deposit Insurance Corporation. The Fund
only buys short-term instruments where the risks of adverse
governmental action are believed by the Manager to be minimal. The
Fund considers these factors along with other appropriate factors
in making an investment decision to acquire such obligations. It
only acquires those which, in the opinion of management, are of an
investment quality comparable to other debt securities bought by
the Fund. The Fund invests in certificates of deposit of selected
banks having less than one billion dollars of assets providing the
certificates do not exceed the level of insurance (currently
$100,000) provided by the applicable government agency.

A certificate of deposit is issued against funds deposited in a
bank or savings and loan association for a definite period of
time, at a specified rate of return. Normally they are negotiable.
However, the Fund occasionally invests in certificates of deposit
which are not negotiable. Such certificates may provide for
interest penalties in the event of withdrawal prior to their
maturity. A bankers' acceptance is a short-term credit instrument
issued by corporations to finance the import, export, transfer or
storage of goods. They are termed "accepted" when a bank
guarantees their payment at maturity and reflect the obligation of
both the bank and drawer to pay the face amount of the instrument
at maturity.

(4) Commercial Paper -- Short-term promissory notes issued by U.S. or
foreign corporations.

(5) Short-term Corporate Debt -- Corporate notes, bonds and debentures
which at the time of purchase have 397 days or less remaining to
maturity.

(6) Repurchase Agreements -- Instruments under which securities are
purchased from a bank or securities dealer with an agreement by
the seller to repurchase the securities at the same price plus
interest at a specified rate. (See "FUND INVESTMENTS - Repurchase
Agreements.")

(7) Taxable Municipal Obligations -- Short-term obligations issued or
guaranteed by state and municipal issuers which generate taxable
income.

The ratings of nationally recognized statistical rating organization
(NRSRO), such as Moody's Investor Services, Inc. ("Moody's") and
Standard and Poor's ("S&P"), which are described in Appendix A,
represent their opinions as to the quality of the money market
instruments which they undertake to rate. It should be emphasized,
however, that ratings are general and are not absolute standards of
quality. These ratings, including ratings of NRSROs other than Moody's
and S&P, are the initial criteria for selection of portfolio
investments, but the Manager further evaluates these securities.

Municipal Obligations

The Tax-Exempt Bond Fund and Tax-Exempt Cash Management Fund can each
invest in "Municipal Obligations." Municipal Obligations are
obligations issued by or on behalf of states, territories, and
possessions of the United States and the District of Columbia and their
political subdivisions, agencies and instrumentalities, including
municipal utilities, or multi-state agencies or authorities. The
interest on Municipal Obligations is exempt from federal income tax in
the opinion of bond counsel to the issuer. Three major classifications
of Municipal Obligations are: Municipal Bonds, which generally have a
maturity at the time of issue of one year or more, Municipal Notes,
which generally have a maturity at the time of issue of six months to
three years, and Municipal Commercial Paper, which generally has a
maturity at the time of issue of 30 to 270 days. The Tax-Exempt Cash
Management Fund only purchases Municipal Obligations that, at the time
of purchase, have 397 days or less remaining to maturity or have a
variable or floating rate of interest.

The term "Municipal Obligations" includes debt obligations issued to
obtain funds for various public purposes, including the construction of
a wide range of public facilities such as airports, bridges, highways,
housing, hospitals, mass transportation, schools, streets, water and
sewer works, and electric utilities. Other public purposes for which
Municipal Obligations are issued include refunding outstanding
obligations, obtaining funds for general operating expenses and lending
such funds to other public institutions and facilities.

Industrial development bonds are issued by or on behalf of public
authorities to obtain funds to provide for the construction, equipment,
repair or improvement of privately operated housing facilities, sports
facilities, convention or trade show facilities, airport, mass transit,
industrial, port or parking facilities, air or water pollution control
facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. They are considered to
be Municipal Obligations if the interest paid thereon qualifies as
exempt from federal income tax in the opinion of bond counsel to the
issuer, even though the interest may be subject to the federal
alternative minimum tax.

Municipal Bonds. Municipal Bonds may be either "general obligation" or
"revenue" issues. General obligation bonds are secured by the issuer's
pledge of its faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable from the revenues
derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise tax or other specific
revenue source (e.g., the user of the facilities being financed), but
not from the general taxing power. Industrial development bonds and
pollution control bonds in most cases are revenue bonds and generally
do not carry the pledge of the credit of the issuing municipality. The
payment of the principal and interest on industrial revenue bonds
depends solely on the ability of the user of the facilities financed by
the bonds to meet its financial obligations and the pledge, if any, of
real and personal property so financed as security for such payment.
The Fund may also invest in "moral obligation" bonds which are normally
issued by special purpose public authorities. If an issuer of moral
obligation bonds is unable to meet its obligations, the repayment of
the bonds becomes a moral commitment but not a legal obligation of the
state or municipality in question.

Municipal Notes. Municipal Notes usually are general obligations of the
issuer and are sold in anticipation of a bond sale, collection of taxes
or receipt of other revenues. Payment of these notes is primarily
dependent upon the issuer's receipt of the anticipated revenues. Other
notes include "Construction Loan Notes" issued to provide construction
financing for specific projects, and "Bank Notes" issued by local
governmental bodies and agencies to commercial banks as evidence of
borrowings. Some notes ("Project Notes") are issued by local agencies
under a program administered by the United States Department of Housing
and Urban Development. Project Notes are secured by the full faith and
credit of the United States.

Bond Anticipation Notes (BANs) are usually general obligations of state
and local governmental issuers which are sold to obtain interim
financing for projects that will eventually be funded through the sale
of long-term debt obligations or bonds. The ability of an issuer to
meet its obligations on its BANs is primarily dependent on the issuer's
access to the long-term municipal bond market and the likelihood that
the proceeds of such bond sales will be used to pay the principal and
interest on the BANs.

Tax Anticipation Notes (TANs) are issued by state and local governments
to finance the current operations of such governments. Repayment is
generally to be derived from specific future tax revenues. TANs are
usually general obligations of the issuer. A weakness in an issuer's
capacity to raise taxes due to, among other things, a decline in its
tax base or a rise in delinquencies, could adversely affect the
issuer's ability to meet its obligations on outstanding TANs.

Revenue Anticipation Notes (RANs) are issued by governments or
governmental bodies with the expectation that future revenues from a
designated source will be used to repay the notes. In general they also
constitute general obligations of the issuer. A decline in the receipt
of projected revenues, such as anticipated revenues from another level
of government, could adversely affect an issuer's ability to meet its
obligations on outstanding RANs. In addition, the possibility that the
revenues would, when received, be used to meet other obligations could
affect the ability of the issuer to pay the principal and interest on
RANs.

Construction Loan Notes are issued to provide construction financing
for specific projects. Frequently, these notes are redeemed with funds
obtained from the Federal Housing Administration.

Bank Notes are notes issued by local governmental bodies and agencies
such as those described above to commercial banks as evidence of
borrowings. The purposes for which the notes are issued are varied but
they are frequently issued to meet short-term working-capital or
capital-project needs. These notes may have risks similar to the risks
associated with TANs and RANs.

Municipal Commercial Paper. Municipal Commercial Paper refers to
short-term obligations of municipalities which may be issued at a
discount and may be referred to as Short-Term Discount Notes. Municipal
Commercial Paper is likely to be used to meet seasonal working capital
needs of a municipality or interim construction financing. Generally
they are repaid from general revenues of the municipality or refinanced
with long-term debt. In most cases Municipal Commercial Paper is backed
by letters of credit, lending agreements, note repurchase agreements or
other credit facility agreements offered by banks or other
institutions.

Variable and Floating Rate Obligations. Certain Municipal Obligations,
obligations issued or guaranteed by the U.S. Government or its agencies
or instrumentalities and debt instruments issued by domestic banks or
corporations may carry variable or floating rates of interest. Such
instruments bear interest at rates which are not fixed, but which vary
with changes in specified market rates or indices, such as a bank prime
rate or tax-exempt money market index. Variable rate notes are adjusted
to current interest rate levels at certain specified times, such as
every 30 days. A floating rate note adjusts automatically whenever
there is a change in its base interest rate adjustor, e.g., a change in
the prime lending rate or specified interest rate indices. Typically
such instruments carry demand features permitting the Fund to redeem at
par.

A Fund's right to obtain payment at par on a demand instrument upon
demand could be affected by events occurring between the date the Fund
elects to redeem the instrument and the date redemption proceeds are
due which affects the ability of the issuer to pay the instrument at
par value. The Manager monitors on an ongoing basis the pricing,
quality and liquidity of such instruments and similarly monitors the
ability of an issuer of a demand instrument, including those supported
by bank letters of credit or guarantees, to pay principal and interest
on demand. Although the ultimate maturity of such variable rate
obligations may exceed one year, the Funds treat the maturity of each
variable rate demand obligation as the longer of (i) the notice period
required before the Fund is entitled to payment of the principal amount
through demand, or (ii) the period remaining until the next interest
rate adjustment. Floating rate instruments with demand features are
deemed to have a maturity equal to the period remaining until the
principal amount can be recovered through demand.

The Funds purchase participation interests in variable rate Municipal
Obligations (such as industrial development bonds). A participation
interest gives the purchaser an undivided interest in the Municipal
Obligation in the proportion that its participation interest bears to
the total principal amount of the Municipal Obligation. A Fund has the
right to demand payment on seven days' notice, for all or any part of
the Fund's participation interest in the Municipal Obligation, plus
accrued interest. Each participation interest is backed by an
irrevocable letter of credit or guarantee of a bank. No Fund committed
during the last fiscal year or intends to commit during the present
fiscal year more than 5% of its net assets to participation interests.

Other Municipal Obligations. Other kinds of Municipal Obligations are
occasionally available in the marketplace, and a Fund may invest in
such other kinds of obligations to the extent consistent with its
investment objective and limitations. Such obligations may be issued
for different purposes and with different security than those mentioned
above.

Risks of Municipal Obligations. The yields on Municipal Obligations are
dependent on a variety of factors, including general economic and
monetary conditions, money market factors, conditions in the Municipal
Obligations market, size of a particular offering, maturity of the
obligation, and rating of the issue. Each Fund's ability to achieve its
investment objective also depends on the continuing ability of the
issuers of the Municipal Obligations in which it invests to meet their
obligation for the payment of interest and principal when due.

Municipal Obligations are subject to the provisions of bankruptcy,
insolvency and other laws affecting the rights and remedies of
creditors, such as the Federal Bankruptcy Act. They are also subject to
federal or state laws, if any, which extend the time for payment of
principal or interest, or both, or impose other constraints upon
enforcement of such obligations or upon municipalities to levy taxes.
The power or ability of issuers to pay, when due, principal of and
interest on Municipal Obligations may also be materially affected by
the results of litigation or other conditions.

From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Obligations. It may be expected that similar
proposals will be introduced in the future. If such a proposal was enacted,
the ability of the Funds to pay "exempt interest" dividends may be
adversely affected. Each Fund would re-evaluate its investment objective
and policies and consider changes in its structure.

Taxable Investments of the Tax-Exempt Bond Fund

The Tax-Exempt Bond Fund may invest up to 20% of its assets in taxable
short-term investments consisting of: Obligations issued or guaranteed
by the United States Government or its agencies or instrumentalities;
domestic bank certificates of deposit and bankers' acceptances;
short-term corporate debt securities such as commercial paper; and
repurchase agreements ("Taxable Investments"). These investments must
have a stated maturity of one year or less at the time of purchase and
must meet the following standards: banks must have assets of at least
$1 billion; commercial paper must be rated at least "A" by S&P or
"Prime" by Moody's or, if not rated, must be issued by companies having
an outstanding debt issue rated at least "A" by S&P or Moody's;
corporate bonds and debentures must be rated at least "A" by S&P or
Moody's. Interest earned from Taxable Investments is taxable to
investors. When, in the opinion of the Fund's Manager, it is advisable
to maintain a temporary "defensive" posture, the Fund may invest more
than 20% of its total assets in Taxable Investments. At other times,
Taxable Investments, Municipal Obligations that do not meet the quality
standards required for the 80% portion of the portfolio and Municipal
Obligations the interest on which is treated as a tax preference item
for purposes of the federal alternative minimum tax will not exceed 20%
of the Fund's total assets.

Temporary Investments for the Tax-Exempt Cash Management Fund

The Tax-Exempt Cash Management Fund may invest, on a temporary basis,
up to 20% of its net assets in taxable short-term investments
consisting of: obligations issued or guaranteed by the United States
Government or its agencies or instrumentalities; U.S. dollar
denominated certificates of deposit issued by U.S. banks and bankers'
acceptances; commercial paper of U.S. corporations; short-term
corporate debt securities; and repurchase agreements ("Temporary
Investments"). These investments must have a stated maturity of 397
days or less at the time of purchase and must meet the same standards
that apply to securities in which the Cash Management Fund invests.
Interest earned from Temporary Investments is taxable to investors.
When, in the opinion of the Fund's Manager, it is advisable to maintain
a temporary "defensive" posture, the Fund may invest more than 20% of
its total assets in Temporary Investments.

Portfolio Turnover

Portfolio turnover normally differs for each Fund, varies from year to
year (as well as within a year) and is affected by portfolio sales
necessary to meet cash requirements for redemptions of Fund shares.
This requirement may in some cases limit the ability of a Fund to
effect certain portfolio transactions. The portfolio turnover rate for
a Fund is calculated by dividing the lesser of purchases or sales of
its portfolio securities during the fiscal year by the monthly average
of the value of its portfolio securities (excluding from the
computation all securities, including options, with maturities at the
time of acquisition of one year or less). A high rate of portfolio
turnover generally involves correspondingly greater brokerage
commission expenses which are paid by the Fund.

No portfolio turnover rate can be calculated for the Money Market Funds
because of the short maturities of the securities in which they invest.

The portfolio turnover rates for each of the other Funds for its most
recent and immediately preceding fiscal periods were as follows
(annualized when reporting period is less than one year):

Balanced Fund 57.0% and 27.6%
Blue Chip Fund 0.5% and 55.4%
Bond Fund 15.2% and12.8%
Capital Value Fund 23.2% and 30.8%
Government Securities Income Fund 17.1% and 10.8%
Growth Fund 21.9% and16.5%
High Yield Fund 65.9% and 39.2%
International Emerging Markets Fund 45.2% and 21.4%
International Fund 38.7% and 26.6%
International SmallCap Fund 99.8% and10.4%
Limited Term Bond Fund 23.8% and 17.4%
MidCap Fund 25.1% and 9.5%
Real Estate Fund 60.4%
SmallCap Fund 20.5%
Tax-Exempt Bond Fund 6.6% and 8.9%
Utilities Fund 11.9% and 22.5%.

Fund History

The Funds were incorporated in Maryland on the following dates:

Balanced Fund November 26, 1986
Blue Chip Fund December 10, 1990
Bond Fund December 2, 1986
Capital Value Fund May 26, 1989*
Cash Management Fund June 10, 1982
International Emerging Markets Fund May 27, 1997
Government Securities Income Fund September 5, 1984
Growth Fund May 26, 1989*
High Yield Fund November 26, 1986
International Fund May 12, 1981
International SmallCap Fund May 27, 1997
Limited Term Bond Fund August 9, 1995
MidCap Fund February 20, 1987
Real Estate Fund May 27, 1997
SmallCap Fund August 13, 1997
Tax-Exempt Bond Fund June 7, 1985
Tax-Exempt Cash Management Fund August 17, 1987
Utilities Fund September 3, 1992

* effective November 1, 1989 the Fund succeeded to the business of a
predecessor Fund that had been incorporated in Delaware of
February 6, 1969

MANAGEMENT OF THE FUND

Board of Directors

Under Maryland law, a Board of Directors oversees each of the Funds. The
Directors have financial or other relevant experience and meet several
times during the year to review contracts, Fund activities and the quality
of services provided to the Funds. Other than serving as Directors, most of
the Board members have no affiliation with the Funds or service providers.

The current Directors and Officers are shown below. Each person also has
the same position with the Principal Variable Contracts Fund, Inc. which is
also sponsored by Principal Life Insurance Company. Unless an address is
shown, the mailing address for the Directors and Officers is Principal
Financial Group, Des Moines, Iowa 50392.

* John E. Aschenbrenner, 49, Director. Senior Vice President, Principal
Life Insurance Company since 1996; Vice President - Individual Markets
1990-1996. Director, Principal Management Corporation and Princor
Financial Services Corporation.

@ James D. Davis, 64, Director. 4940 Center Court, Bettendorf, Iowa.
Attorney. Vice President, Deere and Company, Retired.

Pamela A. Ferguson, 55, Director. 4112 River Oaks Drive, Des Moines, Iowa.
Professor of Mathematics, Grinnell College since 1998. Prior thereto,
President, Grinnell College.

* Dennis P. Francis, 55, Director. Senior Vice President, Principal Life
Insurance Company since 1998; Vice President - Commerical Real Estate
1990-1998.

@ Richard W. Gilbert, 58, Director. 1357 Asbury Avenue, Winnetka,
Illinois. President, Gilbert Communications, Inc. since 1993. Prior
thereto, President and Publisher, Pioneer Press.

*& J. Barry Griswell, 49, Director and Chairman of the Board. President,
Principal Life Insurance Company since 1998; Executive Vice President,
1996-1998; Senior Vice President, 1991-1996. Director and Chairman
of the Board, Principal Management Corporation and Princor Financial
Services Corporation.

*& Stephan L. Jones, 63, Director and President. Vice President, Principal
Life Insurance Company since 1986. Director and President, Princor
Financial Services Corporation and Principal Management Corporation.

@ Barbara A. Lukavsky, 58, Director. 3930 Grand Avenue, Des Moines, Iowa.
President and CEO, Barbican Enterprises, Inc. since 1997. President and
CEO, Lu San ELITE USA, L.C. 1985-1998.

& Richard G. Peebler, 69, Director. 1916 79th Street, Des Moines, Iowa.
Dean and Professor Emeritus, Drake University, College of Business and
Public Administration, since 1996. Prior thereto, Professor, Drake
University, College of Business and Public Administration.

* Craig L. Bassett, 46, Treasurer. Second Vice President and Treasurer,
Principal Life Insurance Company since 1998. Director - Treasury
1996-1998. Prior thereto, Associate Treasurer.

* Michael J. Beer , 38, Financial Officer. Senior Vice President and
Chief Operating Officer, Princor Financial Services Corporation and
Principal Management Corporation, since 1997. Prior thereto, Vice
President and Chief Operating Officer, 1995-1997. Prior thereto,
Financial Officer.

Michael W. Cumings, 47, Assistant Counsel. Counsel, Principal Life
Insurance Company since 1989.

* Arthur S. Filean, 60, Vice President and Secretary. Vice President,
Princor Financial Services Corporation, since 1990. Vice President,
Principal Management Corporation, since 1996.

* Ernest H. Gillum, 43, Assistant Secretary. Vice President - Compliance
and Product Development, Princor Financial Services Corporation and
Principal Management Corporation, since 1998. Prior thereto, Assistant
Vice President, Registered Products, 1995-1998. Prior thereto, Product
Development and Compliance Officer.

Jane E. Karli, 41, Assistant Treasurer. Assistant Treasurer, Principal Life
Insurance Company since 1998; Senior Accounting and Custody Administrator
1994-1998; Prior thereto, Senior Investment Cost Accountant.

* Michael D. Roughton, 47, Counsel. Counsel, Principal Life Insurance
Company since 1994. Prior thereto, Assistant Counsel. Counsel, Invista
Capital Management, Inc., Princor Financial Services Corporation,
Principal Investors Corporation and Principal Management Corporation.

* Considered to be "Interested Persons" as defined in the Investment
Company Act of 1940, as amended, because of current or former
affiliation with the Manager or Principal Life.

@ Member of Audit and Nominating Committee

# Member of Executive Committee (which is selected by the Board and
which may exercise all the powers of the Board, with certain
exceptions, when the Board is not in session. The Committee must
report its actions to the Board.)

COMPENSATION TABLE*
fiscal year ended October 31, 1998

Compensation from Compensation from
Director Each Principal Fund Fund Complex

James D. Davis

Pamela A. Ferguson

Richard W. Gilbert

Barbara A. Lukavsky

Richard G. Peebler

* None of the Funds provide retirement benefits for any of the directors.

The following information relates to compensation paid by each fund during the
fiscal year ended October 31, 1998.
# Member of Executive Committee (which is selected by the Board and which
may exercise all the powers of the Board, with certain exceptions, when
the Board is not in session. The Committee must report its actions to
the Board.)

Principal International
Emerging Markets,
Principal International
SmallCap and Principal
Director Each Principal Fund Principal SmallCap Real Estate

James D. Davis

Pamela A. Ferguson

Richard W. Gilbert

Barbara A. Lukavsky

Richard G. Peebler

* Richard G. Peebler received $750 from each of the Principal Funds. He
received an additional $450 from Principal Capital Value Fund and
Principal Growth Fund and $300 from Principal International Fund,
Principal International Emerging Markets Fund, Principal International
SmallCap Fund and Principal MidCap Fund ($75 from each fund) due to his
participation in the executive committee of each of those funds.

None of the mutual funds provide retirement benefits for any of the directors.
Total compensation from the 20 investment companies included in the fund complex
for the fiscal year ended October 31, 1998 was as follows:

James D. Davis $______

Pamela A. Ferguson $______

Richard W. Gilbert $______

Barbara A. Lukavsky $______

Richard G. Peebler $______

As of December 31, 1998, Principal Life Insurance Company, a life insurance
company organized in 1879 under the laws of Iowa, its subsidiaries and
affiliates owned of record and beneficially the following number of voting
shares or percentage of the outstanding voting shares of each Fund:

% of
No. of Shares Outstanding
Fund Owned Shares Owned

Balanced Fund
Blue Chip Fund
Bond Fund
Capital Value Fund
Cash Management Fund
Government Securities Income Fund
Growth Fund
High Yield Fund
International Emerging Markets Fund
International Fund
International SmallCap Fund
Limited Term Bond Fund
MidCap Fund
Real Estate Fund
SmallCap Fund
Tax-Exempt Bond Fund
Tax-Exempt Cash Management Fund
Utilities Fund

As of December 31, 1998, the Officers and Directors of each Fund as a group
owned less than 1% of the outstanding shares of any of the Funds. Other than as
noted in the above table, the Funds knew of no person who owned 5% or more of
the shares of any one Fund.

MANAGER AND SUB-ADVISOR

The Manager of each of the Funds is Principal Management Corporation, a
wholly-owned subsidiary of Princor Financial Services Corporation which is a
wholly-owned subsidiary of Principal Holding Company. Principal Holding Company
is a holding company which is a wholly-owned subsidiary of Principal Life
Insurance Company, a life insurance company organized in 1879 under the laws of
the state of Iowa. The address of the Manager is the Principal Financial Group,
Des Moines, Iowa 50392-0200. The Manager was organized on January 10, 1969 and
since that time has managed various mutual funds sponsored by Principal Life
Insurance Company.

The Manager has executed an agreement with Invista Capital Management, Inc.
("Invista") under which Invista has agreed to assume the obligations of the
Manager to provide investment advisory services for each of the Growth-Oriented
Funds (except the Real Estate Fund), the Government Securities Income Fund and
the Limited Term Bond Fund. The Manager reimburses Invista for the cost of
providing these services. Invista, an indirectly wholly-owned subsidiary of
Principal Life Insurance Company and an affiliate of the Manager, was founded in
1985 and manages investments for institutional investors, including Principal
Life Insurance Company. Assets under management at December 31, 1998 were
approximately $____ billion. Invista's address is 1800 Hub Tower, 699 Walnut,
Des Moines, Iowa 50309.

The Manager, Invista and each of the Funds have adopted a Code of Ethics
designed to prevent persons with access to information regarding the portfolio
trading activity of the Funds from using that information for their personal
benefit. In certain circumstances personal securities trading is permitted in
accordance with procedures established by the Code of Ethics. The Boards of
Directors for the Manager, Invista and each of the Funds periodically review
the Code of Ethics.

Each of the persons affiliated with a Fund who is also an affiliated person of
the Manager or Sub-Advisor is named below, together with the capacities in which
such person is affiliated:
<TABLE>
<CAPTION>

Name Office Held With Each Fund Office Held With The Manager/Invista
<S> <C> <C>

Michael J. Beer Financial Officer Vice President and Chief Operating Officer (Manager)
Arthur S. Filean Vice President and Secretary Vice President (Manager)
Ernest H. Gillum Assistant Secretary Vice President, Compliance and Product Development (Manager)
J. Barry Griswell Director and Chairman of the Board Director and Chairman of the Board (Manager)
Stephan L. Jones Director and President Director and President (Manager)
Michael D. Roughton Counsel Counsel (Manager; Invista)

</TABLE>

COST OF MANAGER'S SERVICES

For providing the investment advisory services, and specified other services,
the Manager, under the terms of the Management Agreement for each Fund, is
entitled to receive a fee computed and accrued daily and payable monthly, at the
following annual rates:
<TABLE>
<CAPTION>
Net Asset Value of Fund

First Next Next Next Over
$100,000,000 $100,000,000 $100,000,000 $100,000,000 $400,000,000
<S> <C> <C> <C> <C> <C>

Balanced, High Yield, and Utilities Funds .60% .55% .50% .45% .40%
International Emerging Markets Fund 1.25% 1.20% 1.15% 1.10% 1.05%
International Fund .75% .70% .65% .60% .55%
International SmallCap Fund 1.20% 1.15% 1.10% 1.05% 1.00%
MidCap Fund .65% .60% .55% .50% .45%
Real Estate Fund .90% .85% .80% .75% .70%
SmallCap Fund .85% .80% .75% .70% .65%
All Other Funds .50% .45% .40% .35% .30%

</TABLE>

There is no assurance that any of the Funds' net assets will reach sufficient
amounts to be able to take advantage of the rate decreases. The net asset of
each Fund on October 31, 1998 and the rate of the fee for each Fund for
investment management services as provided in the Management Agreement for the
fiscal year then ended were as follows:

Management Fee
For Fiscal Year
Net Assets as of Ended
Fund October 31, 1998 October 31, 1998

Balanced Fund $ 142,777,667 .59%
Blue Chip Fund 193,834,531 .48%
Bond Fund 182,742,664 .48%
Capital Value Fund 647,492,207 .38%
Cash Management Fund 308,933,585 .38%
Government Securities Income Fund 283,981,376 .46%
Growth Fund 491,320,149 .41%
High Yield Fund 44,734,802 .60%
International Fund 362,172,335 .68%
International Emerging Markets Fund 12,789,905 1.25%
International SmallCap Fund 21,667,242 1.20%
Limited Term Bond Fund 31,370,705 .50%
MidCap Fund 424,839,839 .56%
Real Estate Fund 11,537,737 .89%
SmallCap Fund 29,776,443 .75%
Tax-Exempt Bond Fund 216,283,905 .47%
Tax-Exempt Cash Management Fund 26,340,314 .50%
Utilities Fund 98,928,795 .60%

* Before waiver.

Under a Sub-Advisory Agreement between Invista and the Manager, Invista performs
all the investment advisory responsibilities of the Manager under the Management
Agreement for the Growth-Oriented Funds (except the Real Estate Fund), the
Government Securities Income Fund, the Limited Term Bond Fund and the Utilities
Fund and is reimbursed by the Manager for the cost of providing such services.

The Manager pays for office space, facilities and simple business equipment and
the costs of keeping the books of the Fund. The Manager also compensates all
personnel who are officers and directors, if such officers and directors are
also affiliated with the Manager.

Each Fund pays all its other corporate expenses incurred in the operation of the
Fund and the continuous public offering of its shares, but not selling expenses.
Among other expenses, the Fund pays its taxes (if any), brokerage commissions on
portfolio transactions, interest, the cost of stock issue and transfer and
dividend disbursement, administration of shareholder accounts, custodial fees,
expenses of registering and qualifying shares for sale after the initial
registration, auditing and legal expenses, fees and expenses of unaffiliated
directors, and costs of shareholder meetings. The Manager pays most of these
expenses in the first instance, and is reimbursed for them by the Fund as
provided in the Management Agreement. The Manager also is responsible for the
performance of certain of the functions described above, such as transfer and
dividend disbursement and administration of shareholder accounts, the cost of
which the Manager is reimbursed by the Fund.

Fees paid for investment management services during the periods indicated were
as follows:
<TABLE>
<CAPTION>

Management Fees For Fiscal Years Ended October 31,

Fund 1998 1997 1996
<S> <C> <C> <C>

Balanced Fund 750,616 556,009 404,461
Blue Chip Fund 764,784 417,958 212,845
Bond Fund 782,241 636,217* 534,366*
Capital Value Fund 2,349,118 2,031,143 1,671,502
Cash Management Fund 2,127,595 2,864,916* 2,555,687*
Government Securities Income Fund 1,239,644 1,227,604 1,223,631
Growth Fund 1,863,070 1,443,120 1,040,897
High Yield Fund 287,858 230,667 159,773
International Emerging Markets Fund 157,324 28,487***
International Fund 2,492,037 1,882,664 1,154,783
International SmallCap Fund 242,403 30,283***
Limited Term Bond Fund 133,825 97,039 18,619***
MidCap Fund 2,548,924 2,004,305 1,293,848
Real Estate Fund 87,653
SmallCap Fund 147,083
Tax-Exempt Bond Fund 974,740 941,387 888,967
Tax-Exempt Cash Management Fund 316,084 499,606* 451,467*
Utilities Fund 531,644 436,296* 375,780*

</TABLE>

*Before waiver.
**Period from February 29, 1996 (Date Operations Commenced) through October
31, 1996.
***Period from August 29, 1997 (Date Operations Commenced) through
October 31, 1997.
****Period from January 1, 1998 (Date Operations Commenced) through October 31,
1998.

The Manager waived $100,270, $59,630 and $25,970 of its fee for the Limited Term
Bond Fund for the years ended October 31, 1998, 1997 and the period ended
October 31, 1996, respectively. The Manager waived $172,366, $60,665, and
$28,413 of its fee for the Bond Fund for the years ended October 31, 1998, 1997
and 1996, respectively. The Manager also waived $59,049, $33,785, and $76,266 of
its fee for the Tax-Exempt Cash Management Fund for the years ended October 31,
1998, 1997 and 1996, respectively. The Manager also waived $1,343, $7,933 and
$13,242 of its fee for the Cash Management Fund for the years ended October 31,
1998, 1997 and 1996, respectively. The Manager also waived $82,515, $79,048, and
$61,622 of its fee for the Utilities Fund for the years ended October 31, 1998,
1997 and 1996, respectively.

Costs reimbursed to the Manager during the periods indicated for providing other
services pursuant to the Management Agreement were as follows:
<TABLE>
<CAPTION>

Reimbursement by Fund
of Certain Costs For
Fund Fiscal Years Ended October 31,

1998 1997 1996
<S> <C> <C> <C>

Balanced Fund 521,852 364,442 251,542
Blue Chip Fund 832,394 402,003 206,942
Bond Fund 482,817 278,385 221,648
Capital Value Fund 1,247,865 837,825 567,786
Cash Management Fund 854,575 1,833,423 1,762,455
Government Securities Income Fund 499,207 407,146 394,360
Growth Fund 1,421,948 1,121,832 837,917
High Yield Fund 217,020 98,481 66,305
International Emerging Markets Fund 119,948 4,116**
International Fund 1,168,106 906,359 598,305
International SmallCap Fund 153,320 4,283**
Limited Term Bond Fund 90,187 44,634 32,982*
MidCap Fund 1,840,474 1,308,608 942,986
Real Estate Fund 76,546
SmallCap Fund 199,807
Tax-Exempt Bond Fund 199,780 135,553 145,931
Tax-Exempt Cash Management Fund 147,850 176,572 205,099
Utilities Fund 304,813 230,151 288,489

</TABLE>

*Period from February 13, 1996 (Date Operations Commenced) through October
31, 1996.
**Period from August 14, 1997 (Date Operations Commenced) through
October 31, 1997.
***Period fromDecember 10, 1997 (Date Operations Commenced) through October 31,
1998.

NOTE: The Manager voluntarily waived a portion of its fee for the Limited
Term Bond Fund from the date operations commenced and intends to
continue such waiver and, if necessary, pay expenses normally
payable by the Limited Term Bond Fund through the period ending
October 31, 1998 in an amount that will maintain a total level of
operating expenses, which as a percent of average net assets
attributable to a class on an annualized basis will not exceed .90%
for the Class A shares, 1.25% for the Class B shares and 1.50% for the
Class R shares. The effect of the waiver was and will be to reduce the
Fund's annual operating expenses and increase the Fund's yield and
effective yield.

The Management Agreements and the Investment Service Agreements, pursuant to
which Principal Life Insurance Company has agreed to furnish certain personnel,
services and facilities required by the Manager, and the Sub-Advisory Agreements
for each of the Growth-Oriented Funds (except the Real Estate Fund), the
Government Securities Income Fund and the Limited Term Bond Fund were last
approved by the Board of Directors for each of the Funds on September 14,
1998.Each of these agreements provides for continuation in effect from year to
year only so long as such continuation is specifically approved at least
annually either by the Board of Directors of the Fund or by vote of a majority
of the outstanding voting securities of the Fund, provided that in either event
such continuation shall be approved by vote of a majority of the Directors who
are not "interested persons" (as defined in the Investment Company Act of 1940)
of the Manager, Principal Life Insurance Company or its subsidiaries or the
Fund, cast in person at a meeting called for the purpose of voting on such
approval. The Agreements may be terminated at any time on 60 days written notice
to the Manager by the Board of Directors of the Fund or by a vote of a majority
of the outstanding securities of the Fund and by the Manager, Invista or
Principal Life Insurance Company, as the case may be, on 60 days written notice
to the Fund. The Agreements will automatically terminate in the event of their
assignment.

BROKERAGE ON PURCHASES AND SALES OF SECURITIES

In distributing brokerage business arising out of the placement of orders for
the purchase and sale of securities for any Fund, the objective of the Fund's
Manager or Sub-Advisor is to obtain the best overall terms. In pursuing this
objective, the Manager or Sub-Advisor considers all matters it deems relevant,
including the breadth of the market in the security, the price of the security,
the financial condition and executing capability of the broker or dealer and the
reasonableness of the commission, if any (for the specific transaction and on a
continuing basis). This may mean in some instances that the Manager or
Sub-Advisor will pay a broker commissions that are in excess of the amount of
commission another broker might have charged for executing the same transaction
when the Manager or Sub-Advisor believes that such commissions are reasonable in
light of (a) the size and difficulty of transactions (b) the quality of the
execution provided and (c) the level of commissions paid relative to commissions
paid by other institutional investors. (Such factors are viewed both in terms of
that particular transaction and in terms of all transactions that broker
executes for accounts over which the Manager or Sub-Advisor exercises investment
discretion. The Manager or Sub-Advisor may purchase securities in the
over-the-counter market, utilizing the services of principal market makers,
unless better terms can be obtained by purchases through brokers or dealers, and
may purchase securities listed on the New York Stock Exchange from non-Exchange
members in transactions off the Exchange.)

The Manager or Sub-Advisor gives consideration in the allocation of business to
services performed by a broker (e.g. the furnishing of statistical data and
research generally consisting of information of the following types: analyses
and reports concerning issuers, industries, economic factors and trends,
portfolio strategy and performance of client accounts). If any such allocation
is made, the primary criteria used will be to obtain the best overall terms for
such transactions. The Manager or Sub-Advisor may pay additional commission
amounts for research services. Such statistical data and research information
received from brokers or dealers may be useful in varying degrees and the
Manager or Sub-Advisor may use it in servicing some or all of the accounts it
manages. Some statistical data and research information may not be useful to the
Manager or Sub-Advisor in managing the client account, brokerage for which
resulted in the Manager's or Sub-Advisor's receipt of the statistical data and
research information. However, in the Manager's or Sub-Advisor's opinion, the
value thereof is not determinable and it is not expected that the Manager's or
Sub-Advisor's expenses will be significantly reduced since the receipt of such
statistical data and research information is only supplementary to the Manager's
or Sub-Advisor's own research efforts. The Manager or Sub-Advisor allocated
portfolio transactions for the Funds indicated in the following table to certain
brokers during the fiscal year ended October 31, 1998 due to research services
provided by such brokers. The table also indicates the commissions paid to such
brokers as a result of these portfolio transactions.

Fund Commissions Paid

Balanced $ 70,261
Blue Chip 41,024
Capital Value 331,316
Growth 276,004
International Emerging Markets 51,821
International 758,808
International SmallCap 101,485
MidCap 242,311
Real Estate* 40,791
SmallCap* 46,957
Utilities 39,470

* Period from December 11, 1997 (date operations commenced)
through October 31, 1998.

Purchases and sales of debt securities and money market instruments usually are
principal transactions; portfolio securities are normally purchased directly
from the issuer or from an underwriter or marketmaker for the securities. Such
transactions are usually conducted on a net basis with the Fund paying no
brokerage commissions. Purchases from underwriters include a commission or
concession paid by the issuer to the underwriter, and the purchases from dealers
serving as marketmakers include the spread between the bid and asked prices.

The following table shows the brokerage commissions paid during the periods
indicated. In each year, 100% of the commissions paid by each Fund went to
broker-dealers which provided research, statistical or other factual
information.

Total Brokerage Commissions Paid
Fund 1998 1997 1996
<S> <C> <C> <C>

Balanced Fund 70,261 47,096 41,537
Blue Chip Fund 41,024 113,923 17,198
Capital Value Fund 331,316 339,994 375,742
Growth Fund 276,004 43,018 64,704
International Emerging Markets Fund* 51,821 45,140 N/A
International Fund 758,808 708,333 338,670
International SmallCap Fund* 101,485 46,970 N/A
MidCap Fund 242,311 98,217 99,466
Real Estate Fund 40,791
SmallCap Fund 46,957
Utilities Fund 39,470 58,450 70,140

* Period from August 14, 1997 (date operations commenced) through
October 31, 1997.
</TABLE>

Brokerage commissions paid to affiliates during the past three fiscal years
ending October 31 were as follows:
<TABLE>
<CAPTION>

Commissions Paid to Goldman Sachs Co.
Total Dollar As Percent of Percent of Dollar Amount
Fund Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C>

Balanced Fund
1998 $2,950 4.20% 1.87%
Growth Fund
1998 5,000 1.81% 1.87%
International Emerging Markets Fund
1998 662 1.28% 1.54%
International Fund
1998 41,600 5.48% 5.79%
International SmallCap Fund
1998 2,326 2.29% 2.96%
SmallCap Fund
1998 210 0.45% 0.61%
Utilities Fund
1998 1,500 3.80% 3.71%
</TABLE>

Commissions Paid to J.P. Morgan Securities
Total Dollar As Percent of Percent of Dollar Amount
Fund Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C>

Balanced Fund
1998 $500 0.71% 1.03%
Blue Chip Fund
1998 1,950 4.75% 5.35%
Capital Value Fund
1998 18,935 5.72% 6.27%
Growth Fund
1998 1,250 0.45% 0.39%
International Emerging Markets Fund
1998 2,570 4.96% 6.77%
International Fund
1998 17,961 2.37% 1.80%
Real Estate Fund
1998 3,205 7.86% 7.67%

</TABLE>

Commissions Paid to Morgan Stanley& Co.
Total Dollar As Percent of Percent of Dollar Amount
Fund Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C>

Balanced Fund
1998 $2,630 3.74% 2.27%
1997 45 - 0.1%
1996 555 1.3% 1.0%
Blue Chip Fund
1998 365 0.89% 0.99%
1997 4,602 4.0% 2.4%
1996 420 3.0% 3.0%
Capital Value Fund
1998 13,740 4.15% 3.78%
1997 9,900 2.9% 2.4%
1996 9,400 2.5% 1.9%
Growth Fund
1998 12,500 4.53% 4.92%
1997 3,250 7.6% 8.5%
International Emerging Markets Fund
1998* 1,499 2.89% 3.64%
1997 1,586 3.5% 9.3%
International Fund
1998 78,938 10.40% 10.03%
1997 20,595 2.9% 2.7%
1996 4,038 1.2% 3.2%
International SmallCap Fund
1998* 4,284 4.22% 7.42%
1997 1,502 3.2% 4.2%
MidCap Fund
1998 7,716 3.18% 4.19%
1997 3,750 3.8% 2.8%
1996 500 .5% .9%
Real Estate Fund
1998 11,540 28.29% 28.36%
SmallCap Fund
1998 840 1.79% 1.65%
Utilities Fund
1998 1,735 4.40% 5.95%

</TABLE>

Morgan Stanley and Co. is affiliated with Morgan Stanley Asset Management, Inc.,
which acts as sub-advisor to two Accounts included in the Fund complex.

The Manager acts as investment advisor for each of the funds sponsored by
Principal Life Insurance Company and it, or Invista where Invista acts as
sub-advisor, places orders to trade portfolio securities for each of these
Funds. If, in carrying out the investment objectives of the funds, occasions
arise when purchases or sales of the same equity securities are to be made for
two or more of the funds at the same time (or, in the case of accounts managed
by Invista, for two or more Funds and any other accounts managed by Invista),
the Manager or Invista may submit the orders to purchase or, whenever possible,
to sell, to a broker/dealer for execution on an aggregate or "bunched" basis.
The Manager (or, in the case of accounts managed by Invista, Invista) may create
several aggregate or "bunched" orders relating to a single security at different
times during the same day. On such occasions, the Manager (or, in the case of
accounts managed by Invista, Invista) will employ a computer program to randomly
order the accounts whose individual orders for purchase or sale make up each
aggregate or "bunched" order. Securities purchased or proceeds of sales received
on each trading day with respect to each such aggregate or "bunched" order shall
be allocated to the various funds (or, in the case of Invista, the various Funds
and other client accounts) whose individual orders for purchase or sale make up
the aggregate or "bunched" order by filling each Fund's (or, in the case of
Invista, each Fund's or other client account's) order in the sequence arrived at
by the random ordering. Securities purchased for funds (or, in the case of
Invista, Funds and other client accounts) participating in an aggregate or
"bunched" order will be placed into those Funds and where applicable, other
client accounts at a price equal to the average of the prices achieved in the
course of filling that aggregate or "bunched" order.

If purchases or sales of the same debt securities are to be made for two or more
of the Funds at the same time, the securities will be purchased or sold
proportionately in accordance with the amount of such security sought to be
purchased or sold at that time for each Fund.

HOW TO PURCHASE SHARES

Each Fund, except the Tax-Exempt Bond Fund and Tax-Exempt Cash Management Fund,
offers investors three classes of shares which bear sales charges in different
forms and amounts: Class A, Class B and Class R shares. The Tax-Exempt
Bond Fund offers only Class A and Class B shares. The Tax-Exempt Cash Management
Fund offers only Class A shares.

Class A Shares. An investor who purchases less than $1 million of Class A
shares (except Class A shares of the Money Market Funds) pays a sales
charge at the time of purchase. As a result, such shares are not subject to
any charges when they are redeemed. An investor who purchases $1 million or
more of Class A shares does not pay a sales charge at the time of purchase.
However, a redemption of such shares occurring within 18 months from the
date of purchase will be subject to a contingent deferred sales charge
("CDSC") at the rate of .75% (.25% for the Limited Term Bond Fund) the
lesser of the value of the shares redeemed (exclusive of reinvested
dividend and capital gain distributions) or the total cost of such shares.
Shares subject to the CDSC which are exchanged into another Principal Fund
will continue to be subject to the CDSC until the original 18 month period
expires. However no CDSC is payable with respect to redemption of Class A
shares used to fund a Principal Mutual Fund 401(a) or Principal Mutual Fund
401(k) retirement plan, except redemptions resulting from the termination
of the plan or transfer of plan assets. In addition, the CDSC will be
waived in connection with 1) redemption of shares from retirement plans to
satisfy minimum distribution rules under the Code or 2) shares redeemed
through a systematic withdrawal plan that permits up to 10% of the value of
a shareholder's Class A shares of a particular Fund on the last business
day of December of each year to be withdrawn automatically in equal monthly
installments throughout the year. Certain purchases of Class A shares
qualify for reduced sales charges. Class A shares for each Fund, except the
Money Market Funds, currently bear a 12b-1 fee at the annual rate of up to
0.25% (0.15% for the Limited Term Bond Fund) of the Fund's average net
assets attributable to Class A shares. See "Distribution Plan."

Class B Shares. Class B shares are purchased without an initial sales
charge, but are subject to a declining CDSC of up to 4% (1.25% for the
Limited Term Bond Fund) if redeemed within six years. Class B shares
purchased under certain sponsored Principal Mutual Fund plans established
after February 1, 1998, are subject to a CDSC of up to 3% if redeemed
within five years of purchase. (See "Plans Other than Administered Employee
Benefit Plans" for discussion of sponsored Principal Mutual Fund plans.)
See "Offering Price of Funds' Shares." Class B shares bear a higher 12b-1
fee than Class A shares, currently at the annual rate of up to 1.00% (.50%
for the Limited Term Bond Fund) of the Fund's average net assets
attributable to Class B shares. See "Distribution Plan." Class B shares
provide an investor the benefit of putting all of the investor's dollars to
work from the time the investment is made, but (until conversion to Class A
shares) have a higher expense ratio and pay lower dividends than Class A
shares due to the higher 12b-1 fee. Class B shares automatically convert
into Class A shares, based on relative net asset value (without a sales
charge), on the first business day of the 85th month after the purchase
date. Class B shares acquired by exchange from Class B shares of another
Principal Fund convert into Class A shares based on the time of the initial
purchase. At the same time, a pro rata portion of all shares purchased
through reinvestment of dividends and distributions convert into Class A
shares, with that portion determined by the ratio that the shareholder's
Class B shares converting into Class A shares bears to the shareholder's
total Class B shares that were not acquired through dividends and
distributions. The conversion of Class B shares to Class A shares is
subject to the continuing availability of a ruling from the Internal
Revenue Service or an opinion of counsel that such conversions will not
constitute taxable events for Federal tax purposes. There can be no
assurance that such ruling or opinion will be available, and the conversion
of Class B shares to Class A shares will not occur if such ruling or
opinion is not available. In such event, Class B shares would continue to
be subject to higher expenses than Class A shares for an indefinite period.

Purchasing Class A and Class B Shares. Purchases are generally made through
registered representatives of Princor or other dealers it selects. If an
order and check are properly submitted to Princor, the shares are offered
at the offering price next computed after the order and check are received
at Princor's main office. If fund shares are purchased by telephone order
or electronic means and thereafter settled by delivery of a check or a
payment by wire, the shares so purchased are issued at the offering price
next computed after the telephone or electronic order are received at
Princor's main office. If an order and check are submitted through a
selected dealer, the shares are issued in accordance with the following: An
order accepted by a dealer on any day before the close of the New York
Stock Exchange and received by Princor before the close of its business on
that day is executed at the offering price computed of the close of the
Exchange on that day. An order accepted by such dealer after the close of
the Exchange and received by Princor before its closing on the following
business day is executed at the offering price computed as of the close of
the Exchange on such following business day. Dealers have the
responsibility to transmit orders to Princor promptly. After an open
account has been established, purchases are executed at the price next
computed after receipt of the investor's check at Princor's main office.
All orders are subject to acceptance by the Fund or Funds and Princor.

Redemptions by shareholders investing by check are effected only after
payment has been collected on the check, which may take up to eight
business days or more. Investors considering redeeming or exchanging shares
or transferring shares to another person shortly after purchase should pay
for those shares with a certified check, bank cashier's check or money
order to avoid any delay in redemption, exchange or transfer.

Which arrangement between Class A and Class B Shares is better for an
investor? The decision as to which class of shares provides a more suitable
investment for an investor depends on a number of factors, including the
amount and intended length of the investment. Investors making investments
that qualify for reduced sales charges might consider Class A shares.
Investors who prefer not to pay an initial sales charge and who plan to
hold their investment for more than seven years might consider Class B
shares. Orders from individuals for Class B shares for $250,000 or more
will be treated as orders for Class A shares unless the shareholder
provides written acknowledgment that the order should be treated as an
order for Class B shares. Sales personnel may receive different
compensation depending on which class of shares are purchased.

Class R Shares. Class R shares are purchased without an initial sales
charge or a contingent deferred sales charge ("CDSC"). Class R shares bear
a higher 12b-1 fee than Class A shares, currently at the annual rate of up
to .75% of the Fund's average net assets attributable to Class R shares.
See "Distribution and Shareholder Servicing Plans and Fees." Class R shares
provide an investor the benefit of putting all of the investor's dollars to
work from the time the investment is made, but (until conversion to Class A
shares) have a higher expense ratio and pay lower dividends than Class A
shares due to the higher 12b-1 fee. Class R shares automatically convert to
Class A shares, based on relative net asset value (without a sales charge),
on the first business day of the 49th month after the purchase date. Class
R shares acquired by exchange from Class R shares of another Principal Fund
convert into Class A shares based on the time of the initial purchase. (See
"To Exchange Shares" in the Prospectus.) At the same time, a pro rata
portion of all shares purchased through reinvestment of dividends and
distributions convert into Class A shares, with that portion determined by
the ratio that the shareholder's Class R shares converting into Class A
shares bears to the shareholder's total Class R shares that were not
acquired through dividends and distributions. The conversion of Class R
shares to Class A shares is subject to the continuing availability of a
ruling from the Internal Revenue Service or an opinion of counsel that such
conversions will not constitute taxable events for Federal tax purposes.
There can be no assurance that such ruling or opinion will be available,
and the conversion of Class R shares to Class A shares will not occur if
such ruling or opinion is not available. In such event, Class R shares
would continue to be subject to higher expenses that Class A shares for an
indefinite period.

Purchasing Class R Shares. Class R shares are offered only to individuals
(and his/her spouse, child, parent, grandchild and trusts primarily for
their benefit) who: receive lump sum distributions from retirement plans
serviced by Principal Life Insurance Company; or are participants in
retirement plans serviced by Principal Life Insurance Company; or own
individual life or disability insurance policies issued by Principal Life
Insurance Company that do not have an insurance agent licensed to sell such
policies assigned to the policies; or have mortgages which are serviced by
Principal Life Insurance Company; or have existing Principal Mutual Fund
Class R Share accounts.

Purchases are generally made by completing an Account Application or a
Principal Mutual Fund IRA Application and mailing it to Princor. Shares are
issued at the offering price next computed after the application is
received at Princor's main office and Princor receives the amount to be
invested. Generally, the initial amount to be invested in a Principal
Mutual Fund IRA is directly transferred to Princor from the AEBP. However,
in some cases the investor purchases shares by check. If investing by
check, shares are issued at the offering price next computed after the
completed application and check are received at Princor's main office.
Subsequent purchases are executed at the price next computed after receipt
of the investor's check at Princor's main office. All orders are subject to
acceptance by the Fund or Funds and Princor. Orders from individuals for
Class R shares that equal or exceed $500,000 are treated as orders for
Class A shares, unless accompanied by a written acknowledgment that the
order should be treated as an order for Class R shares.

Redemptions by shareholders investing by check will be effected only after
payment has been collected on the check, which may take up to 8 business
days or more. Investors considering redeeming or exchanging shares shortly
after purchase should pay for those shares with a certified check, bank
cashier's check or money order to avoid any delay in redemption, exchange
or transfer.

OFFERING PRICE OF FUNDS' SHARES

The Funds offer their respective shares continuously through Princor, which is
the principal underwriter for the Funds and sells shares as agent on behalf of
the Funds. Princor may select other dealers through which shares of the Funds
may be sold. Certain dealers may not sell all classes of shares.

Class A shares
Class A shares of the Money Market Funds are sold to the public at net asset
value; no sales charge applies to purchases of the Money Market Funds. Class A
shares of the Growth-Oriented and Income-Oriented Funds, except the Limited Term
Bond Fund, are sold to the public at the net asset value plus a sales charge
which ranges from a high 4.75% to a low of 0% of the offering price (equivalent
to a range of 4.99% to 0% of the net amount invested) according to the schedule
below. Class A shares of the Limited Term Bond Fund are sold to the public at
the net asset value plus a sales charge which ranges from a high of 1.50% to a
low of 0% of the offering price according to the schedule below. Selected
dealers are allowed a concession as shown. At Princor's discretion, the entire
sales charge may at times be reallowed to dealers. In some situations, depending
on the services provided by the dealer, the concession may be less. Any dealer
allowance on purchases not involving a sales charge is determined by Princor.
Upon notice to all broker-dealers with whom it has a selling agreement, Princor
may allow to broker-dealers electing to participate up to the full applicable
sales charge, as shown in the table below, during periods and for transactions
specified in such notice, and such reallowances may be based in whole or in part
upon attainment of minimum sales levels. Certain commercial banks may make
shares of the Funds available to their customers on an agency basis. Pursuant to
the agreements between Princor and such banks all or a portion of the sales
charge paid by a bank customer in connection with a purchase of Fund shares may
be retained by or remitted to the bank. The Glass-Steagall Act prohibits banks
from underwriting securities, including fund shares; the Act does, however,
permit certain agency transactions and banking regulators have ruled that these
particular agency transactions are not prohibited under the Act.
<TABLE>
<CAPTION>

Sales Charge for
All Funds Except Sales Charge for Dealer Allowance
Limited Term Bond Fund Limited Term Bond Fund as% of Offering Price
Amount Sales Charge as % of: Sales Charge as % of: All Funds Limited
of Offering Amount Offering Amount Except Limited Term Bond
Purchase Price Invested Price Invested Term Bond Fund Fund
<S> <C> <C> <C> <C> <C> <C>

Less than 4.75% 4.99% 1.50% 1.52% 4.00% 1.25%
$50,000

$50,000 but 4.25% 4.44% 1.25% 1.27% 3.75% 1.00%
less than
$100,000

$100,000 but 3.75% 3.90% 1.00% 1.01% 3.25% 0.75%
less than
$250,000

$250,000 but 2.50% 2.56% 0.75% 0.76% 2.00% 0.50%
less than
$500,000

$500,000 but 1.50% 1.52% 0.50% 0.50% 1.25% 0.25%
less than
$1,000,000

$1,000,000 No Sales 0% No Sales 0% .75% 0.25%
or more Charge Charge

</TABLE>

Rights of Accumulation. The applicable sales charge is determined by adding the
current net asset value of any Class A shares and Class B shares already owned
by the investor to the amount of the new purchase. The corresponding percentage
factor in the schedule is then applied to the entire amount of the new purchase.
For example, if an investor currently owns Class A or Class B shares with a
value of $5,000 and makes an additional investment of $45,000 in Class A shares
of a Growth-Oriented Fund (the total of which equals $50,000), the charge
applicable to the $45,000 investment would be 4.25% of the offering price. If
the investor purchases shares of more than one Principal Fund at the same time,
those purchases are aggregated and added to the net asset value of the shares of
Principal Funds already owned by the investor to determine the sales charge for
the new purchase. Class A shares of the Money Market Funds are not counted in
determining either the amount of a new purchase or the current net asset value
of shares already owned, unless the shares of the Money Market Funds were
acquired in exchange for shares of other Principal Funds. If the investor
purchases shares from a broker/dealer other than Princor, the dealer should be
advised of any shares already owned.

Investments made by an individual, or by an individual's spouse and dependent
children purchasing shares for their own account or by a trust primarily for the
benefit of such persons, or by a trustee or other fiduciary purchasing for a
single trust estate or single fiduciary account (including a pension,
profit-sharing, or other employee-benefit trust created pursuant to a plan
qualified under Section 401 of the Internal Revenue Code) will be treated as
investments made by a single investor in calculating the sales charge. In
addition, investments made through an employer by or on behalf of an employee
(including independent contractors) by means of payroll deductions or otherwise,
are also considered investments by a single investor in calculating the sales
charge. Other groups (as allowed by rules of the Securities and Exchange
Commission) may be considered for a reduced sales charge. An investor whose new
account qualifies for a reduced charge on the basis of other accounts owned by
the individual, spouse or children, should be certain to identify those accounts
at the time of the new application.

Statement of Intention (SOI). Another method is available by which a purchaser
may qualify for a reduced sales charge on the purchase of Class A shares of the
Funds. A purchaser may execute an SOI indicating the total amount (excluding
reinvested dividends and capital gains distributions) intended to be invested
(including all investments for the account of the spouse and dependent children
or trusts for the benefit of such persons) in Class A shares (except Class A
shares of the Money Market Funds) and Class B shares of the Funds within a
thirteen-month period (two-year period if the intended investment is made by a
trustee of a Section 401(a) plan or is equal to or greater than $1 million). The
SOI may be submitted by a shareholder other than a trustee of a Principal Mutual
Fund 401(a) plan, within 90 days after the date of the first purchase to be
included within the SOI period. A trustee of a Principal Mutual Fund 401(a) plan
must submit the SOI at the time the first plan purchase is made; the SOI may not
be submitted after the initial plan purchase and the 90 day backdating is not
available. The SOI period begins on the date of the first purchase included for
purposes of satisfying the statement. When an existing shareholder submits an
SOI, the net asset value of all Class A shares (except Class A shares of the
Money Market Funds) and Class B shares in that shareholder's account or accounts
combined for rights of accumulation purposes, is added to the amount that has
been indicated will be invested during the applicable period, and the sales
charge applicable to all purchases of Class A shares made under the SOI is the
sales charge which applies to a single purchase of this total amount.

An SOI may be entered into for any amount provided such amount, when added to
the net asset value of any shares already held, equals or is in excess of the
amount needed to qualify for a reduced sales charge. In the event a shareholder
invests an amount in excess of the indicated amount, such excess is allowed any
further reduced sales charge for which it qualifies.

The SOI provides for a price adjustment if the amount actually invested is less
than the amount specified therein. Sufficient Class A shares belonging to the
shareholder, other than a shareholder that is 401(a) qualified plan trustee, are
held in escrow in the shareholder's account by Princor to make up any difference
in sales charges based on the amount actually purchased. If the intended
investment is completed within the thirteen-month period (or two-year period),
such shares are released to the shareholder. If the total intended investment is
not completed within that period shares are, to the extent necessary, redeemed
and the proceeds used to pay the additional sales charge due. A shareholder that
is 401(a) qualified plan trustee is billed by Princor Financial Services
Corporation for any additional sales charge due at the end of the two-year
period. In any event, the sales charge applicable to these purchases is no more
than the applicable sales charge had the shareholder made all of such purchases
at one time. The SOI does not constitute an obligation on the shareholder to
purchase, nor the Funds to sell, the amount indicated.

Purchases at Net Asset Value.
A Fund's Class A shares may be purchased without a sales charge:
o by its Directors, Principal Life and its subsidiaries and their
employees, officers, directors (active or retired), brokers or agents.
This also includes their immediate family members and trusts for the
benefit of these individuals;
o by the Principal Employees' Credit Union;
o by non-ERISA clients of Invista;
o by any employee or Registered Representative (and their employees) of
an authorized broker-dealer;
o through broker-dealers, investment advisors and other financial
institutions that have entered into an agreement with Princor which
includes a requirement that such shares be sold for the benefit of
clients participating in a "wrap account" or similar program
under which clients pay a fee to the broker-dealer, investment
advisor or financial institution;
o by unit investment trusts sponsored by Principal Life and/or its
subsidiaries or affiliates;
o by certain employee welfare benefit plan customers of Principal Life
with Plan Deposit Accounts;
o by participants who receive distributions from certain annuity
contracts offered by Principal Life (except for shares of Tax-Exempt
Bond Fund);
o to the extent the investment represents the proceeds of a total
surrender of certain Principal Life issued unregistered group annuity
contracts if Principal Life waives any applicable CDSC or other
contract surrender charge; and
o to the extent the purchase proceeds represent a distribution from a
terminating 401(a) plan if the employer or plan trustee has entered
into a written agreement with Princor permitting the group solicitation
of employees/participants. Such purchases are subject to the CDSC which
applies to purchases of $1 million or more as described above.

Class A shares may also be purchased without a sales charge if your Registered
Representative has recently become affiliated with a broker-dealer authorized to
sell shares of the Principal Mutual Funds. The following conditions must be met;
o your purchase of Class A shares must take place within the first 180
days of your Registered Representative's affiliation with the
authorized broker-dealer;
o your investment must represent the sales proceeds from other mutual
fund shares (you must have paid a front-end sales charge or a CDSC) and
the sale must occur within the 180 day period; and
o you must indicate on your Principal Mutual Fund application that you
are eligible for waiver of the front-end sales charge.
o you must send us either:
o the check for the sales proceeds (endorsed to Principal Mutual
Funds) or
o a copy of the confirmation statement from the other mutual fund
showing the sale transaction. If you place your order to buy
Principal Mutual Fund shares on the telephone, you must send us a
copy of the confirmation within 21 days of placing the order. If
we do not receive the confirmation within 21 days, we will sell
enough of your Class A shares to pay the sales charge that
otherwise would have been charged.

Each of the Funds, except Principal Tax-Exempt Bond Fund and Principal
Tax-Exempt Cash Management Fund, have obtained an exemptive order from the
Securities and Exchange Commission ("SEC") to permit each Fund to offer its
shares at net asset value to participants of certain annuity contracts issued by
Principal Life Insurance Company. In addition, each of these Funds are available
at net asset value to the extent the investment represents the proceeds from a
total surrender of certain unregistered annuity contracts issued by Principal
Life Insurance Company and for which Principal Life Insurance Company waives any
applicable contingent deferred sales charges or other contract surrender
charges.

In addition, investors who are clients of a registered representative of Princor
or other dealers through which shares of the Funds are distributed and who has
become affiliated with Princor or such other dealer within 180 days of the date
of the purchase of Class A shares of the Funds may purchase such shares at net
asset value provided that (i) the purchase is made within the first 180 days of
the registered representative's affiliation with the firm involved (as certified
by an officer or partner of the firm); and (ii) the investment represents the
proceeds of a redemption within that 180 day period of shares of another
investment company the purchase of which included a front-end sales charge or
the redemption of which included a contingent deferred sales charge; and (iii)
the investor indicates on the account application that the purchase qualifies
for a net asset value purchase and forwards to Princor either (a) the redemption
check representing the proceeds of the shares redeemed, endorsed to the order of
Princor, or (b) a copy of the confirmation from the other investment company
showing the redemption transaction. In the case of a wire purchase pursuant to
this provision, a copy of the confirmation from the other investment company
showing the redemption must be forwarded to and received by Princor within 21
days following the date of purchase. If the confirmation is not provided within
the 21-day period, a sufficient number of shares is redeemed from the
shareholder's account to pay the otherwise applicable sales charge. Investors
availing themselves of this option should be aware that a redemption from
another mutual fund is a taxable event and may be subject to a surrender charge
imposed by that fund.

Also during the period beginning December 1, 1999 and ending January 31, 2000,
investors may purchase Class A shares of the Funds at net asset value to the
extent that this investment represents the proceeds of a redemption, within the
preceding 60 days, of shares (the purchase price of which shares included a
front-end sales charge on the redemption of which was subject to a contingent
deferred sales charge) of another investment company. This provision does not
apply to purchase of Class A shares used to fund a defined contribution plan.
When making a purchase at net asset value pursuant to this provision, the
investor must indicate on the account application that the purchase qualifies
for a net asset value purchase and must forward to Princor either (i) the
redemption check representing the proceeds of the shares redeemed, endorsed to
the order of Princor Financial Services Corporation, or (ii) a copy of the
confirmation from the other investment company showing the redemption
transactions. In the case of a wire purchase pursuant to this provision, a copy
of the confirmation from the other investment company showing the redemption
must be forwarded to and received by Princor within 21 days following the date
of purchase. If the confirmation is not provided within the 21-day period, a
sufficient number of shares will be redeemed from the shareholder's account to
pay the otherwise applicable sales charge.

Purchases at a Reduced Sales Charge. A reduced sales charge is also
available for purchases of Class A shares of the Funds, except the Limited
Term Bond Fund, to the extent that the investment represents the death
benefit proceeds of one or more life insurance policies or annuity
contracts (other than an annuity contract issued to fund an
employer-sponsored retirement plan that is not an SEP, salary deferral
403(b) plan or HR-10 plan) of which the shareholder is a beneficiary if one
or more of such policies or contracts is issued by Principal Life Insurance
Company, or any directly or indirectly owned subsidiary of Principal Life
Insurance Company, and such investment is made in any Principal Fund within
one year after the date of death of the insured. (Shareholders should seek
advice from their tax advisors regarding the tax consequences of
distributions from annuity contracts.) Such shares may be purchased at net
asset value plus a sales charge which ranges from a high of 2.50% to a low
of 0% of the offering price (equivalent to a range of 2.56% to 0% of the
net amount invested) according to the schedule below:
<TABLE>
<CAPTION>

Sales Charge as a % of:
Dealer Allowance as %
Amount of Purchase Offering Price Net Amount Invested of Offering Price
<S> <C> <C> <C>

Less than $500,000 2.50% 2.56% 2.10%
$500,000 but less than $1,000,000 1.50% 1.52% 1.25%
$1,000,000 or more No Sales Charge 0% .75%
</TABLE>

Sales Charges for Employer-Sponsored Plans

Administered Employee Benefit Plans. Class A shares of the Growth-Oriented
Funds and Income-Oriented Funds, except Principal Limited Term Bond Fund
and, in certain circumstances, Principal Tax-Exempt Bond Fund which is not
available for certain retirement plans, are sold at net asset value to
stock bonus, pension or profit sharing plans that meet the requirements for
qualification under Section 401 of the Internal Revenue Code of 1986, as
amended, certain Section 403(b) Plans, Section 457 Plans and other
Non-qualified Plans administered by Principal Life Insurance Company
pursuant to a written service agreement ("Administered Employee Benefit
Plans"). The service agreement between Principal Life Insurance Company and
the employer relating to the administration of the plan includes a charge
payable by the employer for any commissions which Princor is authorized to
pay in connection with such sales. Principal Life Insurance Company in turn
pays the amount of these charges to Princor. The commission payable by
Princor in connection with any such sale will be determined in accordance
with one of the following schedules:

Schedule 1
Amount of Plan Contributions* Amount Payable by Employer as a
In each year Percent of Plan Contributions

The first $5,000 4.50%
The next $5,000 3.00%
The next $5,000 1.70%
The next $35,000 1.40%
The next $50,000 0.90%
The next $400,000 0.60%
Excess over $500,000 0.25%

Schedule 2

Schedule 2 Schedule 1

The first $50,000 3.00%
The next $50,000 2.00%
The next $400,000 1.00%
The next $2,500,000 0.50%
Excess over $3,000,000 0.25%

*Plan contributions directed to an annuity contract issued by Principal Life
Insurance Company to fund the plan are combined with contributions directed to
the Funds to determine the applicable commission charge.

Generally, the
commission level described in Schedule 2 apply for salary deferral Plans and the
commission level described in Schedule 1 apply to other plans. No commission
will be payable by the employer if shares of the Funds used to fund an
Administered Employee Benefit Plan are purchased through a registered
representative of Princor Financial Services Corporation who is also a Group
Insurance Representative employee of Principal Life Insurance Company.

Plans Other Than Administered Employee Benefit Plans. Shares of the Funds
are offered to fund certain sponsored Princor plans. These plans can be
divided into three categories: Retirement plans meeting the requirements of
Section 401 of the Internal Revenue Code (e.g. 401(k) Plans, Profit Sharing
Plans and Money Purchase Pension Plans); Group Solicited Plan Terminations;
and other employer-sponsored retirement plans (SIMPLE IRA Plans, Simplified
Employee Pension Plans, Salary Reduction Simplified Employee Pension Plans,
Non-Qualified Deferred Compensation Plans, Payroll Deduction Plans ("PDP")
and certain Association Plan.

Princor 401 Plans

When establishing a Princor Section 401 Plan, the employer chooses
whether to fund the plan with either Class A shares or Class B shares.
If Class A shares are used to fund the plan, all plan investments are
treated as made by a single investor to determine whether a reduced
sales charge is available. The sales charge for purchases of less than
$250,000 is 3.75% as a percentage of the offering price and 3.90% of
the net amount invested. The regular sales charge table for Class A
shares applies to purchases $250,000 or more. If Class B shares are
used to fund the plan, contributions into the plan after the plan
assets amount to $250,000 or more, are used to purchase Class A shares
unless the plan trustee directs otherwise. Plan assets are not combined
with investments made outside of the plan to determine the sales charge
applicable to such investments. Investments made by plan participants
outside of the plan are not included with plan assets to determine the
sales charge applicable to the plan.

Group Solicited Plan Terminations

Occasionally, an employer terminates a Section 401 Plan. If the
employer or plan trustee enters into a written agreement with Princor
permitting the group solicitation of the employees/plan participants,
the proceeds of distributions from such plans are eligible to purchase
shares of the funds at net asset value. A redemption of such shares
within 18 months after purchase are subject to a contingent deferred
sales charge ("CDSC") at the rate of .75% (.25% for the Limited Term
Bond Fund) of the lesser of the value of the shares redeemed (exclusive
of reinvested dividends and capital gain distributions) or the total
cost of such shares. The CDSC is waived in connection with (1)
redemption of shares to satisfy IRS minimum distribution rules or (2)
shares redeemed through a systematic withdrawal plan that permits up to
10% of the value of the shareholder's Class A shares of a Fund on the
last business day of December each year to be withdrawn automatically
in equal monthly installments throughout the year.

Other Employer Sponsored Princor Plans

When establishing an employer-sponsored Princor plan, the employer
chooses whether to fund the plan with either Class A shares or Class B
shares. If Class A shares are used to fund the plan, all plan
investments are treated as made by a single investor to determine
whether a reduced sales charge is available. The sales charge for
purchases of less than $250,000 is 3.75% as a percentage of the
offering price and 3.90% of the net amount invested. The regular sales
charge table for Class A shares applies to purchases of $250,000 or
more. If Class B shares are used to fund the plan and a plan
participant has $250,000 or more invested in Class B shares, Class A
shares are purchased with plan contributions attributable to the plan
participant, unless the plan participant elects otherwise. Plan assets
are not combined with investments made outside of the plan to determine
the sales charge applicable to such investments. Investments made by
plan participants outside of the plan are not included with plan assets
to determine the sales charge applicable to the plan.

Shares of the funds are also available to participants of Princor 403(b)
plans at the same sales charge levels available to other employer-sponsored
Princor plans described above. However, contributions by plan participants
are not combined to determine sales charges.

The Funds reserve the right to discontinue offering shares at net asset
value and/or at a reduced sales charge at any time for new accounts and
upon 60-days notice to shareholders of existing accounts. Other types of
sponsored plans may be added in the future.

Class B shares
Class B shares are sold without an initial sales charge, although a CDSC is
imposed if you redeem shares within six years of purchase. Class B shares
purchased under certain sponsored Princor plans established after February
1, 1998, are subject to a CDSC of up to 3% if redeemed within five years of
purchase. (See "Plans Other than Administered Employee Benefit Plans" above
for discussion of sponsored Princor plans.) The following types of shares
may be redeemed without charge at any time: (i) shares acquired by
reinvestment of distributions and (ii) shares otherwise exempt from the
CDSC, as described below. Subject to the foregoing exclusions, the amount
of the charge is determined as a percentage of the lesser of the current
market value or the cost of the shares being redeemed. Therefore, when a
share is redeemed, any increase in its value above the initial purchase
price is not subject to any CDSC. The amount of the CDSC will depend on the
number of years since you invested and the dollar amount being redeemed,
according to the following table:
<TABLE>
<CAPTION>

Contingent Deferred Sales Charge
as a Percentage of
Dollar Amount Subject to Charge
For Certain Sponsored Plans
Commenced After 2/1/98

All Funds All Funds
Years Since Purchase Except Limited Term Limited Term Except Limited Term Limited Term
Payments Made Bond Fund Bond Fund Bond Fund Bond Fund
<S> <C> <C> <C> <C>

2 years or less 4.0% 1.25% 3.00% .75%
more than 2 years, up to 4 years 3.0% 0.75% 2.00% .50%
more than 4 years, up to 5 years 2.0% 0.50% 1.00% .25%
more than 5 years, up to 6 years 1.0% 0.25% None None
more than 6 years None None None None
</TABLE>

In determining whether a CDSC is payable on any redemption, the Fund first
redeems shares not subject to any charge, and then shares held longest during
the six (five) year period. For information on how sales charges are calculated
if shares are exchanged, see "To Exchange Shares" in the Prospectus.

The CDSC is waived on redemptions of Class B shares in connection with the
following types of transactions:
a. Shares redeemed due to a shareholder's death;
b. Shares redeemed due to the shareholder's disability, as defined in the
Internal Revenue Code of 1986 (the "Code"), as amended;
c. Shares redeemed from retirement plans to satisfy minimum distribution
rules under the Code;
d. Shares redeemed to pay surrender charges;
e. Shares redeemed to pay retirement plan fees;
f. Shares redeemed involuntarily from small balance accounts
(values of less than $300);
g. Shares redeemed through a systematic withdrawal plan that permits up to
10% of the value of a shareholder's Class B shares of a particular Fund
on the last business day of December of each year to be withdrawn
automatically in equal monthly installments throughout the year;
h. Shares redeemed from a retirement plan to assure the plan complies with
Sections 401(k), 401(m), 408(k) and 415 of the Code; or
i. Shares redeemed from retirement plans qualified under Section 401(a) of
the Code due to the plan participant's death, disability, retirement or
separation from service after attaining age 55.

Underwriting fees from the sale of shares for the periods indicated were as
follows:
<TABLE>
<CAPTION>

Underwriting Fees for
Fiscal Years Ended October 31,
1998 1997 1996
<S> <C> <C> <C>

Balanced Fund $716,315 $518,345 448,584
Blue Chip Fund 1,230, 098 816,203 469,388
Bond Fund 887,870 582,903 637,949
Capital Value Fund 1,769,043 1,383,995 988,680
Cash Management Fund 19,171 14,123 1,013
Government Securities Income Fund 846,821 737,229 1,233,811
Growth Fund 2,079,726 1,548,696 1,813,439
High Yield Fund 335,156 321,051 164,687
International Emerging Markets Fund** 114,325 33,588 N/A
International Fund 1,369,016 1,524,740 951,553
International SmallCap Fund** 197,039 38,421 N/A
Limited Term Bond Fund* 77,191 50,773 56,766
MidCap Fund 2,447,638 2,152,664 2,112,480
Real Estate Fund 53,280 N/A N/A
SmallCap Fund 398,391 N/A N/A
Tax-Exempt Bond Fund 667,756 558,697 698,730
Tax-Exempt Cash Management Fund 5 0 1,631
Utilities Fund 339,353 169,904 370,724
</TABLE>

* Period from February 29, 1996 (Date Operations Commenced) through October
31, 1996.
**Period from August 29, 1997 (Date Operations Commenced) through October 31,
1997.
***Period from January 1, 1998 (Date Operations Commenced) through October 31,
1998.

DISTRIBUTION PLAN

Rule 12b-1 of the Investment Company Act of 1940 (the "Act"), as amended,
permits a mutual fund to finance distribution activities and bear expenses
associated with the distribution of its shares provided that any payments made
by the Fund are made pursuant to a written plan adopted in accordance with the
Rule. A majority of the Board of Directors of each Fund, including a majority of
the Directors who have no direct or indirect financial interest in the operation
of the Plan or any agreements related to the Plan and who are not "interested
persons" as defined in the Act, adopted the Distribution Plans as described
below. No such Plan was adopted for Class A shares of the Money Market Funds.
Shareholders of each class of shares of each Fund approved the adoption of the
Plan for their respective class of shares.

Class A Distribution Plan. Each of the Funds, except the Money Market
Funds, has adopted a distribution plan for the Class A shares. The Class A
Plan provides that the Fund makes payments from its assets to Princor
pursuant to this Plan to compensate Princor and other selling Dealers for
providing shareholder services to existing Fund shareholders and rendering
assistance in the distribution and promotion of the Fund Class A shares to
the public. The Fund pays Princor a fee after the end of each month at an
annual rate no greater than 0.25% (.15% for the Limited Term Bond Fund) of
the daily net asset value of the Fund. Princor retains such amounts as are
appropriate to compensate for actual expenses incurred in distributing and
promoting the sale of the Fund shares to the public but may remit on a
continuous basis up to .25% (.15% for the Limited Term Bond Fund) to
Registered Representatives and other selected Dealers (including for this
purpose, certain financial institutions) as a trail fee in recognition of
their services and assistance. Class B Distribution Plan. Each Class B Plan
provides for payments by the Fund to Princor at the annual rate of up to
1.00% (.50% for the Limited Term Bond Fund) of the Fund's average net asset
attributable to Class B shares. Princor also receives the proceeds of any
CDSC imposed on redemptions of such shares.

Although Class B shares are sold without an initial sales charge, Princor
pays a sales commission equal to 4.00% (3.00% for certain sponsored plans
or 1.25% for the Limited Term Bond Fund) of the amount invested to dealers
who sell such shares. These commissions are not paid on exchanges from
other Principal Funds. In addition, Princor may remit on a continuous basis
up to .25% (.15% for the Limited Term Bond Fund) to the Registered
Representatives and other selected Dealers (including for this purpose,
certain financial institutions) as a trail fee in recognition of their
services and assistance.

Class R Distribution Plan. Each of the Funds, except the Tax-Exempt Bond
Fund and Tax-Exempt Cash Management Fund, have adopted a distribution plan
for the Class R shares. Each Class R Plan provides for payments by the Fund
to Princor at the annual rate of up to .75% of the Fund's average net
assets attributable to Class R shares.

Although Class R shares are sold without an initial sales charge, Princor
incurs certain distribution expenses. In addition, Princor may remit on a
continuous basis up to .25% to Registered Representatives and other
selected Dealers (including, for this purpose, certain financial
institutions) as a trail fee in recognition of their ongoing services and
assistance.

General Information Regarding Distribution Plans. A representative of
Princor provides to the Fund's Board of Directors, and the Board reviews,
at least quarterly, a written report of the amounts expended pursuant to
the Plans and the purposes for which such expenditures were made.

If expenses under a Plan exceed the compensation limit for Princor
described in the Plan in any one fiscal year, the Fund does not carry over
such expenses to the next fiscal year. The Funds have no legal obligation
to pay any amount pursuant to this Plan that exceeds the compensation
limit. The Funds do not pay, directly or indirectly, interest, carrying
charges, or other financing costs in connection with the Plans. If the
aggregate payments received by Princor under a Plan in any fiscal year
exceed the expenditures made by Princor in that year pursuant to the Plan,
Princor promptly reimburses the Fund for the amount of the excess.

The amount received from each Fund and retained by Princor during the year ended
October 31, 1998 and the manner in which such amounts were spent pursuant to the
Class A Distribution Plan for the last fiscal period of each of the Funds were
as follows:
<TABLE>
<CAPTION>

EXPENDITURES
Fund Amount Prospectus and Sales Salaries & Registered Service Total
Retained Shareholder Brochures Overhead Representative Fees Expenditures
Report Sales
Printing Materials
<S> <C> <C> <C> <C> <C> <C> <C>

Balanced 241,795 5,132 12,151 77,012 22,538 124,963 241,795
Blue Chip 265,449 7,358 17,096 96,066 27,270 117,660 265,449
Bond 341,013 5,951 14,278 84,649 24,871 211,263 341,013
Capital Value 817,936 10,797 25,099 144,595 39,870 597,575 817,936
Government Securities Income 487,256 5,039 12,500 78,969 22,778 367,970 487,256
Growth 795,083 11,128 26,652 150,363 42,246 564,693 795,083
High Yield 89,054 2,785 6,537 38,731 11,783 29,218 89,054
International Emerging Markets 17,129 652 1,722 8,539 5,466 750 17,129
International 611,261 11,751 27,044 147,012 65,397 360,057 611,261
International SmallCap 26,334 951 2,562 12,557 8,429 1,835 26,334
Limited Term Bond 36,351 1,083 2,739 18,632 7,771 6,125 36,351
MidCap 889,082 15,834 36,047 195,886 71,288 570,027 889,082
Real Estate 12,146 672 1,617 6,642 2,985 231 12,146
SmallCap 27,412 1,097 2,961 14,157 7,117 2,080 27,412
Tax-Exempt Bond 441,425 5,536 13,272 78,378 23,523 320,715 441,425
Utilities 191,411 3,401 8,922 55,013 17,158 106,918 191,411
</TABLE>

The amount received from each Fund and retained by Princor during the period
ended October 31, 1998 and the manner in which such amounts were spent pursuant
to the Class B Distribution Plan for the last fiscal period of each of the Funds
were as follows:
<TABLE>
<CAPTION>

EXPENDITURES
Fund Amount Prospectus and Sales Salaries Registered Service Commissions Total
Retained Shareholder Brochures Overhead Representative Fees Expenditures
Report Sales
Printing Materials
<S> <C> <C> <C> <C> <C> <C> <C> <C>

Balanced 141,265.21 2,337 5,394 35,418 7,315 25,346 65,455 141,265
Blue Chip 251,374.65 4,239 9,752 56,565 13,111 45,518 122,191 251,375
Bond 164,902.96 2,670 6,125 37,369 8,256 30,246 80,238 164,903
Capital Value 298,016.25 4,573 10,244 58,181 13,698 64,745 146,575 298,016
Cash Management 4,546.23 193 443 2,179 611 1,121 0 4,546
Government Securities Income 162,933.40 2,087 4,955 32,057 6,769 33,255 83,810 162,933
Growth 370,747.74 4,758 11,146 61,237 15,109 94,760 183,737 370,748
High Yield 73,761.52 1,752 4,273 24,628 6,383 16,226 20,499 73,762
International Emerging Markets 24,803.94 872 2,068 11,905 2,831 2,196 4,932 24,804
International 289,325.03 4,999 11,241 65,109 15,177 73,543 119,257 289,325
International SmallCap 43,155.53 1,286 3,176 18,253 4,401 6,700 9,338 43,156
Limited Term Bond 5,183.75 129 304 2,222 415 1,634 478 5,184
MidCap 448,415.93 6,402 14,780 81,509 19,963 122,285 203,478 448,416
Real Estate 20,673.68 864 1,969 11,743 2,460 452 3,187 20,674
SmallCap 38,517.72 1,252 2,367 9,014 3,047 2,190 20,647 38,518
Tax-Exempt Bond 68,657.74 1,160 2,530 13,107 3,419 16,992 31,449 68,658
Utilities 85,830.39 1,988 4,786 31,228 6,588 17,146 24,095 85,830
</TABLE>

The amount received from each Fund and retained by Princor during the period
ended October 31, 1998 and the manner in which such amounts were spent pursuant
to the Class R Distribution Plan for the last fiscal period of each of the Funds
were as follows:
<TABLE>
<CAPTION>

EXPENDITURES

Fund Amount Prospectus and Sales Registered Service Underwriter's Total
Retained Shareholder Brochures Representative Fees Salaries and Expenditures
Report Sales Overhead
Printing Materials
<S> <C> <C> <C> <C> <C> <C> <C>

Balanced 112,833.63 3,402 7,377 9,888 38,345 53,821 112,834
Blue Chip 190,876.08 4,153 9,181 12,360 63,625 101,557 190,876
Bond 66,915.15 2,082 4,498 6,029 23,372 30,933 66,915
Capital Value 214,972.97 4,898 10,641 14,216 75,565 109,653 214,973
Cash Management 21,021.11 500 1,163 1,628 7,239 10,491 21,021
Government Securities Income 45,977.69 2,524 4,925 6,265 15,539 16,725 45,978
Growth 183,597.70 4,050 8,755 11,710 62,722 96,361 183,598
High Yield 17,845.34 1,051 2,147 2,777 5,948 5,921 17,845
International Emerging Markets 5,973.07 200 518 715 501 4,039 5,973
International 120,268.60 3,519 7,400 9,761 40,089 59,499 120,269
International SmallCap 5,512.27 175 437 595 776 3,530 5,512
Limited Term Bond 10,624.85 783 1,574 2,024 3,835 2,409 10,625
MidCap 171,905.63 4,242 9,012 11,946 57,302 89,404 171,906
Real Estate 6,190.11 439 988 1,171 271 3,321 6,190
SmallCap 10,183.89 58 247 384 2,301 7,195 10,184
Utilities 20,866.73 983 1,980 2,655 6,955 8,293 20,867
</TABLE>

A Plan may be terminated at any time by vote of a majority of the Directors who
are not interested persons (as defined in the Act), or by vote of a majority of
the outstanding voting securities of the class of shares of a Fund to which the
Plan relates. Any change in a Plan that would materially increase the
distribution expenses of a class of shares of a Fund provided for in the Plan
requires approval of the shareholders of the class of shares to which such
increase would relate.

While a Distribution Plan is in effect for a Fund, the selection and nomination
of Directors who are not interested persons of that Fund will be committed to
the discretion of the Directors who are not interested persons.

Each Plan continues in effect from year to year as long as its continuance is
specifically approved at least annually by a majority vote of the directors of
the Fund including a majority of the non-interested directors. The Plans for all
Classes of shares were last approved by each Fund's Board of Directors,
including a majority of the non-interested directors, on September 14, 1998.

DETERMINATION OF NET ASSET VALUE OF FUNDS' SHARES

Growth-Oriented and Income-Oriented Funds

The share price of each class of the Growth-Oriented and Income-Oriented Funds
is calculated every day that the New York Stock Exchange is open. The Funds
treat as customary national business holidays the days when the New York Stock
Exchange is closed (New Year's Day, Martin Luther King, Jr. Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day).

The share price for each class of shares for each Fund is determined by dividing
the value of securities in the Fund's investment portfolio plus all other assets
attributable to that class, less all liabilities attributable to that class, by
the number of Fund shares of that class outstanding. Securities for which market
quotations are readily available, including options and futures traded on an
exchange, are valued at market value, which is for exchanged-listed securities,
the closing price; for United Kingdom-listed securities, the market-maker
provided price; and for non-listed equity securities, the bid price. Non-listed
corporate debt securities, government securities and municipal securities are
usually valued using an evaluated bid price provided by a pricing service. If
closing prices are unavailable for exchange-listed securities, generally the bid
price, or in the case of debt securities an evaluated bid price, is used to
value such securities. When reliable market quotations are not considered to be
readily available, which may be the case, for example, with respect to certain
debt securities, preferred stocks, foreign securities and over-the-counter
options, the investments are valued by using market quotations considered
reliable, prices provided by market makers, which may include dealers with which
the Fund has executed transactions, or estimates of market values obtained from
yield data and other factors relating to instruments or securities with similar
characteristics in accordance with procedures established in good faith by the
Board of Directors. Securities with remaining maturities of 60 days or less are
valued at amortized cost. Other assets are valued at fair value as determined in
good faith through procedures established by the Board of Directors of the Fund.

Generally, trading in foreign securities is substantially completed each day at
various times prior to the close of the New York Stock Exchange. The values of
foreign securities used to compute the share prices are usually determined when
the foreign market closes. Occasionally, events which affect the values of such
securities and foreign currency exchange rates occur between the times at which
the values are generally determined and the close of the New York Stock Exchange
and would therefore not be reflected in the computation of the Fund's net asset
value. If events materially affecting the value of securities occur during such
period, the securities are valued at their fair value as determined in good
faith by the Manager under procedures established and regularly reviewed by the
Board of Directors. To the extent a Fund invests in foreign securities listed on
foreign exchanges which trade on days on which the Fund does not determine its
net asset value, for example Saturdays and other customary national U.S.
holidays, the Fund's net asset value could be significantly affected on days
when shareholders have no access to the Fund.

Certain securities issued by companies in emerging market countries may have
more than one quoted valuation at any given point in time, sometimes referred to
as a "local" price and a "premium" price. The premium price is often a
negotiated price which may not consistently represent a price at which a
specific transaction can be effected. It is the policy of the International
Emerging Markets Fund, International Fund and International SmallCap Fund to
value such securities at prices at which it is expected those shares may be
sold, and the Manager or any sub-adviser is authorized to make such
determinations subject to such oversight by the Fund's Board of Directors as may
from time to time be necessary.

Money Market Funds

The share price of each class of shares of each of the Money Market Funds is
determined at the same time and on the same days as the Growth-Oriented and
Income-Oriented Funds as described above. The share price for each class of
shares of each Fund is computed by dividing the total value of the Fund's
securities and other assets, less liabilities, by the number of Fund shares
outstanding.

All securities held by the Money Market Funds are valued on an amortized cost
basis. Under this method of valuation, a security is initially valued at cost;
thereafter, the Fund assumes a constant proportionate amortization in value
until maturity of any discount or premium, regardless of the impact of
fluctuating interest rates on the market value of the security. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price that
would be received upon sale of the security.

Use of the amortized cost valuation method by the Money Market Funds requires
each Fund to maintain a dollar weighted average maturity of 90 days or less and
to purchase only obligations that have remaining maturities of 397 days or less
or have a variable or floating rate of interest. In addition, each Fund invests
only in obligations determined by its Board of Directors to be of high quality
with minimal credit risks.

The Board of Directors for each of the Money Market Funds has established
procedures designed to stabilize, to the extent reasonably possible, the Fund's
price per share as computed for the purpose of sales and redemptions at $1.00.
Such procedures include a directive to the Manager to test price the portfolio
or specific securities on a weekly basis using a mark-to-market method of
valuation to determine possible deviations in the net asset value from $1.00 per
share. If such deviation exceeds 1/2 of 1%, the Board promptly considers what
action, if any, will be initiated. In the event the Board determines that a
deviation exists which may result in material dilution or other unfair results
to shareholders, the Board takes such corrective action as it regards as
appropriate, including: sale of portfolio instruments prior to maturity; the
withholding of dividends; redemptions of shares in kind; the establishment of a
net asset value per share based upon available market quotations; or splitting,
combining or otherwise recapitalizing outstanding shares. The Fund may also
reduce the number of shares outstanding by redeeming proportionately from
shareholders, without the payment of any monetary compensation, such number of
full and fractional shares as is necessary to maintain the net asset value at
$1.00 per share.

PERFORMANCE CALCULATION

The Principal Funds advertise their performance in terms of total return or
yield for each class of shares. The figures used for total return and yield are
based on the past performance of a Fund. They show the performance of a
hypothetical investment and are not intended to indicate future performance.
Total return and yield vary from time to time depending upon:
o market conditions
o the composition of a Fund's portfolio
o operating expenses

These factors and differences in the methods used in calculating performance
figures should be considered when comparing a Fund's performance to the
performance of other investments.

A Fund may include in its advertisements performance rankings and other
performance-related information published by independent statistical services or
publishers, such as
o Baron's, Changing Times
o Forbes
o Fortune
o Investment Advisor
o Lipper Analytical Services
o Money Magazine
o Stanger's Investment Advisor
o The Wall Street Journal
o USA Today
o U.S. News
o Weisenberger Investment Companies Services
o W. R. Kipplinger's Personal Finance

A Fund may also include in its advertisements comparisons of the performance of
a Fund to that of various market indices, such as:
o Bond Buyer Municipal Index
o Dow Jones Industrials Index
o Dow Jones Utility Index with Income
o Lehman Brothers BAA Corporate Index
o Lehman Brothers GNMA Index
o Lehman Brothers High Yield Index
o Lehman Brothers Municipal Bond Index
o Lehman Brothers Revenue Bond Index
o Brothers Mutual Fund Short Government/Corporate Index
o Lehman Brothers Government Corporate Intermediate Index
o Lehman Brothers Government/Corporate Bond Index
o Merrill Lynch Corporate Government Bond Index
o Morgan Stanley Capital International EAFE (Europe, Australia and
Far East) Index
o Morgan Stanley Capital International EMF (Emerging Markets)
Index
o Salomon Brothers Investment Grade Bond Index
o S&P 500 Index
o Valueline
o World Index

Total Return

The Growth-Oriented and Income-Oriented Funds include its average annual total
return for the one-, five- and ten-year periods as of the last day of the most
recent calendar quarter when advertising total return figures. If the Fund or
class has been in existence for a shorter time period, it uses the time from the
beginning of the Fund (or class) to the end of the most recent calendar quarter.

Average annual total return is calculated by comparing an initial $1,000
investment to the redeemable value of the Fund at the end of 1, 5 or 10 years
(or from the Fund's inception date).

Initial Investment - $1,000 less maximum front-end sales charge (in the
case of Class A shares) Ending redeemable value - assumes the reinvestment
of all dividends and capital gains at net asset value less the applicable
contingent deferred sales charge (in the case of Class B shares).

A Fund may also include in its advertising average annual total return for some
other period or cumulative total return for a specified period. These returns
may include reduced sales charges, reflect no sales charge or CDSC in order to
illustrate the change in a Fund's net asset value over time. Cumulative total
return is calculated:

(Ending redeemable value less the initial investment)
Initial investment

The following table shows as of October 31, 1998 average annual returns for
Class A shares for each of the Funds for the periods indicated:
<TABLE>
<CAPTION>

Fund 1-Year 5-Year 10-Year
<S> <C> <C> <C>

Balanced Fund 5.78% 10.21% 10.43%
Blue Chip Fund 13.87% 16.61% 13.63%**
Bond Fund 2.69% 5.92% 8.61%
Capital Value Fund 10.16% 17.04% 13.55%
Government Securities Income Fund 2.33% 5.47% 8.09%
Growth Fund 9.75% 16.32% 16.44%
High Yield Fund (7.73)% 5.62% 6.35%
International Emerging Markets Fund (24.82)% (28.45)%**** N/A
International Fund (2.86)% 8.93% 9.97%
International SmallCap Fund (4.41)% (3.36)%**** N/A
Limited Term Bond Fund 4.98% 5.76%+ N/A
MidCap Fund (14.02)% 12.25% 14.58%
Real Estate Fund (19.43)%* N/A N/A
SmallCap Fund (19.90)%* N/A N/A
Tax-Exempt Bond Fund 1.74% 4.74% 7.27%
Utilities Fund 25.89% 10.40% 11.56%***

<FN>
* Period beginning December 31, 1997 and ending October 31, 1998.
** Period beginning March 1, 1991 and ending October 31, 1998.
*** Period beginning December 16, 1992 and ending October 31, 1998.
**** Period beginning August 29, 1997 and ending October 31, 1998.
+ Period beginning February 29, 1996 and ending October 31, 1998.
</FN>
</TABLE>

The following table shows as of October 31, 1998 average annual returns for
Class B shares for each of the Funds for the period indicated:

Fund 1-Year 5-Year
<S> <C> <C>

Balanced Fund 6.18% 14.35%(1)
Blue Chip Fund 14.59% 21.21%(1)
Bond Fund 3.04% 9.09%(1)
Capital Value Fund10.71% 22.44%(1)
Government Securities Income Fund 2.60% 8.70%(1)
Growth Fund 10.58% 21.03%(1)
High Yield (7.52)% 6.87%(1)
International Emerging Markets Fund (24.41)% (28.20)%(2)
International Fund (2.68)% 11.50%(1)
International SmallCap Fund (3.90)% (2.90)%(2)
Limited Term Bond Fund (4.99)% 5.70%(3)
MidCap Fund (13.75)% 16.57%(1)
Real Estate Fund (18.98)% N/A
SmallCap Fund (19.51)% N/A
Tax-Exempt Bond Fund 2.01% 8.87%(1)
Utilities Fund 27.23% 18.74%(1)

(1) Period beginning December 9, 1994 and ending October 31, 1998.
(2) Period beginning August 29, 1997 and ending October 31, 1998.
(3) Period beginning February 29, 1996 and ending October 31, 1998.
(4) Period beginning December 31, 1997 and ending October 31, 1998.
</TABLE>

The following table shows as of October 31, 1998 average annual returns for
Class R shares for each of the Funds for the period indicated:

Fund 1-Year 5-Year

Balanced Fund 10.43% 12.44%(1)
Blue Chip Fund 19.01% 17.89%(1)
Bond Fund 7.05% 7.60%(1)
Capital Value Fund 14.77% 19.51%(1)
Government Securities Income Fund 6.66% 6.98%(1)
Growth Fund 14.46% 16.11%(1)
High Yield Fund (3.97)% 4.59%(1)
International Emerging Markets Fund (21.14)% (25.55)%(2)
International Fund 1.13% 11.04%(1)
International SmallCap Fund 0.50% 0.86%(2)
Limited Term Bond Fund 6.12% 5.77%(1)
MidCap Fund (10.37)% 8.48%(1)
Real Estate Fund (15.37)% N/A
SmallCap Fund (15.75)% N/A
Tax-Exempt Bond Fund N/A N/A
Utilities Fund 31.47% 16.13%(1)

(1) Period beginning February 29, 1996 and ending October 31, 1998.
(2) Period beginning August 29, 1997 and ending October 31, 1998.
(3) Period beginning December 31, 1997 and ending October 31, 1998.

Yield

Income-Oriented Funds
Each Income-Oriented Fund computes a yield by:
1. calculating net investment income per share for a 30 day (or one month)
period
2. annualizing net investment income per share, assuming semi-annual
compounding
3. dividing the annualized net investment income by the maximum public
offering price for Class A shares or the net asset value for Class B and
Class R shares for the last day of the same period.

The following table shows as of October 31, 1998 the yield for each class of
shares for each of the Income-Oriented Funds:

<TABLE>
<CAPTION>
Yield as of October 31, 1998

Fund Class A Class B Class R
<S> <C> <C> <C>

Bond Fund 5.16% 4.66% 4.92%
Government Securities Income Fund 6.01% 5.56% 5.44%
High Yield Fund 8.58% 6.96% 8.14%
Limited Term Bond Fund 5.62% 4.71% 4.74%
Tax-Exempt Bond Fund 3.59% 3.35% N/A
</TABLE>

The Tax-Exempt Bond Fund may advertise a tax-equivalent yield. Your
tax-equivalent yield would be calculated by:

[(Tax-exemptportion of the yield) divided by (1 minus your tax rate)] plus
[any portion of the yield which is not tax-exempt]

As of October 31, 1998 the Fund's tax-equivalent yields for Class A and Class B
shares were as follows:

Tax-Equivalent Yield Assumed
Class A Class B Tax Rate
4.99% 4.65% 28%
5.61% 5.23% 36%
5.94% 5.55% 39.6%

Money Market Funds

Each of the Money Market Funds advertises its yield and its effective yield. The
Tax-Exempt Cash Management Fund also advertises its tax-equivalent yield.

Yield is computed by:
o determining the net change (excluding shareholder purchases and
redemptions) in the value of a hypothetical pre-existing account having a
balance of one share at the beginning of the period
o dividing the difference by the value of the account at the beginning of
the base period to obtain the base period return
o multiplying the base period return by (365/7) with the resulting yield
figure carried to at least the nearest hundredth of one percent.

The following table shows as of October 31, 1998 the yield for each class of
shares for each of the Money Market Funds:

Yield as of October 31, 1998
Fund Class A Class B Class R
<S> <C> <C> <C>
Cash Management Fund 4.92% 4.23% 4.50%
Tax-Exempt Cash Management Fund 2.53% N/A N/A
</TABLE>

There may be a difference in the net investment income per share used to
calculate yield and the net investment income per share used for dividend
purposes. This is because the calculation for yield purposes does not include
net short-term realized gains or losses on the Fund's investment, which are
included in the calculation for dividend purposes.

Effective yield is computed by:
o determining the net change (excluding shareholder purchases and
redemptions) in the value of a hypothetical pre-existing account having a
balance of one share at the beginning of the period
o dividing the difference by the value of the account at the beginning of the
base period to obtain the base period return compounding the base period
return by adding 1, raising the sum to a power equal to 365 divided by 7,
and subtracting 1 from the result.
The resulting effective yield figure is carried to at least the nearest
hundredth of one percent.

The following table shows as of October 31, 1998 the effective yield for each
class of shares for each of the Money Market Funds:

Effective Yield as of October 31, 1998

Fund Class A Class B Class R
<S> <C> <C> <C>

Cash Management Fund 5.04% 4.31% 4.60%
Tax-Exempt Cash Management Fund 2.56% N/A N/A
</TABLE>

Your tax-equivalent yield would be calculated by:

[(Tax-exemptportion of the yield) divided by (1 minus your tax rate)] plus
[any portion of the yield which is not tax-exempt]

As of October 31, 1998 the Fund's tax-equivalent yield and tax-equivalent
effective yield for Class A shares and Class B shares were as follows:

Tax-Equivalent Yield Tax-Equivalent Effective Yield Assumed
Class A Class B Class A Class B Tax-Rate
<S> <C> <C>
3.51% 3.56% 28.0%
3.95% 4.00% 36.0%
4.19% 4.24% 39.6%
</TABLE>

The yield quoted at any time for one of the
Money Market Funds represents the amount that has earned during a specific,
recent seven-day period and is a function of: o the quality of investments in
the Fund's portfolio o types of investments in the Fund's portfolio o length of
maturity of investments in the Fund's portfolio o Fund's operating expenses.

The length of maturity for the portfolio is calculated using the average dollar
weighted maturity of all investments. This means that the portfolio has an
average maturity of a stated number of days for its investments. The calculation
is weighted by the relative value of each investment.

The yield for either of the Money Market Funds will fluctuate daily as the
income earned on the investments of the Fund fluctuates. There is no assurance
the yield quoted on any given occasion will remain in effect for any period of
time. It should also be emphasized that the Funds are open-end investment
companies. There is no guarantee that the net asset value or any stated rate of
return will remain constant. A shareholder's investment in either Fund is not
insured. Investors comparing results of the Money Market Funds with investment
results and yields from other sources such as banks or savings and loan
associations should understand these distinctions.
Historical and comparative yield information may be presented by the Funds.

A Fund may include in its advertisements the compounding effect of reinvested
dividends over an extended period of time as illustrated below.

The Power of Compounding

Fund shareholders who reinvest their distributions get the advantage of
compounding. Here's what happens to a $10,000 investment with monthly income
reinvested at 6 percent, 8 percent and 10 percent over 20 years.

These figures assume no change in the value of principal. This chart is for
illustration purposes only and is not an indication of the results a shareholder
may receive as a shareholder of a specific Fund. The return and capital value of
an investment in a Fund vary so that the value, when redeemed, may be worth more
or less than the original cost. A Fund may also include in its advertisements an
illustration of the impact of income taxes and inflation on earnings from bank
certificates of deposit ("CD's"). The interest rate on the hypothetical CD will
be based upon average CD rates for a stated period as reported in the Federal
Reserve Bulletin. The illustrated annual rate of inflation will be the core
inflation rate as measured by the Consumer Price Index for the 12-month period
ended as of the most recent month prior to the advertisement's publication. The
illustrated income tax rate may include any federal income tax rate that may
apply to individuals at the time the advertisement is published. Any such
advertisement will indicate that, unlike bank CD's, an investment in the Fund is
not insured nor is there any guarantee that the Fund's net asset value or any
stated rate of return will remain constant.

An example of a typical calculation included in such advertisements is as
follows: the after-tax and inflation-adjusted earnings on a bank CD, assuming a
$10,000 investment in a six-month bank CD with an annual interest rate of ____%
(monthly average six-month CD rate for the month of October, 1998, as reported
in the Federal Reserve Bulletin) and an inflation rate of ___% (rate of
inflation for the 12-month period ended October 31, 1998 as measured by the
Consumer Price Index) and an income tax bracket of 28% would be $(49).

($10,000 x 5.72%) / 2 = $286 Interest for six-month period
- 80 Federal income taxes (28%)
- 105 Inflation's impact on invested principal
$(10,000 x 2.1%) / 2
($101) After-tax, inflation-adjusted earnings

A Fund may also include in its advertisements an illustration of tax-deferred
accumulation versus currently taxable accumulation in conjunction with the
Fund's use as a funding vehicle for 403(b) plans, IRAs or other retirement
plans. The illustration set forth below assumes a monthly investment of $200, an
annual return of 8% compounded monthly, and a 28% tax bracket.

The information is for illustrative purposes only and is not meant to represent
the performance of any of the Principal Funds. An investment in the Principal
Funds is not guaranteed; values and returns generally vary with changes in
market conditions.
Tax-deferred vs. taxable savings plan

_______________________________________ - $300,059

---------------------------------------

_______________________________________ --- $192,844

---------------------------------------

---------------------------------------
Years: 5 10 15 20 25 30

- With a tax-deferred savings plan
--- Without a tax-deferred savings plan

TAX TREATMENT OF FUNDS, DIVIDENDS AND DISTRIBUTIONS

It is the policy of each Fund to distribute substantially all net investment
income and net realized gains. Through such distributions, and by satisfying
certain other requirements, each Fund intends to qualify for the tax treatment
accorded to regulated investment companies under the applicable provisions of
the Internal Revenue Code. This means that in each year in which a Fund
qualifies, it is exempt from federal income tax upon the amount distributed to
investors. The Tax Reform Act of 1986 imposed an excise tax on mutual funds
which fail to distribute net investment income and capital gains by the end of
the calendar year in accordance with the provisions of the Act. Each Fund
intends to comply with the Act's requirements and to avoid this excise tax.

Dividends from net investment income will be eligible for a 70% dividends
received deduction generally available to corporations to the extent of the
amount of qualifying dividends received by the Funds from domestic corporations
for the taxable year. Distributions from the Money Market Funds and
Income-Oriented Funds are generally not eligible for the corporate dividend
received deduction.

All taxable dividends and capital gains are taxable in the year in which
distributed, whether received in cash or reinvested in additional shares.
Dividends declared with a record date in December and paid in January are deemed
to be distributed to shareholders in December. Each Fund informs its
shareholders of the amount and nature of their taxable income dividends and
capital gain distributions. Dividends from a Fund's net income and distributions
of capital gains, if any, may also be subject to state and local taxation.

The Fund is required in certain cases to withhold and remit to the U.S. Treasury
31% of ordinary income dividends and capital gain dividends, and the proceeds of
redemption of shares, paid to any shareholder (1) who has provided either an
incorrect tax identification number or no number at all, (2) who is subject to
backup withholding by the Internal Revenue Service for failure to report the
receipt of interest or dividend income properly, or (3) who has failed to
certify to the Fund that it is not subject to backup withholding or that it is a
corporation or other "exempt recipient."

A shareholder recognizes gain or loss on the sale or redemption of shares of the
Fund in an amount equal to the difference between the proceeds of the sales or
redemption and the shareholder's adjusted tax basis in the shares. All or a
portion of any loss so recognized may be disallowed if the shareholder purchases
other shares of the Fund within 30 days before or after the sale or redemption.
In general, any gain or loss arising from (or treated as arising from) the sale
or redemption of shares of the Fund is considered capital gain or loss
(long-term capital gain or loss if the shares were held for longer than one
year). However, any capital loss arising from the sales or redemption of shares
held for six months or less is disallowed to the extent of the amount of
exempt-interest dividends received on such shares and (to the extent not
disallowed) is treated as a long-term capital loss to the extent of the amount
of capital gain dividends received on such shares. Capital losses in any year
are deductible only to the extent of capital gains plus, in the case of a
noncorporate taxpayer, $3,000 of ordinary income.

If a shareholder (i) incurs a sales load in acquiring shares of the Fund, (ii)
disposes of such shares less than 91 days after they are acquired and (iii)
subsequently acquires shares of the Fund or another fund at a reduced sales load
pursuant to a right to reinvest at such reduced sales load acquired in
connection with the acquisition of the shares disposed of, then the sales load
on the shares disposed of (to the extent of the reduction in the sales load on
the shares subsequently acquired) shall not be taken into account in determining
gain or loss on the shares disposed of but shall be treated as incurred on the
acquisition of the shares subsequently acquired.

Shareholders should consult their own tax advisors as to the federal, state and
local tax consequences of ownership of shares of the Funds in their particular
circumstances.

Special Tax Considerations

Tax-Exempt Bond Fund and Tax-Exempt Cash Management Fund

The Tax-Exempt Bond Fund and Tax-Exempt Cash Management Fund also intend to
qualify to pay "exempt-interest dividends" to their respective
shareholders. An exempt-interest dividend is that part of dividend
distributions made by either Fund which consist of interest received by
that Fund on tax-exempt Municipal Obligations. Shareholders incur no
federal income taxes on exempt-interest dividends. However, these
exempt-interest dividends may be taxable under state or local law. Fund
shareholders that are corporations must include exempt-interest dividends
in determining whether they are subject to the corporate alternative
minimum tax. Exempt-interest dividends that derive from certain private
activity bonds must be included by individuals as a preference item in
determining whether they are subject to the alternative minimum tax. Each
Fund may also pay ordinary income dividends and distribute capital gains
from time to time. Ordinary income dividends and distributions of capital
gains, if any, are taxable for federal purposes. If a shareholder receives
an exempt-interest dividend with respect to shares of the Funds held for
six months or less, then any loss on the sale or exchange of such shares,
to the extent of the amount of such dividend, is disallowed.

If a
shareholder receives a capital gain dividend with respect to shares held
for six months or less, then any loss on the sale or exchange of such
shares is treated as a long term capital loss to the extent the loss
exceeds any exempt-interest dividend received with respect to such shares,
and is disallowed to the extent of such exempt-interest dividend.

Interest on indebtedness incurred or continued by a shareholder to purchase
or carry shares of either of these Funds is not deductible. Furthermore,
entities or persons who are "substantial users" (or related persons) under
Section 147(a) of the Code of facilities financed by private activity bonds
should consult their tax advisors before purchasing shares of the Funds.

From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Obligations. If legislation is enacted that
eliminates or significantly reduces the availability of Municipal
Obligations, it could adversely affect the ability of the Funds to continue
to pursue their respective investment objectives and policies. In such
event, the Funds would reevaluate their investment objectives and policies.

International Emerging Markets, International and International SmallCap
Funds

In each fiscal year when, at the close of such year, more than 50% of the
value of the total assets of the International Emerging Market,
International or the International SmallCap Funds are invested in
securities of foreign corporations, the Fund may elect pursuant to Section
853 of the Code to permit shareholders to take a credit (or a deduction)
for foreign income taxes paid by the Fund. In that case, shareholders
should include in their report of gross income in their federal income tax
returns both cash dividends received from the Fund and the amount which the
Fund advises is their pro rata portion of foreign income taxes paid with
respect to, or withheld from, dividends and interest paid to the Fund from
its foreign investments. Shareholders are then entitled to subtract from
their federal income taxes the amount of such taxes withheld, or treat such
foreign taxes as a deduction from gross income, if that should be more
advantageous. As in the case of individuals receiving income directly from
foreign sources, the above-described tax credit or tax deduction is subject
to certain limitations. Shareholders or prospective shareholders should
consult their tax advisors on how these provisions apply to them.

Futures Contracts and Options

As previously discussed, some of the Principal Funds invest in futures
contracts or options thereon, index options or options traded on qualified
exchanges. For federal income tax purposes, capital gains and losses on
futures contracts or options thereon, index options or options traded on
qualified exchanges are generally treated as 60% long-term and 40%
short-term. In addition, the Funds must recognize any unrealized gains and
losses on such positions held at the end of the fiscal year. A Fund may
elect out of such tax treatment, however, for a futures or options position
that is part of an "identified mixed straddle" such as a put option
purchased with respect to a portfolio security. Gains and losses on futures
and options included in an identified mixed straddle are considered 100%
short-term and unrealized gain or loss on such positions are not realized
at year end. The straddle provisions of the Code may require the deferral
of realized losses to the extent that a Fund has unrealized gains in
certain offsetting positions at the end of the fiscal year. The Code may
also require recharacterization of all or a part of losses on certain
offsetting positions from short-term to long-term, as well as adjustment of
the holding periods of straddle positions.

GENERAL INFORMATION AND HISTORY

Effective January 1, 1998, the following changes were made to the names of the
Funds:

Old Fund Name New Fund Name
<S> <C>

Princor Balanced Fund, Inc. Principal Balanced Fund, Inc.
Princor Blue Chip Fund, Inc. Principal Blue Chip Fund, Inc.
Princor Bond Fund, Inc. Principal Bond Fund, Inc.
Princor Capital Accumulation Fund, Inc. Principal Capital Value Fund, Inc.
Princor Cash Management Fund, Inc. Principal Cash Management Fund, Inc.
Princor Emerging Growth Fund, Inc. Principal MidCap Fund, Inc.
Princor Government Securities Income Fund, Inc. Principal Government Securities Income Fund, Inc.
Princor Growth Fund, Inc. Principal Growth Fund, Inc.
Princor High Yield Fund, Inc. Principal High Yield Fund, Inc.
Princor Limited Term Bond Fund, Inc. Principal Limited Term Bond Fund, Inc.
Princor Tax-Exempt Bond Fund, Inc. Principal Tax-Exempt Bond Fund, Inc.
Princor Tax-Exempt Cash Management Fund, Inc. Principal Tax-Exempt Cash Management Fund, Inc.
Princor Utilities Fund, Inc. Principal Utilities Fund, Inc.
Princor World Fund, Inc. Principal International Fund, Inc.
</TABLE>

FINANCIAL STATEMENTS

The financial statements for each of the Principal Funds for the year ended
October 31, 1998 are a part of this Statement of Additional Information. The
financial statements appear in the Annual Reports to Shareholders. Reports on
those statements from Ernst & Young LLP, independent auditors, are included in
the Annual Report and are also a part of this Statement of Additional
Information. The Annual Reports are furnished, without charge, to investors who
request copies of the Statement of Additional Information.

APPENDIX A

Description of Bond Ratings:

Moody's Investors Service, Inc. Bond Ratings

Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong
position of such issues.

Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.

A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa: Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
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: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not
well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.

B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of
time may be small.

Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.

Ca: Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.

C: Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.

CONDITIONAL RATING: Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.

RATING REFINEMENTS: Moody's may apply numerical modifiers, 1, 2 and 3 in each
generic rating classification from Aa through B in its bond rating system. 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 a modifier 3
indicates that the issue ranks in the lower end of its generic rating category.

SHORT-TERM NOTES: The four ratings of Moody's for short-term notes are MIG 1,
MIG 2, MIG 3 and MIG 4; MIG 1 denotes "best quality, enjoying strong protection
from established cash flows"; MIG 2 denotes "high quality" with "ample margins
of protection"; MIG 3 notes are of "favorable quality...but lacking the
undeniable strength of the preceding grades"; MIG 4 notes are of "adequate
quality, carrying specific risk for having protection...and not distinctly or
predominantly speculative."

Description of Moody's Commercial Paper Ratings

Moody's Commercial Paper ratings are opinions of the ability to repay punctually
promissory obligations not having an original maturity in excess of nine months.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment capacity of rated issuers:

Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations.

Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations.

Issuers rated Prime-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations.

Issuers rated Not Prime do not fall within any of the Prime rating categories.

Description of Standard & Poor's Corporation's Debt Ratings:

A Standard & Poor's debt rating is a current assessment of the creditworthiness
of an obligor with respect to a specific obligation. This assessment may take
into consideration obligors such as guarantors, insurers, or lessees.

The debt rating is not a recommendation to purchase, sell or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.

The ratings are based on current information furnished by the issuer or obtained
by Standard & Poor's from other sources Standard & Poor's considers reliable.
Standard & Poor's does not perform an audit in connection with any rating and
may, on occasion, rely on unaudited financial information. The ratings may be
changed, suspended or withdrawn as a result of changes in, or unavailability of,
such information, or for other circumstances.

The ratings are based, in varying degrees, on the following considerations:

I. Likelihood of default -- capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with the
terms of the obligation;

II. Nature of and provisions of the obligation;

III. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditor's rights.

AAA: Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.

AA: Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest-rated issues only in small
degree.

A: Debt rated "A" has a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher-rated categories.

BBB: Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in
higher-rated categories.

BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "CC" is
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 "CC" the highest
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.

C: The rating "C" is reserved for income bonds on which no interest is
being paid.

D: Debt rated "D" is in default, and payment of interest and/or repayment
of principal is in arrears.

Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.

Provisional Ratings: The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the bonds being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit quality
subsequent to completion of the project, makes no comment on the likelihood of,
or the risk of default upon failure of, such completion. The investor should
exercise his own judgment with respect to such likelihood and risk.

NR: Indicates that no rating has been requested, that there is insufficient
information on which to base a rating or that Standard & Poor's does
not rate a particular type of obligation as a matter of policy.

Standard & Poor's, Commercial Paper Ratings

A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. Ratings are applicable to
both taxable and tax-exempt commercial paper. The four categories are as
follows:

A: Issues assigned the highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated
with the numbers 1, 2 and 3 to indicate the relative degree of safety.

A-1 This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Issues that possess
overwhelming safety characteristics will be given a "+" designation.

A-2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues
designated "A-1".

A-3 Issues carrying this designation have a satisfactory capacity for
timely payment. They are, however, somewhat more vulnerable to the
adverse effects of changes in circumstances than obligations carrying
the highest designations.

B: Issues rated "B" are regarded as having only an adequate capacity for
timely payment. However, such capacity may be damaged by changing
conditions or short-term adversities.

C: This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.

D: This rating indicates that the issue is either in default or is
expected to be in default upon maturity.

The Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in or unavailability of, such information.

Standard & Poor's rates notes with a maturity of less than three years as
follows:

SP-1 A very strong, or strong, capacity to pay principal and interest.
Issues that possess overwhelming safety characteristics will be given a
"+" designation.

SP-2 A satisfactory capacity to pay principal and interest.

SP-3 A speculative capacity to pay principal and interest.

PRINCIPAL TAX-EXEMPT
CASH MANAGEMENT
FUND, INC.

This Prospectus describes a mutual fund organized by Principal Life
Insurance Company. The fund seeks, through investment in a professionally
managed portfolio of high quality, short-term Municipal Obligations, as high a
level of current interest income exempt from federal income tax as is consistent
with stability of principal and maintenance of liquidity.

The date of this Prospectus is ----------------.

TABLE OF CONTENTS

Money Market Fund
Tax-Exempt Cash Management Fund

Fees and Expenses of the Fund

Primary Investment Strategies and Related Risks

Management, Organization and Capital Structure

Pricing of Fund Shares

Dividends and Distributions

To Sell Shares

To Exchange Shares

General Information about a Fund Account

Financial Highlights

Annual Total Returns Graph for Calendar
Year Ended 12-31 for years 89 through 98.

-------------------------------------------------------

The 7-day yield ending on December 31, 1998 for Class A shares is __.__%. To
obtain the Fund's current yield information, please call 1-800-247-4123.

- --------------------------------------------------------------------------------
Fund Operating Expenses Examples
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A Class A $ $ $ $
-------
Management Fees.... 0.49% You would pay the following expenses if
12b-1 Fees......... -- you did not redeem your shares:
Other Expenses..... 0.31% Class A
-----
Total Fund
Operating Expenses 0.80%
- --------------------------------------------------------------------------------

Day-to-day Fund management:
Since September 1989 Manager: Steve Schneider, CFA. Investment Manager -
Securities Investment of Principal Life
Insurance Company since 1989.

The Principal Tax-Exempt Cash Management Fund seeks to provide as high a level
of current interest income exempt from federal income tax as is consistent, in
the view of the Fund's management, with stability of principal and the
maintenance of liquidity. The Fund seeks to achieve its objective through
investment in a professionally managed portfolio of high quality, short-term
obligations that have been issued by or on behalf of state or local governments
or other public authorities and that pay interest which is exempt from federal
income tax in the opinion of bond counsel to the issuer ("municipal
obligations").

The Fund invests primarily in municipal obligations with fixed, variable or
floating interest rates. Typically such instruments carry demand features
permitting the Fund to redeem at par upon specified notice. The Fund's right to
obtain payment at par on a demand instrument upon demand could be affected by
events occurring between the date the Fund elects to redeem the instrument and
the date redemption proceeds are due. The Manager monitors on an ongoing basis
the pricing, quality and liquidity of such instruments.

In addition, the Manager monitors the ability of an issuer of a demand
instrument to pay principal and interest on demand. Although the ultimate
maturity of such variable rate obligations may exceed one year, the Fund treats
the maturity of each variable rate demand obligation as the longer of
o the notice period required before the Fund is entitled to payment of
the principal amount through demand, or
o the period remaining until the next interest rate adjustment.
Floating rate instruments with demand features are deemed to have a maturity
equal to the period remaining until the principal amount can be recovered
through demand.

The Fund may also invest in bond anticipation notes, tax anticipation notes,
revenue anticipation notes, construction loan notes and bank notes issued by
governmental authorities to commercial banks as evidence of borrowings. Since
these short-term securities frequently serve as interim financing, a weakness in
an issuer's ability to obtain such funds as anticipated could adversely affect
the issuer's ability to meet its obligations on these short-term securities.

o Government securities which are issued or guaranteed by the U.S.
Government, including treasury bills, notes and bonds.
o U.S. Government agency securities which are issued or guaranteed by
agencies or instrumentalities of the U.S.Government. These are backed
either by the full faith and credit of the U.S. Government or by the
credit of the particular agency or instrumentality.
o Bank obligations consisting of:
o certificates of deposit which generally are negotiable
certificates against funds deposited in a commercial bank or
o bankers acceptances which are time drafts drawn on a
commercial bank, usually in connection with international
commercial transactions.
o Commercial paper which is short term promissory notes issued by U.S. or
foreign corporations primarily to finance short term credit needs.
o Short term corporate debt consisting of notes, bonds or debentures which
at the time of purchase by the Fund has 397 days or less remaining
to maturity.
o Repurchase agreements under which securities are purchased with
an agreement by the seller to repurchase the security at the same price
plus interest at a specified rate.Generally these have a short duration
(less than a week) but may also have a longer one.

From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Obligations. It may be expected that similar proposals may
be introduced in the future. If such a proposal were enacted, the ability of the
Fund to pay "exempt interest" dividends may be adversely affected, and the Fund
would reevaluate its investment objective and policies and consider changes in
its structure.

The Tax-Exempt Cash Management Fund is generally a suitably investment for
investors seeking monthly dividends to produce tax-exempt income without
incurring much principal risk or for investors short-term needs.

PRIMARY INVESTMENT STRATEGIES AND RELATED RISKS
The Statement of Additional Information (SAI) contains additional information
about investment strategies and their related risks.

Securities and Investment Practices
Equity securities include common stocks, preferred stocks, convertible
securities and warrants. Common stocks, the most familiar type, represent an
equity (ownership) interest in a corporation. Although equity securities have a
history of long term growth in value, their prices fluctuate based on changes in
a company's financial condition and on overall market and economic conditions.
Smaller companies are especially sensitive to these factors.

Repurchase Agreements and Loaned Securities
The Fund may invest a portion of its assets in repurchase agreements. Repurchase
agreements typically involve the purchase of debt securities from a financial
institution such as a bank, savings and loan association or broker-dealer. A
repurchase agreement provides that the Fund sells back to the seller and that
the seller repurchases the underlying securities at a specified price on a
specific date. Repurchase agreements may be viewed as loans by the Fund
collateralized by the underlying securities. This arrangement results in a fixed
rate of return that is not subject to market fluctuation while the Fund holds
the security. In the event of a default or bankruptcy by a selling financial
institution, the Fund bears a risk of loss. To minimize such risks, the Fund
enters into repurchase agreements only with large, well-capitalized and
well-established financial institutions. In addition, the value of the
collateral underlying the repurchase agreement is always at least equal to the
repurchase price, including accrued interest.

Borrowing
The Fund may borrow money from banks for temporary or emergency purposes. It may
borrow in an amount which permits it to maintain a 300% asset coverage. If due
to market fluctuations or other reasons, the Fund's asset coverage falls below
300% the Fund will reduce its borrowings within three business days. To do this
the Fund may have to sell a portion of its investments at a time when it may not
be advantageous to do so. If the borrowing is more than 5% of the Fund's total
assets, no additional purchases of investment securities will be made.

FEES AND EXPENSES OF THE FUND

The Fund pays ongoing operating fees to the Manager (Principal Management
Corporation), Underwriter and others who provide services to the Fund. These
fees reduce the value of each share you own. See MANAGEMENT, ORGANIZATION AND
CAPITAL STRUCTURE.

PRICING OF FUND SHARES

The Fund's shares are bought and sold at the current share price. The share
price of the Fund is calculated every day the New York Stock Exchange is open.
The share price is determined at the close of business of the Exchange (normally
at 3:00 p.m. Central Time). When we receive your order to sell shares, the share
price used to fill the order is the next price calculated after the order is
placed.

An investment in the Fund is not insured or guaranteed by the FDIC or any other
government agency. Although the Fund seeks to preserve the value of your
investment at $1.00 per share, it is possible to lose money by investing in the
Fund.

The securities of the Fund are valued at amortized cost. The calculation
procedure is described in the Statement of Additional Information. The Fund
reserves the right to determine a share price more than once a day.

NOTES:
o If current market values are not readily available for a security, its
fair value is determined using a policy adopted by the Fund's Board of
Directors.

TO BUY SHARES

Shares of the Fund are no longer offered for sale.

TO SELL SHARES

After you place a sell order in proper form, shares are sold using the next
share price calculated. There is no additional charge for a sale. However, you
will be charged a $6 wire fee if you have the sale proceeds wired to your bank.
Generally, the sale proceeds are sent out on the next business day after the
sell order has been placed. At your request, the check will be sent overnight (a
$15 overnight fee will be deducted from your account unless other arrangements
are made). The Fund can only sell shares after your check making the Fund
investment has cleared your bank. A sell order from one owner is binding on all
joint owners.

Selling shares may create a gain or a loss for federal (and state) income tax
purposes. You should maintain accurate records for use in preparing your income
tax returns.

Generally, sales proceeds checks are:
o payable to all owners on the account (as shown in the account
registration) and
o mailed to address on the account (if not changed within last month)
or previously authorized bank account.
For other payment arrangements, please call Principal Mutual Funds
(1-800-247-4123).

Within 60 days after the sale of shares, the amount of the sale proceeds can be
reinvested in any Principal Mutual Funds' Class A shares without a sales charge
if the Fund shares that were sold were acquired by conversion of Class B shares.

Sell shares by mail
o Send a letter (signed by the owner of the account) to
Principal Mutual Funds
P. O. Box 10423
Des Moines Iowa 50306-9780
o Specify the Fund and account number.
o Specify the number of shares or the dollar amount to be sold.
o A signature guarantee* will be required if the:
o sell order is for more than $100,000;
o account address has been changed within one month of the sell order;
or
o check is payable to a party other than the account shareholder(s) or
Principal Life Insurance Company.

* If required, the signature(s) must be guaranteed by a
commercial bank, trust company, credit union, savings and
loan, national securities exchange member or brokerage firm. A
signature guaranteed by a notary public or savings bank is not
acceptable.

Sell shares in amounts of $100,000 or less by telephone* (1-800-247-4123)
o Address on account must not have been changed within the last month and
o telephone privileges must apply to the account from which the shares are
being sold.
o If our phone lines are busy, you may need to send in a written
sell order.
o To sell shares the same day, the order must be received before
3:00 p.m. Central Time.
o Telephone privileges are not available for Principal Mutual Funds IRAs,
403(b)s, certain employee benefit plans, or on shares for which
certificates have been issued.
o If previously authorized, checks can be sent to a shareholder's U.S.
bank account.

* The Fund and transfer agent reserve the right to refuse telephone
orders to sell shares. The shareholder is liable for a loss resulting
from a fraudulent telephone order that the Fund reasonably believes is
genuine. Each Fund will use reasonable procedures to assure
instructions are genuine. If the procedures are not followed, the Fund
may be liable for loss due to unauthorized or fraudulent transactions.
The procedures include: recording all telephone instructions,
requesting personal identification information (name, phone number,
social security number, birth date, etc.) and sending written
confirmation to the address on the account.

Sell shares by checkwriting
o Checkwriting must be elected on initial application or by written request
to Principal Mutual Funds.
o The Fund can only sell shares after your check making the Fund investment
has cleared your bank.
o Checks must be written for at least $100.
o Checks are drawn on Norwest Bank Iowa, N.A. and its rules concerning
checking accounts apply.
o If the account does not have sufficient funds to cover the check, it is
marked "Insufficient Funds" and returned (the Fund may revoke
checkwriting on accounts on which "Insufficient Funds" checks are drawn).
o Accounts may not be closed by withdrawal check (accounts continue to earn
dividends until checks clear and the exact value of the account is not
known until the check is received by Norwest).
o Not available for Principal Mutual Funds IRAs, 403(b)s, SEPs, SIMPLES,
SAR-SEPs or certain employee benefit plans or shares subject to a CDSC
or on shares for which a certificate has been issued.

Periodic withdrawal plan
You may set up a periodic withdrawal plan
o on a monthly, quarterly, semiannual or annual basis to:
o sell a fixed number of sales ($25 initial minimum amount), or
o sell enough shares to provide a fixed amount of money ($25 initial
minimum amount).
o pay insurance or annuity premiums or deposits to Principal Life
Insurance Company (call us at 1-800-247-4123) for details, and
o to provide an easy method of making monthly installment payments (if the
service is available from your creditor who must supply the necessary
forms).

Your periodic withdrawal plan continues until
o you instruct us to stop, or
o your Fund account is exhausted.

When you set up the withdrawal plan, you select which day you want the sale made
(if none selected, the sale will be made on the 15th of the month). If the
selected date is not a trading day, the sale will take place on the next trading
day (if that day falls in the month after your selected date, the transaction
will take place on the trading day before your selected date). If telephone
privileges apply to the account, you may change the date or amount by
telephoning us at 1-800-247-4123.

Withdrawal payments are sent on or before the third business day after the date
of the sale. Sales made under your periodic withdrawal plan will reduce and may
eventually exhaust your account. The Funds do not normally accept purchase
payments for shares of any Fund except the Cash Management Fund while a periodic
withdrawal plan is in effect (unless the purchase represents a substantial
addition to your account).

The Fund from which the periodic withdrawal is made makes no recommendation as
to either the number of shares or the fixed amount that you withdraw.

TO EXCHANGE SHARES

Shares of the Fund may be exchanged into
o Class A shares of other Principal Mutual Funds.
If the Tax-Exempt Cash Management shares were acquired by direct
purchase, a sales charge will be imposed on the exchange into other
Class A shares. If the Tax-Exempt Cash Management shares were acquired
by exchange from other Funds, conversion of Class B shares or shares
purchased by reinvestment of dividends earned on Class A shares, no
sales charge will be imposed on the exchange into other Class A shares.
o Class B shares of other Principal Mutual Funds - subject to the CDSC

You pay no sales charge or other fee on exchanges from the Fund. However, the
purchase date of the exchanged shares and the CSDC table are used to determine
if the newly acquired shares are subject to the CDSC (and the amount of the CDSC
if any) when they are sold.

You may exchange shares by:
o calling us (1-800-247-4123), if you have telephone privileges on the
account and if the amount of the exchange is $500,000 or less.
o sending a written request to:
Principal Mutual Funds
P. O. Box 10423
Des Moines, Iowa 50306-9780
o completing an Exchange Authorization Form (call us at 1-800-247-4123 to
obtain the form).

Automatic exchange election.
This election authorizes an exchange from the Fund to another Principal Mutual
Fund on a monthly, quarterly, semiannual or annual basis. You can set up an
automatic exchange by:
o by calling us (1-800-247-4123) if telephone privileges apply to the
account from which the exchange is to be made, or
o sending us your written
instructions.

Your automatic exchange continues until:
o you instruct us to stop, or
o your Fund account is exhausted.

General
o An exchange by any joint owner is binding on all joint owners.
o If you do not have an existing account in the Fund to which the exchange
is being made, a new account is established.The new account has the same
owner(s), dividend and capital gain options and dealer of record as the
account from which the shares are being exchanged.
o All exchanges are subject to the minimum investment and eligibility
requirement of the Fund being acquired.
o You may acquire shares of a Fund only if its shares are legally offered
in your state of residence.
o If a certificate has been issued, it must be returned to the Fund before
the exchange can take place.

DIVIDENDS AND DISTRIBUTIONS

The Tax-Exempt Cash Management Fund declares dividends of all its daily net
investment income each day its shares are priced. The dividends are paid daily
and are automatically reinvested back into additional share of the Fund. You may
ask to have your dividends paid to you monthly in cash. These cash payments are
made on the 20th (or preceding business day if the 20th is not a business day)
of each month.

MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE

The Manager

Principal Management Corporation (the "Manager") serves as the manager for the
Funds. In its handling of the business affairs of each Fund, the Manager
provides clerical, recordkeeping and bookkeeping services, and keeps the
financial and accounting records required for the Fund.

The Manager provides the Board of Directors of the Fund a recommended investment
program. The program must be consistent with the Fund's investment objective and
policies. Within the scope of the approved investment program, the Manager
advises the Fund on its investment policies and determines which securities are
bought and sold, and in what amounts.

The Manager is paid a fee by the Fund for its services. The fee paid by the Fund
(as a percentage of the average daily net assets) for the fiscal year ended
October 31, 1998 was 0.49%.

The Principal Tax-Exempt Cash Management Fund, Inc. and the Principal Cash
Management Fund, Inc. (together the Money Market Funds), following authorization
by their boards of directors, and the Manager, have filed an application with
the Securities and Exchange Commission seeking an exemptive order that would
exempt their proposed transaction from Section 17(a) of the Investment Company
Act of 1940. That Section, in pertinent part, makes it unlawful for an
affiliated person of a registered investment company to sell any security to a
registered investment company or to purchase from such registered investment
company any security or other property except in certain circumstances. Both
Money Market Funds are sponsored by Principal Life. They share a common
investment advisor and have common officers and directors. Principal Life owns
more than 5% of the Class A shares of Cash Management. Because of these factors,
the Funds might be deemed to be under common control and affiliated persons of
each other for purposes of Section 17(a).

The proposed transaction provides for Cash Management to acquire the assets and
assume the liabilities of Tax-Exempt Cash Management. In exchange, Tax-Exempt
Cash Management will receive shares of Cash Management. Immediately thereafter,
Tax-Exempt Cash Management will distribute on a pro rata basis to the
shareholders of record of Tax-Exempt Cash Management at the close of business on
the closing date the shares of Cash Management received in the exchange.
Tax-Exempt Cash Management will then dissolve in accordance with applicable
laws.

If the SEC issues the requested order, the Funds will be able to enter into the
proposed transaction. There is no assurance that the SEC will grant the
requested ruling. However, in anticipation of such approval, Tax-Exempt Cash
Management is being managed in such a fashion so as to eliminate or minimize the
tax effect, if any, of the exchange. To this end, as the assets of Tax-Exempt
Cash Management mature, they are being replaced by Eligible Securities with
shorter durations. In addition, shares of Tax-Exempt Cash Management are no
longer being offered for sale.

If the requested ruling is granted, shareholders of the Tax-Exempt Cash
Management Fund will vote on the proposed transaction at a shareholder meeting
called for that purpose. Until the ruling is granted, however, no date for a
shareholder meeting or an effective date for the proposed transaction can be
established.

GENERAL INFORMATION ABOUT A FUND ACCOUNT

Statements
You will receive monthly statements for the Fund . The statements provide the
number and value of shares you own, transactions during the quarter, dividends
declared or paid and other information. The year end statement includes
information for all transactions that took place during the year. Please review
your statement as soon as your receive it. Keep your statements as you may need
them for tax reporting purposes.

Certain purchases and sales are only included on your quarterly statement.
These include accounts when the only activity during the quarter:
o is purchase of shares from reinvested dividends and/or
capital gains;
o is a result of Dividend Relay;
o purchases under a Automatic Investment Plan;
o sales under a periodic withdrawal plan; and
o purchases or sales under an automatic exchange
election.
used to fund certain individual retirement or individual pension plans.
established under a payroll deduction plan.

Signature Guarantees
Certain transactions require that your signature be guaranteed. If required, the
signature(s) must be guaranteed by a commercial bank, trust company, credit
union, savings and loan, national securities exchange member or brokerage firm.
A signature guaranteed by a notary public or savings bank is not acceptable.
Signature guarantees are required:
o if you sell more than $100,000 from the Fund;
o if a sales proceeds check is payable to other than the account
shareholder(s), Principal Life Insurance Company or one of its
affiliates;
o to make a Dividend Relay election from an account with joint owners to
an account with only one owner or different joint owners;
o to change ownership of an account;
o to add telephone transaction services to an existing account;
o to change bank account information designated under an existing
telephone withdrawal plan;
o to have a sales proceeds check mailed to an address other than the
address on the account or to the address on the account if it has been
changed within the preceding month; and
o to add wire privileges to an existing account.

Minimum Account Balance
Generally, the Fund does not have a minimum required balance. Because of the
disproportional high cost of maintaining small accounts, the Fund reserves the
right to set a minimum and sell all shares in an account with a value of less
than $300. The sales proceeds would then be mailed to you. These involuntary
sales will not be triggered just by market conditions. If the Fund exercises
this right, you will be notified that the redemption is going to be made. The
Fund reserves the right to increase the required minimum.

Special Plans
The Fund reserves the right to amend or terminate the special plans described in
this prospectus. Such plans include automatic investment, dividend relay,
periodic withdrawal, and waiver or reduction of sales charges for certain
purchasers. You would be notified of any such action to the extent required by
law.

Financial Statements
You will receive an annual financial statement for the Fund, examined by the
Fund's independent auditors, Ernst & Young, LLP. That report is a part of this
prospectus. You will also receive a semiannual financial statement which is
unaudited. The following financial highlights are based on financial statements
which were audited by Ernst & Young.

Telephone Orders

The Fund reserves the right to refuse telephone orders to sell shares. You are
liable for a loss resulting from a fraudulent telephone order that we reasonably
believe is genuine. We will use reasonable procedures to assure instructions are
genuine. If the procedures are not followed, we may be liable for loss due to
unauthorized or fraudulent transactions. The procedures include: recording all
telephone instructions, requesting personal identification information (name,
phone number, social security number, birth date, etc.) and sending written
confirmation to the policy owner's address of record.

Year 2000 Problem

The business operations of the Funds depend on computer systems that contain
date fields. These systems include securities transfer agent operations and
securities pricing systems. Many of these systems were constructed using a two
digit date field to represent the date. Unless these systems are changed or
modified, they may not be able to distinguish the Year 1900 from the Year 2000
(commonly referred to as the Year 2000 Problem).

At this time, testing of internal systems has been completed. The Manager is now
participating in a corporate-wide initiative lead by senior management
representatives of Principal Life. Currently they are engaged in regression
testing of internal programs. They are also participating in development of
contingency plans in the event that Year 2000 problems develop and/or persist on
or after January 1, 2000. This plan is scheduled to be completed by March 19,
1999. The contingency plan calls for:
o identification of business risks;
o consideration of alternative approaches to critical business risks;
and
o development of action plans to address problems.

Other important Year 2000 initiatives include:
o the service provider for our transfer agent system has renovated its
code. Client testing will occur in the first and second quarters of
1999. The service provider is also participating in a securities
industry wide testing program that is scheduled to be completed by the
end of April 1999;
o the securities pricing system we use has renovated its code and
conducted client testing in June 1998;
o Facilities Management of Principal Life has identified non-systems
issues (heat, lights, water, phone, etc.) and is working with these
service providers to ensure continuity of service; and
o the Manager and other areas of Principal Life have contacted all
vendors with which we do business to receive assurances that they are
able to deal with any Year 2000 problems. We continue to work with
the vendors to identify any areas of risk.

In its budget for 1999 and 2000, the Manager has estimated expenses of between
$100,000 and $500,000 to deal with Year 2000 issues.

FINANCIAL HIGHLIGHTS
Money Market Funds

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

<TABLE>
<CAPTION>
PRINCIPAL TAX-EXEMPT CASH MANAGEMENT FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
- -------------------------------------------------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.................... $1.000 $1.000 $1.000 $1.000 $1.000

Net Investment Income from Operations(b)................ .028 .029 .029 .032 .021

Less Dividends from Net Investment Income............... (.028) (.029) (.029) (.032) (.021)

Net Asset Value, End of Period.......................... $1.000 $1.000 $1.000 $1.000 $1.000

Total Return(c)......................................... 2.89% 2.89% 2.92% 3.24% 2.11%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............. $26,340 $98,939 $98,482 $99,887 $79,736
Ratio of Expenses to Average Net Assets(b)........... .72% .70% .71% .69% .67%
Ratio of Net Investment Income to Average Net Assets. 2.84% 2.93% 2.87% 3.19% 2.08%
</TABLE>

Notes to Financial Highlights

(a) Effective January 1, 1998, the following change was made to the name of
the Money Market Fund:

<TABLE>
<CAPTION>
Former Fund Name New Fund Name
<S> <C>
Princor Tax-Exempt Cash Management Fund, Inc. Principal Tax-Exempt Cash Management Fund, Inc.
</TABLE>

<TABLE>
<CAPTION>
Year Ended Ratio of
October 31, Per Share Expenses
Except Net Investment to Average Amount
as Noted Income Net Assets Waived
<S> <C> <C> <C> <C>

Principal Tax-Exempt Cash Management Fund, Inc.:
Class A 1998 .026 .81 58,145
1997 .029 .73 27,978
1996 .028 .77 69,107
1995 .031 .84 138,574
1994 .019 .85 150,515
</TABLE>

Statement of Additional Information and annual and semi-annual reports can be
obtained free of charge by writing or telephoning Princor Financial Services
Corporation, P.O. Box 10423, Des Moines, IA 50306. Telephone 1-800-247-4123.

Information about the fund can be reviewed and copied at the Securities and
Exchange Commission's Public Reference Room in Washington, D.C. Information on
the operation of the public reference room may be obtained by calling the
Commission at 800-SEC-0330. Reports and other information about the fund is
available on the Commission's internet site at http://www.sec.gov. Copies of
this information may be obtained, upon payment of a duplicating fee, by writing
the Public Reference Section of the Commission, Washington, D.C. 20549-6009.

The U.S. Government does not insure or guarantee an investment in the fund.
There can be no assurance the fund will be able to maintain a stable share price
of $1.00 per share.

Shares of the fund are not deposits or obligations of, or guaranteed or endorsed
by, any financial institution, nor are shares of the funds federally insured by
the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any
other agency.

Principal Tax-Exempt Cash Management Fund, Inc.
-----------------------------------------------

SEC File: 811-05548

MM625 A-_

<PAGE>
PART C
OTHER INFORMATION

Item 24. Financial Statements and Exhibits

(a) Financial Statements included in the Registration
Statement
(1) Part A:
Financial Highlights for each of the five
years in the period ended October 31, 1998.
(2) Part B:
None
(b) Exhibits
(1a) Articles Supplementary (Filed 2/26/96)
(1b) Articles of Amendment and Restatement
(2) Bylaws
(5a) Management Agreement
(5b) Investment Service Agreement (Filed 2/26/96)
(6a) Distribution Agreement (Filed 2/26/96)
(6b) Account Application*
(8a) Custody Agreement (Filed 2/26/96)
(9a) Dealer Selling Agreement
(10) Opinion of Counsel (Filed 2/26/96)
(11) Consent of Independent Auditors
(12) Audited Financial Statements as of October 31,
1998, including the Report of Ernst & Young
LLP, independent auditors for the Registrant.
(13) Investment Letter (Filed 2/26/96)
(16a) Performance Quotations-Class A Shares
(Filed 2/26/96)
(18) Multiple Class Distribution Plan
(27a) Financial Data Schedule-Class A Shares

* To be filed by amendment.

Item 25. Persons Controlled by or Under Common Control with Depositor

Principal Life Insurance Company (an Iowa corporation)
a life group, pension and individual insurance company.

Sponsored the organization of the following mutual funds, some of
which it controls by virtue of owning voting securities:

Principal Balanced Fund, Inc.(a Maryland Corporation) 0.69% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal Blue Chip Fund, Inc.(a Maryland Corporation) 0.93% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal Bond Fund, Inc.(a Maryland Corporation) 1.14% of shares
outstanding owned by Principal Life Insurance Company (including
subsidiaries and affiliates) on December 8, 1998.

Principal Capital Value Fund, Inc. (a Maryland Corporation)
23.99% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal Cash Management Fund, Inc. (a Maryland Corporation)
9.45% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal Government Securities Income Fund, Inc. (a Maryland
Corporation) 0.38% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal Growth Fund, Inc. (a Maryland Corporation) 0.43% of
outstanding shares owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal High Yield Fund, Inc. (a Maryland Corporation) 7.35%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal International Emerging Markets Fund, Inc. (a Maryland
Corporation) 48.93% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal International Fund, Inc. (a Maryland Corporation)
22.80% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal International SmallCap Fund, Inc. (a Maryland
Corporation) 45.14% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal Limited Term Bond Fund, Inc. (a Maryland Corporation)
38.04% of shares outstanding owned by Principal Life Insurance
Company(including subsidiaries and affiliates) on December 8,
1998.

Principal MidCap Fund, Inc. (a Maryland Corporation) 0.63% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998

Principal Real Estate Fund, Inc. (a Maryland Corporation) 72.27%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998

Principal SmallCap Fund, Inc.(a Maryland Corporation) 25.85% of
shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998

Principal Special Markets Fund, Inc. (a Maryland Corporation)
83.04% of shares outstanding of the International Emerging
Markets Portfolio, 42.77% of the shares outstanding of the
International Securities Portfolio, 98.66% of shares outstanding
of the International SmallCap Portfolio and 100% of the shares
outstanding of the Mortgage-Backed Securities Portfolio were
owned by Principal Life Insurance Company (including subsidiaries
and affiliates) on December 8, 1998

Principal Tax-Exempt Bond Fund, Inc. (a Maryland Corporation)
0.54% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on December 8,
1998.

Principal Tax-Exempt Cash Management Fund, Inc. (a Maryland
Corporation) 3.71% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
December 8, 1998.

Principal Utilities Fund, Inc. (a Maryland Corporation) 1.52% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on December 8, 1998.

Principal Variable Contracts Fund, Inc. (a Maryland Corporation)
100% of shares outstanding of the following Accounts owned by
Principal Life Insurance Company and its Separate Accounts on
December 8, 1998: Aggressive Growth, Asset Allocation, Balanced,
Bond, Capital Value, Government Securities, Growth, High Yield,
International, International SmallCap, MicroCap, MidCap, MidCap
Growth, Money Market, Real Estate, SmallCap, SmallCap Growth,
SmallCap Value and Utilities .

Subsidiaries organized and wholly-owned by Principal Life
Insurance Company:

a. Principal Holding Company (an Iowa Corporation) A holding
company wholly-owned by Principal Life Insurance
Company.

b. PT Asuransi Jiwa Principal Egalita Indonesia (an Indonesia
Corporation)

c. Principal Real Estate Services, LLC (a Delaware Corporation)
a limited liability company which acts as a property manager
and real estate service provider.

d. Principal Commercial Funding, LLC (a Delaware
Corporation) a correspondent lender and sevice provider for
loans.

Subsidiaries wholly-owned by Principal Holding Company:

a. Petula Associates, Ltd. (an Iowa Corporation) a real estate
development company.

b. Patrician Associates, Inc. (a California Corporation) a real
estate development company.

c. Principal Development Associates, Inc. (a California
Corporation) a real estate development company.

d. Princor Financial Services Corporation (an Iowa Corporation)
a registered broker-dealer.

e. Invista Capital Management, Inc. (an Iowa Corporation) a
registered investment adviser.

f. Principal Marketing Services, Inc. (a Delaware Corporation)
a corporation formed to serve as an interface between
marketers and manufacturers of financial services products.

g. The Principal Financial Group, Inc. (a Delaware corporation)
a general business corporation established in connection
with the new corporate identity. It is not currently active.

h. Delaware Charter Guarantee & Trust Company (a Delaware
Corporation) a nondepository trust company.

i. The Admar Group, Inc. (a Florida Corporation) a national
managed care service organization that developes and manages
preferred provider organizations.

j. Principal Health Care, Inc. (an Iowa Corporation) a
developer and administrator of managed care systems.

k. Principal Financial Advisors, Inc. (an Iowa Corporation) a
registered investment advisor.

l. Principal Asset Markets, Inc. (an Iowa Corporation) a
residential mortgage loan broker.

m. Principal Portfolio Services, Inc. (an Iowa Corporation) a
mortgage due diligence company.

n. Principal International, Inc. (an Iowa Corporation) a
company formed for the purpose of international business
development.

o. Principal Spectrum Associates, Inc. (a California
Corporation) a real estate development company.

p. Principal Commercial Advisors, Inc. (an Iowa Corporation) a
company that purchases, manages and sells commercial real
estate assets.

q. Principal FC, Ltd. (an Iowa Corporation) a limited purpose
investment corporation.

r. Principal Residential Mortgage, Inc. (an Iowa Corporation) a
residential mortgage loan broker.

s. Equity FC, Ltd. (an Iowa Corporation) engaged in investment
transactions including limited partnership and limited
liability companies.

t. Principal Bank (a Federal Corporation) a Federally chartered
direct delivery savings bank.

u. HealthRisk Resource Group, Inc. (an Iowa Corporation) a
management services organization.

v. Dental-Net, Inc. (an Arizona Corporation) holding company
of Employers Dental Services; a managed dental care services
organization. HMO and dental group practice.

Subsidiaries organized and wholly-owned by Princor Financial Services
Corporation:

a. Principal Management Corporation (an Iowa Corporation) a
registered investment advisor.

b. Principal Investors Corporation (a New Jersey Corporation) a
registered broker-dealer with the Securities Exchange
Commission. It is not currently active.

Subsidiary wholly owned by Delaware Charter Guarantee & Trust Company:

a. Trust Consultants, Inc. (a California Corporation) a
Consulting and Administration of Employee Benefit Plans.

Subsidiaries owned by The Admar Group, Inc.:

a. Admar Corporation (a California Corporation) a managed care
services organization.

b. Admar Insurance Marketing, Inc. (a California Corporation) a
managed care services organization.

c. Benefit Plan Administrators, Inc. (a Colorado Corporation) a
managed care services organization.

d. SelectCare Management Co., Inc. (a California Corporation) a
managed care services organization.

e. Image Financial & Insurance Services, Inc. (a California
Corporation) a managed care services organization.

f. WM. G. Hofgard & Co., Inc. (a California Corporation) a
managed care services organization.

Subsidiary owned by Petula Associates, Ltd.

a. Magnus Properties, Inc. (an Iowa Corporation) which owns
real estate.

Subsidiary owned by Principal Residential Mortgage, Inc.:

a. Reliastar Mortgage Corporation (an Iowa corporation) a
brokerage and servicer of residential mortgage loans

b. Principal JMC, Inc. (an Iowa Corporation) a brokerage
company that originates and sells loans; enters into the
business of organization and sale of real estate mortgages.

Subsidiaries owned by Delta-Net, Inc.

a. Employers Dental Services, Inc. (an Arizona corporation)
a prepaid dental plan organization.

Subsidiaries owned by Principal International, Inc.:

a. Principal Insurance Company (Hong Kong) Limited (a Hong Kong
Corporation) group life and group pension products.

b. Principal International Argentina, S.A. (an Argentina
services corporation).

c. Principal International Asia Limited (a Hong Kong
Corporation) a corporation operating as a regional
headquarters for Asia.

d. Principal International de Chile, S.A. (a Chile
Corporation) a holding company.

e. Principal International Espana, S.A. de Seguros de Vida (a
Spain Corporation) a life insurance company (individual
group), annuities and pension.

f. Principal Mexico Compania de Seguros, S.A. de C.V. (a Mexico
Corporation) a life insurance company (individual and
group), personal accidents.

g. Afore Confia-Principal, S.a. de C.V. (a Mexico Corporation),
pension.

h. Zao Principal International (a Russia Corporation) inactive.

i. Principal Trust Company (Asia) Limited (an Asia trust
company).

j. Principal Asset Management Company (Asia) Ltd. (Hong Kong)
a corporation which manages pension funds.

k. Afore Atlantico Promex, S.A. DE C.V. (a Mexico corporation)
a Mexico Pension Co.

l. Principal Consulting (India) Private Limited (an India
corporation) an India consulting company.

Subsidiaries owned by Principal International Argentina, S.A.:

a. Ethika Administradora de Fondos de Jubilaciones y Pensions
S.A. (an Argentina company) a pension company.

b. Principal Compania de Seguros de Retiro, S.A. (an Argentina
Corporation) an individual annuity/employee benefit company.

c. Principal Life Compania de Seguros, S.A. (an Argentina
Corporation) a life insurance company.

Subsidiary owned by Principal International de Chile, S.A.:

a. Principal Compania de Seguros de Vida Chile S.A. (a Chile
Corporation) life insurance and annuity company.

Subsidiary owned by Principal International Espana, S.A. de Seguros de
Vida:

a. Princor International Espana Sociedad Anonima de Agencia de
Seguros (a Spain Corporation) an insurance agency.

Subsidiary owned by Afore Confia-Principal, S.A. de C.V.:

a. Siefore Confia-Principal, S.A. de C.V. (a Mexico
Corporation) an investment fund company.

Subsidiary owned by Afore Atlantico Promex, S.A. DE C.V.:

a. Siefore A.P. Index S.A. de CV (a Mexico Corporation) a
pension investment fund

Item 26. Number of Holders of Securities - As of: November 30, 1998
(1) (2)
Title of Class Number of Holders
Principal Tax-Exempt Cash Management Fund, Inc.
Common-Class A 1,848

Item 27. Indemnification

Under Section 2-418 of the Maryland General Corporation Law, with respect
to any proceedings against a present or former director, officer, agent or
employee (a "corporate representative") of the Registrant, the Registrant may
indemnify the corporate representative against judgments, fines, penalties, and
amounts paid in settlement, and against expenses, including attorneys' fees, if
such expenses were actually incurred by the corporate representative in
connection with the proceeding, unless it is established that:

(i) The act or omission of the corporate representative was
material to the matter giving rise to the proceeding; and

1. Was committed in bad faith; or

2. Was the result of active and deliberate dishonesty; or

(ii) The corporate representative actually received an improper
personal benefit in money, property, or services; or

(iii) In the case of any criminal proceeding, the corporate
representative had reasonable cause to believe that the act or
omission was unlawful.

If a proceeding is brought by or on behalf of the Registrant, however, the
Registrant may not indemnify a corporate representative who has been adjudged to
be liable to the Registrant. Under the Registrant's Articles of Incorporation
and Bylaws, directors and officers of Registrant are entitled to indemnification
by the Registrant to the fullest extent permitted under Maryland law and the
Investment Company Act of 1940. Reference is made to Article VI, Section 7 of
the Registrant's Articles of Incorporation, Article 12 of Registrant's Bylaws
and Section 2-418 of the Maryland General Corporation Law.

The Registrant has agreed to indemnify, defend and hold the Distributor,
its officers and directors, and any person who controls the Distributor within
the meaning of Section 15 of the Securities Act of 1933, free and harmless from
and against any and all claims, demands, liabilities and expenses (including the
cost of investigating or defending such claims, demands or liabilities and any
counsel fees incurred in connection therewith) which the Distributor, its
officers, directors or any such controlling person may incur under the
Securities Act of 1933, or under common law or otherwise, arising out of or
based upon any untrue statement of a material fact contained in the Registrant's
registration statement or prospectus or arising out of or based upon any alleged
omission to state a material fact required to be stated in either thereof or
necessary to make the statements in either thereof not misleading, except
insofar as such claims, demands, liabilities or expenses arise out of or are
based upon any such untrue statement or omission made in conformity with
information furnished in writing by the Distributor to the Registrant for use in
the Registrant's registration statement or prospectus: provided, however, that
this indemnity agreement, to the extent that it might require indemnity of any
person who is also an officer or director of the Registrant or who controls the
Registrant within the meaning of Section 15 of the Securities Act of 1933, shall
not inure to the benefit of such officer, director or controlling person unless
a court of competent jurisdiction shall determine, or it shall have been
determined by controlling precedent that such result would not be against public
policy as expressed in the Securities Act of 1933, and further provided, that in
no event shall anything contained herein be so construed as to protect the
Distributor against any liability to the Registrant or to its security holders
to which the Distributor would otherwise be subject by reason of willful
misfeasance, bad faith, or gross negligence, in the performance of its duties,
or by reason of its reckless disregard of its obligations under this Agreement.
The Registrant's agreement to indemnify the Distributor, its officers and
directors and any such controlling person as aforesaid is expressly conditioned
upon the Registrant being promptly notified of any action brought against the
Distributor, its officers or directors, or any such controlling person, such
notification to be given by letter or telegram addressed to the Registrant.

Item 28. Business or Other Connection of Investment Adviser

A complete list of the officers and directors of the investment adviser,
Principal Management Corporation, are set out below. This list includes some of
the same people (designated by an *), who are serving as officers and directors
of the Registrant. For these people the information as set out in the Statement
of Additional Information (See Part B) under the caption "Directors and Officers
of the Fund" is incorporated by reference.

John E. Aschenbrenner The Principal Senior Vice President
Director Financial Group Principal Life Insurance
Company

Craig R. Barnes Same President & Chief Executive
Vice President Officer, Invista Capital
Management, Inc.

*Craig L. Bassett Same See Part B
Treasurer

*Michael J. Beer Same See Part B
Senior Vice President
and Chief Operating
Officer

Mary L. Bricker Same Counsel and Assistant
Assistant Corporate Corporate Secretary
Secretary Principal Life
Insurance Company

David J. Drury Same Chief Executive Officer
Director and Chairman of the Board
Principal Life
Insurance Company

*Arthur S. Filean Same See Part B
Vice President

Paul N. Germain Same Vice President -
Vice President - Mutual Fund Operations
Mutual Fund Operations Princor Financial Services
Corporation

*Ernest H. Gillum Same See Part B
Assistant Vice President -
Registered Products

Thomas J. Graf Same Senior Vice President
Director Principal Life
Insurance Company

*J. Barry Griswell Same See Part B
Chairman of the Board
and Director

Joyce N. Hoffman Same Vice President and
Vice President and Corporate Secretary
Corporate Secretary Principal Life
Insurance Company

*Stephan L. Jones Same See Part B
President and Director

Ellen Z. Lamale Same Vice President & Chief Actuary
Director Principal Life Insurance
Company

Gregg R. Narber Same Senior Vice President and
Director General Counsel
Principal Life
Insurance Company

Layne A. Rasmussen Same Controller
Controller - Princor Financial Services
Mutual Funds Corporation

Elizabeth R. Ring Same Controller- Broker Dealer
Controller Operations
Princor Financial Services
Corporation

*Michael D. Roughton Same See Part B
Counsel

Jean B. Schustek Same Product Compliance Officer -
Product Compliance Officer - Princor Financial Services
Registered Products Corporation

Dewain A. Sparrgrove Same Vice President -
Vice President Investment Securities
Principal Life
Insurance Company

Principal Management Corporation serves as investment adviser and dividend
disbursing and transfer agent for, Principal Balanced Fund, Inc., Principal Blue
Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital Value Fund, Inc.,
Principal Cash Management Fund, Inc., Principal Government Securities Income
Fund, Inc., Principal Growth Fund, Inc., Principal High Yield Fund, Inc.,
Principal International Emerging Markets Fund, Inc., Principal International
Fund, Inc., Principal International SmallCap Fund, Inc., Principal Limited Term
Bond Fund, Inc., Principal MidCap Fund, Inc., Principal Real Estate Fund, Inc.,
Principal SmallCap Fund, Inc., Principal Special Markets Fund, Inc., Principal
Tax-Exempt Bond Fund, Inc., Principal Tax-Exempt Cash Management Fund, Inc.,
Principal Utilities Fund, Inc., Principal Variable Contracts Fund, Inc. - funds
sponsored by Principal Life Insurance Company.

Item 29. Principal Underwriters

(a) Princor Financial Services Corporation, principal underwriter for
Registrant, acts as principal underwriter for, Principal Balanced Fund, Inc.,
Principal Blue Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital
Value Fund, Inc., Principal Cash Management Fund, Inc., Principal Government
Securities Income Fund, Inc., Principal Growth Fund, Inc., Principal High Yield
Fund, Inc., Principal International Emerging Markets Fund, Inc., Principal
International Fund, Inc., Principal International SmallCap Fund, Inc., Principal
Limited Term Bond Fund, Inc., Principal MidCap Fund, Inc., Principal Real Estate
Fund, Inc., Principal SmallCap Fund, Inc., Principal Special Markets Fund, Inc.,
Principal Tax-Exempt Bond Fund, Inc., Principal Tax-Exempt Cash Management Fund,
Inc., Principal Utilities Fund, Inc., Principal Variable Contracts Fund, Inc.
and for variable annuity contracts participating in Principal Life
Insurance Company Separate Account B, a registered unit investment trust for
retirement plans adopted by public school systems or certain tax-exempt
organizations pursuant to Section 403(b) of the Internal Revenue Code, Section
457 retirement plans, Section 401(a) retirement plans, certain non- qualified
deferred compensation plans and Individual Retirement Annuity Plans adopted
pursuant to Section 408 of the Internal Revenue Code, and for variable life
insurance contracts issued by Principal Life Insurance Company Variable
Life Separate Account, a registered unit investment trust.

(b) (1) (2) (3)
Positions
and offices Positions and
Name and principal with principal offices with
business address underwriter registrant

John E. Aschenbrenner Director None
The Principal
Financial Group
Des Moines, IA 50392

Robert W. Baehr Marketing Services None
The Principal Officer
Financial Group
Des Moines, IA 50392

Craig L. Bassett Treasurer Treasurer
The Principal
Financial Group
Des Moines, IA 50392

Michael J. Beer Senior Vice President and Financial Officer
The Principal Chief Operating Officer
Financial Group
Des Moines, IA 50392

Mary L. Bricker Assistant Corporate None
The Principal Secretary
Financial Group
Des Moines, IA 50392

Lynn A. Brones Vice President Sales, None
The Principal Princor Investment Network
Financial Group
Des Moines, IA 50392

David J. Drury Director None
The Principal
Financial Group
Des Moines, IA 50392

Arthur S. Filean Vice President Vice President
The Principal and Secretary
Financial Group
Des Moines, IA 50392

Paul N. Germain Vice President- None
The Principal Mutual Fund Operations
Financial Group
Des Moines, IA 50392

Ernest H. Gillum Vice President-Compliance Assistant
The Principal and Product Development Secretary
Financial Group
Des Moines, IA 50392

Jerald L. Bogart Insurance License Officer None
The Principal
Financial Group
Des Moines, IA 50392

Thomas J. Graf Director None
The Principal
Financial Group
Des Moines, IA 50392

J. Barry Griswell Director and Director and
The Principal Chairman of the Chairman of the
Financial Group Board Board
Des Moines, IA 50392

Susan R. Haupts Marketing Officer None
The Principal
Financial Group
Des Moines, IA 50392

Joyce N. Hoffman Vice President and None
The Principal Corporate Secretary
Financial Group
Des Moines, IA 50392

Stephan L. Jones Director and Director and
The Principal President President
Financial Group
Des Moines, IA 50392

Kraig L. Kuhlers Marketing Officer None
The Principal
Financial Group
Des Moines, IA 50392

Ellen Z. Lamale Director None
The Principal
Financial Group
Des Moines, IA 50392

John R. Lepley Senior Vice None
The Principal President - Marketing
Financial Group and Distribution
Des Moines, IA 50392

Gregg R. Narber Director None
The Principal
Financial Group
Des Moines, IA 50392

Kelly A. Paul Systems & Technology None
The Principal Officer
Financial Group
Des Moines, IA 50392

Elise M. Pilkington Assistant Director - None
The Principal Retirement Consulting
Financial Group
Des Moines, IA 50392

Richard L. Prey Director None
The Principal
Financial Group
Des Moines, IA 50392

Layne A. Rasmussen Controller-Mutual Funds None
The Principal
Financial Group
Des Moines, IA 50392

Elizabeth R. Ring Controller None
The Principal
Financial Group
Des Moines, IA 50392

Martin R. Richardson Operations Office- None
The Principal Broker/Dealer Services
Financial Group
Des Moines, IA 50392

Michael D. Roughton Counsel Counsel
The Principal
Financial Group
Des Moines, IA 50392

Jean B. Schustek Product Compliance Officer- None
The Principal Registered Products
Financial Group
Des Moines, IA 50392

Kyle R. Selberg Vice President- None
The Principal Marketing
Financial Group
Des Moines, IA 50392

Minoo Spellerberg Compliance Officer None
The Principal
Financial Group
Des Moines, IA 50392

Roger C. Stroud Assistant Director- None
The Principal Marketing
Financial Group
Des Moines, IA 50392

Item 30. Location of Accounts and Records

All accounts, books or other documents of the Registrant are located at the
offices of the Registrant and its Investment Adviser in the Principal Life
Insurance Company home office building, The Principal Financial Group, Des
Moines, Iowa 50392.

Item 31. Management Services

Inapplicable.

Item 32. Undertakings

Indemnification

Reference is made to Item 27 above, which discusses circumstances under
which directors and officers of the Registrant shall be indemnified by the
Registrant against certain liabilities and expenses incurred by them by reason
of being a director or officer of the Registrant.

Notwithstanding the provisions of Registrant's Articles of Incorporation
and Bylaws, the Registrant hereby makes the following undertaking:

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant, in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person of the Registrant, in connection with
the securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Act and will be governed by the
final adjudication of such issue

Shareholder Communications

Registrant hereby undertakes to call a meeting of shareholders for the
purpose of voting upon the question of removal of a director or directors when
requested in writing to do so by the holders of at least 10% of the Registrant's
outstanding shares of common stock and in connection with such meeting to comply
with the provisions of Section 16(c) of the Investment Company Act of 1940
relating to shareholder communications

Delivery of Annual Report to Shareholders

The registrant hereby undertakes to furnish each person to whom a
prospectus is delivered a copy of the registrant's latest annual report to
shareholders, upon request and without charge.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940 the Registrant has duly caused this Amendment to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized in the City of Des Moines and State of Iowa, on the 30th day of
December, 1998.

Principal Tax-Exempt Cash Management Fund, Inc.

(Registrant)

By /s/ S. L. Jones
--------------------------------------
S. L. Jones
President and Director

Attest:

/s/ A. S. Filean
- --------------------------------------
A. S. Filean
Secretary

Pursuant to the requirement of the Securities Act of 1933, this Amendment to the
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.

Signature Title Date

/s/ S. L. Jones
_____________________________ President and Director 12/30/98
S. L. Jones (Principal Executive Officer) __________

(J. B. Griswell)*
_____________________________ Director and 12/30/98
J. B. Griswell Chairman of the Board __________

/s/ M. J. Beer
_____________________________ Financial Officer (Principal 12/30/98
M. J. Beer Financial and Accounting Officer) __________

(J. E. Aschenbrenner)*
_____________________________ Director 12/30/98
J. E. Aschenbrenner __________

(J. D. Davis)*
_____________________________ Director 12/30/98
J. D. Davis __________

(P. A. Ferguson)*
_____________________________ Director 12/30/98
P. A. Ferguson __________

(D. P. Francis)*
_____________________________ Director 12/30/98
D. P. Francis __________

(R. W. Gilbert)*
_____________________________ Director 12/30/98
R. W. Gilbert __________

(B. A. Lukavsky)*
_____________________________ Director 12/30/98
B. A. Lukavsky __________

(R. G. Peebler)*
_____________________________ Director 12/30/98
R. G. Peebler __________

By /s/ S. L. Jones
-------------------------------------
S. L. Jones
President and Director

*Pursuant to Powers of Attorney
Previously Filed or Included

POWER OF ATTORNEY

The undersigned hereby constitutes and appoints S. L. Jones, J. B. Griswell, M.
D. Roughton, E. H. Gillum and A. S. Filean and each of them (with full power to
each of them to act alone), the undersigned's true and lawful attorney-in-fact
and agent, with full power of substitution to each, for and on behalf and in the
name of the undersigned, to execute and file any documents relating to
registration under the Securities Act of 1933 and the Investment Company Act of
1940 with respect to open-end management investment companies currently
organized or to be organized in the future which are sponsored by Principal Life
Insurance Company, and any and all amendments thereto and reports thereunder
with all exhibits and all instruments necessary or appropriate in connection
therewith, each of said attorneys-in-fact and agents and his or their
substitutes being empowered to act with or without the others or other, and to
have full power and authority to do or cause to be done in the name and on
behalf of the undersigned each and every act and thing necessary or appropriate
to be done in order to effectuate the same, as fully to all intents and purposes
as the undersigned might or could do in person; hereby ratifying and confirming
all that said attorneys-in-fact and agents, or any of them, may do or cause to
be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/R. G. Peebler
________________
R. G. Peebler

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/J. D. Davis
________________
J. D. Davis

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/B. A. Lukavsky
________________
B. A. Lukavsky

POWER OF ATTORNEY

The undersigned hereby constitutes and appoints J. B. Griswell, M. D. Roughton,
E. H. Gillum and A. S. Filean and each of them (with full power to each of them
to act alone), the undersigned's true and lawful attorney-in-fact and agent,
with full power of substitution to each, for and on behalf and in the name of
the undersigned, to execute and file any documents relating to registration
under the Securities Act of 1933 and the Investment Company Act of 1940 with
respect to open-end management investment companies currently organized or to be
organized in the future which are sponsored by Principal Life Insurance Company,
and any and all amendments thereto and reports thereunder with all exhibits and
all instruments necessary or appropriate in connection therewith, each of said
attorneys-in-fact and agents and his or their substitutes being empowered to act
with or without the others or other, and to have full power and authority to do
or cause to be done in the name and on behalf of the undersigned each and every
act and thing necessary or appropriate to be done in order to effectuate the
same, as fully to all intents and purposes as the undersigned might or could do
in person; hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, may do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/S. L. Jones
________________
S. L. Jones

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/R. W. Gilbert
________________
R. W. Gilbert

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/P. A. Ferguson
________________
P. A. Ferguson

POWER OF ATTORNEY

The undersigned hereby constitutes and appoints S. L. Jones, M. D. Roughton, E.
H. Gillum and A. S. Filean and each of them (with full power to each of them to
act alone), the undersigned's true and lawful attorney-in-fact and agent, with
full power of substitution to each, for and on behalf and in the name of the
undersigned, to execute and file any documents relating to registration under
the Securities Act of 1933 and the Investment Company Act of 1940 with respect
to open-end management investment companies currently organized or to be
organized in the future which are sponsored by Principal Life Insurance Company,
and any and all amendments thereto and reports thereunder with all exhibits and
all instruments necessary or appropriate in connection therewith, each of said
attorneys-in-fact and agents and his or their substitutes being empowered to act
with or without the others or other, and to have full power and authority to do
or cause to be done in the name and on behalf of the undersigned each and every
act and thing necessary or appropriate to be done in order to effectuate the
same, as fully to all intents and purposes as the undersigned might or could do
in person; hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, may do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/J. B. Griswell
________________
J. B. Griswell

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/J. E. Aschenbrenner
________________
J. E. Aschenbrenner

POWER OF ATTORNEY

IN WITNESS WHEREOF, the undersigned has hereunto set his hand this 14th day of
September, 1998.

/s/D. P. Francis
________________
D. P. Francis

ARTICLES OF AMENDMENT AND RESTATEMENT

PRINCOR TAX-EXEMPT CASH MANAGEMENT FUND, INC.

Princor Tax-Exempt Cash Management Fund, Inc., a Maryland Corporation
having its principal office in this state in Baltimore, Maryland (hereinafter
called the Corporation), hereby certifies to the State Department of
Assessmentsand Taxation of Maryland, that:

FIRST: The charter of the Corporation is hereby amended by striking out
Article II of the Articles of Incorporation and inserting in lieu thereof the
following:

"Article II
Name

The name of the corporation is Principal Tax-Exempt Cash Management Fund,
Inc. hereinafter called the 'Corporation'."

SECOND: The Corporation desires to restate its charter as amended so that,
as amended, said charter shall be restated as follows:

ARTICLE I
Incorporator

The undersigned Arthur S. Filean and Michael D. Roughton, whose post office
address is The Principal Financial Group, Des Moines, Iowa 50392, being at least
18 years of age, incorporators, hereby form a corporation under and by virtue of
the laws of Maryland.

ARTICLE II
Name

The name of the corporation is Principal Tax-Exempt Cash Management Fund,
Inc. hereinafter called the "Corporation."

ARTICLE III
Corporate Purposes and Powers

The Corporation is formed for the following purposes:

(1) To conduct and carry on the business of an investment company.

(2) To hold, invest and reinvest its assets in securities and other
investments or to hold part or all of its assets in cash.

(3) To issue and sell shares of its capital stock in such amounts and on
such terms and conditions and for such purposes and for such amount or kind of
consideration as may now or hereafter be permitted by law.

(4) To redeem, purchase or acquire in any other manner, hold, dispose of,
resell, transfer, reissue or cancel (all without the vote or consent of the
stockholders of the Corporation) shares of its capital stock, in any manner and
to the extent now or hereafter permitted by law and by these Articles of
Incorporation.

(5) To do any and all additional acts and to exercise any and all
additional powers or rights as may be necessary, incidental, appropriate or
desirable for the accomplishment of all or any of the foregoing purposes.

To carry out all or any part of the foregoing objects as principal, factor,
agent, contractor, or otherwise, either alone or through or in conjunction with
any person, firm, association or corporation, and, in carrying on its business
and for the purpose of attaining or furnishing any of its objects and purposes,
to make and perform any contracts and to do any acts and things, and to exercise
any powers suitable, convenient or proper for the accomplishment of any of the
objects and purposes herein enumerated or incidental to the powers herein
specified, or which at any time may appear conducive to or expedient for the
accomplishment of any such objects and purposes.

To carry out all or any part of the aforesaid objects and purposes, and to
conduct its business in all or any of its branches, in any or all states,
territories, districts and possessions of the United States of America and in
foreign countries; and to maintain offices and agencies in any or all states,
territories, districts and possessions of the United States of America and in
foreign countries.

The foregoing objects and purposes shall, except when otherwise expressed,
be in no way limited or restricted by reference to or inference from the terms
of any other clause of this or any other article of these Articles of
Incorporation or of any amendment thereto, and shall each be regarded as
independent, and construed as powers as well as objects and purposes.

The Corporation shall be authorized to exercise and enjoy all of the
powers, rights and privileges granted to, or conferred upon, corporations of a
similar character by the Maryland General Corporation Law now or hereafter in
force, and the enumeration of the foregoing powers shall not be deemed to
exclude any powers, rights or privileges so granted or conferred.

ARTICLE IV
Principal Office and Resident Agent

The post office address of the principal office of the Corporation in this
State is c/o The Corporation Trust Incorporated, 32 South Street, Baltimore,
Maryland 21202. The name of the resident agent of the Corporation in this State
is The Corporation Trust Incorporated, a corporation of this State, and the post
office address of the resident agent is 32 South Street, Baltimore, Maryland
21202.

ARTICLE V
Capital Stock

Section 1. Authorized Shares: The total number of shares of stock which the
Corporation shall have authority to issue is one bilion (1,000,000,000) shares,
of the par value of one cent ($.01) each and of the aggregate par value of ten
million dollars ($10,000,000). The shares may be issued by the Board of
Directors in such separate and distinct series and classes of series as the
Board of Directors shall from time to time create and establish. The Board of
Directors shall have full power and authority, in its sole discretion, to
establish and designate series and classes of series, and to classify or
reclassify any unissued shares in separate series or classes having such
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications, and terms and conditions of
redemption as shall be fixed and determined from time to time by the Board of
Directors. In the event of establishment of classes, each class of a series
shall represent interests in the assets belonging to that series and have
identical voting, dividend, liquidation and other rights and the same terms and
conditions as any other class of the series, except that expenses allocated to
the class of a series may be borne solely by such class as shall be determined
by the Board of Directors and may cause differences in rights as described in
the following sentence. The shares of a class may be converted into shares of
another class upon such terms and conditions as shall be determined by the Board
of Directors, and a class of a series may have exclusive voting rights with
respect to matters affecting only that class. Expenses related to the
distribution of, and other identified expenses that should properly be allocated
to, the shares of a particular series or class may be charged to and borne
solely by such series or class, and the bearing of expenses solely by a series
or class may be appropriately reflected (in a manner determined by the Board of
Directors) and cause differences in the net asset value attributable to, and the
dividend, redemption and liquidation rights of, the shares of each series or
class. Subject to the authority of the Board of Directors to increase and
decrease the number of, and to reclassify the shares of any series or class,
there are hereby established two classes of common stock, each comprising the
number of shares and having the designation indicated:

Class Number of Shares
Class A 500,000,000
Class B 200,000,000

In addition, the Board of Directors is hereby expressly granted authority to
change the designation of any series or class, to increase or decrease the
number of shares of any series or class, provided that the number of shares of
any series or class shall not be decreased by the Board of Directors below the
number of shares thereof then outstanding, and to reclassify any unissued shares
into one or more series or classes that may be established and designated from
time to time. Notwithstanding the designations herein of series and classes, the
Corporation may refer, in prospectuses and other documents furnished to
shareholders, filed with the Securities and Exchange Commission or used for
other purposes, to a series of shares as a "class" and to a class of shares of a
particular series as a "series."

(a) The Corporation may issue shares of stock in fractional
denominations to the same extent as its whole shares, and shares in
fractional denominations shall be shares of stock having proportionately,
to the respective fractions represented thereby, all the rights of whole
shares, including without limitation, the right to vote, the right to
receive dividends and distributions and the right to participate upon
liquidation of the Corporation, but excluding the right to receive a stock
certificate representing fractional shares.

(b) The holder of each share of stock of the Corporation shall be
entitled to one vote for each full share, and a fractional vote for each
fractional share, of stock, irrespective of the series or class, then
standing in the holder's name on the books of the Corporation. On any
matter submitted to a vote of stockholders, all shares of the Corporation
then issued and outstanding and entitled to vote shall be voted in the
aggregate and not by series or class except that (1) when otherwise
expressly required by the Maryland General Corporation Law or the
Investment Company Act of 1940, as amended, shares shall be voted by
individual series or class, and (2) if the Board of Directors, in its sole
discretion, determines that a matter affects the interests of only one or
more particular series or class or classes then only the holders of shares
of such affected series or class or classes shall be entitled to vote
thereon.

(c) Unless otherwise provided in the resolution of the Board of
Directors providing for the establishment and designation of any new series
or class or classes, each series of stock of the Corporation shall have the
following powers, preferences and rights, and qualifications, restrictions,
and limitations thereof:

(1) Assets Belonging to a Class. All consideration received by the
Corporation for the issue or sale of shares of a particular class,
together with all assets in which such consideration is invested or
reinvested, all income, earnings, profits and proceeds thereof,
including any proceeds derived from the sale, exchange or liquidation
of such assets, and any funds or payments derived from any reinvestment
of such proceeds in whatever form the same may be, shall irrevocably
belong to that class for all purposes, subject only to the rights of
creditors, and shall be so recorded upon the books and accounts of the
Corporation. Such consideration, assets, income, earnings, profits and
proceeds thereof, including any proceeds derived from the sale,
exchange or liquidation of such assets, and any funds or payments
derived from any reinvestment of such proceeds, in whatever form the
same may be, together with any General Items allocated to that class as
provided in the following sentence, are herein referred to as "assets
belonging to" that class. In the event that there are any assets,
income, earnings, profits, proceeds thereof, funds or payments which
are not readily identifiable as belonging to any particular class
(collectively "General Items"), such General Items shall be allocated
by or under the supervision of the Board of Directors to and among any
one or more of the classes established and designated from time to time
in such manner and on such basis as the Board of Directors, in its sole
discretion, deems fair and equitable, and any General Items so
allocated to a particular class shall belong to that class. Each such
allocation by the Board of Directors shall be conclusive and binding
for all purposes.

(2) Liabilities Belonging to a Class. The assets belonging to each
particular class shall be charged with the liabilities of the
Corporation in respect of that class and all expenses, costs, charges
and reserves attributable to that class, and any general liabilities,
expenses, costs, charges or reserves of the Corporation which are not
readily identifiable as belonging to any particular class shall be
allocated and charged by or under the supervision of the Board of
Directors to and among any one or more of the classes established and
designated from time to time in such manner and on such basis as the
Board of Directors, in its sole discretion, deems fair and equitable.
The liabilities, expenses, costs, charges and reserves allocated and so
charged to a class are herein referred to as "liabilities belonging to"
that class. Expenses related to the shares of a series may be borne
solely by that series (as determined by the Board of Directors). Each
allocation of liabilities, expenses, costs, charges and reserves by the
Board of Directors shall be conclusive and binding for all purposes.

(3) Dividends. The Board of Directors may from time to time
declare and pay dividends or distributions, in stock, property or cash,
on any or all series of stock or classes of series, the amount of such
dividends and property distributions and the payment of them being
wholly in the discretion of the Board of Directors. Dividends may be
declared daily or otherwise pursuant to a standing resolution or
resolutions adopted only once or with such frequency as the Board of
Directors may determine, after providing for actual and accrued
liabilities belonging to that class. All dividends or distributions on
shares of a particular class shall be paid only out of surplus or other
lawfully available assets determined by the Board of Directors as
belonging to such class. Dividends and distributions may vary between
the classes of a series to reflect differing allocations of the expense
of each class of that series to such extent and for such purposes as
the Boards of Directors may deem appropriate. The Board of Directors
shall have the power, in its sole discretion, to distribute in any
fiscal year as dividends, including dividends designated in whole or in
part as capital gains distributions, amounts sufficient, in the opinion
of the Board of Directors, to enable the Corporation, or where
applicable each series or class of a series of shares, to qualify as a
regulated investment company under the Internal Revenue Code of 1986,
as amended, or any successor or comparable statute thereto, and
regulations promulgated thereunder, and to avoid liability for the
Corporation, or each series of shares or class of a series, for Federal
income and excise taxes in respect of that or any other year.

(4) Liquidation. In the event of the liquidation of the
Corporation or of the assets attributable to a particular series or
class, the shareholders of each series or class that has been
established and designated and is being liquidated shall be entitled to
receive, as a series or class, when and as declared by the Board of
Directors, the excess of the assets belonging to that series or class
over the liabilities belonging to that series or class. The holders of
shares of any series or class shall not be entitled thereby to any
distribution upon liquidation of any other series or class. The assets
so distributable to the shareholder of any particular series or class
shall be distributed among such shareholders according to their
respective rights taking into account the proper allocation of expenses
being borne by that series or class. The liquidation of assets
attributable to any particular series or class in which there are
shares then outstanding may be authorized by vote of a majority of the
Board of Directors then in office, subject to the approval of a
majority of the outstanding voting securities of that series or class,
as defined in the Investment Company Act of 1940, as amended. In the
event that there are any general assets not belonging to any particular
series or class of stock and available for distribution, such
distribution shall be made to holders of stock of various series or
classes in such proportion as the Board of Directors determines to be
fair and equitable, and such determination by the Board of Directors
shall be conclusive and binding for all purposes.

(5) Redemption. All shares of stock of the Corporation shall have
the redemption rights provided for in Article V, Section 5.

(d) The Corporation's shares of stock are issued and sold, and all
persons who shall acquire stock of the Corporation shall do so, subject to
the condition and understanding that the provisions of the Corporation's
Articles of Incorporation, as from time to time amended, shall be binding
upon them.

Section 2. Quorum Requirements and Voting Rights: Except as otherwise
expressly provided by the Maryland General Corporation Law, the presence in
person or by proxy of the holders of one-third of the shares of capital stock of
the Corporation outstanding and entitled to vote thereat shall constitute a
quorum at any meeting of the stockholders, except that where the holders of any
series or class are required or permitted to vote as a series or class,
one-third of the aggregate number of shares of that series or class outstanding
and entitled to vote shall constitute a quorum.

Notwithstanding any provision of Maryland General Corporation Law requiring
a greater proportion than a majority of the votes of all series or classes or of
any series or class of the Corporation's stock entitled to be cast in order to
take or authorize any action, any such action may be taken or authorized upon
the concurrence of a majority of the aggregate number of votes entitled to be
cast thereon subject to the applicable laws and regulations as from time to time
in effect or rules or orders of the Securities and Exchange Commission or any
successor thereto. All shares of stock of this Corporation shall have the voting
rights provided for in Article V, Section 1, paragraph (b).

Section 3. No Preemptive Rights: No holder of shares of capital stock of
the Corporation shall, as such holder, have any right to purchase or subscribe
for any shares of the capital stock of the Corporation which the Corporation may
issue or sell (whether consisting of shares of capital stock authorized by these
Articles of Incorporation, or shares of capital stock of the Corporation
acquired by it after the issue thereof, or other shares) other than any right
which the Board of Directors of the Corporation, in its discretion, may
determine.

Section 4. Determination of Net Asset Value: The net asset value of each
share of each series or class of each series of the Corporation shall be the
quotient obtained by dividing the value of the net assets of the Corporation, or
if applicable of the series or class (being the value of the assets of the
Corporation or of the particular series or class or attributable to the
particular series or class less its actual and accrued liabilities exclusive of
capital stock and surplus), by the total number of outstanding shares of the
Corporation or the series or class, as applicable. Such determination may be
made on a series-by-series basis or made or adjusted on a class-by-class basis,
as appropriate, and shall include any expenses allocated to a specific series or
class thereof. The Board of Directors may adopt procedures for determination of
net asset value consistent with the requirements of applicable statutes and
regulations and, so far as accounting matters are concerned, with generally
accepted accounting principles. The procedures may include, without limitation,
procedures for valuation of the Corporation's portfolio securities and other
assets, for accrual of expenses or creation of reserves and for the
determination of the number of shares issued and outstanding at any given time.

Section 5. Redemption and Repurchase of Shares of Capital Stock: Any
shareholder may redeem shares of the Corporation for the net asset value of each
series or class thereof by presentation of an appropriate request, together with
the certificates, if any, for such shares, duly endorsed, at the office or
agency designated by the Corporation. Redemptions as aforesaid, or purchases by
the Corporation of its own stock, shall be made in the manner and subject to the
conditions contained in the bylaws or approved by the Board of Directors.

Section 6. Purchase of Shares: The Corporation shall be entitled to
purchase shares of any series or class of its capital stock, to the extent that
the Corporation may lawfully effect such purchase under Maryland General
Corporation Law, upon such terms and conditions and for such consideration as
the Board of Directors shall deem advisable, by agreement with the stockholder
at a price not exceeding the net asset value per share computed in accordance
with Section 4 of this Article.

Section 7. Redemption of Minimum Amounts:

(a) If after giving effect to a request for redemption by a
stockholder, the aggregate net asset value of his remaining shares of any
series or class will be less than the Minimum Amount then in effect, the
Corporation shall be entitled to require the redemption of the remaining
shares of such series or class owned by such stockholder, upon notice given
in accordance with paragraph (c) of this Section, to the extent that the
Corporation may lawfully effect such redemption under Maryland General
Corporation Law.

(b) The term "Minimum Amount" when used herein shall mean Three Hundred
Dollars ($300) unless otherwise fixed by the Board of Directors from time
to time, provided that the Minimum Amount may not in any event exceed Five
Thousand Dollars ($5,000).

(c) If any redemption under paragraph (a) of this Section is upon
notice, the notice shall be in writing personally delivered or deposited in
the mail, at least thirty days prior to such redemption. If mailed, the
notice shall be addressed to the stockholder at his post office address as
shown on the books of the Corporation, and sent by certified or registered
mail, postage prepaid. The price for shares redeemed by the Corporation
pursuant to paragraph (a) of this Section shall be paid in cash in an
amount equal to the net asset value of such shares, computed in accordance
with Section 4 of this Article.

Section 8. Mode of Payment: Payment by the Corporation for shares of any
series or class of the capital stock of the Corporation surrendered to it for
redemption shall be made by the Corporation within three business days of such
surrender out of the funds legally available therefor, provided that the
Corporation may suspend the right of the holders of capital stock of the
Corporation to redeem shares of capital stock and may postpone the right of such
holders to receive payment for any shares when permitted or required to do so by
law. Payment of the redemption or purchase price may be made in cash or, at the
option of the Corporation, wholly or partly in such portfolio securities of the
Corporation as the Corporation may select.

Section 9. Rights of Holders of Shares Purchased or Redeemed: The right of
any holder of any series or class of capital stock of the Corporation purchased
or redeemed by the Corporation as provided in this Article to receive dividends
thereon and all other rights of such holder with respect to such shares shall
terminate at the time as of which the purchase or redemption price of such
shares is determined, except the right of such holder to receive (I) the
purchase or redemption price of such shares from the Corporation or its
designated agent and (ii) any dividend or distribution or voting rights to which
such holder has previously become entitled as the record holder of such shares
on the record date for the determination of the stockholders entitled to receive
such dividend or distribution or to vote at the meeting of stockholders.

Section 10. Status of Shares Purchased or Redeemed: In the absence of any
specification as to the purpose for which such shares of any series or class of
capital stock of the Corporation are redeemed or purchased by it, all shares so
redeemed or purchased shall be deemed to be retired in the sense contemplated by
the laws of the State of Maryland and may be reissued. The number of authorized
shares of capital stock of the Corporation shall not be reduced by the number of
any shares redeemed or purchased by it.

Section 11. Additional Limitations and Powers: The following provisions are
inserted for the purpose of defining, limiting and regulating the powers of the
Corporation and of the Board of Directors and stockholders:

(a) Any determination made in good faith and, so far as accounting
matters are involved, in accordance with generally accepted accounting
principles by or pursuant to the direction of the Board of Directors, as to
the amount of the assets, debts, obligations or liabilities of the
Corporation, as to the amount of any reserves or charges set up and the
propriety thereof, as to the time of or purpose for creating such reserves
or charges, as to the use, alteration or cancellation of any reserves or
charges (whether or not any debt, obligation or liability for which such
reserves or charges shall have been created shall have been paid or
discharged or shall be then or thereafter required to be paid or
discharged), as to the establishment or designation of procedures or
methods to be employed for valuing any investment or other assets of the
Corporation and as to the value of any investment or other asset, as to the
allocation of any asset of the Corporation to a particular series or class
or classes of the Corporation's stock, as to the funds available for the
declaration of dividends and as to the declaration of dividends, as to the
charging of any liability of the Corporation to a particular series or
class or classes of the Corporation's stock, as to the number of shares of
any series or class or classes of the Corporation's outstanding stock, as
to the estimated expense to the Corporation in connection with purchases or
redemptions of its shares, as to the ability to liquidate investments in
orderly fashion, or as to any other matters relating to the issue, sale,
purchase or redemption or other acquisition or disposition of investments
or shares of the Corporation, or in the determination of the net asset
value per share of shares of any series or class of the Corporation's stock
shall be conclusive and binding for all purposes.

(b) Except to the extent prohibited by the Investment Company Act of
1940, as amended, or rules, regulations or orders thereunder promulgated by
the Securities and Exchange Commission or any successor thereto or by the
bylaws of the Corporation, a director, officer or employee of the
Corporation shall not be disqualified by his position from dealing or
contracting with the Corporation, nor shall any transaction or contract of
the Corporation be void or voidable by reason of the fact that any
director, officer or employee or any firm of which any director, officer or
employee is a member, or any corporation of which any director, officer or
employee is a stockholder, officer or director, is in any way interested in
such transaction or contract; provided that in case a director, or a firm
or corporation of which a director is a member, stockholder, officer or
director is so interested, such fact shall be disclosed to or shall have
been known by the Board of Directors or a majority thereof. Nor shall any
director or officer of the Corporation be liable to the Corporation or to
any stockholder or creditor thereof or to any person for any loss incurred
by it or him or for any profit realized by such director or officer under
or by reason of such contract or transaction; provided that nothing herein
shall protect any director or officer of the Corporation against any
liability to the Corporation or to its security holders to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of
his office; and provided always that such contract or transaction shall
have been on terms that were not unfair to the Corporation at the time at
which it was entered into. Any director of the Corporation who is so
interested, or who is a member, stockholder, officer or director of such
firm or corporation, may be counted in determining the existence of a
quorum at any meeting of the Board of Directors of the Corporation which
shall authorize any such transaction or contract, with like force and
effect as if he were not such director, or member, stockholder, officer or
director of such firm or corporation.

(c) Specifically and without limitation of the foregoing paragraph (b)
but subject to the exception therein prescribed, the Corporation may enter
into management or advisory, underwriting, distribution and administration
contracts, custodian contracts and such other contracts as may be
appropriate.

ARTICLE VI

Directors

Section 1. Number of Directors: The number of directors in office may be
changed from time to time in the manner specified in the bylaws of the
Corporation, but this number shall never be less than three.

Section 2. Certain Powers of Board of Directors: The business and affairs
of the Corporation shall be managed under the direction of the Board of
Directors, which shall have and may exercise all powers of the Corporation
except those powers which are by law, by these Articles of Incorporation or by
the by-laws of the Corporation conferred upon or reserved to the stockholders.
In addition to its other powers explicitly or implicitly granted under these
Articles of Incorporation, by law or otherwise, the Board of Directors of the
Corporation (a) is expressly authorized to make, alter, amend or repeal bylaws
for the Corporation, (b) is empowered to authorize, without stockholder
approval, the issuance and sale from time to time of shares of capital stock of
the Corporation, whether now or hereafter authorized, in such amounts, for such
amount and kind of consideration and on such terms and conditions as the Board
of Directors shall determine, (c) is empowered to classify or reclassify any
unissued stock, whether now or hereafter authorized, by setting or changing the
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications, or terms or conditions of
redemption of such stock and (d) shall have the power from time to time to set
apart out of any assets of the Corporation otherwise available for dividends a
reserve or reserves for taxes or for any other proper purposes, and to reduce,
abolish or add to any such reserve or reserves from time to time as said Board
of Directors may deem to be in the best interests of the Corporation; and to
determine in its discretion what part of the assets of the Corporation available
for dividends in excess of such reserve or reserves shall be declared in
dividends and paid to the stockholders of the Corporation.

ARTICLE VII

Indemnification

The Corporation shall indemnify its directors, including any director who
serves another corporation, partnership, joint venture, trust or other
enterprise in any capacity at the request of the Corporation, to the maximum
extent permitted by the Maryland General Corporation Law and the Investment
Company Act of 1940. The Corporation shall indemnify its officers to the same
extent as its directors and to such further extent as is consistent with law.
The Corporation shall indemnify its employees and agents to the extent provided
by its Board of Directors.

ARTICLE VIII

Amendments

The Corporation reserves the right from time to time to make any amendment
of these Articles of Incorporation now or hereafter authorized by law, including
any amendment which alters the contract rights, as expressly set forth in these
Articles of Incorporation, of any outstanding capital stock. "Articles of
Incorporation" or "these Articles of Incorporation" as used herein and in the
bylaws of the Corporation shall be deemed to mean these Articles of
Incorporation as from time to time amended or restated.

ARTICLE IX
Duration

The duration of the Corporation shall be perpetual.

THIRD: The provisions set forth in the articles of restatement as described
in the second paragraph hereof are all the provisions of the charter currently
in effect, as amended.

FOURTH: The charter, as amended herein, is not otherwise amended by the
articles of restatement.

FIFTH: The current post office address of principal office of the
Corporation in the State of Maryland is c/o The Corporation Trust Incorporated,
32 South Street, Baltimore, Maryland 21202. The name of the resident agent of
the Corporation in the State of Maryland is The Corporation Trust Incorporation,
a Maryland corporation, and the post office address of the resident agent is 32
South Street, Baltimore, Maryland 21202.

SIXTH: The Corporation has nine directors. The names of the directors are
as follows:

James D. Davis David K. Kauf
Roy W. Ehrle Ronald E. Keller
Pamela A. Ferguson Barbara A. Lukavsky
Richard W. Gilbert Richard G. Peebler
Stephan L. Jones

SEVENTH: The board of directors of the Corporation on March 10, 1997 duly
and unanimously adopted a resolution in which was set forth the foregoing
amendment to and restatement of the charter, declaring that the said amendment
and restatement as proposed was advisable and directing that it be submitted for
action thereon by the stockholders of the Corporation at the special meeting to
be held on September 16, 1997.

EIGHTH: Notice setting forth a summary of the changes to be effected by
said amendment and restatement of the charter and stating that a purpose of the
meeting of the stockholders would be to take action thereon, was given, as
required by law, to all stockholders entitled to vote thereon. The amendment and
restatement of the charter of the Corporation as hereinabove set forth was
approved by the stockholders of the Corporation at said meeting by affirmative
vote of a majority of all votes entitled to be cast thereon.

NINTH: The amendment and restatement of the charter of the Corporation as
hereinabove set forth has been duly advised by the board of directors and
approved by the stockholders of the Corporation.

TENTH: The Articles of Amendment and Restatement shall become effective on
January 1, 1998.

IN WITNESS WHEREOF, Principal Tax-Exempt Cash Management Fund, Inc. has
caused these presents to be signed in its name and on its behalf by its Vice
President and its Secretary on December 22, 1997.

Princor Tax-Exempt Cash Management Fund, Inc.

/s/ Arthur S. Filean
By __________________________________________
Arthur S. Filean, Vice President and Secretary

Attest

/s/ Ernest H. Gillum
- --------------------------------------------
Ernest H. Gillum, Assistant Secretary

The UNDERSIGNED, Vice President of Princor Tax-Exempt Cash Management Fund,
Inc., who executed on behalf of said corporation the foregoing Articles of
Amendment and Restatement, of which this certificate is made a part, hereby
acknowledges, in the name on behalf of said corporation, the foregoing Articles
of Amendment and Restatement to be the corporate act of said corporation and
further certifies that, to the best of his knowledge, information and belief,
the matters and facts set forth therein with respect to the approval thereof are
true in all material respects, under the penalties of perjury.

/s/ Arthur S. Filean
Arthur S. Filean
Vice President and Secretary
Princor Tax-Exempt Cash Management Fund, Inc.

BYLAWS

PRINCIPAL TAX-EXEMPT CASH MANAGEMENT FUND, INC.

ARTICLE 1

Name, Fiscal Year

1.01 The name of this Corporation shall be Principal Tax-Exempt Cash
Management Fund, Inc. Except as otherwise from time to time provided by the
Board of Directors, the fiscal year of the Corporation shall begin November 1
and end October 31.

ARTICLE 2

Stockholders' Meetings

2.01 Place of Meetings. All meetings of the stockholders shall be held
at such place within or without the State of Maryland, as is stated in the
notice of meeting.

2.02 Annual Meetings. The Board of Directors of the Fund shall
determine whether or not an annual meeting of stockholders shall be held. In the
event that an annual meeting of stockholders is held, such meeting shall be held
on the first Tuesday after the first Monday of October in each year or on such
other day during the first 31-day period following the first Tuesday after the
first Monday of October as the directors may determine.

2.03 Special Meetings. Special meetings of the stockholders shall be
held whenever called by the chairman of the board, the president or the Board of
Directors.

2.04 Notice of Shareholders' Meetings. Notice of each shareholders'
meeting stating the place, date and hour of the meeting and the purpose or
purposes for which the meeting is called shall be given by mailing such notice
to each shareholder of record at his address as it appears on the records of the
Corporation not less than 10 nor more than 90 days prior to the date of the
meeting. Any meeting at which all shareholders entitled to vote are present
either in person or by proxy or of which those not present have waived notice in
writing shall be a legal meeting for the transaction of business notwithstanding
that notice has not been given as herein provided.

2.05 Quorum. Except as otherwise expressly required by law, these
bylaws or the Articles of Incorporation, as from time to time amended, at any
meeting of the stockholders the presence in person or by proxy of the holders of
one-third of the shares of capital stock of the Corporation issued and
outstanding and entitled to vote, shall constitute a quorum, but a lesser
interest may adjourn any meeting from time to time and the meeting may be held
as adjourned without further notice. When a quorum is present at any meeting a
majority of the stock represented thereat shall decide any question brought
before such meeting unless the question is one upon which by express provision
of law or of these bylaws or the Articles of Incorporation a larger or different
vote is required, in which case such express provision shall govern.

2.06 Proxies and Voting. Stockholders of record may vote at any meeting
either in person or by written proxy signed by the stockholder or by the
stockholder's duly authorized attorney-in-fact dated not more than eleven months
before the date of exercise, which shall be filed with the Secretary of the
meeting before being voted. Each stockholder shall be entitled to one vote for
each share of stock held, and to a fraction of a vote equal to any fractional
share held.

2.07 Stock Ledger. The Corporation shall maintain at the office of the
stock transfer agent of the Corporation, or at the office of any successor
thereto as stock transfer agent of the Corporation, an original stock ledger
containing the names and addresses of all stockholders and the number of shares
of each class held by each stockholder. Such stock ledger may be in written form
or any other form capable of being converted into written form within a
reasonable time for visual inspection.

ARTICLE 3

Board of Directors

3.01 Number, Service. The Corporation shall have a Board of Directors
consisting of not less than three and no more than fifteen members. The number
of Directors to constitute the whole board within the limits above-stated shall
be fixed by the Board of Directors. The Directors may be chosen (i) by
stockholders at any annual meeting of stockholders held for the purpose of
electing directors or at any meeting held in lieu thereof, or at any special
meeting called for such purpose, or (ii) by the Directors at any regular or
special meeting of the Board to fill a vacancy on the Board as provided in these
bylaws and Maryland General Corporation Law. Each director should serve until
the next annual meeting of shareholders and until a successor is duly qualified
and elected, unless sooner displaced.

3.02 Powers. The Board of Directors shall be responsible for the entire
management of the business of the Corporation. In the management and control of
the property, business and affairs of the Corporation the Board of Directors is
hereby vested with all the powers possessed by the Corporation itself so far as
this designation of authority is not inconsistent with the laws of the State of
Maryland, but subject to the limitations and qualifications contained in the
Articles of Incorporation and in these bylaws.

3.03 Executive Committee and Other Committees. The Board of Directors
may elect from its members an Executive Committee of not less than three which
may exercise certain powers of the Board of Directors when the board is not in
session pursuant to Maryland law. The Executive Committee may make rules for the
holding and conduct of its meetings and keeping the records thereof, and shall
report its action to the Board of Directors.

The Board of Directors may elect from its members such other
committees from time to time as it may desire. The number composing such
committees and the powers conferred upon them shall be determined by the Board
of Directors at its own discretion.

3.04 Meetings. Regular meetings of the Board of Directors may be held
in such places within or without the State of Maryland, and at such times as the
board may from time to time determine, and if so determined, notices thereof
need not be given. Special meetings of the Board of Directors may be held at any
time or place whenever called by the president or a majority of the directors,
notice thereof being given by the secretary or the president, or the directors
calling the meeting, to each director. Special meetings of the Board of
Directors may also be held without formal notice provided all directors are
present or those not present have waived notice thereof.

3.05 Quorum. A majority of the members of the Board of Directors from
time to time in office but in no event not less than one-third of the number
constituting the whole board shall constitute a quorum for the transaction of
business provided, however, that where the Investment Company Act of 1940
requires a different quorum to transact business of a specific nature, the
number of directors so required shall constitute a quorum for the transaction of
such business.

A lesser number may adjourn a meeting from time to time and
the meeting may be held without further notice. When a quorum is present at any
meeting a majority of the members present thereat shall decide any question
brought before such meeting except as otherwise expressly required by law, the
Articles of Incorporation or these bylaws.

3.06 Action by Directors Other than at a Meeting. Any action required
or permitted to be taken at any meeting of the Board of Directors, or of any
committee thereof, may be taken without a meeting, if a written consent to such
action is signed by all members of the Board of Directors or such committee, as
the case may be, and such written consent is filed with the minutes of
proceedings of the Board of Directors or committee.

3.07 Holding of Meetings by Conference Telephone Call. At any regular
or special meeting, members of the Board of Directors or any committee thereof
may participate by conference telephone or similar communications equipment by
means of which all persons participating in the meeting can hear each other.
Participation in a meeting pursuant to this Section shall constitute presence in
person at such meeting.

ARTICLE 4

Officers

4.01 Selection. The officers of the Corporation shall be a president,
one or more vice presidents, a secretary and a treasurer. The Board of Directors
may, if it so determines, also elect a chairman of the board. All officers shall
be elected by the Board of Directors and shall serve at the pleasure of the
board. The same person may hold more than one office except the offices of
president and vice president.

4.02 Eligibility. The chairman of the board, if any, and the president
shall be directors of the Corporation. Other officers need not be directors.

4.03 Additional Officers and Agents. The Board of Directors may appoint
one or more assistant treasurers, one or more assistant secretaries and such
other officers or agents as it may deem advisable, and may prescribe the duties
thereof.

4.04 Chairman of the Board of Directors. The chairman of the board, if
any, shall preside at all meetings of the Board of Directors at which he is
present. He shall have such other authority and duties as the Board of Directors
shall from time to time determine.

4.05 The President. The president shall be the chief executive officer
of the Corporation; he shall have general and active management of the business,
affairs and property of the Corporation, and shall see that all orders and
resolutions of the Board of Directors are carried into effect. He shall preside
at meetings of stockholders, and of the Board of Directors unless a chairman of
the board has been elected and is present.

4.06 The Vice Presidents. The vice presidents shall respectively have
such powers and perform such duties as may be assigned to them by the Board of
Directors or the president. In the absence or disability of the president, the
vice presidents, in the order determined by the Board of Directors, shall
perform the duties and exercise the powers of the president.

4.07 The Secretary. The secretary shall keep accurate minutes of all
meetings of the stockholders and directors, and shall perform all duties
commonly incident to his office and as provided by law and shall perform such
other duties and have such other powers as the Board of Directors shall from
time to time designate. In his absence an assistant secretary or secretary pro
tempore shall perform his duties.

4.08 The Treasurer. The treasurer shall, subject to the order of the
Board of Directors and in accordance with any arrangements for performance of
services as custodian, transfer agent or disbursing agent approved by the board,
have the care and custody of the money, funds, securities, valuable papers and
documents of the Corporation, and shall have and exercise under the supervision
of the Board of Directors all powers and duties commonly incident to his office
and as provided by law. He shall keep or cause to be kept accurate books of
account of the Corporation's transactions which shall be subject at all times to
the inspection and control of the Board of Directors. He shall deposit all funds
of the Corporation in such bank or banks, trust company or trust companies or
such firm or firms doing a banking business as the Board of Directors shall
designate. In his absence, an assistant treasurer shall perform his duties.

ARTICLE 5

Vacancies

5.01 Removals. The stockholders may at any meeting called for the
purpose, by vote of the holders of a majority of the capital stock issued and
outstanding and entitled to vote, remove from office any director and, unless
the number of directors constituting the whole board is accordingly decreased,
elect a successor. To the extent consistent with the Investment Company Act of
1940, the Board of Directors may by vote of not less than a majority of the
directors then in office remove from office any director, officer or agent
elected or appointed by them and may for misconduct remove any thereof elected
by the stockholders.

5.02 Vacancies. If the office of any director becomes or is vacant by
reason of death, resignation, removal, disqualification, an increase in the
authorized number of directors or otherwise, the remaining directors may by vote
of a majority of said directors choose a successor or successors who shall hold
office for the unexpired term; provided that vacancies on the Board of Directors
may be so filled only if, after the filling of the same, at least two-thirds of
the directors then holding office would be directors elected to such office by
the stockholders at a meeting or meetings called for the purpose. In the event
that at any time less than a majority of the directors were so elected by the
stockholders, a special meeting of the stockholders shall be called forthwith
and held as promptly as possible and in any event within sixty days for the
purpose of electing an entire new Board of Directors.

ARTICLE 6

Certificates of Stock

6.01 Certificates. The Board of Directors may adopt a policy of not
issuing certificates except in extraordinary situations as may be authorized
from time to time by an officer of the Corporation. If such a policy is adopted,
a stockholder may obtain a certificate or certificates of the capital stock of
the Corporation owned by such stockholder only if the stockholder demonstrates a
specific reason for needing a certificate. If issued, the certificate shall be
in such form as shall, in conformity to law, be prescribed from time to time by
the Board of Directors. Such certificates shall be signed by the chairman of the
Board of Directors or the president or a vice president and by the treasurer or
an assistant treasurer or the secretary or an assistant secretary. If such
certificates are countersigned by a transfer agent or registrar other than the
Corporation or an employee of the Corporation, the signatures of the
aforementioned officers upon such certificates may be facsimile. In case any
officer or officers who have signed, or whose facsimile signature or signatures
have been used on, any such certificate or certificates shall cease to be such
officer or officers of the Corporation, whether because of death, resignation or
otherwise, before such certificate or certificates have been delivered by the
Corporation, such certificate or certificates may nevertheless be adopted by the
Corporation and be issued and delivered as though the person or persons who
signed such certificate or certificates or whose facsimile signature or
signatures have been used thereon had not ceased to be such officer or officers
of the Corporation.

6.02 Replacement of Certificates. The Board of Directors may direct a
new certificate or certificates to be issued in place of any certificate or
certificates theretofore issued by the Corporation alleged to have been lost or
destroyed. When authorizing such issue of a new certificate or certificates, the
Board of Directors may, in its discretion and as a condition precedent to the
issuance thereof, require the owner of such lost or destroyed certificate or
certificates, or its legal representative, to advertise the same in such manner
as it shall require and/or to give the Corporation a bond in such sum as it may
direct as indemnity against any claim that may be made against the Corporation
with respect to the certificate alleged to have been lost or destroyed.

6.03 Stockholder Open Accounts. The Corporation may maintain or cause
to be maintained for each stockholder a stockholder open account in which shall
be recorded such stockholder's ownership of stock and all changes therein, and
certificates need not be issued for shares so recorded in a stockholder open
account unless requested by the stockholder and such request is approved by an
officer.

6.04 Transfers. Transfers of stock for which certificates have been
issued will be made only upon surrender to the Corporation or the transfer agent
of the Corporation of a certificate for shares duly endorsed or accompanied by
proper evidence of succession, assignment or authority to transfer, whereupon
the Corporation will issue a new certificate to the person entitled thereto,
cancel the old certificate and record the transaction on its books. Transfers of
stock evidenced by open account authorized by Section 6.03 will be made upon
delivery to the Corporation or the transfer agent of the Corporation of
instructions for transfer or evidence of assignment or succession, in each case
executed in such manner and with such supporting evidence as the Corporation or
transfer agent may reasonably require.

6.05 Closing Transfer Books. The transfer books of the stock of the
Corporation may be closed for such period (not to exceed 20 days) from time to
time in anticipation of stockholders' meetings or the declaration of dividends
as the directors may from time to time determine.

6.06 Record Dates. The Board of Directors may fix in advance a date,
not exceeding sixty days preceding the date of any meeting of stockholders, or
the date for the payment of any dividend, or the date for the allotment of
rights, or the date when any change or conversion or exchange of capital stock
shall go into effect, or a date in connection with obtaining any consent or for
any other lawful purpose, as a record date for the determination of the
stockholders entitled to notice of, and to vote at, any such meeting, and any
adjournment thereof, or entitled to receive payment of any such dividend, or to
any such allotment of rights, or to exercise the rights in respect of any such
change, conversion or exchange of capital stock, or to give such consent, and in
such case such stockholders and only such stockholders as shall be stockholders
of record on the date as fixed shall be entitled to such notice of, and to vote
at, such meeting, and any adjournment thereof, or to receive payment of such
dividend, or to receive such allotment of rights, or to exercise such rights, or
to give such consent, as the case may be, notwithstanding any transfer of any
stock on the books of the Corporation after any such record date fixed as
aforesaid.

6.07 Registered Ownership. The Corporation shall be entitled to
recognize the exclusive right of a person registered on its books as the owner
of shares to receive dividends, and to vote as such owner and shall not be bound
to recognize any equitable or other claim to or interest in such share or shares
on the part of any other person, whether or not it shall have express or other
notice thereof, except as otherwise provided by the laws of the State of
Maryland.

ARTICLE 7

Notices

7.01 Manner of Giving. Whenever under the provisions of the statutes or
of the Articles of Incorporation or of these bylaws notice is required to be
given to any director, committee member, officer or stockholder, it shall not be
construed to mean personal notice, but such notice may be given, in the case of
stockholders, in writing, by mail, by depositing the same in a United States
post office or letter box, in a postpaid sealed wrapper, addressed to each
stockholder at such address as it appears on the books of the Corporation, or,
in default to other address, to such stockholder at the General Post Office in
the City of Baltimore, Maryland, and, in the case of directors, committee
members and officers, by telephone, or by mail or by telegram to the last
business address known to the secretary of the Corporation, and such notice
shall be deemed to be given at the time when the same shall be thus mailed or
telegraphed or telephoned.

7.02 Waiver. Whenever any notice is required to be given under the
provisions of the statutes or of the Articles of Incorporation or of these
bylaws, a waiver thereof in writing, signed by the person or persons entitled to
said notice, whether before or after the time stated therein, shall be deemed
equivalent thereto.

ARTICLE 8

General Provisions

8.01 Disbursement of Funds. All checks, drafts, orders or instructions
for the payment of money and all notes of the Corporation shall be signed by
such officer or officers or such other person or persons as the Board of
Directors may from time to time designate.

8.02 Voting of Stock in Other Corporations. Unless otherwise ordered by
the board of directors, any officer or, at the direction of any such officer,
any Manager shall have full power and authority to attend and act and vote at
any meeting of stockholders of any corporation in which this Corporation may
hold stock, at of any such meeting may exercise any and all the rights and
powers incident to the ownership of such stock. Any officer of this corporation
or, at the direction of any such officer, any Manager may execute proxies to
vote shares of stock of other corporations standing in the name of this
Corporation."

8.03 Execution of Instruments. Except as otherwise provided in these
bylaws, all deeds, mortgages, bonds, contracts, stock powers and other
instruments of transfer, reports and other instruments may be executed on behalf
of the Corporation by the president or any vice president or by any other
officer or agent authorized to act in such matters, whether by law, the Articles
of Incorporation, these bylaws, or any general or special authorization of the
Board of Directors. If the corporate seal is required, it shall be affixed by
the secretary or an assistant secretary.

8.04 Seal. The corporate seal shall have inscribed thereon the name of
the Corporation, the year of its incorporation and the words "Corporate Seal,
Maryland." The seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise.

ARTICLE 9

Regulations

9.01 Investment and Related Matters. The Corporation shall not purchase
or hold securities in violation of the investment restrictions enumerated in its
then current prospectus and the registration statement or statements filed with
the Securities and Exchange Commission pursuant to the Securities Act of 1933
and the Investment Company Act of 1940, as amended, nor shall the Corporation
invest in securities the purchase of which would cause the Corporation to
forfeit its rights to continue to publicly offer its shares under the laws,
rules or regulations of any state in which it may become authorized to so offer
its shares unless, by specific resolution of the Board of Directors, the
Corporation shall elect to discontinue the sale of its shares in such state.

9.02 Other Matters. When used in this section the following words shall
have the following meanings: "Sponsor" shall mean any one or more corporations,
firms or associations which have distributor's contracts in effect with this
Corporation. "Manager" shall mean any corporation, firm or association which may
at the time have an investment advisory contract with this Corporation.

(a) Limitation of Holdings by this Corporation of Certain
Securities and of Dealings with Officers or Directors. This Corporation shall
not purchase or retain securities of any issuer if those officers and directors
of the Fund or its Manager owning beneficially more than one-half of one per
cent (0.5%) of the shares or securities of such issuer together own beneficially
more than five per cent (5%) of such shares or securities; and each officer and
director of this Corporation shall keep the treasurer of this Corporation
informed of the names of all issuers (securities of which are held in the
portfolio of this Corporation) in which such officer or director owns as much as
one-half of one percent (1/2 of 1%) of the outstanding shares or securities and
(except in the case of a holding by the treasurer) this Corporation shall not be
charged with knowledge of any such security holding in the absence of notice
given if as aforesaid if this Corporation has requested such information not
less often than quarterly. The Corporation will not lend any of its assets to
the Sponsor or Manager or to any officer or director of the Sponsor or Manager
or of this Corporation and shall not permit any officer or director, and any
officer or director of the Sponsor or Manager, to deal for or on behalf of the
Corporation with himself as principal agent, or with any partnership,
association or corporation in which he has a financial interest. Nothing
contained herein shall prevent (1) officers and directors of the Corporation
from buying, holding or selling shares in the Corporation, or from being
partners, officers or directors of or otherwise financially interested in the
Sponsor or the Manager or any company controlling the Sponsor or the Manager;
(2) employment of legal counsel, registrar, transfer agent, dividend disbursing
agent or custodian who is, or has a partner shareholder, officer or director who
is, an officer or director of the Corporation, if only customary fees are
charged for services to the Corporation; (3) sharing statistical and research
expenses and office hire and expenses with any other investment company in which
an officer or director of the Corporation is an officer or director or otherwise
financially interested.

(b) Limitation Concerning Participating by Interested Persons
in Investment Decisions. In any case where an officer or director of the
Corporation or of the Manager, or a member of an advisory committee or portfolio
committee of the Corporation, is also an officer or a director of another
corporation, and the purchase or sale of shares issued by that other corporation
is under consideration, the officer or director or committee member concerned
will abstain from participating in any decision made on behalf of the
Corporation to purchase or sell any securities issued by such other corporation.

(c) Limitation on Dealing in Securities of this Corporation by
certain Officers, Directors, Sponsor or Manager. Neither the Sponsor nor
Manager, nor any officer or director of this Corporation or of the Sponsor or
Manager shall take long or short positions in securities issued by this
Corporation, provided, however, that:

(1) The Sponsor may purchase from this Corporation
shares issued by this Corporation if the orders to purchase from this
Corporation are entered with this Corporation by the Sponsor upon receipt by the
Sponsor of purchase orders for shares of this Corporation and such purchases
are not in excess of purchase orders received by the Sponsor.

(2) The Sponsor may in the capacity of agent for
this Corporation buy securities issued by this Corporation offered for sale by
other persons.

(3) Any officer or director of this Corporation
or of the Sponsor or Manager or any Company controlling the Sponsor or Manager
may at any time, or from time to time, purchase from this Corporation or from
the Sponsor shares issued by this Corporation at the price available to the
public at the moment of such purchase or, to the extent that such person is a
stockholder, at the price available to stockholders of the Corporation
generally at the moment of such purchase, no such purchase to be in
contravention of any applicable state or federal requirement.

(d) Securities and Cash of this Corporation to be held by
Custodian subject to certain Terms and Conditions.

(1) All securities and cash owned by this Corporation
shall as hereinafter provided, be held by or deposited with a bank or trust
company having (according to its last published report) not less than two
million dollars ($2,000,000) aggregate capital, surplus and undivided profits
(which bank or trust company is hereby designated as "Custodian"), provided such
a Custodian can be found ready and willing to act.

(2) This Corporation shall enter into a written
contract with the Custodian regarding the powers, duties and compensation of the
Custodian with respect to the cash and securities of this Corporation held by
the Custodian. Said contract and all amendments thereto shall be approved by
the Board of Directors of this Corporation.

(3) This Corporation shall upon the resignation or
inability to serve of its Custodian or upon change of the Custodian:

(aa) in case of such resignation or
inability to serve, use its best efforts to obtain a successor Custodian;

(bb) require that the cash and securities
owned by this Corporation be delivered directly to the successor Custodian; and

(cc) In the event that no successor
Custodian can be found, submit to the stockholders, before permitting delivery
of the cash and securities owned by this Corporation otherwise than to a
successor Custodian, the question whether or not this Corporation shall be
liquidated or shall function without a Custodian.

(e) Amendment of Investment Advisory Contract. Any investment
advisory contract entered into by this Corporation shall not be subject to
amendment except by (1) affirmative vote at a shareholders meeting, of the
holders of a majority of the outstanding stock of this Corporation, or (2) a
majority of such Directors who are not interested persons (as the term is
defined in the Investment Company Act of 1940) of the Parties to such
agreements, cast in person at a board meeting called for the purpose of voting
on such amendment.

(f) Reports relating to Certain Dividends. Dividends paid from
net profits from the sale of securities shall be clearly revealed by this
Corporation to its shareholders and the basis of calculation shall be set forth.

ARTICLE 10

Purchases and Redemption of Shares:
Suspension of Sales

10.01 Purchase by Agreement. The Corporation may purchase its shares by
agreement with the owner at a price not exceeding the net asset value next
computed following the time when the purchase or contract to purchase is made.

10.02 Redemption. The Corporation shall redeem such shares as are
offered by any stockholder for redemption upon the presentation of a written
request therefor, duly executed by the record owner, to the office or agency
designated by the Corporation. If the shareholder has received stock
certificates, the request must be accompanied by the certificates, duly endorsed
for transfer, in acceptable form; and the Corporation will pay therefor the net
asset value of the shares next effective following the time at which the
request, in acceptable form, is so presented. Payment for said shares shall
ordinarily be made by the Corporation to the stockholder within seven days after
the date on which the shares are presented.

10.03 Suspension of Redemption. The obligations set out in Section
10.02 may be suspended (i) for any period during which the New York Stock
Exchange, Inc. is closed other than customary week-end and holiday closings, or
during which trading on the New York Stock Exchange, Inc. is restricted, as
determined by the rules and regulations of the Securities and Exchange
Commission or any successor thereto; (ii) for any period during which an
emergency, as determined by the rules and regulations of the Securities and
Exchange Commission or any successor thereto, exists as a result of which
disposal by the Corporation of securities owned by it is not reasonably
practicable or as a result of which it is not reasonably practicable for the
Corporation to fairly determine the value of its net assets; or (iii) for such
other periods as the Securities and Exchange Commission or any successor thereto
may by order permit for the protection of security holders of the Corporation.
Payment of the redemption or purchase price may be made in cash or, at the
option of the Corporation, wholly or partly in such portfolio securities of the
Corporation as the Corporation may select.

10.04 Suspension of Sales. The Corporation reserves the right to
suspend sales of its shares if, in the judgment of the majority of the Board of
Directors or a majority of the Executive Committee of its Board, if such
committee exists, it is in the best interest of the Corporation to do so, such
suspension to continue for such period as may be determined by such majority.

ARTICLE 11

Fractional Shares

11.01 The Board of Directors may authorize the issue from time to time
of shares of the capital stock of the Corporation in fractional denominations,
provided that the transactions in which and the terms upon which shares in
fractional denominations may be issued may from time to time be determined and
limited by or under authority of the Board of Directors.

ARTICLE 12

Indemnification

12.01 (a) Every person who is or was a director, officer or employee of
this Corporation or of any other corporation which he served at the request of
this Corporation and in which this Corporation owns or owned shares of capital
stock or of which it is or was a creditor shall have a right to be indemnified
by this Corporation against all liability and reasonable expenses incurred by
him in connection with or resulting from a claim, action, suit or proceeding in
which he may become involved as a party or otherwise by reason of his being or
having been a director, officer or employee of this Corporation or such other
corporation, provided (1) said claim, action, suit or proceeding shall be
prosecuted to a final determination and he shall be vindicated on the merits, or
(2) in the absence of such a final determination vindicating him on the merits,
the Board of Directors shall determine that he acted in good faith and in a
manner he reasonably believed to be in the best interest of the Corporation in
the case of conduct in the director's official capacity with the Corporation and
in all other cases, that the conduct was at least not opposed to the best
interest of the Corporation, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful; said
determination to be made by the Board of Directors acting through a quorum of
disinterested directors, or in its absence on the opinion of counsel.

(b) For purposes of the preceding subsection: (1) "liability
and reasonable expenses" shall include but not be limited to reasonable counsel
fees and disbursements, amounts of any judgment, fine or penalty, and reasonable
amounts paid in settlement; (2) "claim, action, suit or proceeding" shall
include every such claim, action, suit or proceeding, whether civil or criminal,
derivative or otherwise, administrative, judicial or legislative, any appeal
relating thereto, and shall include any reasonable apprehension or threat of
such a claim, action, suit or proceeding; (3) the termination of any proceeding
by judgment, order, settlement, conviction or upon a plea of nolo contendere or
its equivalent creates a rebuttable presumption that the director did not meet
the standard of conduct set forth in subsection (a)(2), supra.

(c) Notwithstanding the foregoing, the following limitations
shall apply with respect to any action by or in the right of the Corporation:
(1) no indemnification shall be made in respect of claim, issue or matter as to
which the person seeking indemnification shall have been adjudged to be liable
for negligence or misconduct in the performance of his duty to the Corporation
unless and only to the extent that the Court of Chancery of the State of
Maryland or the court in which such action or suit was brought shall determine
upon application that despite the adjudication of liability but in view of all
the circumstances of the case, such person is fairly and reasonably entitled to
indemnity for such expenses which the Court of Chancery or such other court
shall deem proper; and (2) indemnification shall extend only to reasonable
expenses, including reasonable counsel's fees and disbursements.

(d) The right of indemnification shall extend to any person
otherwise entitled to it under this bylaw whether or not that person continues
to be a director, officer or employee of this Corporation or such other
corporation at the time such liability or expense shall be incurred. The right
of indemnification shall extend to the legal representative and heirs of any
person otherwise entitled to indemnification. If a person meets the requirements
of this bylaw with respect to some matters in a claim, action suit, or
proceeding, but not with respect to others, he shall be entitled to
indemnification as to the former. Advances against liability and expenses may be
made by the Corporation on terms fixed by the Board of Directors subject to an
obligation to repay if indemnification proves unwarranted.

(e) This bylaw shall not exclude any other rights of
indemnification or other rights to which any director, officer or employee may
be entitled to by contract, vote of the stockholders or as a matter of law.

If any clause, provision or application of this Section shall
be determined to be invalid, the other clauses, provisions or applications of
this Section shall not be affected but shall remain in full force and effect.
The provisions of this bylaw shall be applicable to claims, actions, suits or
proceedings made or commenced after the adoption hereof, whether arising from
acts or omissions to act occurring before or after the adoption hereof.

(f) Nothing contained in this bylaw shall be construed to
protect any director or officer of the Corporation against any liability to the
Corporation or its security holders to which he would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his office.

ARTICLE 13

Amendments

13.01 These bylaws may be amended or added to, altered or repealed at
any annual or special meeting of the stockholders by the affirmative vote of the
holders of a majority of the shares of capital stock issued and outstanding and
entitled to vote, provided notice of the general purport of the proposed
amendment, addition, alteration or repeal is given in the notice of said
meeting, or, at any meeting of the Board of Directors by vote of a majority of
the directors then in office, except that the Board of Directors cannot amend
Article 5 to permit removal by said Board without cause of any director elected
by the stockholders.

MANAGEMENT AGREEMENT
AMENDMENT AND RESTATEMENT

AGREEMENT to be effective January 1, 1998, by and between PRINCIPAL
TAX-EXEMPT CASH MANAGEMENT FUND, INC.(formerly known as Princor Tax-Exempt Cash
Management Fund, Inc.), a Maryland corporation (hereinafter called the "Fund")
and PRINCIPAL MANAGEMENT CORPORATION (formerly known as Princor Management
Corporation), an Iowa corporation (hereinafter called "the Manager").

W I T N E S S E T H:

WHEREAS, The Fund has furnished the Manager with copies properly certified
or authenticated of each of the following:

(a) Certificate of Incorporation of the Fund;

(b) Bylaws of the Fund as adopted by the Board of Directors;

(c) Resolutions of the Board of Directors of the Fund selecting the Manager
as investment adviser and approving the form of this Agreement; and

(d) Resolutions of the Board of Directors of the Fund and Minutes of the
Special Meeting of Shareholders of the Fund approving the modification
of this Agreement.

WHEREAS, the modification of this Agreement requires that:

FIRST: This Agreement is hereby amended by striking out Section 6 of the
Agreement and inserting in lieu thereof the following:

" 6. SERVICES FURNISHED BY THE MANAGER

The Manager (in addition to the services to be performed by it pursuant to
Sections 1 and 2 hereof) will:

(a) Act as, and provide all services customarily performed by, the transfer
and paying agent of the Fund including, without limitation, the
following:

(i) preparation and distribution to shareholders of reports, tax
information, notices, proxy statements and proxies;

(ii) preparation and distribution of dividend and capital gain
payments to shareholders;

(iii)issuance, transfer and registry of shares, and maintenance of
open account system;

(iv) delivery, redemption and repurchase of shares, and remittances to
shareholders; and

(v) communication with shareholders concerning items (i), (ii), (iii)
and (iv) above.

In the carrying out of this function the Manager may contract with
others for data systems, processing services and other administrative
services.

(b) Use its best efforts to qualify the Capital Stock of the Fund for sale
in states and jurisdictions other than those in which initially
qualified, as directed by the Fund; and

The Manager will maintain records in reasonable detail that will support the
amount it charges the Fund for performance of the services set forth in this
Section 6. At the end of each calendar month the Fund will pay the Manager for
its performance of these services."

SECOND: This Agreement is hereby amended by striking out Section 8 of the
Agreement and renumbering Sections 9 through 13 hereof.

THIRD: The Fund desires to restate its Management Agreement as amended so
that, as amended, said Agreement shall be restated as follows:

NOW THEREFORE, in consideration of the premises and mutual agreements
herein contained, the Fund hereby appoints the Manager to act as investment
adviser and manager of the Fund, and the Manager agrees to act, perform or
assume the responsibility therefor in the manner and subject to the conditions
hereinafter set forth. The Fund will furnish the Manager from time to time with
copies, properly certified or authenticated, of all amendments of or supplements
to the foregoing, if any.

1. INVESTMENT ADVISORY SERVICES

The Manager will regularly perform the following services for the Fund:

(a) Provide investment research, advice and supervision;

(b) Provide investment advisory, research and statistical facilities and
all clerical services relating to research, statistical and investment
work;

(c) Furnish to the Board of Directors of the Fund (or any appropriate
committee of such Board), and revise from time to time as economic
conditions require, a recommended investment program for the Fund's
portfolio consistent with the Fund's investment objective and policies;

(d) Implement such of its recommended investment program as the Fund shall
approve, by placing orders for the purchase and sale of securities,
subject always to the provisions of the Fund's Certificate of
Incorporation and Bylaws and the requirements of the Investment Company
Act of 1940, as each of the same shall be from time to time in effect;

(e) Advise and assist the officers of the Fund in taking such steps as are
necessary or appropriate to carry out the decisions of its Board of
Directors and any appropriate committees of such Board regarding the
general conduct of the investment business of the Fund; and

(f) Report to the Board of Directors of the Fund at such times and in such
detail as the Board may deem appropriate in order to enable it to
determine that the investment policies of the Fund are being observed.

2. CORPORATE ADMINISTRATIVE SERVICES

In addition to the investment advisory services set forth in Section 1, the
Manager will perform the following corporate administrative services:

(a) Furnish the services of such of the Manager's officers and employees as
may be elected officers or directors of the Fund, subject to their
individual consent to serve and to any limitations imposed by law;

(b) Furnish office space, and all necessary office facilities and
equipment, for the general corporate functions of the Fund (i.e.,
functions other than (i) underwriting and distribution of Fund shares;
(ii) custody of Fund assets, and (iii) transfer and paying agency
services); and

(c) Furnish the services of the supervisory and clerical personnel
necessary to perform the general corporate functions of the Fund.

(d) Determine the net asset value of the shares of the Fund's Capital Stock
as frequently as the Fund shall request, or as shall be required by
applicable law or regulations.

3. RESERVED RIGHT TO DELEGATE DUTIES AND SERVICES TO OTHERS

The Manager in assuming responsibility for the various services as set
forth in this Agreement reserves the right to enter into agreements with others
for the performance of certain duties and services or to delegate the
performance of some or all of such duties and services to Principal Mutual Life
Insurance Company, or an affiliate thereof.

4. EXPENSES BORNE BY THE MANAGER

The Manager will pay:

(a) The compensation and expenses of all officers and executive employees
of the Fund;

(b) The compensation and expenses of all directors of the Fund who are
persons affiliated with the Manager; and

(c) The expenses of the organization of the Fund, including its
registration under the Investment Company Act of 1940, and the initial
registration and qualification of its Capital Stock for sale under the
Securities Act of 1933 and the Blue Sky laws of the states in which it
initially qualifies.

5. COMPENSATION OF THE MANAGER BY FUND

For all services to be rendered and payments made as provided in Sections
1, 2 and 4 hereof, the Fund will accrue daily and pay the Manager within five
days after the end of each calendar month a fee based on the average of the
values placed on the net assets of the Fund as of the time of determination of
the net asset value on each trading day throughout the month in accordance with
the following schedule.

Average Daily Net Fee as a Percentage of
Assets of the Fund Average Daily Net Assets
----------------------------------- ------------------------
First $100,000,000 0.50%
Next 100,000,000 0.45%
Next 100,000,000 0.40%
Next 100,000,000 0.35%
Amount Over 400,000,000 0.30%

Net asset value shall be determined pursuant to applicable provisions of
the Certificate of Incorporation of the Fund. If pursuant to such provisions the
determination of net asset value is suspended, then for the purposes of this
Section 5 the value of the net assets of the Fund as last determined shall be
deemed to be the value of the net assets for each day the suspension continues.

The Manager may, at its option, waive all or part of its compensation
for such period of time as it deems necessary or appropriate.

6. SERVICES FURNISHED BY THE MANAGER

The Manager (in addition to the services to be performed by it pursuant
to Sections 1 and 2 hereof) will:

(a) Act as, and provide all services customarily performed by, the
transfer and paying agent of the Fund including, without
limitation, the following:

(i) preparation and distribution to shareholders of reports, tax
information, notices, proxy statements and proxies;

(ii) preparation and distribution of dividend and capital gain
payments to shareholders;

(iii)issuance, transfer and registry of shares, and maintenance
of open account system;

(iv) delivery, redemption and repurchase of shares, and
remittances to shareholders; and

(v) communication with shareholders concerning items (i), (ii),
(iii) and (iv) above.

In the carrying out of this function the Manager may contract
with others for data systems, processing services and other
administrative services.

(b) Use its best efforts to qualify the Capital Stock of the Fund for
sale in states and jurisdictions other than those in which
initially qualified, as directed by the Fund; and

7. EXPENSES BORNE BY FUND

The Fund will pay the following expenses:

(a) Taxes, including in case of redeemed shares any initial
transfer taxes, and governmental fees (except with respect to
the Fund's organization and the initial qualification and
registration of its Capital Stock);

(b) Portfolio brokerage fees and incidental brokerage expenses;

(d) The fees of its independent auditor and its legal counsel,
incurred subsequent to the Fund's organization and the
initial qualification and registration of its Capital Stock;

(e) The fees and expenses of the Custodian of its assets;

(f) The fees and expenses of all directors of the Fund who are
not persons affiliated with the Manager; and

(g) The cost of meetings of shareholders.

8. AVOIDANCE OF INCONSISTENT POSITION

In connection with purchases or sales of portfolio securities for the
account of the Fund, neither the Manager nor any of the Manager's directors,
officers or employees will act as a principal or agent or receive any
commission.

9. LIMITATION OF LIABILITY OF THE MANAGER

The Manager shall not be liable for any error of judgment or mistake of
law or for any loss suffered by the Fund in connection with the matters to which
this Agreement relates, except a loss resulting from willful misfeasance, bad
faith or gross negligence on the Manager's part in the performance of its duties
or from reckless disregard by it of its obligations and duties under this
Agreement.

10. DURATION AND TERMINATION OF THIS AGREEMENT

This Agreement shall continue in effect from year to year provided that
the continuance is specifically approved at least annually either by the Board
of Directors of the Fund or by a vote of a majority of the outstanding voting
securities of the Fund and in either event by vote of a majority of the
directors of the Fund who are not interested persons of the Manager, Principal
Mutual Life Insurance Company, or the Fund cast in person at a meeting called
for the purpose of voting on such approval. This Agreement may, on sixty days
written notice, be terminated at any time without the payment of any penalty, by
the Board of Directors of the Fund, by vote of a majority of the outstanding
voting securities of the Fund, or by the Manager. This Agreement shall
automatically terminate in the event of its assignment. In interpreting the
provisions of this Section 10, the definitions contained in Section 2(a) of the
Investment Company Act of 1940 (particularly the definitions of "interested
person," "assignment" and "voting security") shall be applied.

11. AMENDMENT OF THIS AGREEMENT

No provision of this Agreement may be changed, waived, discharged or
terminated orally, but only by an instrument in writing signed by the party
against which enforcement of the change, waiver, discharge or termination is
sought, and no amendment of this Agreement shall be effective until approved by
vote of the holders of a majority of the Fund's outstanding voting securities
and by vote of a majority of the directors who are not interested persons of the
Manager, Principal Mutual Life Insurance Company or the Fund cast in person at a
meeting called for the purpose of voting on such approval.

12. ADDRESS FOR PURPOSE OF NOTICE

Any notice under this Agreement shall be in writing, addressed and
delivered or mailed, postage prepaid, to the other party at such address as such
other party may designate for the receipt of such notices. Until further notice
to the other party, it is agreed that the address of the Fund and that of the
Manager for this purpose shall be The Principal Financial Group, Des Moines,
Iowa 50392.

13. MISCELLANEOUS

The captions in this Agreement are included for convenience of reference
only, and in no way define or delimit any of the provisions hereof or otherwise
affect their construction or effect. This Agreement may be executed
simultaneously in two or more counterparts, each of which shall be deemed an
original, but all of which together shall constitute one and the same
instrument.

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed by their respective officers thereunto duly authorized.

PRINCIPAL TAX-EXEMPT CASH
MANAGEMENT FUND, INC.

By /s/ Arthur S. Filean
Arthur S. Filean, Vice President

PRINCIPAL MANAGEMENT CORPORATION

By /s/ Stephan L. Jones
Stephan L. Jones, President

PRINCOR FINANCIAL SERVICES CORPORATION
The Principal Financial Group
Des Moines, Iowa 50392-0200
(515) 247-5711

DEALER
SELLING AGREEMENT
FOR SHARES OF
THE PRINCIPAL FAMILY OF MUTUAL FUNDS

Dealer Selling Agreement between Princor Financial Services Corporation
("Princor", "We" or "Us") and _________________________________________
("Dealer" or "You") dated as of __________________________.

As Distributor and Principal Underwriter for the Principal Funds (hereinafter
collectively referred to as the "Funds" and individually as a "Fund"), each an
open-end investment company of which we are, or may become, Distributor and
whose shares are offered to the public at an offering price which may or may not
include a sales charge, we invite you to become a Selected Dealer to distribute
shares of the Funds.

1. Each Fund offers two classes of shares - one class which bears a front-end
load (the "Class A Shares) and one class which bears a deferred load (the
"Class B Shares"). (The Class A Shares and the Class B Shares are
collectively referred to as the "Shares"). Class A Shares of the Money
Market Funds are offered at net asset value, without any sales charge.

2. Orders for shares received from you and accepted by us will be at the
current public offering price applicable to each order as established by
the then current Prospectus of each Fund. The procedure relating to the
handling of orders shall be subject to instructions which we shall forward
from time to time to all Selected Dealers. Each Fund reserves the right to
withdraw shares from sale temporarily or permanently. All orders are
subject to acceptance or rejection by us and the Fund, each in its sole
discretion.

3. The sales charge applicable to any sale of Class A Shares by you and the
dealer discount applicable to any order from you for the purchase of Class
A Shares accepted by us shall be that percentage of the applicable public
offering price determined as set forth in the Funds' then current
Prospectus and/or Statement of Additional Information.

The rates of any sales charge and/or dealer discount for Class A Shares are
subject to change by us from time to time, and any orders placed after the
effective date of such change will be subject to the rate(s) in effect at
the time of receipt of the payment by us.

Any such sales charges and discounts to selected dealers are subject to
reductions under a variety of circumstances as may be described in the
Funds' then current Prospectus and/or Statement of Additional Information.
To obtain any such reductions, we must be notified when a sale takes place
which would qualify for the reduced charge. There is currently no sales
charge, selling concession or discount on purchases of Shares by the
reinvestment of dividends or capital gains distributions, or when there is
a transfer from one Fund to another Fund or from one account to another
account.

4. If you sell Class B Shares, we will pay you a sales commission equal to the
percentage of the aggregate net asset value of such Class B shares sold as
set forth in the Funds' then current Prospectus and/or Statement of
Additional Information.

We will pay such sales commissions to you bi-monthly on the 15th and last
day of each month.

The rates of any sales charge and/or dealer discount for Class B Shares are
subject to change by us from time to time, and any orders placed after the
effective date of such change will be subject to the rate(s) in effect at
the time of receipt of the payment by us.

We shall be entitled to any contingent deferred sales charges ("CDSC") on
any Shares sold. If, with respect to any Class B Shares sold by you, any
CDSC is waived as provided in the Funds' then current Prospectus and/or
Statement of Additional Information, then in any such case you shall remit
to us promptly upon notice an amount equal to the commissions or a portion
of the commission paid on such shares.

5. Redemption of Shares will be made at the net asset value of such Shares in
accordance with the then current Prospectus and Statement of Additional
Information of the Funds less, in the case of Class B Shares, any
applicable CDSC payable to us.

6. All of the Funds (the "Plan Funds") have adopted a Distribution Plan (the
"Plan") pursuant to Rule 12b-1 under the Investment Company Act of 1940
(the "1940 Act"). No such Agreement has been adopted by Princor Cash
Management Fund or Princor Tax-Exempt Cash Management Fund for its Class A
shares. Each Agreement defines service to be provided by Selected Dealers
for which they will be compensated pursuant to the Plan.

(a) As a Selected Dealer, you agree to provide distribution assistance and
administrative support services in connection with the distribution of
shares of the Plan Funds to customers who may from time to time
directly or beneficially-owned Shares, including but not limited to
distributing sales literature, answering routine customer inquiries
regarding the Plan Funds, assisting in the establishment and
maintenance of accounts in the Plan Funds and in the processing of
purchases and redemptions of Shares, making the Plan Funds' investment
plans and dividend options available, and providing such other
information and services in connection with the distribution of Plan
Funds Shares as may be reasonably requested from time to time.

(b) For such services, you will be compensated in accordance with the then
current Prospectus of the Plan Funds.

(c) The Plan may be terminated at any time without payment of any penalty
by any Fund in accordance with the rules governing such plans
promulgated by the Securities and Exchange Commission.

(d) The provisions of the Plan are incorporated herein and made a part
hereof by reference, and will continue in full force and effect so
long as its continuance is approved at least annually pursuant to Rule
12b-1.

7. Each party to this Agreement represents that it currently is and, while
this Agreement is in effect, will continue to be a member in good standing
of the National Association of Securities Dealers, Inc. ("NASD") and agrees
to abide by all Rules and Regulations of that Association, including the
NASD Rules of Fair Practice. If you are a foreign dealer, not eligible for
membership in the Association, you still agree to abide by the Rules and
Regulations of the Association. We both agree to comply with all applicable
state and federal laws, rules and regulations of the Securities and
Exchange Commission and other authorized United States or foreign
regulatory agencies. You further agree that you will not sell, offer for
sale, or solicit shares of the Funds in any state where they have not been
qualified for sale. You will solicit applications and sell shares only in
accordance with the terms and on the basis of the representations contained
in the appropriate prospectus and any supplemental literature furnished by
us.

8. You must represent that you are currently a member of SIPC and, while this
agreement is in effect, will continue to be a member of SIPC. You agree to
notify us immediately if your SIPC membership status changes.

9. IT IS AGREED

(a) That neither of us shall withhold placing customers' orders for shares
so as to profit as a result of such withholding.

(b) We shall not purchase shares from the Funds except for the purpose of
covering purchase orders already received, and you shall not purchase
shares of the Funds except for the purpose of covering purchase orders
already received by you or for your own bona fide investment purposes,
provided, however, any shares purchased for your own bona fide
investment purposes will not be resold except through redemption of
the Funds. Delivery of certificates, if any, for Shares purchased
shall be made by a Fund only against receipt of the purchase price. If
payment for the Shares purchased and all necessary applications and
documents required by the Funds or us are not received within five
business days or such shorter time as may be required by law, the sale
may be cancelled forthwith without any responsibility or liability on
our part or on the part of the Funds (in which case you will be
responsible for any loss, including loss of profit, suffered by a Fund
resulting from your failure to make payments or provide documents as
aforesaid), or, at our option, we may cause the Shares ordered to be
redeemed by the relevant Fund (in which case we may hold you
responsible for any loss).

(c) We shall accept only unconditional orders. Any right granted to you to
sell shares on behalf of the Funds will not apply to shares issued in
connection with the merger or consolidation of any other investment
company with a Fund or its acquisition, purchase or otherwise, of all
or substantially all the assets of any investment company or
substantially all the outstanding shares of any such company. Also,
any such right shall not apply to shares issued, sold, or transferred,
whether Treasury or newly issued shares, that may be offered by a Fund
to its shareholders as stock dividends or splits for not less than
"net asset value."

(d) We reserve the right to reject any order or application for shares or
to withdraw the offering of shares entirely, and to change any sales
charge and dealer concession, provided that no such change shall
affect concessions on orders accepted by us prior to notice of such
change, unless such change results from a reduction in sales charges
because of legal requirements.

(e) You shall not purchase shares of a Fund from a shareholder at a price
per share which is lower than the current net asset value per share
which is next computed after the receipt of the tender of such shares
by the shareholder.

(f) If shares of the Fund are tendered for redemption within seven
business days after confirmation by us of your original purchase order
for such shares, (i) you shall immediately refund to us the full
concession allowed to you on the original sale, and (ii) we shall pay
to the Fund our share of the "sales charge" on the original sale by
us, and shall also pay to the Fund the refund which we received under
(i) above. You shall be notified by us of such redemption within ten
days of the date on which proper request for redemption is delivered
to us or the Fund. Termination or cancellation of this Agreement shall
not relieve you or us from requirements of this subparagraph (f).

(g) This agreement may not be assigned or transferred in any manner
including by operation of law.

10. We will furnish you, without charge, reasonable quantities of Prospectuses
and sales material or supplemental literature relating to the sale of
shares of the Funds.

11. In all sales of shares, you act as principal and are not employed by us as
broker-agent or employee. You are not authorized to act for us nor to make
any representations in our behalf. In purchasing or selling shares
hereunder you are entitled to rely only upon the current Prospectus and
supplemental literature approved in writing by us. In the offer and sale of
shares of the Funds, you shall not use any Prospectus or supplemental
literature not approved in writing by us. No person is authorized to make
any representations concerning shares of the Funds except those contained
in a current Prospectus and supplemental literature approved in writing by
us. You will use your best efforts in the promotion of sales of Shares and
will be responsible for the proper instruction and training of all sales
personnel employed by you. In making sales of Shares, you and your
personnel will conform to the compliance standards set forth in Exhibit A
hereto.

12. You will indemnify, defend, and hold harmless our firm and all of its
affiliates, and their officers, directors, employees, agents, and assignees
against all losses, claims, demands, liabilities, and expenses, including
reasonable legal and other expenses incurred in defending such claims or
liabilities, whether or not resulting in any liability to any of them, or
which they or any of them may incur, including but not limited to alleged
violations of the Securities Act of 1933, as amended and/or to the
Securities Exchange Act of 1934, as amended, arising out of the offer or
sale of any securities pursuant to this Agreement, or arising out of the
breach of any of the terms and conditions of this Agreement, other than any
claim, demand, or liability arising from any untrue statement or alleged
untrue statement of a material fact contained in a prospectus for the
Funds, as filed and in effect with the SEC, or any amendment or supplement
thereto, or in any application prepared or approved in writing by our
counsel and filed with any state regulatory agency in order to register or
qualify under the securities laws thereof (the "blue sky applications"), or
which shall arise out of or be based upon any omission or alleged omission
to state therein a material fact required to be stated in the prospectus or
any of the blue sky applications or which is necessary to make the
statements or a part thereof not misleading, which indemnity provision
shall survive the termination of this Agreement.

13. No obligation not expressly assumed by us in this Agreement shall be
implied.

14. Either party to this Agreement may terminate this Agreement by written
notice to the other party. We may modify this Agreement at any time by
written notice to you. Any notice shall be deemed to have been given on the
date upon which it was either delivered personally or by fax transmission
to the other party or to any office or member thereof, or was mailed
post-paid or delivered to a telegraph office for transmission at his or its
address as shown herein.

15. All communications to us should be sent to the above address. Any notice to
you shall be duly given if mailed or telegraphed to you at the address
specified by you herein.

16. This Agreement shall be construed in accordance with the laws of the State
of Iowa and shall be binding upon both parties hereto when signed by both
of us in the spaces provided below. This Agreement shall not be applicable
to shares of the Funds in any state in which those shares are not qualified
for sale.

17. This Agreement shall be binding upon both parties hereto when executed by
both parties and supersedes any prior agreement or understanding between us
and you with respect to the sale of the Shares and any of the Funds.

18. This Agreement is in all respects subject to Section 26 of the Rules of
Fair Practice of the NASD which shall control any provisions to the
contrary in this Agreement.

19. If the foregoing represents your understanding, please so indicate by
signing in the proper space below.

PRINCOR FINANCIAL SERVICES CORPORATION

By:

Title:

We accept the offer set forth above, which constitutes a Selling Agreement with
us.

BY:
Signature

Please type or print name

TITLE:

DEALER:

ADDRESS:

DATE:

APPENDIX A

Compliance Standards

Princor Financial Services Corporation ("Princor"), as distributor for the
Principal Funds which offers their shares on both a front-end load and deferred
load basis, has established compliance standards setting forth the basis upon
which shares of the Principal Funds may be sold. These standards are designed
for each broker/dealer ("dealer") which distributes shares of the Principal
Funds and for such dealer's financial advisers.

As Principal Funds are offered with two different arrangements of sales and
distribution fees, it is important for an investor not only to choose a fund
that best suits his or her investment objectives, but also to choose the sales
financing method which best suits the investor's particular situation. To assist
clients of those firms which distribute shares of the Principal Funds in these
decisions and to ensure proper supervision of Principal Fund purchase
recommendations, Princor requires that such dealers adhere to the following
compliance standards when selling Principal Funds:

1. Any purchase that results in a shareholder having less than $250,000
invested in Principal Fund accounts that are aggregated for rights of
accumulation purposes may be either front-end load (Class A) or subject
to a contingent deferred sales charge (Class B).

The dealer's branch office manager (or other appropriate reviewing
officer) must review for suitability the purchase order ticket for
shares subject to either a front-end or a contingent deferred sales
charge, given the relevant facts and circumstances, including but not
limited to:

(a) the specific purchase order dollar amount;
(b) the length of time the investor expects to hold the shares
purchased; and
(c) any other relevant circumstances, such as the availability of
purchases under letters of intent or pursuant to rights of
accumulation.

2. Any mutual fund purchase order that results in a shareholder having
$250,000 or more invested in Principal Fund accounts that are
aggregated for rights of accumulation purposes should be for shares
which are subject to a front-end sales load (Class A shares) because
there are few circumstances under which it is advantageous for an
investor to place such an order for Class B shares. Such an order
placed for shares subject to a contingent deferred sales charge must be
approved by the dealer's regional director (or a person of comparable
status) and confirmed in writing by the investor.

General Guidelines

There are instances where one financing method may be more advantageous to an
investor than the other. For example, investors who qualify for a significant
discount on a front-end sales load may determine that a front-end load purchase
is preferable to payment of the higher SEC Rule 12b-1 distribution fee and the
contingent deferred sales charge imposed upon Class B shares.

On the other hand, an investor whose order would not qualify for a discount may
wish to defer the sales load and have all funds invested in shares initially.

Responsibility of Branch Office Manager
(or other appropriate reviewing officer)

The dealer's branch office manager or other appropriate reviewing officer (the
"Reviewing Officer") must ensure that the registered representative has advised
the client of the available financing methods offered by the Principal Funds,
and the impact of choosing one method over another. In certain instances, it may
be appropriate for the branch office manager to discuss the purchase directly
with the client.

Effectiveness

These compliance guidelines are effective immediately upon execution of a dealer
agreement with Princor with respect to any order for shares of any Principal
Fund for which Princor acts as distributor.
Questions relating to these compliance guidelines should be directed by the
dealer to its national mutual fund sales and marketing group or its Legal
Department or Compliance Director. Princor will advise dealers of any changes in
these guidelines in the future.

Consent of Independent Auditors

We consent to the reference to our firm under the captions "Financial
Statements" in the Prospectus in Part A and "Financial Statements" in Part B and
to the incorporation by reference in Part B of our report dated November 25,
1998 on the financial statements and financial highlights of Principal
Tax-Exempt Cash Management Fund, Inc. in this Post Effective Amendment No. 20 to
Form N-1A Registration Statement under the Securities Act of 1933 (Registration
No. 33-21710) and related prospectus of Principal Tax-Exempt Cash Management
Fund, Inc.

ERNST & YOUNG LLP

Des Moines, Iowa
December 28, 1998

Planning for the Future...One Dollar at a Time

In the spring of 1982, Kay and Bill were contacted by a registered
representative. The registered representative asked if he could talk to them
about investing for their future. Bill hesitated, but Kay realized the need to
start planning for retirement. During their first meeting, the registered
representative helped Bill and Kay put together a household budget, and provided
them with four words to get their investment plan going: "One dollar per day."

One dollar per day. Though it didn't sound like much, Kay felt $30 per month was
all their budget could spare back in 1982. At the time, Kay had just realized a
dream and opened her own beauty shop. Bill worked at the local car dealership.
Together, they earned about $23,000.

In the early years, Bill didn't share Kay's enthusiasm for investing; he didn't
think $30 per month would ever amount to anything. Kay thought differently.
Following her registered representative's suggestion, she began investing $30
each month into an Individual Retirement Account (IRA).

Since she needed her money to grow and knew she would be investing for several
years, Kay (with her registered representative's help) selected the Principal
Growth Fund A. She made her first automatic monthly investment on June 30, 1982.

Within two years, Kay felt their budget would allow an increase in her monthly
contributions. In October 1984, during an annual review with her registered
representative, he suggested she raise the amount to $50 per month. Kay agreed,
commenting, "We don't even miss the money. It's just become part of our monthly
budget."

Five years passed and Kay's beauty shop business grew, as did her Principal
Growth Fund-A account. By the end of 1987, her investment had grown to $3,475.
Encouraged by the increasing value of her investment, on December 31, 1987, she
bumped up her monthly contribution to $75 and split it equally among Class A
shares of three Principal funds---Growth, International and MidCap. Her
accumulation even impressed Bill, who decided it was high time he opened a
Principal Mutual Funds IRA for himself.

In January 1989, Kay boosted her monthly automatic investments to $150, which
she maintains to this day. Over the past sixteen years, Kay has invested a total
of $21,245 into her funds. She remains very satisfied with the values of her
Principal Mutual Funds accounts. As of September 30, 1998, her Principal Mutual
Funds IRA was valued at $52,275.

Now, Kay has switched her $150 monthly contribution to a Roth IRA. She is
excited about reaping the tax advantages of this new type of IRA while still
realizing the same investment choices and benefits she has always enjoyed with
Principal Mutual Funds.

Over the years, Kay has encouraged many of her friends, relatives, and clients
to start investing for their futures with Principal Mutual Funds. Kay has been a
great source of referrals for her registered representative, not he least of
whom was her husband Bill!

One dollar per day. We know it doesn't sound like much, but for Kay and Bill
Green, it meant the beginnings of an investment plan which should lead to a more
secure future and a more comfortable retirement.

This story does not represent any actual investor, but does reflect actual
investment results of the Principal Mutual Funds mentioned. Past results do not
guarantee future performance. Returns and principal values fluctuate with
changes in market conditions so that the value at redemption may be more or less
than original cost. Withdrawals made from an IRA before age 59 1/2 may be
subject to penalties.

Total return represents the overall performance of an investment for a specific
period of time, assuming the reinvestment of dividends and capital gains and
after applicable expenses. Average annual total returns for A Shares are with a
maximum 4.75% sales charge. Average annual total returns for B Shares are with a
maximum 4% contingent deferred sales charge.

Average Annual Returns through 9/30/98
Including Sales Charges

1 yr. 5 yr. 10 yr.
Principal Growth Fund-A -1.89% 15.34% 15.59%
Principal Growth Fund-B -1.44% 19.20% --
Principal MidCap Fund-A -22.61% 11.44% 13.76%
Principal MidCap Fund-B -22.29% 14.99% --
Principal International Fund-A -16.93% 8.66% 9.44%
Principal International Fund-B -16.87% 9.24% --

Dear Shareholder

This has been a year that we all expected would occur eventually. After a long
bull market, stocks retreated in the third quarter. Equities fell nearly 20%, as
measured by the Standard & Poor's 500 index. For the first time in several
years, some stock funds show negative 12-month returns for the period ending
9/30/98.

Unnerved by negative economic and market events across the globe, including the
financial system collapse in Russia and the spreading of the Asian problems to
Brazil and Latin America, investors sought the safety of US Treasuries. Global
markets declined in the third quarter, with no major market remaining unscathed.
Only Hong Kong and several other distressed Asian markets held losses to a
minimum, likely because they had already fallen to such depths in the last 12
months. Europe, Japan and Latin America all recorded double-digit declines;
however, weakness in the US dollar helped offset these declines for US-dollar
investors.

Bonds were strong by comparison, especially high-quality issues. The 30-year
Treasury bond, considered the safest investment in the world, gained 10% as its
yield slipped below 5% for the first time ever.

Despite the market volatility, many positives still exist for the US economy:

o Interest rates are falling, feeling like a "tax cut" for consumers who
refinance mortgages.

o Prices are falling. Gasoline is under $1 in many regions; another "tax cut."
And prices continue to fall on computers, cars, furniture and fast food.

o Consumer spending is strong. Consumers continue to be a big driver in
economic growth.

o Gross domestic product (GDP) is positive--around 2% for the second half of
1998; sharply lower than the first quarter, but still positive.

We believe that many stocks are priced fairly. Despite recent jitters, we are
confident that owning good companies will always be rewarded over the long term.
The keys to successful investing include patience...a focus on the
long-term...and discipline to look beyond the latest financial headlines. The
investor profile on the inside cover illustrates the importance and benefits of
committing to a long-term investment plan.

We are proud to note that 1999 will mark our 30th anniversary. In an industry
which has experienced most of its expansion in the past decade, we offer you a
history of investment experience which most funds groups can't. In addition, our
investment team is part of, and supported by, an extensive group which has over
$70 billion in assets under management for the Principal Financial Group(R)--a
diversified group of financial services companies for over 119 years.

As a customer, keeping you informed about your investments is very important to
us. We hope that you will take some time to review this report. Given the market
volatility, we've included some thoughts about strategies to help you endure
uncertain financial markets on the following page. On the subsequent page is a
glossary of financial terms to help with your understanding of this report.

Thank you for your confidence in the Principal Mutual Funds.

Sincerely

/s/Stephan L. Jones

Stephan L. Jones
President
Princor Financial Services Corporation

Market Correction . . . Bear Market
What Do They Mean, and How Can You Protect Yourself

While "bull market" and "rally" are words we prefer to see, sometimes we must
face up to their antonyms. But do we really know what these words mean?

The words "correction" and "bear market" are often used interchangeably. What is
a bear market? A common definition is a decline in stock prices of 20% or more
over a period of at least two months. By comparison, a market correction is
usually defined as a steep decline in stock prices which may last only a few
days or weeks.

Bear markets have occurred, on average, about once every four or five years.
Since 1956, stocks as measured by the Dow Jones Industrial Average have
experienced nine periods generally regarded as bear markets.

How Can You Protect Your Investment Program?

Diversification helps reduce the market risk involved in owning a few individual
stocks. Stock mutual funds provide diversification by holding many different
issues. They enable investors to avoid putting "all their eggs in one basket" as
can be the case when investing in just a few individual securities. However,
owning a mutual fund does not eliminate the risk involved with investing in the
stock market. Investors should consider owning a variety of asset classes.

For example, a balanced portfolio of stocks, bonds and short-term securities can
help reduce the impact of a bear market. During one of the worst bear markets in
recent history - which began in January 1973 and lasted 23 months to December
1974 - the Standard & Poor's 500 Index fell 36%. A $10,000 investment in stocks
at the beginning of the bear market declined to $6364. A portfolio of 60% stocks
and 40% bonds (measured by the Salomon Brothers Corporate Bonds - US) fared
better by declining to $7770.* Of course, past performance does not guarantee
future results.

One common mistake made by investors during bear markets is to sell at or near
the bottom. Prudent investors are prepared by holding balanced portfolios
reflecting their objectives, risk tolerances and time horizons.

Are You Prepared For a Bear Market?

Market downturns are inevitable. Here are some guidelines to help you manage
your assets when downturns occur.

Stay calm. Watching investment values decline can be agonizing and cause you to
second guess your investment mix. The markets often move in irregular
cycles. Keep your focus on the long term, not avoiding a short-term loss.

Continue investing. When investment values decline, you have an opportunity to
invest at lower prices. Continue to make contributions if you invest
regularly through an automatic investment plan. Although, such a plan does
not assure a profit or protect against loss in a declining market.

Consider the tax consequences if you sell. If you've owned your investments for
some time, the outstanding gains over the past several years may impose a
substantial capital gain if your sell or exchange fund shares.

No one knows when or how severe the next bear market will be. Be prepared to
weather declines in stock and bond values over lengthy periods. You'll be glad
you did when the words "Bull Market" and "Rally" are back in the news!

* Source: CDA/Weisenberger

The Dow Jones Industrial Average is an index which follows stock price movements
of 30 blue chip U.S. companies. The stocks represent primarily industrial
companies, with some service-oriented companies.

S&P 500 Index is a market capitalization weighted index composed of 500
widely-held common stocks listed on the New York, American and Over-the-Counter
markets. The index encompasses approximately 75% of the total value of the U.S.
stock market.

Salomon Brothers Corporate Bonds - US is an index of long-term corporate bonds,
high-grade industrial and utility bonds rated Aa or better with an average
maturity of approximately 23 years.

The value of these indexes will vary according to the aggregate value of the
common equity of each of the securities included. The indexes represent asset
types which are subject to risk, including the possible loss of principal. These
are unmanaged indexes into which direct investment is not possible.
Commonly-Used Investment Terms

In this annual report, you may find some of the following investment terms. As a
result, we felt it might be useful to include a brief definition of some of the
more common investment terms.

Returns

o Total Return calculations show the overall dollar or percentage change in
value of a hypothetical fund investment assuming the reinvestment of all
portfolio distributions (i.e., dividends and capital gains).

o Average Annual Total Returns illustrate the annually compounded returns that
would have produced the fund's cumulative total returns if fund performance
had been constant over the period measured. Average annual returns are not the
same as year-by-year returns, and are reported in standard increments, usually
1, 3, 5 and 10 years.

Portfolio Statistics

o Price to Earnings (P/E) Ratio is a stock value measurement arrived at by
dividing a company's stock price by its earnings per share. The result is
expressed as a multiple rather than a percentage. A P/E ratio can be expressed
in current terms by using the current price divided by the most recent
quarter's earnings, or in future terms by dividing the current price by
projected earnings.

o Portfolio Turnover provides the percentage of the fund's portfolio which is
replaced during a given time period, usually one year.

o Expense Ratio refers to fund operating expenses and is expressed as a
percentage of net assets. Shareholders pay these expenses (e.g., management
fees paid to the portfolio manager for investment advisory services)
indirectly as they are deducted from income generated by the fund's portfolio
holdings not shareholder accounts.

Stock Types

o Blue Chip Stocks are stocks of the most well-established U.S. companies.
Typically, they are large, stable companies which have
demonstrated consistent earnings and the potential for long-term growth.

o Cyclical Stocks are those whose price and earnings tend to follow the ups
and downs of the business cycle. Some examples would
include: stocks of automobile manufacturers and steel producers.

o Growth Stocks are stocks of companies who have experienced above-average
earnings growth and are expected to continue such growth. These stocks often
sell at high P/E ratios. Examples might include: high-tech, health care and
consumer staples stocks.

o Value Stocks are those companies whose stocks are believed to be undervalued
and, therefore, attractive. These stocks generally have low P/E ratios and
higher dividend yields.

o Large Capitalization Stocks (Large-Cap) are generally considered to be stocks
of companies with a market capitalization (total value of a company's
outstanding stock) of more than $5 billion. These stocks tend to comprise the
Dow Jones Industrial Average, the S&P 500 and the Russell 1000 Index.

o Medium Capitalization Stocks (Mid-Cap) are usually thought to be stocks of
companies with a market capitalization (total value of a company's outstanding
stock) of $1 - $5 billion. These stocks tend to make up the S&P 400.

o Small Capitalization Stocks (Small-Cap) are stocks of companies with a market
capitalization (total value of a company's outstanding stock) of less than $1
billion. These tend to be the stocks which make up the Nasdaq Composite Index
and the Russell 2000 Index.

Table of Contents

Page
Market Correction . . . Bear Market-- What Do They Mean, and How Can You
Protect Yourself............................................................ 2
Portfolio Managers' Comments................................................ 6

Domestic Growth-Oriented Funds Financial Statements and Highlights
Statements of Assets and Liabilities..................................... 20
Statements of Operations................................................. 22
Statements of Changes in Net Assets...................................... 24
Notes to Financial Statements............................................ 26
Schedules of Investments
Balanced Fund.......................................................... 32
Blue Chip Fund......................................................... 35
Capital Value Fund..................................................... 36
Growth Fund............................................................ 37
MidCap Fund............................................................ 39
Real Estate Fund....................................................... 41
SmallCap Fund.......................................................... 42
Utilities Fund......................................................... 44
Financial Highlights..................................................... 46

International Growth-Oriented Funds Financial Statements and Highlights
Statements of Assets and Liabilities..................................... 56
Statements of Operations................................................. 57
Statements of Changes in Net Assets...................................... 58
Notes to Financial Statements............................................ 60
Schedules of Investments
International Emerging Markets Fund.................................... 68
International Fund..................................................... 70
International SmallCap Fund............................................ 72
Financial Highlights..................................................... 76

Income-Oriented Funds Financial Statements and Highlights
Statements of Assets and Liabilities..................................... 80
Statements of Operations................................................. 82
Statements of Changes in Net Assets...................................... 84
Notes to Financial Statements............................................ 86
Schedules of Investments
Bond Fund.............................................................. 94
Government Securities Income Fund...................................... 97
High Yield Fund........................................................ 97
Limited Term Bond Fund................................................. 99
Tax-Exempt Bond Fund................................................... 100
Financial Highlights..................................................... 106

Money Market Funds Financial Statements and Highlights
Statements of Assets and Liabilities..................................... 114
Statements of Operations................................................. 115
Statements of Changes in Net Assets...................................... 116
Notes to Financial Statements............................................ 118
Schedules of Investments
Cash Management Fund................................................... 122
Tax-Exempt Cash Management Fund........................................ 124
Financial Highlights..................................................... 128

Report of Independent Auditors.............................................. 131
Federal Income Tax Information.............................................. 132
Principal Mutual Funds...................................................... 137

<TABLE>
<CAPTION>
Principal Funds Performance

Average Annual Total Returns
As of October 31, 1998
- --------------------------------------------------------------------------------------------
1 Year 5 Years 10 Years
--------------------- --------------------- -----------------
with without with without with without
sales sales sales sales sales sales
A Shares of: charge charge charge charge charge charge
- ------------------------------ --------------------- --------------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Balanced 5.78% 11.00% 10.21% 11.28% 10.43% 10.96%
Blue Chip 13.87 19.48 16.61 17.74 13.63(a) 14.34(a)
Bond 2.69 7.76 5.92 6.95 8.61 9.14
Capital Value 10.16 15.59 17.04 18.17 13.55 14.09
Government Securities Income 2.33 7.38 5.47 6.49 8.09 8.61
Growth 9.75 15.17 16.32 17.44 16.44 17.00
High Yield (7.73) (3.18) 5.62 6.64 6.35 6.86
International (2.86) 1.93 8.93 9.98 9.97 10.50
International Emerging Markets (24.82) (21.11) (28.45)(b) (25.45)(b)
International SmallCap (4.11) 0.30 (3.36)(b) 0.69(b)
Limited Term Bond 4.98 6.57 5.76(c) 6.36(c)
MidCap (14.02) (9.78) 12.25 13.33 14.58 15.13
Real Estate (19.43)(d) (15.45)(d)
SmallCap (19.90)(d) (15.95)(d)
Tax-Exempt Bond 1.74 6.76 4.74 5.75 7.27 7.79
Utilities 25.89 32.10 10.40 11.47 11.56(e) 12.48(e)
</TABLE>
1 Year 5 Years(f)
--------------------- ---------------------
with without with without
B Shares of: CDSC* CDSC* CDSC* CDSC*
- ------------------------------ --------------------- ---------------------
Balanced 6.18% 10.18% 14.35% 14.87%
Blue Chip 14.59 18.59 21.21 21.65
Bond 3.04 7.04 9.09 9.68
Capital Value 10.71 14.71 22.44 22.87
Government Securities Income 2.60 6.60 8.70 9.30
Growth 10.58 14.58 21.03 21.47
High Yield (7.52) (3.93) 6.87 7.50
International (2.68) 1.27 11.50 12.06
International Emerging Markets (24.41) (21.26) (28.20)(b) (25.65)(b)
International SmallCap (3.90) 0.10 (2.90)(b) (0.52)(b)
Limited Term Bond 4.99 6.24 5.70(c) 5.95(c)
MidCap (13.75) (10.24) 16.57 17.06
Real Estate (18.98)(d) (15.67)(d)
SmallCap (19.51)(d) (16.15)(d)
Tax-Exempt Bond 2.01 6.01 8.87 9.47
Utilities 27.23 31.23 18.74 19.21
* Contingent Deferred Sales Charge

R Shares of: 1 Year 5 Years(c)
- ------------------------------ ---------- ----------
Balanced 10.43% 12.44%
Blue Chip 19.01 17.89
Bond 7.05 7.60
Capital Value 14.77 19.51
Government Securities Income 6.66 6.98
Growth 14.46 16.11
High Yield (3.97) 4.59
International 1.13 11.04
International Emerging Markets (21.14) (25.55)
International SmallCap 0.50 0.86
Limited Term Bond 6.12 5.77
MidCap (10.37) 8.48
Real Estate (15.37)(d)
SmallCap (15.75)(d)
Utilities 31.47 16.13

(a) Partial period,
from effective date 3/1/91
(b) Partial period,
from effective date 8/29/97
(c) Partial period,
from effective date 2/29/96
(d) Partial period,
from effective date 12/31/97
(e) Partial period,
from effective date 12/16/92
(f) Partial period,
from effective date 12/9/94

Total return represents the overall perfor-mance of an investment for a specific
period of time, assuming the reinvestment of dividends and capital gains and
after applicable expenses. Average annual total returns for A shares are with
and without maximum 4.75% sales charge. Average annual total returns for B
shares are with and without maximum 4.0% contingent deferred sales charge. Total
returns reflect past performance. Past performance does not predict future
performance. The investment return and principal value of an investment will
fluctuate so that shares, when redeemed, may be worth more or less than their
original cost.

PORTFOLIO MANAGERS' COMMENTS

Principal Management Corporation, the adviser to the Principal Mutual Funds, is
staffed with investment professionals who manage each individual fund. Comments
by these individuals in the following paragraphs summarize in capsule form the
general strategy and recent results of each fund over the past year. We believe
any Principal Mutual Fund should, under normal circumstances, represent only a
portion of an investor's total investments. For most investors, a portfolio
should be balanced among stocks, bonds, and cash reserves to fit their own needs
and risk tolerance. Those who maintain this balanced approach should be aware of
the short-term results, but focus on the long term. Past performance is no
guarantee of future results. Fund values will fluctuate so that the shares, upon
redemption, may be worth more or less than their original cost.

Growth-Oriented Funds

Domestic Growth Funds

Principal Balanced Fund
- -----------------------
Marty Schafer Judi Vogel

Comparison of Change in Value of $10,000 Investment in the Balanced Fund Class
A, Lipper Balanced Fund Average, Lehman Brothers Government/Corporate Bond Index
and S&P 500 Stock Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 11.00% 11.28% 10.96%
Class B 10.18% 14.87%* -
Class R 10.43% 12.44%** -
- --------------------------------------------

Lehman Gov't. Lipper
Balanced Corporate Balanced S&P 500
Fund Bond Average Index
-------- ------------- -------- -------
9,527 10,000 10,000 10,000
1989 10,580 11,214 11,708 12,640
1990 9,387 11,831 11,097 11,693
1991 12,586 13,649 14,257 15,611
1992 14,079 15,085 15,502 17,167
1993 15,802 17,141 17,799 19,727
1994 15,951 16,346 17,673 20,488
1995 18,215 18,987 20,743 25,899
1996 20,965 20,011 23,821 32,135
1997 24,295 21,774 28,468 42,450
1998 26,966 24,012 31,067 51,785

Note: Past performance is not predictive of future performance. The performance
of Class B and Class R shares will vary from the performance of Class A shares
based on the differences in loads and fees.

* Since inception date 12/9/94
** Since inception date 2/29/96

A real mood swing occurred in the second half of the year versus the optimism
and high expectations evident in the first half. The last few months have been
characterized by tremendous volatility in the markets and increasing aversion to
risk on the part of investors. Unnerved by negative economic and market events
across the globe, including the financial system collapse in Russia and the
spreading of Asian contagion to Brazil and Latin America, investors have
recently sought the safety and security of U.S. Treasury bonds, shunning nearly
everything else in the process. International returns have been dismal with
domestic equity results only slightly better. Small cap stocks, down 20% in the
third quarter, have been especially hard hit. While the U.S. economic expansion
does continue, negative pressures are mounting. Accordingly, confidence in
continued growth and prosperity has been shaken. Market participants now require
greater compensation to take on risk in both stocks and bonds.

The Balanced Fund, with 55% in stocks and convertibles and 45% in fixed income
and cash, enjoyed above average returns for the year. With a focus on high
quality bonds and undervalued stocks, the Fund is positioned to perform well in
this period of global uncertainty. There is no independent market index against
which to measure returns of balanced portfolios. However, the S&P 500 Stock
Index and the Lehman Brothers Government/Corporate Bond Index are presented for
your information.

Principal Blue Chip Fund
- ------------------------
Mark Williams

Comparison of Change in Value of $10,000 Investment in the Blue Chip Fund Class
A, Lipper Growth & Income Fund Average and S&P 500 Stock Index

- -----------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Years 10 Year
- ------------------------------------------------
Class A 19.48% 17.74% 14.34%*
Class B 18.59% 21.65%** -
Class R 19.01% 17.89%*** -
- -----------------------------------------------

Blue Lipper S&P 500
Chip Growth & Income Stock
Fund Fund Average Index
------ --------------- -------
9,524 10,000 10,000
1991 10,181 10,544 10,911
1992 11,190 11,499 11,998
1993 11,822 13,424 13,787
1994 12,600 13,763 14,319
1995 15,455 16,510 18,100
1996 18,267 20,011 22,459
1997 22,391 25,638 29,668
1998 26,753 28,174 36,192

* Since inception date 3/1/91
** Since inception date 12/9/94
*** Since inception date 2/29/96

Principal Blue Chip Fund's investment strategy continues to concentrate on those
companies with a significant operating history, a well-capitalized balance
sheet, and a history of consistent increases in earnings and dividends. Special
importance is placed on the consistency of dividend increases, for two reasons.
First, by increasing the dividend, management sends a signal of confidence to
investors. Management generally increases the dividend when they are confident
of future business conditions. Second, companies that consistently increase the
dividend provide investors the benefit of a rising income stream. This differs
from bond investors who receive a fixed income stream.

For the year ended October 31, 1998, Principal Blue Chip Fund remained very
competitive versus its benchmarks. The Fund had a return of 19.5% well
outperforming the Lipper Growth and Income Fund Average with a 9.9% return, yet
underperforming the S&P 500 Index at 22.0%.

For the first half of the year, the S&P 500 Stock Index turned in strong
performance. The performance was remarkable given the mix of economic news.
During the period, the inflation-adjusted price of oil hit its lowest levels
since before the energy crisis of the 1970s. The Fund's two biggest positive
contributors to performance in the fourth quarter 1997 were consumer durables
and industrial cyclicals. The fact that the Fund was not invested in durables
was an advantage versus the benchmark. However, in cyclicals, stock selection
made the difference in fund performance. The first quarter of 1998 tells a
different story as the Fund lost some ground versus the benchmarks. Healthcare
was the best performing fund sector and technology the poorest performing sector
relative to the benchmarks. The second half of the year was an extremely
volatile (and negative) market. Major indices suffered their worst declines
since 1990, and third-quarter performance was the worst since the third quarter
of 1990. Investors saw markets rebound in September and October; however, this
late recovery was not enough to recapture the losses from July and August.
Principal Blue Chip Fund was no exception with technology and consumer cyclicals
sectors once again playing a major factor in sector underperformance. Stock
selection in the consumer staples sector versus the benchmark was a positive
contribution to the Fund.

Principal Capital Value Fund
- ----------------------------
Catherine Zaharis

Comparison of Change in Value of $10,000 Investment in the Capital Value Fund
Class A, Lipper Growth & Income Fund Average and S&P 500 Stock Index

- -----------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- -----------------------------------------------
Class A 15.59% 18.17% 14.09%
Class B 14.71% 22.87%* -
Class R 14.77% 19.51%** -
- -----------------------------------------------

Lipper S&P 500
Capital Growth & Income Stock
Accumulation Fund Average Index
------------ --------------- -------
9,526 10,000 10,000
1989 10,840 12,047 12,640
1990 8,908 10,864 11,693
1991 12,528 14,503 15,611
1992 13,990 15,817 17,167
1993 15,447 18,465 19,727
1994 16,477 18,931 20,488
1995 19,433 22,709 25,899
1996 24,565 27,526 32,135
1997 30,795 35,266 42,450
1998 35,590 38,754 51,785

* Since Inception date 12/9/94
** Since Inception date 2/29/96

The strategy for the Principal Capital Value Fund is to look for companies that
are priced at a discount relative to their historical levels. Fund managers
focus on the future and how companies are valued relative to their worth as
ongoing business operations. This strategy gives the Fund a foundation based on
the underlying value of the business.

The most recent period has been marked by extreme volatility in the equity
markets. As uncertainty increased regarding the impact of worldwide economic
concerns on the U.S. economy, the stock market has reacted dramatically to any
change in the landscape.

Two issues drive stock prices currently earnings and interest rates. Until this
summer, both had a positive impact on stocks. Suddenly, earnings strength became
a concern to stock investors. Although the concerns have been offset by recent
Fed actions of lowering interest rates, the tug of war is not over, and greater
stock volatility could remain.

The S&P 500 Index continues to be led by a narrow group of stocks whose
valuations keep them out of the Fund's screening process. Therefore, the Fund
has lagged the S&P 500 for the latest period. However, most funds are
underweighted in this small group of companies, so in a comparison to its peers
the Fund's returns have been attractive. Management continues to focus on
companies where sustainability of earnings may be more predictable.

Principal Growth Fund
- ---------------------
Mike Hamilton

Comparison of Change in Value of $10,000 Investment in the Growth Fund Class A,
Lipper Growth Fund Average and S&P 500 Stock Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 15.17% 17.44% 17.00%
Class B 14.58% 21.47%* -
Class R 14.46% 16.11%** -
- --------------------------------------------

Lipper S&P 500
Growth Growth Stock
Fund Fund Average Index
------ ------------ -------
9,527 10,000 10,000
1989 11,245 12,431 12,640
1990 10,210 10,983 11,693
1991 16,265 15,522 15,611
1992 18,665 16,742 17,167
1993 20,500 19,600 19,727
1994 22,514 19,902 20,488
1995 27,758 24,674 25,899
1996 30,701 29,231 32,135
1997 39,773 37,206 42,450
1998 45,801 40,785 51,785

* Since Inception date 12/9/94
** Since Inception date 2/29/96

The bull market took a breather during the third quarter as stock prices staged
a broad pull back even though the domestic economy continued to grow. Global
conditions, particularly the continuing crisis in Asian financial markets and
problems in Latin America and Canada, seemed to make many investors
uncomfortable. Temporarily, they forgot about our relatively strong domestic
economy with its low interest rates, high level of consumer confidence and
falling commodity prices. The S&P 500 fell 19% from its high in mid-July, until
it reached its low at the end of August as investors sold good stocks along with
poor ones and generally fled to the safety of Treasury securities.

Principal Growth Fund performed as well as its peers during the retrenchment,
finishing between the S&P 500 Index and the Lipper Growth Fund Average
performances for the year ended October 31.

The Fund is built on the belief that markets behave rationally over time. This
means during portions of a market cycle, some Fund holdings may be out of favor.
As long as the fundamental business prospects of the companies are sound, the
Fund will hold these companies until they reach full value. The Manager looks
for companies with competitive advantages that will allow them to earn
above-average returns for many years. The Fund buys and holds these stocks to
make a profit as owners of the companies.

Principal MidCap Fund
- ---------------------
Mike Hamilton

Comparison of Change in Value of $10,000 Investment in the MidCap Fund Class A,
Lipper Mid-Cap Fund Average and S&P 500 Stock Index

- ---------------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- ---------------------------------------------------
Class A -9.78% 13.33% 15.13%
Class B -10.24% 17.06* -
Class R -10.37% 8.48** -
- ---------------------------------------------------

Lipper S&P 500
Mid Cap Stock
MidCap Fund Average Index
------ ------------ -------
9,523 10,000 10,000
1989 11,389 12,646 12,640
1990 9,378 10,886 11,693
1991 15,653 17,405 15,611
1992 17,475 18,632 17,167
1993 20,911 23,149 19,727
1994 22,345 23,639 20,488
1995 28,246 29,433 25,899
1996 33,018 34,811 32,135
1997 43,339 42,748 42,450
1998 39,101 41,512 51,785

* Since Inception date 12/9/94
** Since Inception date 2/29/96

The relatively solid performance of the U.S. economy in terms of low interest
rates, consumer confidence and moderate earnings growth was overshadowed in the
minds of U.S. stock investors during late summer. A growing awareness of
mounting problems in other economies led U.S. markets to join those of Europe,
Japan and Latin America in recording double-digit losses at the end of August.
By October, stock prices began to rebound as the Fed exerted leadership to keep
the domestic economy on track. Central banks acted to reinflate world economies.

Both the Principal MidCap Fund and the Lipper Mid-Cap Fund Average finished well
behind the S&P 500 Index for the year. This is due to the Index being heavily
weighted in large companies. These familiar names found investors preferrence
for most of this year as concerns grew over the aging bull market.

The Manager's investment approach in the Fund is based on attempting to estimate
the true economic value of a company and then purchasing the stock at a discount
to this value. As long as the fundamental business prospects of the company are
sound, the Fund will hold that company in its portfolio. This means that during
any portions of a market cycle, some portion of the holdings may be out of
favor. As a long-term investors, the Manager looks for results over two or more
market cycles and refrains from chasing the market during wild short-term price
swings.

Principal Real Estate Fund
- --------------------------
Kelly Rush

Comparison of Change in Value of $10,000 Investment in the Real Estate Fund,
Lipper Real Estate Fund Average and Morgan Stanley REIT Index

- -------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- -------------------------------------------
Class A -15.45%* - -
Class B -15.67%* - -
Class R -15.37%* - -
- -------------------------------------------

Principal Real Estate Fund, Inc.

REF REF REF Lipper Morgan S&P 500
Fund Fund Fund Real Estate Stanley Daily
Class A Class B Class R Fund Avg. REIT Reinv
------- ------- ------- ---------- -------
9,521 10,000 10,000 10,000 10,000 10,000
1998 8,068 8,452 8,482 8,318 8,346 11,463

* Since Inception date 12/31/97

Principal Real Estate Fund opened to the public in January 1998. The fund
invests primarily in equity securities of companies engaged principally in the
real estate industry. Fund managers have available the resources of real estate
professionals within the Principal Financial Group to identify companies
possessing the attributes considered essential for successful real estate
investing.

Real estate markets enjoyed a strong year in 1998, and real estate companies
experienced record earnings growth. While the operating environment was robust,
the prices of real estate company stocks were falling. Several factors have
contributed to the decline. The most predominant reason for the decline has been
the fear of deteriorating conditions in 1999 and beyond. For the period ended
October 31, 1998 Principal Real Estate Fund performed slightly better than the
Morgan Stanley REIT Index and the Lipper Real Estate Fund Average because of its
underweighting in the hotel sector and overweighting in companies which have
proven to be resilient in the face of market pressure.

Declining earnings growth from the record setting levels of 1998 is inevitable.
The transition from abnormally high earnings growth to a lower sustainable
earnings growth level has caused investor nervousness and price declines in
1998. This drop provided an attractive price entry point, in the Manager's
opinion, for patient investors in search of value opportunities supported by an
above average level of current income.

Principal SmallCap Fund
- -----------------------
John McClain Mark Williams

Comparison of Change in Value of $10,000 Investment in the SmallCap Fund, Lipper
Small-Cap Fund Average and S&P 600 Stock Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A -15.95%* - -
Class B -16.15%* - -
Class R -15.17%* - -
- --------------------------------------------

Principal SmallCap Fund, Inc.

SCF SCF SCF Lipper
Fund Fund Fund Small Cap S&P
Class A Class B Class R Fund Average 600
------- ------- ------- ----------- ------
9,527 10,000 10,000 10,000 10,000
1998 7,975 8,352 8,391 8,683 8,782

* Since Inception date 12/31/97

This is the first annual report of Principal SmallCap Fund, Inc., as its
inception date was January 1, 1998. Fund strategy is to take the best that
small-cap growth stocks have to offer and combine it in a single portfolio with
the best that small-cap value stocks have to offer. By doing so, managers hope
to provide superior results when compared to other small-cap funds.

Initially, approximately 60% of the Fund's assets were invested in growth stocks
with the balance in value stocks. The original allocation of 60/40 was still in
place at fiscal year end. This allocation was chosen initially for two reasons.
First, the small-cap value sector has outperformed the small-cap growth sector
for several measurement periods. Fund managers believe the performance balance
going forward has a good chance of being reversed, or at least not expanded
further. Second, the opportunities for superior stock selection are greater in
the growth area at this time.

Performance for small companies during July through September was a continuation
of poor performance logged earlier in the year. At October 31, the Principal
SmallCap Fund was below its benchmark with a return of -16.0 (net of expenses)
versus that of the Lipper SmallCap Fund Average at -13.2%. The Fund was ahead of
its benchmarks for the first part of the year until June erased its positive
performance. Approximately 65% of the Fund underperformance in the spring and
early summer was due to sector allocation choices and the rest was security
selection. Specifically, technology holdings were under severe pressure during
June as the Asian economic problems reignited investor concerns. The months of
July through September followed June's lead with continued negative returns. For
the benchmark, seven sectors had losses greater than 20%, three had losses
greater than 15% and one sector (Utilities) had a positive return. The Principal
SmallCap Fund experienced similar sector performance trends. The Fund
underperformed the benchmark due to exposure in the consumer cyclicals and
financial sectors.

Looking forward, small stocks are more attractive relative to large stocks than
at anytime in the last twenty years. This is based on trailing and projected
profits. Fund managers believe this is an opportunity.

Principal Utilities Fund
- ------------------------
Catherine Zaharis

Comparison of Change in Value of $10,000 Investments in the Utilities Fund Class
A, Lipper Utilities Fund Average, Dow Jones Utilities Index with Income and S&P
500 Stock Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 32.10% 11.47% 12.48*
Class B 31.23% 19.21%** -
Class R 31.47% 16.13%*** -
- --------------------------------------------

Dow Jones
Dow Jones Utilities Lipper
Utilities Utilities With Income Utilities Fund S&P 500
Fund With Income Index Average Index
--------- ----------- ------------ -------------- -------
9,524 10,000 10,000 10,000
1993 11,250 11,658 11,575 10,979
1994 9,540 9,349 10,475 11,402
1995 11,864 11,810 26.32% 12,325 14,414
1996 12,829 13,216 11.91% 13,733 17,885
1997 14,658 14,879 12.58% 16,179 23,625
1998 19,364 19,027 27.88% 19,720 28,821

* Since Inception date 12/16/92
** Since Inception date 12/9/94
*** Since Inception date 2/29/96

The utility industry continues to evolve on all fronts -- electrics, gas and
telephones. Convergence continues to be a theme on the electric and gas side.
Companies are trying to provide as many products and services as possible to
each customer, and a natural growth aspect is other utility products. Another
theme is concentration. Some companies favor a focus on making electricity and
others believe they are better sellers of electricity.

Regardless of the strategy, the goal is growth, a rare occurrence in a mature
industry. Fund management's goal is to look at each strategy, the company's
strengths and weaknesses, and determine if the company's plans are achievable.
As events are changing rather rapidly, an increasing awareness of corporate
plans is a must.

Telecommunications is in a similar situation with one distinction. This sector
still enjoys substantial growth of business from existing product lines and
regions, but it is still important to understand and believe each company's
growth strategy.

Principal Utilities Fund, with its focus on quality and long term success, has
enjoyed success. For the past year, the Fund outperformed both its index and
peer group. When the index does well, the Fund tends to be near the top of its
peer group as the Fund's current strategy is to hold only utility stocks. Fund
managers were also aided by a lack of foreign utilities, which have struggled
substantially in the past year.

International Growth Funds

Principal International Emerging Markets Fund
- ---------------------------------------------
Kurt Spieler

Comparison of Change in Value of $10,000 Investment in the International
Emerging Markets Fund, Lipper Emerging Markets Fund Average and MSCI EMF Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A -21.11% -25.45%* -
Class B -21.26% -25.65%* -
Class R -21.14% -25.55%* -
- --------------------------------------------

IEM IEM IEM Lipper Emerging
Fund Fund Fund Markets
Class A Class B Class R Fund Average
------- ------- ------- --------------
9,524 10,000 10,000 10,000
1997 7,895 8,280 8,280 8,816
1998 6,228 6,520 6,530 6,010

* Since Inception date 8/29/97

Principal International Emerging Markets Fund experienced high volatility in the
second half of the fiscal year. From April 30 to the low on September 11, the
Fund returned -38%. Catalyst events for the negative returns include high
interest rates, a deterioration in the macroeconomic environment and low
liquidity in many emerging markets. In the Manager's view, emerging markets
became ridiculously oversold in September after the Russian debt moratorium and
devaluation. The second and third quarter represented the two worst quarters
since inception of emerging market indices. Since September 11, emerging markets
have rallied with the Fund returning a positive 18% through October 31. Reasons
for the rally include the decline in interest rates in many countries (including
the U.S.), increased stability in Asia and Latin America, and cheap valuations.

The Fund outperformed both the MSCI Emerging Market Free Index and Lipper
Emerging Market Index in the second half. Relative returns were +7.4% vs. MSCI
and +7.6% vs. Lipper. This is a result of the strategy of focusing on countries
that require less external financing from the international community. This list
includes such countries as Israel, Poland, Hungary, Hong Kong and Singapore. The
Fund portfolio remains diversified by region with EMEA (Eastern Europe, Middle
East, Africa) making up 37% of assets, Latin America 31% and Asia 25%. The
portfolio is defensive by country and company with no exposure in Russia and
Malaysia. Generally, the Fund holds companies that have strong cash generative
abilities and solid balance sheets. Overall, the Fund strategy is founded on the
belief that international markets are inefficient. The manager will continue to
add value by buying high quality companies at a discount to their investment
value, and find these undervalued companies through application of internal
research and bottom-up analysis.

Principal International Fund
- ----------------------------
Scott Opsal

Comparison of Change in Value of $10,000 Investment in the International Fund
Class A, Lipper International Fund Average and MSCI EAFE Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 1.93% 9.98% 10.50%
Class B 1.27% 12.06%* -
Class R 1.13% 11.04%** -
- --------------------------------------------

Lipper MSCI
International International EAFE
Fund Average Index
------------- ------------- ------
9,534 10,000 10,000
1989 10,048 11,493 10,814
1990 10,141 11,406 9,428
1991 11,545 12,377 10,083
1992 11,358 11,771 8,750
1993 16,059 15,704 12,028
1994 17,600 17,365 13,242
1995 17,781 17,259 13,193
1996 21,047 19,111 14,575
1997 25,354 21,097 15,249
1998 25,842 21,955 16,720

* Since Inception date 12/9/94
** Since Inception date 2/29/96

Global investment markets experienced considerable volatility of returns during
the past year. In the first half of 1998, international equity markets advanced
due to strong economic growth and low interest rates throughout the world and as
Europe moved closer to Monetary Union. The third quarter saw the international
markets collapse, as investors became increasingly risk averse. The Fund's
European overweighting provided an early benefit as investor enthusiasm drove up
stock prices based on strong fundamentals. Emerging markets exposure to hurt the
Fund's return relative to the Morgan Stanley's EAFE Index as these markets
underperformed for the year. Near zero weighting in Japan benefited the Fund as
this country continued to experience financial problems.

World stock markets' volatility was highlighted during the third quarter as
markets came crashing down and investors sought safety. The markets had been
highly valued during the year as they were "priced for perfection" with strong
consumer confidence and an attractive investment outlook. As Asian troubles
spread, other markets experienced problems during the year, and Russia's
currency devaluation in August brought the problem to a head. This, in
connection with the short-term debt problems in Brazil, led investors to demand
higher risk premiums and place their money in safer investments.

Entering the second half, the Fund was positioned defensively to limit the
downside risk in the market. Unfortunately, any exposure to emerging markets
hurt investment returns. During the year, growth-oriented investments performed
better than value investments. Investors sought safety in large capitalization,
blue chip companies despite their higher valuations. Management's value approach
to investing led the Fund to avoid these high valuation companies. The currency
exposure during the past year was neutral to the Fund's overall return.

Looking forward, the Fund's current strategy remains defensive in all respects.
The Fund is overweighted in Europe which, despite the world's troubles, still
has the most robust economic outlook of the developed markets. The recently
weaker U.S. dollar may negatively impact Europe's exporters, but Fund managers
expect European economic growth to remain well above recession levels. And,
reasonable earnings performance is expected from the portfolio. The Fund's
overweighting in the U.K. is not based on a top-down view of that economy.
Rather, it reflects the fact that Fund managers have uncovered a fair number of
unique companies and discrete opportunities there which offer
higher-than-average expected returns. Latin America continues to face economic
weakness. Although we are seeing prices that more fully reflect that outlook and
will be researching "deep value" opportunities where we think the stock price
has overly discounted the company's future prospects. The Fund's manager
continues to monitor the Asian markets in hopes of identifying interesting
investments when the market turns.

Principal International SmallCap Fund
- -------------------------------------
Darren Sleister

Comparison of Change in Value of $10,000 Investment in the International
SmallCap Fund, Lipper International Small-Cap Fund Average and Morgan Stanley
Capital International EAFE

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 0.30% 0.69%* -
Class B 0.10% 0.52%* -
Class R 0.50% 0.86%* -
- --------------------------------------------

ISF ISF ISF Lipper Int'l
Fund Fund Fund SmallCap MSCI
Class A Class B Class R Fund Average EAFE
------- ------- ------- ------------- ------
9,524 10,000 10,000 10,000 10,000
1997 9,486 9,960 9,960 9,736 9,748
1998 9,514 9,970 10,010 9,774 10,689

* Since Inception date 8/29/97

The ancient Chinese cure "May you live in interesting times," could now describe
the recent investment environment. SmallCap international stocks have fluctuated
widely recently as high levels of volatility gripped equity markets in general.
The Asian economic malaise crept into other parts of the world in the past
several months. For instance, Russia defaulted on some of its debt which sent
emerging country financial markets into a tailspin. Brazil's economy hovered on
the edge of collapse and was pressured recently into accepting a bailout
package. In short, the current state of world affairs does not favor strong
economic growth in many areas outside of the U.S. As small stocks tend to
benefit from a strong economic environment, the current perception is that small
companies should be sold. In many cases this has been accomplished in
spectacular fashion, resulting in small stocks becoming an excellent value.

Given the uncertainty surrounding Asia, Fund managers continue to favor
companies operating with clearly defined Western-management principles. As such,
the Principal International SmallCap Fund is heavily weighted in European,
Australian and Canadian stocks. At this time, growth companies offer the best
risk/return trade-off compared to more traditional value stocks. Management's
bottom-up, borderless stock selection criteria has taken the Fund to the
telecommunications, temporary employment, information technology, deep-sea oil
exploration and development, and niche financial companies. The Fund Manager
continues to choose stocks on an individual, stand-alone basis. This means the
industry and country exposures are the output of finding solid individual
investments rather than attempting to predict changes in economic activity or
currencies.

The Fund's investment philosophy firmly believes that paying less for a stock is
better than paying more. It is recognized that buying into a falling market can
be difficult as prices tomorrow may well be lower than today. However, stocks
are purchased for the long run and the Fund continues to invest in those
companies believed to generate solid returns for the longer term. When markets
sell off violently and the underlying economic conditions are not changing
significantly, this is generally a good buying opportunity. Investors in the
Fund should remember that volatility is not avoidable at all times but Fund
managers use such times to benefit shareholders.

Investment results for the period generally paralled the Lipper International
SmallCap Fund average. Results lagged the Morgan Stanley EAFE Index due to
different country weightings in the Fund and a much lower average capitalization
level in the Fund. The EAFE index is comprised of much larger companies that
pertained better in this market.

Important Notes on the Growth-Oriented Funds:

Dow Jones Utility Index with Income: This average is a price-weighted average of
15 utility companies that are listed on the New York Stock Exchange and are
involved in the production of electrical energy.

Lehman Brothers Government/Corporate Bond Index: This index consists of publicly
issued securities from the Government Index and the Corporate Index. The
Government Index includes U.S. Treasuries and Agencies. The Corporate Index
includes U.S. Corporate and Yankee debentures and secured notes from the
Industrial, Utility, Finance, and Yankee categories.

Lipper Balanced Fund Average: This average consists of funds whose primary
objective is to conserve principal by maintaining at all times a balanced
portfolio of both stocks and bonds. Typically, the stock/bond ratio ranges
around 60%/40%. The one-year average currently contains 395 funds.

Lipper Emerging Markets Fund Average: This average consists of funds which
invest at least 65% of their total assets in emerging market equity securities,
where "emerging market" is defined by a country's GNP per capita or other
economic measures. The one-year average currently contains 151 funds.

Lipper Growth & Income Fund Average: This average consists of funds which
combine a growth of earnings orientation and an income requirement for level
and/or rising dividends. The one-year average currently contains 725 funds.

Lipper Growth Fund Average: This average consists of funds which normally invest
in companies whose long-term earnings are expected to grow significantly faster
than the earnings of the stocks represented in the major unmanaged stock
indices. The one-year average currently contains 944 funds.

Lipper International Small Cap Funds Average: This average consists of funds
which invest at least 65% of their assets in equity securities of non-United
States companies with market capitalizations less than U.S. $1 billion at the
time of purchase. The one-year average currently contains 53 funds.

Lipper Mid-Cap Fund Average: This average consists of funds which, by prospectus
or portfolio practice, limit their investments to companies with average market
capitalizations and/or revenues between $800 million and the average market
capitalization of the Wilshire 4500 Index (as captured by the Vanguard Index
Extended Market Fund). The one-year average currently contains 302 funds.

Lipper International Fund Average: This average consists of funds which invest
in securities primarily traded in markets outside of the United States. The
one-year average currently contains 489 funds.

Lipper Real Estate Fund Average: This average consists of funds which invest 65%
of their equity portfolio in equity securities of domestic and foreign companies
engaged in the real estate industry. The one-year average currently contains 88
funds.

Lipper Small-Cap Fund Average: This average consists of funds which invest
primarily in companies with market capitalizations less than $1 billion at the
time of purchase. The one-year average currently contains 588 funds.

Lipper Utilities Fund Average: This average consists of funds which invest 65%
of their equity portfolio in utility shares. The one-year average currently
contains 100 funds.

Morgan Stanley EAFE (Europe, Australia and Far East) Index: This average
reflects an arithmetic, market value weighted average of performance of more
than 900 securities which are listed on the stock exchanges of the following
countries: Australia, Austria, Belgium, Denmark, Netherlands, New Zealand,
Norway, Singapore/Malaysia, Spain, Sweden, Switzerland, and the United Kingdom.

Morgan Stanley EMF (Emerging Markets Free) Index: This average is capitalization
weighted and consists of stocks from 26 countries. These countries include:
Argentina, Brazil, Chile, China Free, Columbia, Czech Republic, Greece, Hungary,
India, Indomesia Free, Israel, Jordan, Korea at 50%, Malaysia Free, Mexico Free,
Pakistan, Peru, Philippines Free, Poland, Portugal, South Africa, Sri Lanka,
Taiwan at 50%, Thailand Free, Turkey and Venezuela.

Morgan Stanley REIT Index: This is a capitalization-weighted index of the most
actively traded real estate investment trusts, and is designed to be a measure
of real estate equity performance.

Standard & Poor's 500 Stock Index: This is an unmanaged index of 500 widely held
common stocks representing industrial, financial, utility and transportation
companies listed on the New York Stock Exchange, American Stock Exchange and the
Over-the-Counter market.

Standard & Poor's 600 Index: This is a market-value weighted index consisting of
600 domestic stocks chosen for market size, liquidity and industry group
representation.

Note: Mutual fund data from Lipper Analytical Services, Inc.

Income-Oriented Funds

Principal Bond Fund
- -------------------
Scott Bennett

Comparison of Change in Value of $10,000 Investment in the Bond Fund Class A,
Lipper Corporate Debt BBB Rated Fund Average and Lehman Brothers BAA Corporate
Index

- -------------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- -------------------------------------------------
Class A 7.76% 6.95% 9.14%
Class B 7.04% 9.68%* -
Class R 7.05% 7.60%** -
- -------------------------------------------------

Lehman Lipper
Bond Baa BBB Corp.
Fund Index Average
------ ------ ---------
9,522 10,000 10,000
1989 10,623 11,236 10,944
1990 10,950 11,549 11,232
1991 12,706 13,641 13,151
1992 14,070 15,217 14,572
1993 16,211 17,635 16,773
1994 15,236 16,852 15,873
1995 18,242 20,111 18,154
1996 19,107 21,484 19,159
1997 21,047 23,667 20,993
1998 22,682 25,142 22,181

* Since Inception date 12/9/94
** Since Inception date 2/29/96

For the year ending October 31, 1998, the Principal Bond Fund outperformed its
competition and the Lehman Brothers BAA Corporate Index by posting strong
absolute returns during a period of market upheaval and general economic
uncertainty. Corporate bonds, which make up the bulk of the Fund's holdings,
benefited from lower Treasury rates over the past year. However, they have been
impacted by investor fears of an expansion of the global economic slowdown and
problems in the financial markets. This has resulted in extreme investor risk
aversion as evidenced by U.S. Treasuries being the star performer of the bond
market during the past year. Because of these fears, corporate bonds have
underperformed Treasuries as buyers demanded a much greater premium to hold
corporates. This extreme bias towards Treasuries eased in the last several weeks
of October allowing corporates to improve their relative performance.

Principal Bond Fund has performed well in this environment by increasing the
credit quality of the portfolio, maintaining a somewhat longer duration than its
peers and continuing to focus on domestic companies. The biggest contributor to
the outperformance during the past year has been the increased quality emphasis
of the portfolio with 33% of the portfolio rated A- or higher including 4% which
is rated AAA. This has been significant as the higher the credit quality, the
higher the return during the past year. The bulk of the higher-rated bonds in
the Fund are in liquid instruments which can be sold quickly and reinvested in
higher yielding investments as market conditions improve.

Principal Government Securities Income Fund
- -------------------------------------------
Marty Schafer

Comparison of Change in Value of $10,000 Investment in the Government Securities
Income Fund Class A, Lipper GNMA Fund Average and Lehman Brothers GNMA Inex

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 7.38% 6.49% 8.61%
Class B 6.60% 9.30%* -
Class R 6.66% 6.98%** -
- --------------------------------------------

Government Lehman Lipper
Securities GNMA GNMA
Income Fund Index Average
9,521 10,000 10,000
1989 10,554 11,142 10,976
1990 11,206 12,067 11,777
1991 13,085 14,129 13,536
1992 14,111 15,371 14,660
1993 15,776 16,536 15,851
1994 14,789 16,281 15,363
1995 17,370 18,755 17,458
1996 18,423 20,096 18,427
1997 20,124 21,946 19,973
1998 21,609 23,520 21,325

* Since Inception date 12/9/94
** Since Inception date 2/29/96

Being long in duration* and fully invested set the stage for a very respectable
year. For three quarters of the past year, the economy was led by reasonable
growth, shrinking federal deficits and non-threatening inflation which pushed
interest rates lower. However, the fourth quarter was marked by financial
turmoil which wreaked havoc in the U.S. bond and stock markets. This was
followed by an unprecedented contraction in liquidity and dramatically wider
spreads across all fixed income products. Nevertheless, the Fund's disciplined
and long-term investment approach, combined with its long-term economic
forecast, has produced a very solid performance. For the year ended October 31,
1998, the Fund outperformed both the Lipper and Lehman Indices.

Fund management continues to believe the current portfolio is well positioned
for the period ahead. Value is added by selecting undervalued mortgage-backed
securities, combined with adjusting the duration of the portfolio as needed. As
of October 31, 1998, the duration of the fund was 3.34 years versus the index of
2.05 years. Given the absolute level of current interest rates, we plan on
moving the fund duration closer to the index over the coming quarters.

Principal High Yield Fund
- -------------------------
Mark Denkinger

Comparison of Change in Value of $10,000 Investment in the High Yield Fund Class
A, Lipper High Current Yield Fund Average and Lehman Brothers High Yield
Composite Bond Index

- -----------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- -----------------------------------------------
Class A -3.18% 6.64% 6.86%
Class B -3.93% 7.50%* -
Class R -3.97% 4.59%** -
- -----------------------------------------------

Lehman Lipper
High High Yield High Yield
Yield Fund Index Average
---------- ---------- ----------
9,526 10,000 10,000
1989 9,779 10,195 10,111
1990 8,360 8,885 8,875
1991 10,499 13,209 12,101
1992 12,091 15,224 14,084
1993 13,399 17,949 16,911
1994 13,593 18,168 16,841
1995 15,187 21,016 19,065
1996 16,992 23,349 21,476
1997 19,086 26,553 24,582
1998 18,479 26,420 23,758

* Since Inception date 12/9/94
** Since Inception date 2/29/96

After several years of strong returns, the high yield market underperformed its
fixed income counterparts for the year ended October 31, 1998. Principal High
Yield Fund posted a total return of -3.18% for the year. This performance
trailed the Lehman Brothers High Yield Index return of -.50%, but slightly
outperformed the Lipper High Current Yield Fund Average of -3.35%. The relative
performance was negatively impacted by the Fund's exposure to Indonesia in the
first half the year. After seeing spreads continue to narrow for the first three
quarters of the year, spreads widened substantially in the fourth quarter.
August was one of the worst performing months in high yield history as the Fund
returned -6.58%. With financial problems throughout Asia, Russia and Latin
America continuing, investors became risk averse and looked to U.S. Treasuries
as a safe haven. High yield securities were adversely impacted with these market
conditions and followed the equity markets lower. Unlike other fixed income
securities, high yield securities have a higher correlation to the equity market
than to interest rates.

The high yield market was very active for most of 1998. New issues continued at
a frivolous pace setting new records each month. This new issue volume, combined
with historically low default rates, low inflation and a strong economy
continued to make the high yield market attractive for the first half of fiscal
1998. The August market downturn changed all this, and spreads widened
substantially and new issues came to a halt. Returns turned negative and the
outlook was grim heading into October. October experienced a dramatic change in
tone from the first to second halves of the month. The first half of October
continued negative returns and spread widening. During the second half, market
returns were decidedly positive and spreads narrowed as confidence and money
flows returned to the market. With default rates remaining low, it became
evident that current spreads were more than compensating for the potential risks
in the market.

Principal High Yield Fund maintains a BB- average quality. While Fund managers
have increased the exposure to CCC quality and non-rated securities during the
year, the overall quality of the portfolio has not significantly changed. This
is a relatively conservative risk position compared to other funds in the high
yield market and worked to the Fund's benefit during these troubling times.
Going forward, Fund managers will be more willing to lower the quality of the
Fund when market conditions warrant the increased risk. Throughout 1998, the
number of bonds in the portfolio has been reduced and the focus on sector
diversification has been renewed. At October 31, 1998, the Fund was well
diversified among 50 bonds of various sectors and it is currently overweighted
in telecommunication/media. Also, exposure to securities of a cyclical nature
has been reduced in anticipation of a slower economy. Principal High Yield Fund
continues to demonstrate its worth as an asset class that can enhance overall
portfolio diversification and returns.

Principal Limited Term Bond Fund
- --------------------------------
Marty Schafer

Comparison of Change in Value of $10,000 Investment in the Limited Term Bond
Fund, Lipper Short-Intermediate Investment Grade Debt Fund Average and Lehman
Brothers Intermediate Government/Corporate Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 6.57% 6.36%* -
Class B 6.24% 5.95%* -
Class R 6.12% 5.77%* -
- --------------------------------------------

Limited Term Limited Term
Bond Fund Bond Fund
Class A Class B
------------ ------------
9,851 10,000
1996 10,208 10,332
1997 10,897 10,985
1998 11,614 11,670

Limited Term Lehman Brothers Lipper Intermediate
Bond Fund Government Corporate Investment Grade
Class R Intermediate Index Bond Fund Average
------------ -------------------- -------------------
10,000 10,000 10,000
1996 10,324 10,368 10,357
1997 10,944 11,145 11,032
1998 11,615 12,161 11,801

* Since Inception date 2/29/96

Principal Limited Term Bond Fund continues to be an investment well suited for
those investors looking to improve on lower yielding money markets funds and
similar investments.

Fund managers kept duration shorter than the benchmarks and produced returns
through asset selection. For the year, this process led to slightly below
average performance as rates fell; again showing duration dominates performance.
Absolute returns for fixed income sectors (not including treasuries) were solid
for the year, however, in comparison to treasuries it was a poor year.

For three quarters of the past year the economy was led by reasonable growth,
shrinking federal deficits and non-threatening inflation which pushed interest
rates lower. However, the fourth quarter was marked by financial turmoil which
wreaked havoc in the U.S. bond and stock markets. Investor confidence was
undermined by: Asia, Russia, Latin America, hedge funds, supply stock market,
etc. There was only one place for many investors to hide - U.S. Treasuries.

Fund strategy continues to stay fully invested, find the best value among
various short-term fixed income securities, maintain high credit quality
standards and manage duration within the target range.

Principal Tax-Exempt Bond Fund
- ------------------------------
Dan Garrett

Comparison of Change in Value of $10,000 Investment in the Tax-Exempt Bond Fund
Class A, Lipper General Municipal Debt Tax-Exempt Bond Fund Average and Lehman
Brothers Municipal Bond Index

- --------------------------------------------
Total Returns
As of October 31, 1998
1 Year 5 Year 10 Year
- --------------------------------------------
Class A 6.76% 5.75% 7.79%
Class B 6.01% 9.47%* -
- --------------------------------------------

Lehman Lipper
Tax-Exempt Municipal General
Bond Fund Bond Index Municipal Debt
---------- ---------- --------------
9,523 10,000 10,000
1989 10,471 10,811 10,779
1990 10,895 11,613 11,376
1991 12,322 13,027 12,775
1992 13,212 14,119 13,720
1993 15,215 16,107 15,839
1994 14,087 15,405 14,911
1995 16,345 17,691 16,954
1996 17,339 18,700 17,820
1997 18,849 20,287 19,267
1998 20,124 21,914 20,639

Note: Past performance is not predictive of future performance. The performance
of Class B will vary from the performance of Class A shares based on the
differences in loads and fees.

* Since Inception date 12/9/94

Principal Tax-Exempt Bond Fund strives to provide income free from federal tax
while preserving capital. The financial markets were quite volatile the past few
months. For disciplined investors, these gyrations were reminders of why
long-term goals and asset allocation are sound ideas.

Supported by strong local and state budget surpluses and ongoing growth in the
domestic economy, municipal bond values were steadier than other bond sectors
during this turmoil. The Fund focuses on projects for the public good (e.g.,
utilities, industrial pollution control) where the revenues for debt service is
tied to corporate guarantees. These bonds tend to provide higher income than the
average bond in both the Lehman Municipal Bond Index and the Fund's Lipper peer
group with only a slightly higher risk. With fears of global market turmoil,
markets have seen the risk premium's increase reflected in lower prices. The
less liquid a bond (the ability to find a buyer), the more severe the price
drop.

The Fund has a slightly lower credit quality (average rating A) than its Lipper
peers (AA) or the Lehman Index (AA). This resulted in lower average prices on
the Fund's holdings for the past few months. This underperformance is slight and
covers a few months when fears of extreme credit market turmoil prevailed. This
fear has since been calmed by moves of the Fed and other global banks to lower
rates ensuring that markets will function, credit will be available for
businesses and consumers at reasonable rates, and financial markets will provide
liquidity for securities trading. As risk premiums have come down, the Fund's
holdings have risen faster than its peers.

Looking forward, the U.S. economy shows signs of continued low inflation with
steady growth. The Fund's holdings in higher coupon revenue bonds should
continue to provide positive relative return compared to the broader municipal
market and the Fund's peers. The Fund's disciplined approach continues to
provide good value for those seeking high tax-exempt income.

Principal Cash Management Fund
Principal Tax-Exempt Cash Management Fund
- -----------------------------------------
Mike Johnson Steve Schneider

On September 29, 1998, at the Federal Open Market Committee (FOMC) meeting, the
Federal Reserve cut its targeted Fed Funds rate** by .25% to 5.25%. Two weeks
later the Fed stepped in again and cut Fed funds by an additional .25% to 5.00%.
These were the first Fed funds adjustments to take place since March 1997 and
the first downward moves since January 1996. The rate cuts were aimed at easing
the effects of a global slowdown on the U.S. economy. Rates had been holding
quite steady through the year until Alan Greenspan began dropping hints about a
potential rate cut. Following these comments, the market began pricing in a .25%
to .50% downward adjustment in rates. The industry's average maturity for the
bulk of fiscal 1998 was in the high 50 and 60+ day area. The Funds strove to
stay on top of the industry average. However, due to a planned early May
redemption resulting from the transition of certain "sweep accounts" (short-term
balances of customers of securities dealers) to another fund organization the
Funds' average days lagged significantly. Barring unusual circumstances, Fund
management actively monitors the industry averages to keep both yields and
average maturities in line. Both funds continue to invest from a list of high
credit quality investments that is carefully monitored.

Investment in the money market funds is neither insured nor guaranteed by the
U.S. Government. While the Funds strive to maintain a $1.00 per share net asset
value, it is possible to lose money by investing in them.

Principal Tax-Exempt Cash Management Fund income dividends are exempt from
federal taxation but may not be exempt from state and local taxes. The
alternative minimum tax applies to some investors.

Important Notes for Income-Oriented Funds:

Greater credit risks are inherent in a fund which invests primarily in high
yield bonds.

* Duration is the dollar weighted, present value of cash flows, principal and
interest, expressed in time.

** The Fed Funds rate is the rate at which banks lend to each other on an
overnight basis.

Lehman Brothers Baa Corporate Index: An unmanaged index of all publicly issued,
fixed-rate, nonconvertible, dollar-denominated, SEC-registered corporate debt
rated Baa or BBB by Moody's or Standard & Poor's.

Lehman Brothers GNMA Index: An unmanaged index of 15- and 30-year fixed-rate
securities backed by mortgage pools of the Government National Mortgage
Association (GNMA) and Graduated Payment Mortgages (GPMs) with at least $100
million outstanding and one year or more to maturity.

Lehman Brothers High Yield Composite Bond Index: An unmanaged index of all
publicly issued fixed, dollar-denominated, SEC-registered corporate debt rated
Ba1 or lower with at least $100 million outstanding and one year or more to
maturity.

Lehman Brothers Intermediate Government/Corporate Index: An unmanaged index of
U. S. Government agency and Treasury securities and investment-grade corporate
debt securities with maturities of five to ten years.

Lehman Brothers Municipal Bond Index: An unmanaged index of investment-grade,
tax-exempt bonds which have been issued within the last five years and at least
one year or more to maturity. This index is classified into four main sectors:
General Obligation, Revenue, Insured and Prerefunded.

Lipper Corporate Debt BBB Rated Fund Average: This average consists of funds
which invest at least 65% of their assets in corporate and government debt
issues rated in the top four grades. The one-year average currently contains 91
funds.

Lipper General Municipal Debt Fund Average: This average consists of funds which
invest at least 65% of their assets in municipal debt issues in the top four
credit ratings. The one-year average currently contains 239 funds.

Lipper GNMA Fund Average: This average consists of funds which invest a least
65% of their assets in Government National Mortgage Association securities. The
one-year average currently contains 51 funds.

Lipper High Current Yield Fund Average: This average consists of funds which aim
at high (relative) current yield from fixed-income securities. No quality or
maturity restrictions. They tend to invest in lower grade debt issues. The
one-year average currently contains 235 funds.

Lipper Short-Intermediate Investment Grade Debt Fund Average: This average
consists of funds which invest at least 65% of their assets in investment-grade
debt issues rated in the top four grades with dollar-weighted average maturities
of one to five years. The one-year average currently contains 94 funds.

Note: Mutual fund data from Lipper Analytical Services, Inc.
October 31, 1998

STATEMENTS OF ASSETS AND LIABILITIES

Principal Principal Principal Principal Principal Principal
Balanced Blue Chip Capital Value Growth MidCap Real Estate
GROWTH FUNDS (DOMESTIC) Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc.

Investment in securities
<S> <C> <C> <C> <C> <C> <C>
-- at cost $125,244,229 $155,325,151 $478,777,622 $305,883,113 $332,380,783 $12,930,842

Assets
Investment in securities
-- at value (Note 4) $140,184,928 $192,975,605 $642,787,372 $500,523,733 $428,959,431 $11,535,535
Cash........................ 2,002 2,007 2,671 2,032 6,877 2,195
Receivables:
Dividends and interest.... 829,209 111,884 1,018,354 467,753 196,306 16,877
Investment securities sold 1,711,697 320,900 3,600,782 -- -- --
Capital Stock sold........ 201,239 658,133 702,535 951,013 419,030 4,297
Other assets................ 3,953 708 25,013 8,637 3,395 --

Total Assets 142,933,028 194,069,237 648,136,727 501,953,168 429,585,039 11,558,904
Liabilities
Accrued expenses............ 111,941 46,689 354,341 319,251 364,182 21,167
Payables:
Investment securities
purchased -- -- -- 9,438,610 4,054,794 --
Capital Stock reacquired.. 43,420 188,017 290,179 875,158 326,224 --

Total Liabilities 155,361 234,706 644,520 10,633,019 4,745,200 21,167

Net Assets Applicable to
Outstanding Shares.......... 142,777,667 $193,834,531 $647,492,207 $491,320,149 $424,839,839 $11,537,737

Net Assets Consist of:
Capital Stock............... $ 93,597 $89,454 $208,612 $ 87,647 $ 106,816 $ 13,750
Additional paid-in capital.. 122,961,011 156,056,332 439,309,526 300,079,580 328,552,043 13,496,703
Accumulated undistributed
net investment income..... 500,739 607 3,066,439 982,816 -- 35,698
Accumulated undistributed
net realized gain (loss)
on investment
transactions...... 4,281,621 37,684 40,897,880 (4,470,514) (397,668) (613,107)
Net unrealized appreciation
(depreciation)of
investments.. 14,940,699 37,650,454 164,009,750 194,640,620 96,578,648 (1,395,307)

Total Net Assets $142,777,667 $193,834,531 $647,492,207 $491,320,149 $424,839,839 $11,537,737

Capital Stock
(par value: $.01 a share):
Shares authorized.......... 100,000,000 100,000,000 100,000,000 100,000,000 100,000,000 100,000,000

Net Asset Value Per Share:
Class A:
Net Assets............... $104,414,116 $126,740,153 $565,052,308 $395,954,359 $332,942,120 $ 5,489,536
Shares issued and
outstanding............ 6,832,891 5,837,421 18,189,057 7,059,140 8,344,793 654,401
Net asset value per
share... $15.28 $21.71 $31.07 $56.09 $39.90 $8.39
Maximum offering price
per share(a).......... $16.04 $22.79 $32.62 $58.89 $41.89 $8.81

Class B:
Net Assets.............. $18,929,793 $34,223,360 $44,764,507 $64,808,709 $68,357,748 $3,119,646
Shares issued and
outstanding........... 1,243,950 1,587,969 1,448,791 1,157,692 1,739,784 372,195
Net asset value
per share(b).......... $15.22 $21.55 $30.90 $55.98 $39.29 $8.38

Class R:
Net Assets........ $19,433,758 $32,871,018 $37,675,392 $30,557,081 $23,539,971 $2,928,555
Shares issued and
outstanding 1,282,856 1,520,018 1,223,310 547,909 596,991 348,440
Net asset value per
share $15.15 $21.63 $30.80 $55.77 $39.43 $8.40

<FN>
(a) Maximum offering price is equal to net asset value plus a front-end sales
charge of 4.75% of the offering price or 4.99% of the net asset value.
(b) Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charge.
</FN>
See accompanying notes.
</TABLE>

October 31, 1998

STATEMENTS OF ASSETS AND LIABILITIES

Principal Principal
SmallCap Utilities
GROWTH FUNDS (DOMESTIC) Fund, Inc. Fund, Inc.

Investment in securities
-- at cost $33,007,985 $68,557,497

Assets
Investment in securities
-- at value (Note 4) $29,620,107 $98,511,173
Cash........................ 3,088 30,500
Receivables:
Dividends and interest.... 4,679 336,744
Investment securities sold -- --
Capital Stock sold........ 235,364 201,826
Other assets................ 21 514

Total Assets 29,863,259 99,080,757
Liabilities
Accrued expenses............ 32,840 112,172
Payables:
Investment securities
purchased -- --
Capital Stock reacquired.. 53,976 39,790

Total Liabilities 86,816 151,962

Net Assets Applicable to
Outstanding Shares.......... $29,776,443 $98,928,795

Net Assets Consist of:
Capital Stock............... $ 35,322 $ 61,406
Additional paid-in capital.. 34,355,800 67,157,974
Accumulated undistributed
net investment income..... -- 280,319
Accumulated undistributed
net realized gain (loss)
on investment
transactions...... (1,226,801) 1,475,420
Net unrealized appreciation
(depreciation)of
investments.. (3,387,878) 29,953,676

Total Net Assets $29,776,443 $98,928,795

Capital Stock
(par value: $.01 a share):
Shares authorized.......... 100,000,000 100,000,000

Net Asset Value Per Share:
Class A:
Net Assets............... $18,437,838 $83,533,366
Shares issued and
outstanding............ 2,186,171 5,183,590
Net asset value per
share... $8.43 $16.11
Maximum offering price
per share(a).......... $8.85 $16.91

Class B:
Net Assets.............. $6,650,394 $11,390,675
Shares issued and
outstanding........... 791,193 707,750
Net asset value
per share(b).......... $8.41 $16.09

Class R:
Net Assets........ $4,688,211 $4,004,754
Shares issued and
outstanding 554,813 249,210
Net asset value per
share $8.45 $16.07

(a) Maximum offering price is equal to net asset value plus a front-end sales
charge of 4.75% of the offering price or 4.99% of the net asset value.
(b) Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charge.

See accompanying notes.

Year Ended October 31, 1998, Except as Noted

STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>

Principal Principal Principal Principal Principal
Balanced Blue Chip Capital Value Growth MidCap
GROWTH FUNDS (DOMESTIC) Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc.

Net Investment Income
Income:
Dividends................................... $ 1,386,241 $ 2,704,996 $ 14,038,593 4,527,977 3,036,707
Interest.................................... 3,893,561 283,944 822,481 2,792,407 1,865,304

Total Income 5,279,802 2,988,940 14,861,074 7,320,384 4,902,011
Expenses:
Management and investment advisory fees (Note 3) 750,616 764,784 2,349,118 1,863,070 2,548,924
Distribution and shareholder servicing
fees (Notes 1 and 3)..................... 497,017 704,240 1,313,474 1,346,009 1,525,106
Transfer and administrative services
(Notes 1 and 3)......................... 521,852 832,394 1,247,865 1,421,948 1,840,474
Registration fees (Note 1).................. 48,742 89,529 110,642 89,906 101,101
Custodian fees.............................. 5,061 3,970 2,460 4,244 4,821
Auditing and legal fees..................... 6,392 7,422 6,175 10,717 8,342
Directors' fees............................. 7,384 7,385 7,372 7,446 7,371
Other....................................... 9,028 11,443 39,501 29,568 33,839

Total Gross Expenses 1,846,092 2,421,167 5,076,607 4,772,908 6,069,978
Less: Management and investment
advisory fees waived............... -- -- -- -- --

Total Net Expenses 1,846,092 2,421,167 5,076,607 4,772,908 6,069,978

Net Investment Income (Operating Loss) 3,433,710 567,773 9,784,467 2,547,476 (1,167,967)

Net Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) from investment
transactions 4,283,465 21,090 40,907,350 (4,470,515) (397,666)
Net realized gains from other investment
companies .................................. -- -- -- -- --
Change in unrealized appreciation/
depreciation of investments.............. 4,621,248 23,303,399 33,306,303 58,299,881 (47,859,461)

Net Realized and Unrealized
Gain (Loss) on Investments 8,904,713 23,324,489 74,213,653 53,829,366 (48,257,127)

Net Increase (Decrease) in Net Assets
Resulting from Operations $12,338,423 $23,892,262 $83,998,120 $56,376,842 (49,425,094)

<FN>
(a)Period from December 11, 1997 (date operations commenced) through October
31, 1998.

See accompanying notes.
</FN>
</TABLE>

Year Ended October 31, 1998, Except as Noted

STATEMENTS OF OPERATIONS

Principal Principal Principal
Real Estate SmallCap Utilities
GROWTH FUNDS (DOMESTIC) Fund, Inc.(a) Fund, Inc.(a) Fund, Inc

Net Investment Income
Income:
Dividends................................... 438,265 74,378 $3,334,804
Interest.................................... 68,103 103,891 104,549

Total Income 506,368 178,269 3,439,353
Expenses:
Management and investment advisory fees (Note 3) 87,653 147,083 531,644
Distribution and shareholder servicing
fees (Notes 1 and 3)..................... 33,946 75,049 294,281
Transfer and administrative services
(Notes 1 and 3)......................... 76,546 199,807 304,813
Registration fees (Note 1).................. 3,977 3,039 31,613
Custodian fees.............................. 1,746 4,493 1,789
Auditing and legal fees..................... 6,256 3,849 4,899
Directors' fees............................. 2,775 2,700 7,385
Other....................................... 1,300 514 5,987

Total Gross Expenses 214,199 436,534 1,182,411
Less: Management and investment
advisory fees waived............... -- -- 82,515

Total Net Expenses 214,199 436,534 1,099,896

Net Investment Income (Operating Loss) 292,169 (258,265) 2,339,457

Net Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) from investment
transactions (631,002) (1,226,801) 1,540,023
Net realized gains from other investment
companies .................................. 17,895 -- --
Change in unrealized appreciation/
depreciation of investments.............. (1,395,307) (3,387,878) 19,641,699

Net Realized and Unrealized
Gain (Loss) on Investments (2,008,414) (4,614,679) 21,181,722

Net Increase (Decrease) in Net Assets
Resulting from Operations $(1,716,245) $(4,872,944) $23,521,179

<FN>
(a)Period from December 11, 1997 (date operations commenced) through October
31, 1998.

See accompanying notes.
</FN>
</TABLE>

Years Ended October 31, Except as Noted

STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Principal Principal Principal
Balanced Blue Chip Capital Value
GROWTH FUNDS (DOMESTIC) Fund, Inc. Fund, Inc. Fund, Inc.
1998 1997 1998 1997 1998 1997
Operations
<S> <C> <C> <C> <C> <C> <C>

Net investment income(operating loss) 3,433,710 2,134,586 567,773 773,899 9,784,467 9,136,213
Net realized gain (loss) from
investment transactions 4,283,465 7,456,891 21,090 12,146,669 40,907,350 44,903,311
Change in unrealized appreciation/
depreciation of investments 4,621,248 3,601,722 23,303,399 617,291 33,306,303 57,109,297
Net Increase (Decrease) in Net Assets
Resulting from Operations 12,338,423 13,193,199 23,892,262 13,537,859 83,998,120 111,148,821

Dividends and Distributions to Shareholders
From net investment income:
Class A.................................... (2,435,139) (1,962,353) (571,140) (664,560) (9,413,649) (8,406,934)
Class B ................................... (269,151) (152,316) (21,463) (25,978) (302,359) (131,991)
Class R.................................... (300,221) (102,915) (42,466) (42,305) (272,715) (86,476)
From net realized gain on investments:
Class A ................................... (5,882,074) (6,130,810) (8,442,806) (1,212,100) (40,827,739) (60,902,870)
Class B ................................... (842,073) (566,868) (1,993,541) (188,032) (2,381,772) (1,471,954)
Class R.................................... (725,965) (112,915) (1,692,630) (55,610) (1,697,455) (338,789)
Tax return of capital distributions:
Class A ................................... -- -- -- -- -- --
Class B ................................... -- -- -- -- -- --
Class R.................................... -- -- -- -- -- --

Total Dividends and Distributions (10,454,623) (9,028,177) (12,764,046) (2,188,585) (54,895,689) (71,339,014)

Capital Share Transactions (Note 5)
Shares sold:
Class A.................................... 23,880,103 21,449,772 46,354,686 34,250,614 73,344,881 57,963,775
Class B ................................... 8,010,824 5,741,685 15,736,209 11,442,392 17,966,775 15,764,589
Class R.................................... 11,459,488 9,101,517 18,838,628 14,353,877 22,090,590 16,511,369
Shares issued in reinvestment of dividends and
distributions:
Class A.................................... 8,093,981 7,361,276 8,730,513 1,791,093 49,153,586 68,083,831
Class B ................................... 1,101,436 712,904 2,000,486 211,943 2,633,936 1,583,642
Class R.................................... 1,026,031 215,722 1,734,897 97,891 2,028,417 425,209
Shares redeemed:
Class A ................................... (14,404,904) (17,550,684) (15,983,191) (9,512,640) (78,578,133) (103,901,296)
Class B ................................... (2,320,820) (943,794) (3,609,645) (1,463,536) (4,560,133) (1,795,682)
Class R ................................... (3,017,907) (846,178) (4,847,775) (1,259,802) (5,699,984) (1,636,526)

Net Increase (Decrease) in Net Assets
from Capital Share Transactions 33,828,232 25,242,220 68,954,808 49,911,832 78,379,935 52,998,911

Total Increase 35,712,032 29,407,242 80,083,024 61,261,106 107,482,366 92,808,718

Net Assets
Beginning of period........................... 107,065,635 77,658,393 113,751,507 52,490,401 540,009,841 447,201,123
End of period [including undistributed
net investment income as set forth below]... 142,777,667 107,065,635 193,834,531 113,751,507 647,492,207 540,009,841

Undistributed Net Investment Income ........... 500,739 75,127 607 79,494 3,066,439 3,270,973
<FN>
(a) Period from December 11, 1997 (date operations commenced) through
October 31, 1998.

See accompanying notes.
</FN>
</TABLE>
Years Ended October 31, Except as Noted

STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>

Principal Principal Principal
Growth MidCap Real Estate
GROWTH FUNDS (DOMESTIC) Fund, Inc. Fund, Inc. Fund, Inc.
1998 1997 1998 1997 1998(a)
Operations
<S> <C> <C> <C> <C> <C>
Net investment income(operating loss) 2,547,476 2,008,065 (1,167,967) 419,786 292,169
Net realized gain (loss) from
investment transactions (4,470,515) 11,213,338 (397,666) 10,456,322 (613,107)
Change in unrealized appreciation/
depreciation of investments 58,299,881 65,942,389 (47,859,461) 80,084,426 (1,395,307)
Net Increase (Decrease) in Net Assets
Resulting from Operations 56,376,842 79,163,792 (49,425,094) 90,960,534 (1,716,245)

Dividends and Distributions to Shareholders
From net investment income:
Class A.................................... (2,281,014) (1,853,254) -- (741,359) (118,861)
Class B ................................... (84,298) (14,911) -- (4,780) (70,429)
Class R.................................... (5,786) (8,766) -- (594) (67,181)
From net realized gain on investments:
Class A ................................... (9,421,497) (2,178,840) (8,489,268) (7,708,737) --
Class B ................................... (1,280,548) (232,571) (1,505,719) (989,543) --
Class R.................................... (518,291) (27,607) (456,798) (95,503) --
Tax return of capital distributions:
Class A ................................... -- -- (3,831) -- --
Class B ................................... -- -- (351) -- --
Class R.................................... -- -- (114) -- --

Total Dividends and Distributions (13,591,434) (4,315,949) (10,456,081) (9,540,516) (256,471)

Capital Share Transactions (Note 5)
Shares sold:
Class A.................................... 80,738,775 54,732,684 84,673,707 76,822,359 6,657,527
Class B ................................... 23,436,918 14,638,635 26,339,797 24,764,751 3,740,670
Class R.................................... 16,186,162 13,558,095 14,593,610 14,520,116 3,419,415
Shares issued in reinvestment of dividends and
distributions:
Class A.................................... 11,393,839 3,915,241 8,301,363 8,245,913 117,899
Class B ................................... 1,340,964 244,569 1,491,031 981,686 72,055
Class R.................................... 524,005 36,360 456,912 96,080 69,699
Shares redeemed:
Class A ................................... (49,829,917) (35,146,370) (60,048,924)(36,719,008) (394,690)
Class B ................................... (6,849,158) (4,184,396) (9,249,916) (4,945,062) (118,103)
Class R ................................... (4,298,409) (1,144,394) (5,504,466) (1,479,854) (54,019)

Net Increase (Decrease) in Net Assets
from Capital Share Transactions 72,643,179 46,650,424 61,053,114 82,286,981 13,510,453

Total Increase 115,428,587 121,498,267 1,171,939 163,706,999 11,537,737

Net Assets
Beginning of period........................... 375,891,562 254,393,295 423,667,900 259,960,901 --
End of period [including undistributed
net investment income as set forth below]... 491,320,149 375,891,562 424,839,839 423,667,900 11,537,737

Undistributed Net Investment Income .......... 982,816 813,820 -- 36,047 35,698

<FN>
(a) Period from December 11, 1997 (date operations commenced) through
October 31, 1998.

See accompanying notes.
</FN>
</TABLE>

Years Ended October 31, Except as Noted

STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>

Principal Principal
SmallCap Utilities
GROWTH FUNDS (DOMESTIC) Fund, Inc. Fund, Inc.
1998(a) 1998 1997
Operations
<S> <C> <C> <C>
Net investment income(operating loss) (258,265) 2,339,457 2,768,051
Net realized gain (loss) from
investment transactions (1,226,801) 1,540,023 1,274,214
Change in unrealized appreciation/
depreciation of investments (3,387,878) 19,641,699 5,564,046
Net Increase (Decrease) in Net Assets
Resulting from Operations (4,872,944) 23,521,179 9,606,311

Dividends and Distributions to Shareholders
From net investment income:
Class A.................................... -- (2,238,576) (2,431,314)
Class B ................................... -- (202,869) (183,927)
Class R.................................... -- (59,525) (28,627)
From net realized gain on investments:
Class A ................................... -- -- --
Class B ................................... -- -- --
Class R.................................... -- -- --
Tax return of capital distributions:
Class A ................................... (4,160) -- --
Class B ................................... (3,120) -- --
Class R.................................... (3,120) -- --

Total Dividends and Distributions (10,400) (2,500,970) (2,643,868)

Capital Share Transactions (Note 5)
Shares sold:
Class A.................................... 22,354,702 12,723,975 5,270,881
Class B ................................... 8,073,780 4,293,220 2,196,079
Class R.................................... 5,958,145 2,547,194 1,364,313
Shares issued in reinvestment of dividends and
distributions:
Class A.................................... 4,160 1,973,186 2,147,554
Class B ................................... 3,120 182,379 165,257
Class R.................................... 3,120 59,486 28,603
Shares redeemed:
Class A ................................... (967,357) (13,805,582) (15,663,584)
Class B ................................... (232,397) (2,155,400) (1,595,827)
Class R ................................... (537,486) (725,248) (272,901)

Net Increase (Decrease) in Net Assets
from Capital Share Transactions 34,659,787 5,093,210 (6,359,625)

Total Increase 29,776,443 26,113,419 602,818

Net Assets
Beginning of period........................... -- 72,815,376 72,212,558
End of period [including undistributed
net investment income as set forth below]... 29,776,443 98,928,795 72,815,376

Undistributed Net Investment Income ........... -- 280,319 445,581

<FN>
(a) Period from December 11, 1997 (date operations commenced) through
October 31, 1998.

See accompanying notes.
</FN>
</TABLE>

October 31, 1998

NOTES TO FINANCIAL STATEMENTS

Note 1 -- Significant Accounting Policies

Principal Balanced Fund, Inc., Principal Blue Chip Fund, Inc., Principal Capital
Value Fund, Inc., Principal Growth Fund, Inc., Principal MidCap Fund, Inc.,
Principal Real Estate Fund, Inc., Principal SmallCap Fund, Inc. and Principal
Utilities Fund, Inc. (the "Domestic Growth Funds") are registered under the
Investment Company Act of 1940, as amended, as open-end diversified management
investment companies and operate in the mutual fund industry.

Effective January 1, 1998, the following changes were made to the names of the
Domestic Growth Funds:

Former Fund Name New Fund Name
- -------------------------------------- ----------------------------------
Princor Balanced Fund, Inc. Principal Balanced Fund, Inc.
Princor Blue Chip Fund, Inc. Principal Blue Chip Fund, Inc.
Princor Capital Accumulation Fund, Inc. Principal Capital Value Fund, Inc.
Princor Growth Fund, Inc. Principal Growth Fund, Inc.
Princor Emerging Growth Fund, Inc. Principal MidCap Fund, Inc.
Princor Utilities Fund, Inc. Principal Utilities Fund, Inc.

On December 11, 1997, the initial purchases of 400,000 shares of Class A Capital
Stock, 300,000 shares of Class B Capital Stock and 300,000 shares of Class R
Capital Stock of each of Principal Real Estate Fund, Inc. and Principal SmallCap
Fund, Inc. were made by Principal Life Insurance Company (formerly known as
Principal Mutual Life Insurance Company) (see Note 3). Effective December 31,
1997, Principal Real Estate Fund, Inc. and Principal SmallCap Fund, Inc. each
began offering Class A and Class B shares to the public and Class R shares to
eligible purchasers.

Class A shares generally are sold with an initial sales charge based on
declining rates and certain purchases may be subject to a contingent deferred
sales charge ("CDSC"). Class B shares are sold without an initial sales charge,
but are subject to a declining CDSC on certain redemptions made within six years
of purchase. Class R shares are sold without an initial sales charge and are not
subject to a CDSC. Class B shares and Class R shares bear higher ongoing
distribution fees than Class A shares. Class B shares automatically convert into
Class A shares, based on relative net asset value (without a sales charge) after
seven years. Class R shares automatically convert into Class A shares, based on
relative net asset value (without a sales charge) after four years. All classes
of shares for each fund represent interests in the same portfolio of
investments, and will vote together as a single class except where otherwise
required by law or as determined by each of the Domestic Growth Funds'
respective Board of Directors. In addition, the Board of Directors of each fund
declares separate dividends on each class of shares.

The Domestic Growth Funds allocate daily all income, expenses (other than
class-specific expenses), and realized and unrealized gains or losses to each
class of shares based upon the relative proportion of the value of shares
outstanding of each class. Expenses specifically attributable to a particular
class are charged directly to such class. Class-specific expenses charged to
each class during the periods ended October 31, 1998, which are included in the
corresponding captions of the Statement of Operations, were as follows:
<TABLE>
<CAPTION>

Distribution and Transfer and
Shareholder Servicing Fees Administrative Services Registration Fees
Class A Class B Class R Class A Class B Class R Class A Class B Class R
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Principal Balanced Fund, Inc. 241,795 140,18 115,035 121,030 28,933 25,380 12,833 7,101 9,962
Principal Blue Chip Fund, Inc. 265,449 247,915 190,876 139,580 44,191 36,727 31,197 11,989 13,307
Principal Capital Value Fund, Inc. 789,870 296,909 226,695 341,696 59,885 54,503 36,224 16,356 13,383
Principal Growth Fund, Inc. 790,328 367,515 188,166 450,403 95,041 46,878 30,541 10,811 11,436
Principal MidCap Fund, Inc. 869,425 483,775 171,906 516,585 123,162 59,007 26,629 13,205 11,889
Principal Real Estate Fund, Inc. 13,607 16,949 3,390 2,520 1,036 403 1,700 287 1,684
Principal SmallCap Fund, Inc. 40,552 30,209 4,288 15,514 4,511 1,153 1,401 1,201 102
Principal Utilities Fund, Inc. 191,411 82,003 20,867 78,984 13,075 6,383 10,105 7,256 7,035
</TABLE>

The Domestic Growth Funds value securities for which market quotations are
readily available at market value, which is determined using the last reported
sale price or, if no sales are reported, as is regularly the case for some
securities traded over-the-counter, the last reported bid price. When reliable
market quotations are not considered to be readily available, which may be the
case, for example, with respect to certain debt securities and preferred stocks,
the investments are valued by using prices provided by market makers or
estimates of market values obtained from yield data and other factors relating
to instruments or securities with similar characteristics in accordance with
procedures established in good faith by each fund's Board of Directors.
Securities with remaining maturities of 60 days or less are valued at amortized
cost, which approximates market.

The Domestic Growth Funds record investment transactions generally one day after
the trade date, except for short-term investment transactions which are recorded
generally on the trade date. The identified cost basis has been used in
determining the net realized gain or loss from investment transactions and
unrealized appreciation or depreciation of investments. The Domestic Growth
Funds record dividend income on the ex-dividend date. Interest income is
recognized on an accrual basis.

The Domestic Growth Funds may, pursuant to an exemptive order issued by the
Securities and Exchange Commission, transfer uninvested funds into a joint
trading acount. The order permits the Domestic Growth Funds' cash balances to be
deposited into a single joint account along with the cash of other registered
investment companies managed by Principal Management Corporation (formerly known
as Princor Management Corporation) (the "Manager"). These balances may be
invested in one or more short-term instruments.

Dividends and distributions to shareholders are recorded on the ex-dividend
date. Dividends and distributions to shareholders from net investment income and
net realized gain from investments are determined in accordance with federal tax
regulations, which may differ from generally accepted accounting principles.
Permanent book and tax basis differences are reclassified within the capital
accounts based on their federal tax basis treatment; temporary differences do
not require reclassification. Reclassifications made for Principal MidCap Fund,
Inc. and Principal SmallCap Fund, Inc. for the year ended October 31, 1998
aggregated $1,172,263 and $268,657 respectively. Other reclassifications made
for the periods ended October 31, 1998 and 1997 were not material.

Dividends and distributions which exceed net investment income and net realized
capital gains for financial reporting purposes, but not for tax purposes, are
reported as dividends in excess of net investment income or distributions in
excess of net realized capital gains. To the extent distributions exceed current
and accumulated earnings and profits for federal income tax purposes, they are
reported as return of capital distributions.

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

Note 2 -- Federal Income Taxes

No provision for federal income taxes is considered necessary because each fund
is qualified as a "regulated investment company" under the Internal Revenue Code
and intends to distribute each year substantially all of its net investment
income and realized capital gains to shareholders. The cost of investments for
federal income tax reporting purposes approximates that used for financial
reporting purposes.

At October 31, 1998, the Domestic Growth Funds had approximate net capital loss
carryforwards as follows:
<TABLE>
<CAPTION>

Principal Principal Principal Principal
Growth MidCap Real Estate SmallCap
Net Capital Loss Carryforwards Expire In: Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc.

Note 3 -- Management Agreement and Transactions With Affiliates

The Domestic Growth Funds have agreed to pay investment advisory and management
fees to Principal Management Corporation (wholly owned by Princor Financial
Services Corporation, a subsidiary of Principal Life Insurance Company) computed
at an annual percentage rate of each fund's average daily net assets. The annual
rate used in this calculation for the Domestic Growth Funds is as follows:

<TABLE>
<CAPTION>
Net Asset Value of Funds
(in millions)

First Next Next Next Over
$100 $100 $100 $100 $400

<S> <C> <C> <C> <C> <C>
Principal Balanced Fund, Inc. 0.60% 0.55% 0.50% 0.45% 0.40%
Principal Blue Chip Fund, Inc. 0.50% 0.45% 0.40% 0.35% 0.30%
Principal Capital Value Fund, Inc. 0.50% 0.45% 0.40% 0.35% 0.30%
Principal Growth Fund, Inc. 0.50% 0.45% 0.40% 0.35% 0.30%
Principal MidCap Fund, Inc. 0.65% 0.60% 0.55% 0.50% 0.45%
Principal Real Estate Fund, Inc. 0.90% 0.85% 0.80% 0.75% 0.70%
Principal SmallCap Fund, Inc. 0.85% 0.80% 0.75% 0.70% 0.65%
Principal Utilities Fund, Inc. 0.60% 0.55% 0.50% 0.45% 0.40%
</TABLE>

The Domestic Growth Funds also reimburse the Manager for transfer and
administrative services, including the cost of accounting, data processing,
supplies and other services rendered.

The Manager voluntarily waived a portion of its fee for the Principal Utilities
Fund, Inc. The waivers are in amounts that maintain total operating expenses
within certain limits. The limits are expressed as a percentage of average net
assets attributable to each class on an annualized basis during the reporting
period. The amount waived and the operating expense limits, which were
maintained at or below those shown, are as follows:

<TABLE>
<CAPTION>
Amount Waived

Year Ended Year Ended Expense
October 31, 1998 October 31, 1997 Limit

Principal Utilities Fund, Inc.
<S> <C> <C> <C>
Class A $60,477 $65,940 1.15%
Class B 9,557 3,753 1.95%
Class R 12,481 9,355 1.65%
</TABLE>

The Manager ceased its waiver of expenses October 31, 1998.

Princor Financial Services Corporation, as principal underwriter, receives
proceeds of any CDSC on certain Class A and Class B share redemptions. The
charge is based on declining rates which for Class A shares begin at .75%, and
for Class B shares at 4.00%, of the lesser of the current market value or the
cost of shares being redeemed. Princor Financial Services Corporation also
retains sales charges on sales of Class A shares based on declining rates which
begin at 4.75% of the offering price. The aggregate amount of these charges
retained, by fund, for the periods ended October 31, 1998 were as follows:

Class A Class B

Principal Balanced Fund, Inc. $ 682,760 $ 33,555
Principal Blue Chip Fund, Inc. 1,172,738 57,361
Principal Capital Value Fund, Inc. 1,691,500 77,543
Principal Growth Fund, Inc. 1,990,628 89,098
Principal MidCap Fund, Inc. 2,295,383 152,254
Principal Real Estate Fund, Inc. 52,363 917
Principal SmallCap Fund, Inc. 397,232 1,159
Principal Utilities Fund, Inc. 302,546 36,807

No brokerage commissions were paid by the Domestic Growth Funds to Princor
Financial Services Corporation during the periods ended October 31, 1998 and
1997. Brokerage commissions were paid to other affiliates by the following
funds:

Periods Ended Year Ended
October 31, 1998 October 31, 1997

Principal Balanced Fund, Inc. $ 6,080 $15,194
Principal Blue Chip Fund, Inc. 2,315 21,243
Principal Capital Value Fund, Inc. 32,675 17,016
Principal Growth Fund, Inc. 18,750 4,637
Principal MidCap Fund, Inc. 7,716 3,750
Principal Real Estate Fund, Inc. 14,745 --
Principal SmallCap Fund, Inc. 1,050 --
Principal Utilities Fund, Inc. 3,235 4,665

The Domestic Growth Funds bear distribution and shareholder servicing fees with
respect to Class A shares computed at an annual rate of up to .25% of the
average daily net assets attributable to Class A shares of each fund. Each of
the Domestic Growth Funds adopted a distribution plan with respect to Class B
shares that provides for distribution and shareholder servicing fees computed at
an annual rate of up to 1.00% of the average daily net assets attributable to
Class B shares of each fund. Each of the Domestic Growth Funds adopted a
distribution plan with respect to Class R shares that provides for distribution
and shareholder servicing fees computed at an annual rate of up to .75% of the
average daily net assets attributable to Class R shares of each fund.
Distribution and shareholder servicing fees are paid to Princor Financial
Services Corporation; a portion of the fees are subsequently remitted to retail
dealers. Pursuant to the distribution agreements, fees unused by the principal
underwriter at the end of the fiscal year are returned to the Domestic Growth
Funds.

At October 31, 1998, Principal Life Insurance Company, subsidiaries of Principal
Life Insurance Company and benefit plans sponsored on behalf of Principal Life
Insurance Company owned shares of the Domestic Growth Funds as follows:

Class A Class B Class R

Principal Balanced Fund, Inc. 56,947 111 2,661
Principal Blue Chip Fund, Inc. 64,478 99 71
Principal Capital Value Fund, Inc. 5,004,324 71 52
Principal Growth Fund, Inc. 37,577 37 27
Principal MidCap Fund, Inc. 46,739 45 32
Principal Real Estate Fund, Inc. 409,528 306,709 307,067
Principal SmallCap Fund, Inc. 400,425 300,319 300,319
Principal Utilities Fund, Inc. 85,553 123 92

Note 4 -- Investment Transactions

For the periods ended October 31, 1998, the cost of investment securities
purchased and proceeds from investment securities sold (not including short-term
investments and U.S. government securities) by the Domestic Growth Funds were as
follows:

Purchases Sales

Principal Balanced Fund, Inc. $ 86,937,874 $ 29,929,482
Principal Blue Chip Fund, Inc. 54,535,363 735,207
Principal Capital Value Fund, Inc. 167,160,767 138,801,462
Principal Growth Fund, Inc. 144,105,468 89,116,523
Principal MidCap Fund, Inc. 131,971,760 106,338,131
Principal Real Estate Fund, Inc. 18,328,496 5,192,357
Principal SmallCap Fund, Inc. 35,175,646 3,215,257
Principal Utilities Fund, Inc. 12,674,891 10,367,659

At October 31, 1998, net unrealized appreciation (depreciation) of investments
by the Domestic Growth Funds was composed of the following:

<TABLE>
<CAPTION>
Net Unrealized
Appreciation

Gross Unrealized (Depreciation)

Appreciation (Depreciation) of Investments

<S> <C> <C> <C>
Principal Balanced Fund, Inc. $ 17,834,181 $ (2,893,482) $ 14,940,699
Principal Blue Chip Fund, Inc. 44,720,024 (7,069,570) 37,650,454
Principal Capital Value Fund, Inc. 179,712,466 (15,702,716) 164,009,750
Principal Growth Fund, Inc. 197,621,764 (2,981,144) 194,640,620
Principal MidCap Fund, Inc. 135,193,328 (38,614,680) 96,578,648
Principal Real Estate Fund, Inc. 55,032 (1,450,339) (1,395,307)
Principal SmallCap Fund, Inc. 2,447,869 (5,835,747) (3,387,878)
Principal Utilities Fund, Inc. 30,487,207 (533,531) 29,953,676
</TABLE>

The Domestic Growth Funds' investments are with various issuers in various
industries. The Schedules of Investments contained herein summarize
concentrations of credit risk by issuer and industry.

Note 5 -- Capital Share Transactions

Transactions in Capital Stock by fund were as follows:

<TABLE>
<CAPTION>
Principal Principal Principal Principal
Balanced Blue Chip Capital Value Growth
Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc.

Year Ended October 31, 1998:
Shares sold:
<S> <C> <C> <C> <C>
Class A ......................................... 1,578,648 2,196,999 2,383,996 1,435,543
Class B ......................................... 531,549 749,555 582,574 414,689
Class R ......................................... 764,170 893,287 717,506 290,030
Shares issued in reinvestment of dividends
and distributions:
Class A ........................................... 551,343 445,659 1,687,027 219,136
Class B ........................................... 75,490 102,886 91,259 26,054
Class R ......................................... 70,471 89,024 70,217 10,249
Shares redeemed:
Class A ......................................... (952,391) (760,092) (2,537,205) (888,842)
Class B ......................................... (153,016) (171,471) (148,042) (121,844)
Class R ......................................... (202,139) (231,149) (186,811) (76,609)

Net Increase 2,264,125 3,314,698 2,660,521 1,308,406

Year Ended October 31, 1997:
Shares sold:
Class A ......................................... 1,484,901 1,757,696 2,094,307 1,188,640
Class B ......................................... 394,660 585,899 569,099 315,097
Class R ......................................... 632,661 734,050 600,469 296,077
Shares issued in reinvestment of dividends
and distributions:
Class A ........................................... 521,642 97,219 2,633,617 89,929
Class B ........................................... 50,747 11,785 61,682 5,779
Class R ......................................... 15,156 5,263 16,393 863
Shares redeemed:
Class A ......................................... (1,197,833) (495,337) (3,785,181) (760,739)
Class B ......................................... (65,006) (73,924) (64,340) (91,289)
Class R ......................................... (57,684) (62,702) (58,005) (23,813)

Net Increase 1,779,244 2,559,949 2,068,041 1,020,544

Principal Principal Principal Principal
MidCap Real Estate SmallCap Utilities
Fund, Inc. Fund, Inc. Fund, Inc. Fund, Inc.

Periods Ended October 31, 1998, Except as Noted:
Shares sold:
Class A ......................................... 1,891,397 684,793 2,291,199 853,517
Class B ......................................... 593,857 377,186 817,321 286,360
Class R ......................................... 327,198 346,800 610,143 172,466
Shares issued in reinvestment of dividends
and distributions:
Class A ........................................... 188,881 13,045 425 130,341
Class B ........................................... 34,300 7,946 319 12,065
Class R ......................................... 10,456 7,688 319 3,932
Shares redeemed:
Class A ......................................... (1,383,727) (43,437) (105,453) (928,474)
Class B ......................................... (215,454) (12,937) (26,447) (144,160)
Class R ......................................... (127,550) (6,048) (55,649) (48,307)

Net Increase 1,319,358 1,375,036 3,532,177 337,740

Year Ended October 31, 1997:
Shares sold:
Class A ......................................... 1,925,742 N/A N/A 442,282
Class B ......................................... 622,365 N/A N/A 182,586
Class R ......................................... 363,949 N/A N/A 114,303
Shares issued in reinvestment of dividends
and distributions:
Class A ........................................... 223,920 N/A N/A 179,204
Class B ........................................... 27,006 N/A N/A 13,766
Class R ......................................... 2,629 N/A N/A 2,382
Shares redeemed:
Class A ......................................... (920,261) N/A N/A (1,312,610)
Class B ......................................... (125,040) N/A N/A (133,160)
Class R ......................................... (36,211) N/A N/A (23,006)

Net Increase (Decrease) 2,084,099 (534,253)
</TABLE>

Note 6 -- Line of Credit

The Domestic Growth Funds participate with other funds and portfolios managed by
Principal Management Corporation in an unsecured joint line of credit with a
bank, which allows the funds to borrow up to $60,000,000, collectively.
Borrowings are made solely to facilitate the handling of unusual and/or
unanticipated short-term cash requirements. Interest is charged to each fund,
based on its borrowings, at a rate equal to the Fed Funds Rate plus .50%.
Additionally, a commitment fee is charged at the annual rate of .08% on the
average unused portion of the line of credit. The commitment fee is allocated
among the participating funds and portfolios in proportion to their average net
assets during each quarter. At October 31, 1998, the Domestic Growth Funds had
no outstanding borrowings under the line of credit.

Note 7 -- Year 2000 Problem (Unaudited)

Like other mutual funds, financial and business organizations and individuals
around the world, the Domestic Growth Funds could be adversely affected if the
computer systems used by the Manager and other service providers do not properly
process and calculate date-related information and data from and after January
1, 2000. This is commonly known as the "Year 2000 Problem." The Manager is
taking steps it believes are reasonably designed to address the Year 2000
Problem with respect to computer systems it uses and to obtain reasonable
assurances that comparable steps are being taken by each fund's other major
service providers. At this time, however there can be no assurance that these
steps will be sufficient to avoid any adverse impact to the funds.

October 31, 1998

SCHEDULES OF INVESTMENTS

GROWTH FUNDS (DOMESTIC)

PRINCIPAL BALANCED FUND, INC.

Shares
Held Value
Common Stocks (54.08%)

Auto & Home Supply Stores (0.71%)
Autozone, Inc. 38,700(a) $ 1,018,294

Bakery Products (0.37%)
Sara Lee Corp. 8,900 531,219

Beverages (0.87%)
Pepsico, Inc. 36,700 1,238,625
Business Credit Institutions (0.19%)
Associates First Capital `A' 3,840 270,720
Chemicals & Allied Products (0.51%)
Dow Chemical Co. 7,800 730,275
Commercial Banks (4.50%)
BankAmerica Corp. 15,500 890,281
BankBoston Corp. 19,200 706,800
Bankers Trust Corp. 12,500 785,156
Chase Manhattan Corp. 14,700 835,144
First Union Corp. 21,292 1,234,936
Fleet Financial Group, Inc. 29,400 1,174,162
PNC Financial Corp. 15,900 795,000
6,421,479
Commercial Printing (0.70%)
R. R. Donnelley & Sons Co. 23,100 996,188
Communications Equipment (0.35%)
General Instrument Corp. 19,600(a) 503,475
Computer & Data Processing
Services (2.46%)
Adobe Systems, Inc. 23,700 879,862
Electronic Data Systems Corp. 37,600 1,529,850
First Data Corp. 41,600 1,102,400
3,512,112
Computer & Office Equipment (2.84%)
3COM Corp. 14,200(a) 512,087
Compaq Computer Corp. 26,900 850,712
Hewlett-Packard Co. 16,700 1,005,131
International Business
Machines Corp. 11,300 1,677,344
4,045,274
Consumer Products (2.71%)
Fortune Brands, Inc. 34,300 1,134,044
UST, Inc. 29,500 1,003,000
RJR Nabisco Holdings Corp. 11,000 314,187
Philip Morris Cos., Inc. 27,700 1,416,162
3,867,393
Crude Petroleum & Natural Gas (1.35%)
Texaco, Inc. 32,500 1,927,656
Department Stores (0.62%)
Dillard's, Inc., Class A 28,600 888,388
Drugs (4.23%)
Abbott Labs 14,200 666,512
American Home Products Corp. 23,900 1,165,125
Johnson & Johnson 19,200 1,564,800
Merck & Co., Inc. 13,100 1,771,775
Pharmacia & Upjohn, Inc. 16,500 873,469
6,041,681
Electric Services (2.66%)
Central & Southwest Corp. 51,500 1,432,344
Dominion Resources, Inc. 19,900 919,131
Houston Industries, Inc. 26,700 829,369
Potomac Electric Power Co. 23,400 612,787
3,793,631
Electrical Industrial Apparatus (0.82%)
Emerson Electric Co. 17,800 1,174,800
Electronic Distribution Equipment (0.56%)
General Electric Co. 9,100 796,250
Fats & Oils (0.74%)
Archer Daniels Midland Co. 63,193 1,054,533
Federal & Federally-Sponsored
Credit (0.32%)
Federal National Mortgage Association 6,400 453,200
Fire, Marine & Casualty Insurance (2.99%)
Citigroup, Inc. 19,100 898,894
General Re Corp. 5,100 1,120,406
Loews Corp. 12,800 1,202,400
Safeco Corp. 24,300 1,052,494
4,274,194
General Industrial Machinery (0.80%)
Pall Corp. 45,500 1,148,875
Tyco International Ltd. 1 47
1,148,922
Grain Mill Products (0.83%)
Ralston-Ralston Purina Group 35,400 1,181,475
Groceries & Related Materials (1.00%)
Sysco Corp. 53,200 1,433,075
Grocery Stores (1.71%)
Albertson's, Inc. 17,700 983,456
American Stores Co. 44,900 1,462,056
2,445,512
Industrial Inorganic Chemicals (0.53%)
Eastman Chemical Co. 4,850 284,938
Praxair Inc. 11,800 474,950
759,888
Jewlery, Silverware & Plated Ware (0.13%)
Jostens, Inc. 8,400 189,525
Life Insurance (0.43%)
Lincoln National Corp. 8,100 614,588
Machinery, Equipment & Supplies (0.83%)
Grainger (W. W.), Inc. 25,600 1,179,200
Management & Public Relations (0.45%)
Dun & Bradstreet Corp. 22,500 638,438
Meat Products (0.98%)
Tyson Foods, Inc. 60,850 1,399,550
Medical Instruments & Supplies (0.67%)
St. Jude Medical, Inc. 33,850(a) 956,263
Medical Services & Health
Insurance (1.68%)
Aon Corp. 11,400 706,800
Conseco, Inc. 18,100 627,844
Pacificare Health Systems,
Inc., Class B 13,600(a) 1,071,000
2,405,644
Metal Forgings & Stampings (0.47%)
Newell Co. 15,100 664,400
Miscellaneous Converted Paper
Products (0.81%)
Minnesota Mining & Mfg. Co. 14,400 1,152,000
Miscellaneous Food & Kindred
Products (0.43%)
Universal Foods Corp. 28,600 620,263
Miscellaneous Transportation
Equipment (0.44%)
FMC Corp. 12,400(a) 633,175
Motor Vehicles & Equipment (0.56%)
Ford Motor Co. 14,654 794,979
Paper Mills (1.81%)
Fort James Corp. 16,962 683,781
Kimberly Clark Corp. 30,800 1,486,100
Union Camp Corp. 9,600 412,800
2,582,681
Petroleum Refining (3.44%)
Amerada Hess Corp. 17,500 966,875
Amoco Corp. 22,300 1,251,587
Atlantic Richfield Co. 19,700 1,356,838
Exxon Corp. 18,800 1,339,500
4,914,800
Plumbing & Heating (0.14%)
Masco Corp. 7,200 202,950
Pulp Mills (0.37%)
Boise Cascade Corp. 18,900 529,200
Rubber & Plastics Footwear (0.46%)
Nike, Inc. 14,900 650,944
Sanitary Services (1.75%)
Browning-Ferris Industries, Inc. 24,800 878,850
Waste Management, Inc. 35,742 1,612,858
2,491,708
Security Brokers & Dealers (0.19%)
Bear Stearns Cos., Inc. 7,500 267,656
Telephone Communication (2.36%)
AT&T Corp. 13,800 859,050
GTE Corp. 18,600 1,091,587
Motorola, Inc. 19,200 998,400
SBC Communications, Inc. 9,100 421,444
3,370,481
Variety Stores (0.31%)
Wal-Mart Stores, Inc. 6,400 441,600

Total Common Stocks 77,208,304

Principal
Amount Value
Bonds (31.22%)

Beverages (0.70%)
Seagram Co., Ltd.
Notes; 6.50%; 4/1/2003 $1,000,000 1,007,195

Blast Furnace & Basic
Steel Products (0.76%)
Carpenter Technology Corp.
Medium-Term Notes;
6.99%; 4/20/2018 800,000 794,285
Quanex Corp. Convertible
Subordinated Debentures;
6.88%; 6/30/2007 350,000 309,750
1,104,035
Business Credit Institutions (2.20%)
CIT Group Holdings
Senior Medium-Term Notes;
6.38%; 10/1/2002 1,000,000 1,019,533
Ford Motor Credit Co. Notes;
7.75%; 3/15/2005 1,000,000 1,108,054
Heller Financial, Inc. Notes;
6.44%; 10/6/2002 1,000,000 1,004,575
3,132,162
Commercial Banks (0.99%)
NationsBank Corp.
Subordinated Notes;
7.80%; 9/15/2016 1,300,000 1,415,406

Communications Equipment (1.00%)
Motorola, Inc.
Debentures;
7.50%; 5/15/2025 1,291,000 1,431,487

Computer & Office Equipment (1.51%)
International Business Machines Corp.
Debentures;
7.00%; 10/30/2025 1,300,000 1,412,437
Seagate Technology, Inc.
Senior Notes;
7.37%; 3/1/2007 750,000 748,074
2,160,511
Consumer Products (1.39%)
Philip Morris Cos., Inc. Notes;
7.25%; 9/15/2001 1,500,000 1,579,070
6.15%; 3/15/2010 400,000 404,384
1,983,454
Department Stores (0.82%)
Dillard's, Inc.
Notes; 7.38%; 6/1/2006 600,000 639,737
Fred Meyer, Inc. Senior Notes;
7.38%; 3/1/2005 500,000 526,855
1,166,592
Electric Services (0.75%)
Virginia Electric & Power Co.
First Mortgage Bond;
7.38%; 7/1/2002 1,000,000 1,069,860

Farm & Garden Machinery (0.85%)
Deere & Co.
Senior Debentures;
8.50%; 1/9/2022 $1,000,000 1,210,995

Forest Products (0.68%)
Weyerhaeuser Co.
Debentures;
6.95%; 10/1/2027 1,000,000 971,997

Functions Closely Related to
Banking (0.94%)
J.P. Morgan & Co., Inc.
Subordinated Notes;
6.70%; 11/01/2007 1,300,000 1,338,949

General Government (1.13%)
Province of Quebec, Canada
Debentures;
7.50%; 7/15/2002 500,000 536,180
7.00%; 1/30/2007 1,000,000 1,076,580
1,612,760
General Industrial Machinery (1.10%)
Ingersoll-Rand
Medium-Term Notes;
6.46%; 11/19/2003 1,000,000 1,042,574
Timken Co.
Medium-Term Notes;
7.30%; 8/13/2002 500,000 532,203
1,574,777
Miscellaneous Investing (1.76%)
Federal Realty Investment Trust Notes;
8.88%; 1/15/2000 1,000,000 1,039,864
Kimco Realty Corp. Senior Notes;
6.50%; 10/1/2003 1,500,000 1,465,956
2,505,820
Mortgage Bankers & Brokers (0.71%)
Countrywide Funding Corp.
Medium-Term Notes;
6.54%; 4/14/2000 1,000,000 1,011,842

Motion Picture Production &
Services (0.38%)
Viacom, Inc.
Guaranteed Senior Notes;
7.75%; 6/1/2005 500,000 541,852

Motor Vehicles & Equipment (2.04%)
Chrysler Corp. Debentures;
7.45%; 3/1/2027 1,400,000 1,535,401
General Motors Corp. Debentures;
7.70%; 4/15/2016 1,250,000 1,380,664
2,916,065
Paper & Paper Products (0.33%)
Boise Cascade Office Products Corp.
Notes; 7.05%; 5/15/2005 500,000 471,235

Paper Mills (0.71%)
International Paper Co. Notes;
6.88%; 7/10/2000 1,000,000 1,018,075

Personal Credit Institutions (1.47%)
Associates Corp. of North America
Senior Notes; 6.45%; 10/15/2001 1,000,000 1,026,550
General Electric Capital Corp.
Notes; 6.50%; 11/1/2026 1,000,000 1,065,532
2,092,082
Petroleum & Petroleum Products (0.74%)
Enron Corp. Notes;
6.75%; 9/1/2004 1,000,000 1,051,830

Plumbing & Heating, Except
Electricity (0.73%)
Masco Corp. Notes;
6.13%; 9/15/2003 1,000,000 1,037,319

Railroads (1.62%)
Norfolk Southern Debentures;
9.00%; 3/1/2021 1,000,000 1,282,295
Union Pacific Corp. Notes;
7.00%; 6/15/2000 1,000,000 1,023,642
2,305,937
Security Brokers & Dealers (2.18%)
Lehman Brothers, Inc.
Senior Subordinated Notes;
6.13%; 2/1/2001 1,000,000 989,724
Merrill Lynch & Co.
Notes; 7.00%; 1/15/2007 1,000,000 1,017,921
Morgan Stanley Group, Inc.
Debentures; 8.88%; 10/15/2001 1,000,000 1,095,804
3,103,449
Surety Insurance (2.10%)
Allstate Corp.
Debentures; 6.75%; 5/15/2018 2,000,000 1,961,674
MBIA, Inc.
Debentures; 7.00%; 12/15/2025 1,000,000 1,037,524
2,999,198
Telephone Communication (0.80%)
AT&T Corp.
Senior Notes; 7.75%; 3/1/2007 1,000,000 1,146,477

Trucking & Courier Services,
Except Air (0.04%)
Builders Transport, Inc. Convertible
Subordinated Debentures;
6.50%; 5/1/2011 306,000(b) 59,670

Trusts (0.79%)
Salomon Smith Barney Holdings, Inc.
Notes; 7.98%; 3/1/2000 1,100,000 1,131,938

Total Bonds 44,572,969

Description of Issue Principal
Type Rate Maturity Amount Value

Federal Home Loan Mortgage Corporation (FHLMC)
Certificates (2.63%)

FHLMC 6.50% 10/1/2027 $1,891,366 $1,906,535
FHLMC 7.00 12/1/2027 1,816,008 1,852,474

Total FHLMC Certificates 3,759,009

Government National Mortgage Association (GNMA)
Certificates (3.03%)

GNMA II 6.00 6/20/2026-9/20/2028 4,403,248 4,331,792

Principal
Amount Value

U.S. Government Treasury Note (1.53%)

Treasury Note (1.53%)
6.00%; 2/15/2026 $2,000,000 $ 2,184,376

Asset-Backed Securities (2.10%)

Motor Vehicles & Equipment (1.39%)
GMAC Commercial Mortgage Securities,
Inc. Mortgage Pass-Through Certificates,
Series 1998-C2, Class C; 6.50%;
8/15/2008 2,000,000 1,975,460

Personal Credit Institutions (0.72%)
Chase Manhattan Credit Card Master Trust
Asset-Backed Certificates, Series 97-2,
Class A; 6.30%; 4/15/2003 1,000,000 1,024,250

Total Asset-Backed Securities 2,999,710

Commercial Paper (3.59%)

Personal Credit Institutions (3.59%)
Investment in Joint Trade Account;
Associates Corp.;
5.72%; 11/2/1998 5,128,768 5,128,768

Total Portfolio Investments (98.18%) 140,184,928

Cash, receivables and other assets,
net of liabilities (1.82%) 2,592,739

Total Net Assets (100.00%) $142,777,677

(a) Non-income producing security - No dividend paid during the period.
(b) Non-income producing - Security in default.

PRINCIPAL BLUE CHIP FUND, INC.

Shares
Held Value
Common Stocks (96.06%)

Bakery Products (3.27%)
Sara Lee Corp. 106,200 $ 6,338,812

Beverages (5.55%)
Anheuser-Busch Cos., Inc. 111,300 6,615,394
Pepsico, Inc. 122,600 4,137,750
10,753,144
Commercial Banks (4.20%)
Bank One Corp. 85,419 4,174,854
J.P. Morgan & Co., Inc. 42,000 3,958,500
8,133,354
Computer & Office Equipment (6.08%)
Automatic Data Processing, Inc. 74,300 5,781,469
Hewlett-Packard Co. 99,700 6,000,694
11,782,163
Drugs (12.10%)
American Home Products Corp. 111,100 5,416,125
Johnson & Johnson 74,800 6,096,200
Merck & Co., Inc. 44,800 6,059,200
Pharmacia & Upjohn, Inc. 111,000 5,876,063
23,447,588
Eating & Drinking Places (3.04%)
McDonald's Corp. 88,000 5,885,000
Electronic Distribution Equipment (5.52%)
Emerson Electric Co. 77,300 5,101,800
General Electric Co. 64,000 5,600,000
10,701,800
Fire, Marine & Casualty Insurance (4.91%)
American International Group 57,375 4,891,219
Chubb Corp. 75,300 4,630,950
9,522,169
General Industrial Machinery (3.01%)
Pall Corp. 231,200 5,837,800

Grain Mill Products (2.36%)
Kellogg Co. 138,500 4,570,500

Grocery Stores (3.31%)
Sysco Corp. 238,200 6,416,512

Medical Instruments & Supplies (3.16%)
Becton, Dickinson & Co. 145,200 6,116,550

Metal Cans & Shipping Containers (2.39%)
Crown Cork & Seal Co., Inc. 145,400 4,634,625

Miscellaneous Converted Paper
Products (2.20%)
Minnesota Mining & Mfg. Co. 53,400 4,272,000

Miscellaneous Food & Kindered
Products (2.70%)
Bestfoods 96,000 5,232,000

Miscellaneous Shopping Goods (1.90%)
Toys `R' Us, Inc. 188,700(a) 3,691,444

Petroleum Refining (7.75%)
Exxon Corp. 83,100 5,920,875
Mobil Corp. 63,000 4,768,312
Royal Dutch Petroleum Co. ADR 88,100 4,338,925
15,028,112
Preserved Fruits & Vegetables (2.54%)
H.J. Heinz Co. 84,900 4,934,812

Sanitary Services (2.51%)
Browning-Ferris Industries, Inc. 137,100 4,858,481

Sugar & Confectionery Products (2.95%)
Wrigley Wm. Jr. Co. 70,600 5,714,187

Telephone Communication (8.89%)
AT&T Corp. 90,300 5,621,175
GTE Corp. 112,900 6,625,819
Motorola, Inc. 95,800 4,981,600
17,228,594
Variety Stores (3.59%)
Wal-Mart Stores, Inc. 100,800 6,955,200

Women's Clothing Stores (2.13%)
The Limited, Inc. 161,100 4,128,188

Total Common Stocks 186,183,035

Principal
Amount Value
Commercial Paper (3.50%)

Personal Credit Institutions (3.50%)
Investment in Joint Trade Account;
Associates Corp.; 5.72%; 11/2/1998 6,792,570 6,792,570

Total Portfolio Investments (99.56%) 192,975,605

Cash, receivables and other assets,
net of liabilities (0.44%) 858,926

Total Net Assets (100.00%) $193,834,531

(a) Non-income producing security - No dividend paid during the period.

PRINCIPAL CAPITAL VALUE FUND, INC.
Shares
Held Value
Common Stocks (95.46%)

Beverages (3.29%)
Anheuser-Busch Cos., Inc. 285,000 16,939,688
Pepsico, Inc. 129,700 4,377,375
21,317,063
Commercial Banks (18.75%)
Bank One Corp. 324,764 15,872,840
BankAmerica Corp. 161,000 9,247,438
BankBoston Corp. 201,400 7,414,038
Chase Manhattan Corp. 200,000 11,362,500
Comerica, Inc. 270,000 17,415,000
First Union Corp. 320,760 18,604,080
KeyCorp 459,000 13,913,437
Summit Bancorp 364,500 13,828,219
Union Planters Corp. 296,100 13,750,144
121,407,696
Commercial Printing (1.03%)
R. R. Donnelley & Sons Co. 155,000 6,684,375

Communications Equipment (2.10%)
Harris Corp. 386,900 13,565,681

Computer & Office Equipment (1.60%)
Hewlett-Packard Co. 82,000 4,935,375
International Business Machines Corp. 36,600 5,432,813
10,368,188
Crude Petroleum & Natural Gas (1.75%)
Texaco, Inc. 190,600 11,304,962

Department Stores (2.24%)
Sears, Roebuck & Co. 322,300 14,483,356

Drugs (7.29%)
Abbott Labs 94,800 4,449,675
American Home Products Corp. 231,300 11,275,875
Merck & Co., Inc. 85,000 11,496,250
Pharmacia & Upjohn, Inc. 378,000 20,010,375
47,232,175
Electric Services (4.51%)
Dominion Resources, Inc. 98,200 4,535,612
FPL Group, Inc. 85,100 5,324,069
Houston Industries, Inc. 530,000 16,463,125
Potomac Electric Power Co. 110,000 2,880,625
29,203,431
Electrical Industrial Apparatus (1.24%)
Emerson Electric Co. 121,394 8,012,004

Electronic Distribution Equipment (1.09%)
General Electric Co. 81,000 7,087,500

Fats & Oils (1.06%)
Archer Daniels Midland Co. 410,550 6,851,053

General Industrial Machinery (1.28%)
Pall Corp. 329,300 8,314,825
Tyco International Ltd. 7 424
8,315,249
Grain Mill Products (2.35%)
Kellogg Co. 264,800 8,738,400
Ralston-Ralston Purina Group 195,000 6,508,125
15,246,525
Greeting Cards (2.29%)
American Greetings Corp. 369,100 14,810,137

Groceries & Related Products (1.75%)
Sysco Corp. 421,000 11,340,687

Grocery Stores (1.41%)
American Stores Co. 280,000 9,117,500

Life Insurance (2.31%)
American General Corp. 218,600 14,974,100

Machinery, Equipment & Supplies (1.28%)
Grainger (W. W.), Inc. 180,600 8,318,888

Management & Public Relations (1.19%)
Dun & Bradstreet Corp. 270,600 7,678,275

Meat Products (1.17%)
Tyson Foods, Inc. 329,550 7,579,650

Medical Services & Health
Insurance (1.07%)
Aon Corp. 111,900 6,937,800

Metal Cans & Shipping Containers (4.03%)
Ball Corp. 251,000 10,589,063
Crown Cork & Seal Co., Inc. 485,600 15,478,500
26,067,563
Metal Forgings & Stampings (0.68%)
Newell Co. 100,200 4,408,800

Miscellaneous Converted Paper
Products (3.94%)
Avery Dennison Corp. 301,600 12,497,550
Minnesota Mining & Mfg. Co. 162,600 13,008,000
25,505,550
Miscellaneous Food & Kindred
Products (0.32%)
Universal Foods Corp. 96,600 2,095,013

Paper Mills (2.54%)
Kimberly Clark Corp. 341,200 16,462,900

Petroleum Refining (6.39%)
Amoco Corp. 70,000 3,928,750
Atlantic Richfield Co. 204,600 14,091,825
Chevron Corp. 190,000 15,485,000
Exxon Corp. 110,100 7,844,625
41,350,200
Plumbing & Heating, Except
Electrical (2.80%)
Masco Corp. 643,000 18,124,562

Rental of Railroad Cars (2.56%)
GATX Corp. 480,000 16,560,000

Sanitary Services (2.30%)
Browning-Ferris Industries, Inc. 420,000 14,883,750

Telephone Communication (7.85%)
AT&T Corp. 245,500 15,282,375
SBC Communications, Inc. 395,280 18,306,405
US West, Inc. 300,000 17,212,500
50,801,280

Total Common Stocks 618,095,913

Principal
Amount Value

Commercial Paper (3.81%)

Personal Credit Institutions (3.81%)
Investment in Joint Trade Account,
Associates Corp.; 5.72%; 11/2/1998 24,691,459 24,691,459

Total Portfolio Investments (99.27%) 642,787,372

Cash and receivables, net of liabilities (0.73%) 4,704,835

Total Net Assets (100.00%) $647,492,207

PRINCIPAL GROWTH FUND, INC.

Shares
Held Value
Common Stocks (88.88%)

Advertising (1.19%)
Interpublic Group of Cos., Inc. 100,000 5,850,000

Beverages (2.90%)
Coca-Cola Co. 60,000 4,057,500
Pepsico, Inc. 302,500 10,209,375
14,266,875
Carpets & Rugs (0.71%)
Shaw Industries, Inc. 200,000 3,475,000

Cash Grains (1.71%)
Pioneer Hi-Bred International, Inc. 300,000 8,400,000

Commercial Banks (8.37%)
Bank One Corp. 178,500 8,724,188
BankAmerica Corp. 71,644 4,115,052
Firstar Corp. 150,000 8,512,500
FirstMerit Corp. 100,000 2,650,000
National City Corp. 72,000 4,630,500
Norwest Corp. 100,000 3,718,750
US Bancorp 240,000 8,760,000
41,110,990

Communications Equipment (3.69%)
General Instrument Corp. 175,000(a) 4,495,312
Lucent Technologies 90,000 7,216,875
Northern Telecom Ltd. (Foreign) 150,000 6,421,875
18,134,062
Computer & Data Processing
Services (2.58%)
Gtech Holdings Corp. 139,300(a) 3,343,200
Microsoft Corp. 88,000(a) 9,317,000
12,660,200
Computer & Office Equipment (5.56%)
Automatic Data Processing, Inc. 100,000 7,781,250
Ceridian Corp. 172,800(a) 9,914,400
Compaq Computer Corp. 67,567 2,136,806
Hewlett-Packard Co. 79,100 4,760,831
Pitney Bowes, Inc. 49,400 2,720,088
27,313,375
Consumer Products (1.32%)
Philip Morris Cos., Inc. 127,200 6,503,100
Department Stores (0.81%)
May Department Stores 65,000 3,965,000
Drugs (14.75%)
American Home Products Corp. 185,200 9,028,500
Bristol-Myers Squibb Co. 50,000 5,528,125
Forest Laboratories, Inc. 132,600(a) 5,544,338
Genzyme Corp. - General Division 100,756(a) 4,238,049
Johnson & Johnson 128,000 10,432,000
Lilly (Eli) & Co. 100,000 8,093,750
Merck & Co., Inc. 75,800 10,251,950
Pharmacia & Upjohn, Inc. 220,000 11,646,250
Smithkline Beecham PLC ADR 120,000 7,650,000
72,412,962
Electrical Goods (0.30%)
Avnet, Inc. 30,000 1,492,500
Electronic Components &
Accessories (3.49%)
Intel Corp. 132,000 11,772,750
Linear Technology Corp. 90,000 5,366,250
17,139,000
Electronic Distribution Equipment (0.71%)
General Electric Co. 40,000 3,500,000
Federal & Federally Sponsored
Credit (3.13%)
Federal Home Loan Mtg. 65,700 3,777,750
Federal National Mortgage
Association 163,600 11,584,925
15,362,675
Fire, Marine & Casualty Insurance (1.14%)
Citigroup, Inc. 118,650 5,583,966
Forest Products (0.09%)
Georgia Timber Group 20,000 443,750
General Industrial Machinery (3.72%)
Ingersoll-Rand Co. 105,000 5,302,500
Tyco International Ltd. 209,400 12,969,712
18,272,212
Grain Mill Products (2.89%)
General Mills, Inc. 50,000 3,675,000
Ralston-Ralston Purina Group 315,000 10,513,125
14,188,125
Groceries & Related Products (1.44%)
Sysco Corp. 262,800 7,079,175
Grocery Stores (0.12%)
Casey's General Stores, Inc. 42,104 589,456
Hospitals (1.92%)
Humana, Inc. 105,000(a) 1,988,437
Universal Health Services, Inc. 145,400(a) 7,460,838
9,449,275
Investment Offices (0.89%)
AMVESCAP PLC Sponsored ADR 120,000 4,395,000
Lumber & Other Building Materials (2.66%)
Home Depot, Inc. 300,000 13,050,000
Medical Instruments & Supplies (2.86%)
Becton, Dickinson & Co. 140,000 5,897,500
Boston Scientific Corp. 150,000(a) 8,165,625
14,063,125
Medical Services & Health
Insurance (2.60%)
Aon Corp. 60,000 3,720,000
Foundation Health Systems, Inc. 147,500(a) 1,733,125
Pacificare Health Systems, Inc. 28,540(a) 2,247,525
Torchmark Corp. 56,700 2,480,625
United Healthcare Corp. 60,000 2,613,750
12,795,025
Miscellaneous Converted Paper
Products (0.51%)
Minnesota Mining & Mfg. Co. 31,400 2,512,000
Miscellaneous Fabricated Metal
Products (0.75%)
Parker-Hannifin Corp. 103,350 3,694,763
Miscellaneous Food & Kindred
Products (0.55%)
Bestfoods 50,000 2,725,000
Motor Vehicles & Equipment (0.83%)
Dana Corp. 98,000 4,097,625
Petroleum Refining (2.05%)
Atlantic Richfield Co. 40,000 2,755,000
Exxon Corp. 102,600 7,310,250
10,065,250
Plumbing & Heating, Except
Electric (0.92%)
Masco Corp. 160,000 4,510,000
Radio, Television, & Computer
Stores (0.20%)
Tandy Corp. 20,000 991,250
Refrigeration & Service Machinery (0.42%)
Tecumseh Products Co. 40,000 2,080,000
Sanitary Services (1.07%)
Browning-Ferris Industries, Inc. 80,000 2,835,000
Waste Management, Inc. 53,945 2,434,268
5,269,268
Soap, Cleaners & Toilet Goods (3.06%)
Colgate-Palmolive Co. 80,000 7,070,000
Ecolab, Inc. 266,400 7,958,700
15,028,700
Sugar & Confectionery Products (0.91%)
Wrigley Wm. Jr. Co. 55,000 4,451,563
Telephone Communication (4.20%)
AT&T Corp. 103,730 6,457,193
MCI Worldcom, Inc. 256,829(a) 14,189,802
20,646,995
Toys & Sporting Goods (0.90%)
Mattel, Inc. 123,046 4,414,275
Women's & Children's
Undergarments (0.96%)
Warnaco Group 185,200 4,734,175

Total Common Stocks 436,715,712

Principal
Amount Value
Bond (0.50%)

Electrical Industrial Apparatus (0.50%)
Liebert Co.; Convertible Subordinated
Debentures; 8.00%; 11/15/2010 $ 500,000 $ 2,443,750

Commercial Paper (12.49%)

Business Credit Institutions (6.45%)
American Express Credit Corp.;
5.10%; 11/9/1998 5,190,000 5,184,118
5.10%; 11/16/1998 13,740,000 13,710,802
General Electric Capital Corp.
5.27%; 11/9/1998 9,955,000 9,943,342
5.08%; 11/16/1998 2,840,000 2,833,989
31,672,251
Personal Credit Institutions (6.04%)
Ford Motor Credit Co.
5.04%; 11/2/1998 485,000 484,932
5.28%; 11/2/1998 13,150,000 13,148,082

Household Finance Corp.
5.28%; 11/9/1998 490,000 489,425
5.10%; 11/23/1998 15,600,000 15,551,380
Investment in Joint Trade Account;
Associates Corp.;
5.72%; 11/2/1998 18,201 18,201
29,692,020

Total Commercial Paper 61,364,271

Total Portfolio Investments (101.87%) 500,523,733

Liabilities, net of cash, receivables and
other assets (-1.87%) $(9,203,584)

Total Net Assets (100.00%) $491,320,149

(a) Non-income producing security - No dividend paid during the period.

PRINCIPAL MIDCAP FUND, INC.
Shares
Held Value
Common Stocks (88.53%)

Blast Furnace & Basic Steel
Products (1.24%)
Carpenter Technology 150,000 $ 5,259,375

Carpets & Rugs (0.81%)
Shaw Industries, Inc. 198,700 3,452,412

Chemicals & Allied Products (0.29%)
Sigma-Aldrich Corp. 40,400 1,248,613

Commercial Banks (9.53%)
Associated Banc Corp. 167,535 5,884,667
First Federal Capital Corp. 328,796 5,014,139
Independent Bank Corp. Michigan 104,265 2,111,366
Mercantile Bancorp, Inc. 195,529 8,933,231
Merchants Bancorp, Inc. 116,200 3,486,000
North Fork Bancorp, Inc. 362,187 7,198,467
Peoples Heritage Financial
Group, Inc. 197,800 3,560,400
Princeton National Bancorp, Inc. 150,000 2,531,250
Summit Bancorp 46,950 1,781,166
40,500,686
Commercial Printing (0.34%)
Merrill Corp. 87,200 1,460,600

Computer & Data Processing
Services (9.19%)
American Management Systems, Inc. 101,000(a) 3,099,438
Cadence Design Systems, Inc. 177,700(a) 3,798,337
Cerner Corp. 238,900(a) 5,345,387
HBO & Co. 276,000 7,245,000
ICG Communications, Inc. 129,000(a) 2,668,688
Microsoft Corp. 73,200(a) 7,750,050
Synopsys, Inc. 201,900(a) 9,135,975
39,042,875
Computer & Office Equipment (3.58%)
3COM Corp. 150,000(a) 5,409,375
Cabletron Systems, Inc. 102,000(a) 1,160,250
EMC Corp. 134,000(a) 8,626,250
15,195,875
Construction & Related Machinery (0.61%)
Cooper Cameron Corp. 75,000(a) 2,606,250

Crude Petroleum & Natural Gas (2.46%)
Devon Energy Corp. 165,000 5,589,375
Newfield Exploration Co. 200,000(a) 4,862,500
10,451,875
Dairy Products (0.20%)
Dreyer's Grand Ice Cream, Inc. 65,400 858,375

Department Stores (1.24%)
Saks, Inc. 232,060(a) 5,279,365

Drugs (5.80%)
Centocor, Inc. 140,700(a) 6,261,150
Dura Pharmaceuticals, Inc. 282,000(a) 3,401,625
Genzyme Corp. - General Division 83,000(a) 3,491,187
Pharmacia & Upjohn, Inc. 75,700 4,007,369
Watson Pharmaceuticals 134,000(a) 7,453,750
24,615,081
Electronic Components &
Accessories (6.22%)
Altera Corp. 125,000(a) 5,203,125
Intel Corp. 70,300 6,269,881
Linear Technology Corp. 99,900 5,956,538
Solectron Corp. 157,300(a) 9,005,425
26,434,969
Engineering & Architectural
Services (1.15%)
Paychex, Inc. 98,043 4,877,639

Fabricated Rubber Products, NEC (2.02%)
Weatherford International 314,800 8,558,625

Fire, Marine & Casualty Insurance (0.94%)
Berkley W.R. Corp. 132,750 4,003,242

General Industrial Machinery (4.14%)
Flow International Corp. 187,200(a) 1,965,600
Kaydon Corp. 181,600 6,378,700
Pentair, Inc. 137,500 5,173,438
Roper Industries, Inc. 228,000 4,061,250
17,578,988
Grocery Stores (0.93%)
Casey's General Stores, Inc. 282,800 3,959,200

Holding Offices (0.64%)
ISB Financial Corp. 109,100 2,713,863

Hospitals (2.49%)
Humana, Inc. 249,300(a) 4,721,119
Universal Health Services,
Inc., Class B 114,000(a) 5,849,625
10,570,744
Hotels & Motels (0.88%)
Four Seasons Hotel, Inc. 163,100 3,751,300

Household Appliances (1.65%)
Maytag Corp. 141,300 6,985,519

Industrial Inorganic Chemicals (0.37%)
ICN Pharmaceuticals, Inc. 67,821 1,585,316

Industrial Machinery, NEC (1.58%)
Coltec Industries 401,000(a) 6,691,687

Insurance Agents, Brokers &
Services (1.82%)
Equifax, Inc. 200,000 7,737,500

Investment Offices (1.20%)
AMVESCAP PLC Sponsored ADR 138,920 5,087,945

Iron & Steel Foundries (0.25%)
Atchison Casting Corp. 111,100(a) 1,062,394

Laundry, Cleaning & Garment
Services (0.91%)
G&K Services, Inc. 84,600 3,870,450

Measuring & Controlling Devices (0.00%)
ISCO, Inc. 1 2

Meat Products (1.07%)
Michael Foods, Inc. 188,500 4,524,000

Medical Instruments & Supplies (2.24%)
Boston Scientific Corp. 68,100(a) 3,707,194
Steris Corp. 252,600(a) 5,809,800
9,516,994
Medical Services & Health
Insurance (4.65%)
Alternative Living Services 234,200(a) 6,118,475
Foundation Health Systems,
Inc., Class A 332,340(a) 3,904,995
Orthofix International NV 156,200(a) 1,991,550
Pacificare Health Systems,
Inc., Class B 51,391 4,047,041
United Healthcare Corp. 85,000 3,702,813
19,764,874
Miscellaneous Chemical Products (0.87%)
Cytec Industries 72,600(a) 1,742,400
H.B. Fuller Co. 47,500 1,953,437
3,695,837
Miscellaneous Investing (0.35%)
Cendant Corp. 129,938(a) 1,486,166

Office Furniture (0.55%)
Chromcraft Revington, Inc. 142,800(a) 2,311,575

Oil & Gas Field Service (1.08%)
Diamond Offshore Drilling 150,000 4,603,125

Operative Builders (1.41%)
D. R. Horton, Inc. 294,500 4,675,187
Pulte Corp. 50,400 1,297,800
5,972,987
Paints & Allied Products (0.79%)
RPM, Inc. 200,500 3,370,906

Personal Credit Institutions (0.16%)
Firstplus Financial Group 152,000(a) 674,500

Plumbing, Heating &
Air Conditioning (0.85%)
Apogee Enterprises, Inc. 343,700 3,608,850

Refrigeration & Service Machinery (0.31%)
Tecumseh Products Co. 25,200 1,310,400

Sanitary Services (1.75%)
Browning-Ferris Industries, Inc. 86,200 3,054,713
Republic Services, Inc., Class A 200,000(a) 4,375,000
7,429,713
Savings Institutions (4.86%)
Greenpoint Financial Corp. 190,000 6,234,375
Sterling Financial Corp. 124,133(a) 2,032,678
TCF Financial Corp. 333,100 7,848,669
WSFS Financial Corp. 265,000 4,538,125
20,653,847
Security Brokers & Dealers (0.75%)
Jefferies Group, Inc. 106,400 3,192,000

Telephone Communication (2.83%)
Hyperion Telecomm, Inc., Class A 300,000(a) 2,925,000
McLeodUSA, Inc. 171,300(a) 6,263,156
Winstar Communications, Inc. 105,000 2,835,000
12,023,156
Toys & Sporting Goods (0.66%)
Mattel, Inc. 78,050 2,800,044

Trucking & Courier Services,
Except Air (0.43%)
J.B. Hunt Transport Services, Inc. 109,900 1,840,825

Women's And Children's
Undergarments (0.44%)
Warnaco Group, Class A 73,612 1,881,707

Total Common Stocks 376,102,269

Principal
Amount Value
Bond (0.01%)

Management & Public Relations (0.01%)
Complete Management, Inc.
Convertible Debentures;
8.00%; 12/15/2003 $ 200,000 $ 39,750

Commercial Paper (12.43%)

Business Credit Institutions (2.22%)
American Express Credit Corp.;
5.10%;11/9/1998 5,365,000 5,358,920
General Electric Capital Corp.;
5.10%; 11/2/1998 1,915,000 1,914,729
5.45%; 11/6/1998 700,000 699,470
5.22%; 11/9/1998 555,000 554,356
5.08%; 11/16/1998 925,000 923,030
9,450,505
Personal Credit Institutions (10.21%)
Investment in Joint Trade Account;
Associates Corp.;
5.73%; 11/02/1998 $18,845,800 $18,845,800
Ford Motor Credit Co.;
5.28%; 11/02/1998 7,940,000 7,938,844
Household Finance Corp.;
5.09%; 11/16/1998 4,110,000 4,101,284
5.10%; 11/23/1998 12,520,000 12,480,979
43,366,907

Total Commercial Paper 52,817,412

Total Portfolio Investments (100.97%) 428,959,431

Liabilities, net of cash, receivables and
other assets (-0.97%) (4,119,592)

Total Net Assets (100.00%) $424,839,839

(a) Non-income producing security - No dividend paid during the period.

PRINCIPAL REAL ESTATE FUND, INC.
Shares
Held Value
Common Stocks (96.45%)

Apartment REITs (21.77%)
Archstone Comm. Trust 17,400 $ 350,175
Apartment Investment & Management Co. 4,300 150,231
Avalonbay Communities, Inc. 9,987 320,832
BRE Properties, Inc. 9,400 226,775
Camden Property Trust 9,900 266,063
Equity Residential Properties Trust 8,000 336,000
Gables Residential Trust 10,500 276,281
Irvine Apartment Communities, Inc. 12,200 320,250
Walden Residential Properties, Inc. 11,500 265,219
2,511,826
Factory Outlet REITs (1.49%)
Chelsea GCA Realty 5,000 171,875

Hotel REITs (9.62%)
Felcor Lodging Trust 7,600 179,075
Host Marriott Corp. 24,300(a) 352,350
Meristar Hospitality Corp. 19,500 360,750
Sunstone Hotel Investors, Inc. 24,000 217,500
1,109,675
Mall REITs (12.69%)
CBL & Associates Properties, Inc. 11,500 299,719
General Growth Properties 6,500 231,156
Rouse Co. 9,500 266,594
Simon Property Group, Inc. 13,000 389,187
Taubman Centers, Inc. 20,300 277,856
1,464,512
Manufactured Housing REITs (2.75%)
Manufactured Home Communities, Inc. 6,000 $ 149,625
Sun Communities, Inc. 5,000 167,188
316,813
Mortgage, Mixed Use & Miscellaneous
REITs (6.00%)
Bradley Real Estate, Inc. 22,700 476,700
Eastgroup Properties, Inc. 11,300 215,406
692,106
Net Lease REITs (2.72%)
Trinet Corporate Realty Trust, Inc. 10,900 313,375

Office & Industrial REITs (31.55%)
Prologis Trust 10,900 237,756
Arden Realty Group, Inc. 6,900 149,213
Cabot Industrial Trust 24,600 492,000
Carramerica Realty Corp. 18,400 414,000
Cornerstone Properties 13,000 201,500
Duke Realty Investments, Inc. 12,300 293,663
Equity Office Properties Trust 8,500 204,000
First Industrial Realty Trust, Inc. 17,000 435,624
Highwoods Properties, Inc. 11,000 307,312
Kilroy Realty Corp. 10,900 241,844
Liberty Property Trust 9,000 207,000
Mack-Cali Realty Corp. 6,700 198,488
Spieker Properties, Inc. 7,500 258,750
3,641,150
Self Storage REITs (2.88%)
Storage USA 10,900 331,769

Shopping Center REITs (4.98%)
Burnham Pacific Properties, Inc. 16,200 212,625
Federal Realty Investment Trust 16,000 362,000
574,625

Total Common Stocks 11,127,726

Principal
Amount Value
Commercial Paper (3.53%)

Federal & Federally Sponsored
Credit (3.53%)
Investment in Joint Trade Account;
Federal National Mortgage
Association; 5.45%; 11/2/1998 $407,686 $ 407,809

Total Portfolio Investments (99.98%) 11,535,535

Cash & receivables, net of liabilities (0.02%) 2,202

Total Net Assets (100.00%) $11,537,737

(a) Non-income producing security - No dividend paid during the period.

PRINCIPAL SMALLCAP FUND, INC.
Shares
Held Value
Common Stocks (91.84%)

Blast Furnace & Basic Steel
Products (1.05%)
Carpenter Technology Corp. 8,900 $ 312,056

Commercial Banks (3.16%)
Associated Banc-Corp. 9,925 348,616
First Federal Capital Corp. 22,500 343,125
Valley National Bancorp 9,200 248,400
940,141
Commercial Printing (0.66%)
World Color Press, Inc. 6,450(a) 195,919

Communications Equipment (5.65%)
DSP Communications, Inc. 60,700(a) 595,619
Reltec Corp. 20,000(a) 430,000
Sawtek, Inc. 25,100(a) 506,706
Spectrian Corp. 14,100(a) 150,694
1,683,019
Communications Services, NEC (1.06%)
Smartalk Teleservices, Inc. 13,000(a) 75,562
World Access, Inc. 11,250(a) 240,469
316,031
Computer & Data Processing
Services (7.02%)
Advanced Communications System, Inc. 17,950(a) 175,013
Barra, Inc. 8,950(a) 236,056
Cotelligent, Inc. 21,000(a) 396,375
Gtech Holdings Corp. 8,250(a) 198,000
Hypercom Corp. 22,500(a) 213,750
ICG Communications, Inc. 13,100(a) 271,006
SPSS, Inc. 9,200(a) 175,950
Structural Dynamics Research Corp. 10,000(a) 143,750
Synopsys, Inc. 6,200(a) 280,550
2,090,450
Computer & Office Equipment (1.10%)
Smart Modular Technologies, Inc. 15,650(a) 328,650

Construction & Related Machinery (1.31%)
JLG Industries, Inc. 23,500 389,219

Crude Petroleum & Natural Gas (1.49%)
Forcenergy, Inc. 14,250(a) 84,609
Nuevo Energy Co. 16,900(a) 358,069
442,678
Drugs (4.55%)
Chirex, Inc. 16,100(a) 245,525
Dura Pharmaceuticals, Inc. 16,500(a) 199,031
Inhale Therapeutic Systems, Inc. 11,950(a) 313,688
Liposome Co., Inc. 60,000(a) 375,000
Matritech, Inc. 90,900(a) 221,569
1,354,813
Eating & Drinking Places (1.74%)
CEC Entertainment, Inc. 9,800(a) 276,850
Ruby Tuesday, Inc. 14,200 239,625
516,475
Electric Services (1.29%)
TNP Enterprises, Inc. 11,400 $ 384,750

Electronic Components &
Accessories (6.06%)
DII Group, Inc. 21,050(a) 309,172
Flextronics International, Ltd. 11,250(a) 584,297
Jabil Circuit, Inc. 7,950(a) 368,184
Microchip Technology, Inc. 9,100(a) 246,269
Sanmina Corp. 7,200(a) 295,200
1,803,122
Fabricated Structural Metal
Products (1.26%)
Aavid Thermal Technologies, Inc. 25,000(a) 375,000

Family Clothing Stores (0.65%)
Pacific Sunwear of California, Inc. 9,000(a) 194,625

Fire, Marine & Casualty Insurance (2.24%)
Berkley W.R. Corp. 10,600 319,656
HCC Insurance Holdings, Inc. 19,300 346,194
665,850
Footwear, Except Rubber (1.27%)
Wolverine World Wide, Inc. 28,900 377,506

Furniture & Home Furnishing
Stores (0.92%)
Cost Plus, Inc. 9,100(a) 273,000

General Industrial Machinery (1.43%)
General Scanning, Inc. 16,750(a) 92,125
Regal-Beloit Corp. 15,800 332,787
424,912
Grain Mill Products (1.27%)
Ralcorp Holdings, Inc. 21,500(a) 378,938

Hotels & Motels (0.91%)
Four Seasons Hotel, Inc. 8,000 184,000
Servico, Inc. 17,950(a) 87,506
271,506
Industrial Machinery, NEC (0.43%)
Industrial Distribution Group, Inc. 17,750(a) 128,688

Industrial Organic Chemicals (0.62%)
CFC International, Inc. 21,450(a) 185,006

Lumber & Other Building Materials (1.13%)
Eagle Hardware & Garden, Inc. 14,500(a) 337,125

Measuring & Controlling Devices (3.24%)
Cytyc Corporation 24,050(a) 402,837
Integrated Measurement Systems, Inc. 24,300(a) 182,250
Quickturn Design Systems, Inc. 34,500(a) 379,500
964,587
Medical Instruments & Supplies (3.63%)
ADAC Laboratories 16,500(a) 488,813
Focal, Inc. 26,850(a) 258,431
Hologic, Inc. 24,400 333,975
1,081,219
Men's & Boys' Clothing Stores (2.05%)
Abercrombie & Fitch Co. 8,000(a) $ 317,500
Hot Topic, Inc. 15,600(a) 292,500
610,000
Men's & Boys' Furnishings (0.72%)
Nautica Enterprises, Inc. 10,350(a) 214,116

Metal Forgings & Stampings (1.26%)
Varlen Corp. 12,600 376,425

Metal Services, NEC (1.20%)
BMC Industries, Inc. 49,700 357,219

Miscellaneous Apparel & Accessory
Stores (2.06%)
Pier 1 Imports, Inc. 28,000 259,000
The Buckle, Inc. 19,600(a) 355,250
614,250
Miscellaneous Chemical Products (1.18%)
H.B. Fuller Co. 8,500 349,562

Miscellaneous Converted Products (1.49%)
Shorewood Packaging Corp. 27,675(a) 442,800

Miscellaneous Electrical Equipment &
Supplies (0.69%)
Motorcar Parts & Accessories 16,550(a) 206,875

Miscellaneous Equipment Rental &
Leasing (0.43%)
T & W Financial Corp. 11,000(a) 129,250

Miscellaneous Fabricated Metal
Products (1.13%)
Watts Industries, Inc. 18,300 336,262

Miscellaneous Manufacturers (1.09%)
Russ Berrie & Co. 16,500 325,875

Miscellaneous Shopping Goods
Stores (0.68%)
Zale Corp. 8,600(a) 203,713

Miscellaneous Textile Goods (1.06%)
Kellwood Co. 11,600 316,100

Motor Vehicles & Equipment (1.03%)
United Auto Group, Inc. 22,300(a) 306,625

Non-Store Retailers (0.93%)
USA Floral Products, Inc. 30,450(a) 277,856

Office Furniture (2.42%)
Chromcraft Revington, Inc. 22,100(a) 357,744
Kimball International, Inc., Class B 19,600 363,212
720,956
Oil & Gas Field Services (0.76%)
Marine Drilling Co., Inc. 20,250(a) 226,547

Personal Credit Institutions (0.10%)
Firstplus Financial Group, Inc. 6,450(a) 28,622

Personnel Supply Services (0.80%)
Remedytemp, Inc. 13,000(a) 237,250

Petroleum Refining (0.95%)
IRI International Corp. 52,000(a) 282,750

Photographic Equipment &
Supplies (0.87%)
Imax Corp. 10,100(a) 258,812

Plumbing, Heating & Air
Conditioning (0.96%)
Apogee Enterprises, Inc. 27,200 285,600

Public Building & Related
Furniture (0.34%)
BE Aerospace Inc. 4,700(a) 101,050

Rubber & Plastics Footwear (0.62%)
Vans, Inc. 22,200(a) 183,150

Savings Institutions (1.15%)
Community First Bankshares, Inc. 17,200 341,850

Security Brokers & Dealers (1.24%)
Jefferies Group, Inc. 12,300 369,000

Soap, Cleaners & Toilet Goods (1.86%)
Carter-Wallace Inc. 20,900 370,975
Digene Corp. 30,550(a) 183,300
554,275
Surety Insurance (1.85%)
CMAC Investment Corp. 6,600 276,375
Enhance Financial Services Group, Inc. 11,200 275,100
551,475
Telephone Communication (3.10%)
Audiovox Corp., Class A 88,900(a) 488,950
Intermedia Communications, Inc. 9,000(a) 166,500
Winstar Communications, Inc. 9,900(a) 267,300
922,750
Women's Clothing Stores (2.68%)
St. John Knits, Inc. 11,450 231,147
Wet Seal, Inc., Class A 26,900(a) 568,262
799,409

Total Common Stocks 27,345,709

Principal
Amount Value
Commercial Paper (7.64%)

Federal & Federally Sponsored
Credit (7.64%)
Investment in Joint Trade Account;
Federal National Mortgage
Association; 5.45%; 11/2/1998 $2,274,742 $2,274,398

Total Portfolio Investments (99.48%) 29,620,107

Cash, receivables and other assets,
net of liabilities (0.52%) 156,336

Total Net Assets (100.00%) $29,776,443

(a) Non-income producing security - No dividend paid during the period.

PRINCIPAL UTILITIES FUND, INC.
Shares
Held Value
Common Stocks (96.40%)

Combination Utility Services (22.22%)
Baltimore Gas & Electric Co. 82,500 $2,588,438
Cilcorp, Inc. 15,100 777,650
Citizens Utilities 334,483 3,010,347
L G & E Energy Corp. 45,400 1,197,425
Montana Power Co. 47,800 2,070,338
Nipsco Industries, Inc. 83,200 2,490,800
Pacificorp 107,600 2,051,125
Scana Corp. 85,600 2,894,350
Utilicorp United, Inc. 69,000 2,479,687
Washington Water Power Co. 40,500 761,906
Wisconsin Energy Corp. 54,300 1,662,937
21,985,003
Electric Services (36.12%)
Allegheny Energy 86,000 2,644,500
Carolina Power & Light Co. 50,300 2,307,513
Dominion Resources, Inc. 46,300 2,138,481
Duke Energy Corp. 42,700 2,762,156
Edison International 109,400 2,885,425
Enron Corp. 58,680 3,095,370
FPL Group, Inc. 37,600 2,352,350
GPU, Inc. 62,400 2,691,000
Houston Industries, Inc. 94,900 2,947,831
Ipalco Enterprises, Inc. 10,000 458,750
MidAmerican Energy Holdings 56,800 1,476,800
Pinnacle West Capital Corp. 59,700 2,615,606
Southern Co. 85,800 2,418,488
Teco Energy, Inc. 90,500 2,500,062
Texas Utilities Holdings 55,600 2,432,500
35,726,832
Gas Production & Distribution (3.52%)
AGL Resources, Inc. 54,400 1,139,000
New Jersey Resources Corp. 38,700 1,487,531
Peoples Energy Corp. 23,300 859,188
3,485,719
Telephone Communication (34.54%)
Ameritech Corp. 96,600 $5,210,362
AT&T Corp. 46,900 2,919,525
Bell Atlantic Corp. 73,600 3,910,000
BellSouth Corp. 59,500 4,748,844
GTE Corp. 52,900 3,104,569
MCI Worldcom, Inc. 81,724 4,515,251
RCN Corp. 81,000(a) 1,303,594
Sprint Corp. 53,400 4,098,450
US West, Inc. 76,000 4,360,500
34,171,095

Total Common Stocks 95,368,649

Principal
Amount Value
Commercial Paper (3.18%)

Personal Credit Institutions (3.18%)
Investment in Joint Trade Account;
Associates Corp.;
5.72%; 11/2/1998 $3,142,524 $3,142,524

Total Portfolio Investments (99.58%) 98,511,173

Cash, receivables and other assets,
net of liabilities (0.42%) 417,622

Total Net Assets (100.00%) $98,928,795

(a) Non-income producing security - No dividend paid during the period.

FINANCIAL HIGHLIGHTS

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>

PRINCIPAL BALANCED FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $15.11 $14.61 $13.74 $12.43 $13.26
Income from Investment Operations:
Net Investment Income............................... .42 .35 .38 .41 .32
Net Realized and Unrealized Gain (Loss) on Investments 1.15 1.81 1.59 1.31 (.20)

Total Dividends and Distributions (1.40) (1.66) (1.10) (.41) (.95)

Net Asset Value, End of Period......................... $15.28 $15.11 $14.61 $13.74 $12.43

Total Return(b)........................................ 11.00% 15.88% 15.10% 14.18% .94%

Total Dividends and Distributions (1.28) (1.55) (.99) (.30)

Net Asset Value, End of Period......................... $15.22 $15.05 $14.56 $13.71

Total Return(b)........................................ 10.18% 14.96% 14.10% 18.72%(c)

PRINCIPAL BALANCED FUND, INC.(a)
Class R shares 1998 1997 1996(f)
Net Asset Value, Beginning of Period................... $14.98 $14.52 $13.81
Income from Investment Operations:
Net Investment Income............................... .33 .29 .24
Net Realized and Unrealized Gain (Loss) on Investments 1.15 1.76 .73

Total from Investment Operations 1.48 2.05 .97
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.28) (.30) (.26)
Distributions from Capital Gains.................... (1.03) (1.29) --

Total Dividends and Distributions (1.31) (1.59) (.26)

Net Asset Value, End of Period......................... $15.15 $14.98 $14.52

Total Return(b)........................................ 10.43% 15.16% 7.52%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $19,434 $9,745 $875
Ratio of Expenses to Average Net Assets............. 1.88% 1.99% 1.49%(d)
Ratio of Net Investment Income to Average Net Assets 2.22% 1.66% 2.26%(d)
Portfolio Turnover Rate............................. 57.0% 27.6% 32.6%(d)

Total Dividends and Distributions (2.20) (.67) (.61) (.21) (.26)

Net Asset Value, End of Period......................... $21.71 $20.22 $17.10 $15.03 $12.45

Total Return(b)........................................ 19.48% 22.57% 18.20% 22.65% 6.58%

Total Dividends and Distributions (2.10) (.50) (.48) (.15)

Net Asset Value, End of Period......................... $21.55 $20.14 $17.03 $14.99

Total Return(b)........................................ 18.59% 21.59% 17.18% 26.20%(c)

PRINCIPAL BLUE CHIP FUND, INC.(a)
Class R shares 1998 1997 1996(f)
Net Asset Value, Beginning of Period................... $20.16 $17.08 $16.21
Income from Investment Operations:
Net Investment Income............................... .02 .13 .12
Net Realized and Unrealized Gain (Loss) on Investments 3.57 3.53 .90

Total from Investment Operations 3.59 3.66 1.02
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.04) (.12) (.15)
Distributions from Capital Gains.................... (2.08) (.46) --

Total Dividends and Distributions (2.12) (.58) (.15)

Net Asset Value, End of Period......................... $21.63 $20.16 $17.08

Total Return(b)........................................ 19.01% 21.82% 7.02%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $32,871 $15,502 $1,575
Ratio of Expenses to Average Net Assets............. 1.85% 1.89% 1.48%(d)
Ratio of Net Investment Income to Average Net Assets .02%(e) .45% .68%(d)
Portfolio Turnover Rate............................. .5% 55.4% 13.3%(d)

Total Dividends and Distributions (3.00) (4.33) (1.90) (.74) (1.90)

Net Asset Value, End of Period......................... $31.07 $29.69 $27.72 $23.69 $20.83

Total Return(b)........................................ 15.59% 25.36% 26.41% 17.94% 6.67%

Total Dividends and Distributions (2.73) (4.07) (1.69) (.30)

Net Asset Value, End of Period......................... $30.90 $29.51 $27.58 $23.61

Total Return(b)........................................ 14.71% 24.13% 25.19% 25.06%(c)

PRINCIPAL CAPITAL VALUE FUND, INC.(a)
Class R shares 1998 1997 1996(f)
Net Asset Value, Beginning of Period................... $29.44 $27.57 $24.73
Income from Investment Operations:
Net Investment Income............................... .28 .30 .19
Net Realized and Unrealized Gain (Loss) on Investments 3.84 5.74 2.81

Total from Investment Operations 4.12 6.04 3.00
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.29) (.32) (.16)
Distributions from Capital Gains.................... (2.47) (3.85) --

Total Dividends and Distributions (2.76) (4.17) (.16)

Net Asset Value, End of Period......................... $30.80 $29.44 $27.57

Total Return(b)........................................ 14.77% 24.36% 12.74%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $37,675 $18,326 $1,752
Ratio of Expenses to Average Net Assets............. 1.50% 1.50% 1.16%(d)
Ratio of Net Investment Income to Average Net Assets .88% .93% 1.18%(d)
Portfolio Turnover Rate............................. 23.2% 30.8% 50.2%(d)

Total Dividends and Distributions (1.83) (.68) (1.53) (.94) (2.09)

Net Asset Value, End of Period......................... $56.09 $50.43 $39.54 $37.22 $31.14

Total Return(b)........................................ 15.17% 29.55% 10.60% 23.29% 9.82%

Total Dividends and Distributions (1.58) (.39) (1.23) (.20)

Net Asset Value, End of Period......................... $55.98 $50.36 $39.43 $37.10

Total Return(b)........................................ 14.58% 28.92% 9.80% 31.48%(c)

PRINCIPAL GROWTH FUND, INC.(a)
Class R shares 1998 1997 1996(f)
Net Asset Value, Beginning of Period................... $50.16 $39.40 $39.27
Income from Investment Operations:
Net Investment Income............................... .02 .06 .10
Net Realized and Unrealized Gain (Loss) on Investments 7.09 11.16 .13

Total from Investment Operations 7.11 11.22 .23
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.01) (.09) (.10)
Distributions from Capital Gains.................... (1.49) (.37) --

Total Dividends and Distributions (1.50) (.46) (.10)

Net Asset Value, End of Period......................... $55.77 $50.16 $39.40

Total Return(b)........................................ 14.46% 28.72% 1.12%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $30,557 $16,265 $2,014
Ratio of Expenses to Average Net Assets............. 1.59% 1.69% 1.42%(d)
Ratio of Net Investment Income to Average Net Assets .01% .00% .14%(d)
Portfolio Turnover Rate............................. 21.9% 16.5% 1.8%(d)

Total Dividends and Distributions (1.10) (1.29) (.89) (.20) (.09)

Net Asset Value, End of Period......................... $39.90 $45.33 $35.75 $31.45 $25.08

Total Return(b)........................................ (9.78)% 31.26% 16.89% 26.89% 6.86%

Total Dividends and Distributions (1.10) (1.19) (.76) (.02)

Net Asset Value, End of Period......................... $39.29 $44.88 $35.48 $31.31

Total Return(b)........................................ (10.24)% 30.64% 16.07% 35.65%(c)

PRINCIPAL MIDCAP FUND, INC.(a)
Class R shares 1998 1997 1996(f)
Net Asset Value, Beginning of Period................... $45.10 $35.67 $33.77
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.28) (.12) .04
Net Realized and Unrealized Gain (Loss) on Investments (4.29) 10.74 1.88

Total from Investment Operations (4.57) 10.62 1.92
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- (.01) (.02)
Distributions from Capital Gains.................... (1.10) (1.18) --

Total Dividends and Distributions (1.10) (1.19) (.02)

Net Asset Value, End of Period......................... $39.43 $45.10 $35.67

Total Return(b)........................................ (10.37)% 30.56% 6.20%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $23,540 $17,448 $2,016
Ratio of Expenses to Average Net Assets............. 1.89% 1.87% 1.53%(d)
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (.82)% (.45)% .29%(d)
Portfolio Turnover Rate............................. 25.1% 9.5% 12.3%(d)

PRINCIPAL REAL ESTATE FUND, INC.
Class A shares 1998(g)
Net Asset Value, Beginning of Period................... 10.15
Income from Investment Operations:
Net Investment Income............................... .20
Net Realized and Unrealized Gain (Loss) on Investments (1.76)

Total from Investment Operations (1.56)
Less Dividends:
Dividends from Net Investment Income................ (.20)

Total Dividends (.20)

Net Asset Value, End of Period......................... $8.39

Total Return(b)........................................ (15.45)%(c)

PRINCIPAL REAL ESTATE FUND, INC.
Class B shares 1998(g)
Net Asset Value, Beginning of Period................... 10.15
Income from Investment Operations:
Net Investment Income............................... .20
Net Realized and Unrealized Gain (Loss) on Investments (1.78)

Total from Investment Operations (1.58)
Less Dividends:
Dividends from Net Investment Income................ (.19)

Total Dividends (.19)

Net Asset Value, End of Period......................... 8.38

Total Return(b)........................................ (15.67)%(c)

PRINCIPAL REAL ESTATE FUND, INC.
Class R shares 1998(g)
Net Asset Value, Beginning of Period................... 10.15
Income from Investment Operations:
Net Investment Income............................... .23
Net Realized and Unrealized Gain (Loss) on Investments (1.78)

Total from Investment Operations (1.55)
Less Dividends:
Dividends from Net Investment Income................ (.20)

Total Dividends (.20)

Net Asset Value, End of Period......................... 8.40

Total Return(b)........................................ (15.37)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ 2,928
Ratio of Expenses to Average Net Assets............. 1.99%(d)
Ratio of Net Investment Income to Average Net Assets 3.07%(d)
Portfolio Turnover Rate............................. 60.4%(d)

PRINCIPAL SMALLCAP FUND, INC.
Class A shares 1998(g)
Net Asset Value, Beginning of Period................... 9.92
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.08)
Net Realized and Unrealized Gain (Loss) on Investments (1.41)

Total from Investment Operations (1.49)
Less Dividends:
Dividends from Net Investment Income................ --

Total Dividends --

Net Asset Value, End of Period......................... $8.43

Total Return(b)........................................ (15.95)%(c)

PRINCIPAL SMALLCAP FUND, INC.
Class B shares 1998(g)
Net Asset Value, Beginning of Period................... 9.91
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.11)
Net Realized and Unrealized Gain (Loss) on Investments (1.39)

Total from Investment Operations (1.50)
Less Dividends:
Dividends from Net Investment Income................ --

Total Dividends --

Net Asset Value, End of Period......................... $8.41

Total Return(b)........................................ (16.15)%(c)

PRINCIPAL SMALLCAP FUND, INC.
Class R shares 1998(g)
Net Asset Value, Beginning of Period................... 9.91
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.07)
Net Realized and Unrealized Gain (Loss) on Investments (1.39)

Total from Investment Operations (1.46)
Less Dividends:
Dividends from Net Investment Income................ --
Total Dividends --

Net Asset Value, End of Period......................... $8.45

Total Return(b)........................................ (15.75)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ 4,688
Ratio of Expenses to Average Net Assets............. 2.07%(d)
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (1.12)%(d)
Portfolio Turnover Rate............................. 20.5%(d)

PRINCIPAL UTILITIES FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
Net Asset Value, Beginning of Period................... $12.55 $11.40 $10.94 $9.25 $11.45
Income from Investment Operations:
Net Investment Income(h)............................ .41 .48 .44 .48 .46
Net Realized and Unrealized Gain (Loss) on Investments 3.59 1.12 .45 1.70 (2.19)

Total Dividends and Distributions (.44) (.45) (.43) (.49) (.47)

Net Asset Value, End of Period......................... $16.11 $12.55 $11.40 $10.94 $9.25

Total Return(b)........................................ 32.10% 14.26% 8.13% 24.36% (15.20)%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $83,533 $64,366 $66,322 $65,873 $56,747
Ratio of Expenses to Average Net Assets(h).......... 1.15% 1.15% 1.17% 1.04% 1.00%
Ratio of Net Investment Income to Average Net Assets 2.73% 3.90% 3.85% 4.95% 4.89%
Portfolio Turnover Rate............................. 11.9% 22.5% 34.2% 13.0% 13.8%

PRINCIPAL UTILITIES FUND, INC.(a)
Class B shares 1998 1997 1996 1995(e)
Net Asset Value, Beginning of Period................... $12.53 $11.38 $10.93 $9.20
Income from Investment Operations:
Net Investment Income(h)............................ .30 .38 .36 .40
Net Realized and Unrealized Gain (Loss) on Investments 3.59 1.13 .43 1.77

Total Dividends and Distributions (.33) (.36) (.34) (.44)

Net Asset Value, End of Period......................... $16.09 $12.53 $11.38 $10.93

Total Return(b)........................................ 31.23% 13.41% 7.23% 24.18%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $11,391 $6,937 $5,579 $3,952
Ratio of Expenses to Average Net Assets(h).......... 1.90% 1.90% 1.93% 1.72%(d)
Ratio of Net Investment Income to Average Net Assets 2.04% 3.14% 3.07% 3.84%(d)
Portfolio Turnover Rate............................. 11.9% 22.5% 34.2% 13.0%(d)

PRINCIPAL UTILITIES FUND, INC.(a)
Class R shares 1998 1997 1996(f)
Net Asset Value, Beginning of Period................... $12.49 $11.33 $11.75
Income from Investment Operations:
Net Investment Income(h)............................ .33 .39 .28
Net Realized and Unrealized Gain (Loss) on Investments 3.58 1.14 (.41)

Total from Investment Operations 3.91 1.53 (.13)
Less Dividends and Distributions:
Dividends from Net Investment Income................ (.33) (.37) (.29)
Distributions from Capital Gains.................... -- -- --

Total Dividends and Distributions (.33) (.37) (.29)

Net Asset Value, End of Period......................... $16.07 $12.49 $11.33

Total Return(b)........................................ 31.47% 13.72% (.31)%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $4,005 $1,512 $311
Ratio of Expenses to Average Net Assets(h).......... 1.65% 1.65% 1.47%(d)
Ratio of Net Investment Income to Average Net Assets 2.21% 3.35% 3.77%(d)
Portfolio Turnover Rate............................. 11.9% 22.5% 34.2%(d)
</TABLE>

Notes to Financial Highlights

(a) Effective January 1, 1998, the following changes were made to the names of
the Domestic Growth Funds:

(b) Total return is calculated without the front-end sales charge or contingent
deferred sales charge.

(d) Computed on an annualized basis.

(f) Period from February 29, 1996, date Class R shares first offered to
eligible purchasers, through October 31, 1996. Certain of the Domestic
Growth Funds' Class R shares recognized net investment income for the
period from the initial purchase of Class R shares on February 27, 1996
through February 28, 1996 as follows, none of which was distributed to the
sole shareholder, Principal Management Corporation. Additionally, the
Domestic Growth Funds incurred unrealized gains (losses) on investments
during the initial interim period as follows. This represents Class R share
activities of each fund prior to the initial offering of Class R shares:

Per Share
Net Investment Per Share
Income Unrealized (Loss)

Principal Balanced Fund, Inc. $-- $(.03)
Principal Blue Chip Fund, Inc. .01 (.02)
Principal Capital Value Fund, Inc. .01 (.11)
Principal Growth Fund, Inc. .01 .10
Principal MidCap Fund, Inc -- .19

(g) Period from December 31, 1997, date Class A and Class B shares first
offered to the public and Class R shares first offered to eligible
purchasers, through October 31, 1998. With respect to Principal Real Estate
Fund, Inc. Class A, Class B and Class R shares, net investment income
aggregating $.03 per share for the period from the initial purchase of
shares on December 11, 1997 through December 30, 1997 was recognized, of
which $.01 per share was distributed to its sole shareholder, Principal
Life Insurance Company, during the period. With respect to Principal
SmallCap Fund, Inc. Class A, Class B and Class R shares, net investment
income aggregating $.01 per share from the initial purchase of shares on
December 11, 1997 through December 30, 1997 was recognized. Principal
SmallCap Fund, Inc. Class A, Class B and Class R distributed a tax return
of capital of $.01 per share to the sole shareholder Principal Life
Insurance Company, during the period. Principal Real Estate Fund, Inc. and
Principal SmallCap Fund, Inc. Class A, Class B and Class R shares incurred
unrealized gains (losses) on investments during the initial interim period
as follows. This represents Class A, Class B and Class R share activities
of each fund prior to the initial public offering of each class of shares.

Per Share Unrealized
Gain (Loss)

Class Class Class
A B R

Principal Real Estate Fund, Inc. $ .13 $ .13 $ .13
Principal SmallCap Fund, Inc. (.08) (.09) (.09)

(h) Without the Manager's voluntary waiver of a portion of certain of its
expenses (see Note 3 to the financial statements) for the periods
indicated, Principal Utilities Fund, Inc. would have had per share net
investment income and the ratios of expenses to average net assets as
shown:

Class B 1998 .29 2.00% 9,557
1997 .37 1.95% 3,753
1996 .34 2.06% 6,690
1995(e) .40 1.81%(d) 1,338

Class R 1998 .28 2.10% 12,481
1997 .31 2.67% 9,355
1996(f) .28 1.47%(d) --

October 31, 1998

STATEMENTS OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>

Principal Principal
International Principal International
Emerging Markets International SmallCap
GROWTH FUNDS (INTERNATIONAL) Fund, Inc. Fund, Inc. Fund, Inc.

<S> <C> <C> <C>
Investment in securities -- at cost........ $16,534,258 $327,089,074 $22,704,728

Assets
Investment in securities -- at value (Note 4) $12,795,683 $368,412,087 $21,433,644
Cash.................................... 19,179 20,827 4,413
Receivables:
Dividends and interest.................. 26,337 800,343 37,404
Investment securities sold.............. 70,239 841,417 356,814
Capital Stock sold...................... 7,669 559,034 38,716
Other assets............................... -- 1,979 --

Total Assets 12,919,107 370,635,687 21,870,991
Liabilities
Accrued expenses........................... 39,471 396,493 49,926
Payables:
Net payable for foreign currency
contract (Note 5).................... 19,040 89,575 --
Investment securities purchased......... 70,691 7,560,762 65,603
Capital Stock reacquired................ -- 416,522 3,220
Indebtedness (Note 7) ..................... -- -- 85,000

Total Liabilities 129,202 8,463,352 203,749

Net Assets Applicable to Outstanding Shares $12,789,905 $362,172,335 $21,667,242

Net Assets Consist of:
Capital Stock.............................. $ 19,571 $ 393,967 $ 21,695
Additional paid-in capital................. 17,964,592 294,729,701 22,744,050
Accumulated undistributed net
investment income ...................... -- 4,262,374 --
Accumulated undistributed net realized
gain (loss) from investment and
foreign currency transactions........... (1,436,265) 21,542,398 171,669
Net unrealized appreciation (depreciation)
of investments.......................... (3,738,575) 41,323,013 (1,271,084)
Net unrealized appreciation (depreciation) on
translation of assets and liabilities in
foreign currencies...................... (19,418) (79,118) 912

Total Net Assets $12,789,905 $362,172,335 $21,667,242

Capital Stock (par value: $.01 a share):
Shares authorized.......................... 100,000,000 100,000,000 100,000,000
Net Asset Value Per Share:
Class A: Net Assets....................... $7,312,361 $302,756,625 $11,765,019
Shares issued and outstanding. 1,117,661 32,894,131 1,177,376
Net asset value per share...... $6.54 $9.20 $9.99
Maximum offering price per share(a) $6.87 $9.66 $10.49

Class B: Net Assets....................... $3,275,343 $41,676,330 $6,585,150
Shares issued and outstanding. 502,111 4,560,292 660,703
Net asset value per share(b)... $6.52 $9.14 $9.97

Class R: Net Assets....................... $2,202,201 $17,739,380 $3,317,073
Shares issued and outstanding. 337,289 1,942,312 331,451
Net asset value per share............... $6.53 $9.13 $10.01

See accompanying notes.

Year Ended October 31, 1998

STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>

Principal Principal
International Principal International
Emerging Markets International SmallCap
GROWTH FUNDS (INTERNATIONAL) Fund, Inc. Fund, Inc. Fund, Inc.

Net Investment Income
Income:
<S> <C> <C> <C>
Dividends............................. $ 329,076 $ 9,704,858 $ 338,236
Withholding tax on foreign dividends... (17,844) (1,140,879) (29,429)
Interest............................... 56,907 1,282,335 65,346

Total Income 368,139 9,846,314 374,153

Expenses:
Management and investment advisory
fees (Note 3)....................... 157,324 2,492,037 242,403
Distribution and shareholder servicing
fees (Notes 1 and 3)................ 54,053 1,022,931 81,404
Transfer and administrative services
(Notes 1 and 3)..................... 119,948 1,168,106 153,320
Registration fees (Note 1)............. 43,535 98,860 37,217
Custodian fees ........................ 37,425 120,802 16,497
Auditing and legal fees ............... 9,712 10,214 9,229
Directors' fees ....................... 7,526 7,390 7,115
Other ................................. 622 27,346 1,005

Total Net Expenses 430,145 4,947,686 548,190

Net Investment Income (Operating Loss) (62,006) 4,898,628 (174,037)

Net Realized and Unrealized Gain (Loss)on
Investments and Foreign
Currencies Net realized gain (loss) from:
Investment transactions................ (1,349,593) 21,724,953 365,750
Foreign currency transactions.......... (10,717) (159,094) (2,884)
Change in unrealized appreciation/depreciation of:
Investments............................ (1,750,572) (21,749,628) (1,229,130)
Translation of assets and liabilities in
foreign currencies.................. (21,381) (101,686) 889

Net Realized and Unrealized Gain (Loss)
on Investments and Foreign Currencies (3,132,263) (285,455) (865,375)

Net Increase (Decrease) in Net Assets
Resulting from Operations $(3,194,269) $ 4,613,173 $(1,039,412)

</TABLE>

See accompanying notes.

Years Ended October 31, Except as Noted

STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>

Principal Principal
International Principal International
Emerging Markets International SmallCap
GROWTH FUNDS (INTERNATIONAL) Fund, Inc. Fund, Inc. Fund, Inc.

<S> <C> <C> <C> <C> <C> <C>
1998 1997(a) 1998 1997 1998 1997(a)
Operations
Net investment income (operating loss).... $(62,006) $(861) $4,898,628 $3,090,074 $ (174,037) $ (1,911)

Net realized gain (loss) from investment and
foreign currency transactions.......... (1,360,310) (85,030) 21,565,859 7,071,870 362,866 (154,500)
Change in unrealized appreciation/depreciation
of investments and translation of assets
and liabilities in foreign currencies (1,771,953) (1,986,040) (21,851,314) 32,599,107 (1,228,241) (41,931)

Net Increase (Decrease) in Net
Assets Resulting from Operations (3,194,269) (2,071,931) 4,613,173 42,761,051 (1,039,412) (198,342)

Dividends and Distributions to Shareholders
From net investment income:
Class A................................ -- -- (3,230,657) (2,378,873) -- --
Class B ............................... -- -- (135,323) (79,037) -- --
Class R ............................... -- -- (60,535) (19,984) -- --

From net realized gain on investments and
foreign currency transactions:
Class A ............................... -- -- (6,125,804) (6,657,874) -- --
Class B ............................... -- -- (754,887) (635,525) -- --
Class R................................ -- -- (272,111) (55,824) -- --

Total Dividends and Distributions -- -- (10,579,317) (9,827,117) -- --

Capital Share Transactions (Note 6)
Shares sold:
Class A................................ 4,862,019 5,966,460 61,935,765 96,500,904 8,737,574 6,307,287
Class B ............................... 1,321,774 3,867,018 14,284,105 20,265,356 3,023,591 4,967,080
Class R................................ 609,470 3,028,924 9,941,189 11,220,828 532,826 3,022,777
Shares issued in reinvestment of dividends
and distributions:
Class A................................ -- -- 9,196,905 8,872,973 -- --
Class B ............................... -- -- 870,916 696,974 -- --
Class R................................ -- -- 332,448 75,789 -- --
Shares redeemed:
Class A ............................... (797,000) (7,197) (44,920,651) (26,121,521) (2,487,754) (7,102)
Class B ............................... (339,033) (118,315) (6,478,598) (5,667,020) (895,810) (97,291)
Class R ............................... (338,015) -- (3,796,800) (1,083,455) (192,387) (5,795)

Net Increase in Net Assets from
Capital Share Transactions 5,319,215 12,736,890 41,365,279 104,760,828 8,718,040 14,186,956

Total Increase 2,124,946 10,664,959 35,399,135 137,694,762 7,678,628 13,988,614

Net Assets
Beginning of period....................... 10,664,959 -- 326,773,200 189,078,438 13,988,614 --

End of period (including undistributed net
investment income as set forth below). 12,789,905 10,664,959 362,172,335 326,773,200 21,667,242 13,988,614

Undistributed Net Investment Income....... $ -- $ -- $4,262,374 $2,790,261 $ -- $ --

<FN>
(a) Period from August 14, 1997 (date operations commenced) through October 31,
1997.
</FN>

See accompanying notes.
</TABLE>

October 31, 1998

NOTES TO FINANCIAL STATEMENTS

Principal International Emerging Markets Fund, Inc.
Principal International Fund, Inc.
Principal International SmallCap Fund, Inc.

Note 1 -- Significant Accounting Policies

Principal International Emerging Markets Fund, Inc., Principal International
Fund, Inc. and Principal International SmallCap Fund, Inc. (the "International
Growth Funds") are registered under the Investment Company Act of 1940, as
amended, as open-end diversified management investment companies and operate in
the mutual fund industry.

Effective January 1, 1998, Princor World Fund, Inc. changed its name to
Principal International Fund, Inc.

On August 14, 1997, the initial purchases of 400,000 shares of Class A Capital
Stock, 300,000 shares of Class B Capital Stock and 300,000 shares of Class R
Capital Stock of each of Principal International Emerging Markets Fund, Inc. and
Principal International SmallCap Fund, Inc. were made by Principal Life
Insurance Company (formerly known as Principal Mutual Life Insurance Company)
(see Note 3). Effective August 29, 1997, Principal International Emerging
Markets Fund, Inc. and Principal International SmallCap Fund, Inc. began
offering Class A and Class B shares to the public and Class R shares to eligible
purchasers.

Class A shares generally are sold with an initial sales charge based on
declining rates and certain purchases may be subject to a contingent deferred
sales charge ("CDSC"). Class B shares are sold without an initial sales charge,
but are subject to a declining CDSC on certain redemptions made within six years
of purchase. Class R shares are sold without an initial sales charge and are not
subject to a CDSC. Class B shares and Class R shares bear a higher ongoing
distribution fee than Class A shares. Class B shares automatically convert into
Class A shares, based on relative net asset value (without a sales charge) after
seven years. Class R shares automatically convert into Class A shares, based on
relative net asset value (without a sales charge) after four years. All classes
of shares for each fund represent interests in the same portfolio of
investments, and will vote together as a single class except where otherwise
required by law or as determined by each of the International Growth Funds'
respective Board of Directors. In addition, the Board of Directors of each fund
declares separate dividends on each class of shares.

The International Growth Funds allocate daily all income, expenses (other than
class-specific expenses), and realized and unrealized gains or losses to each
class of shares based upon the relative proportion of the value of shares
outstanding of each class. Expenses specifically attributable to a particular
class are charged directly to such class. Class-specific expenses charged to
each class during the year ended October 31, 1998, which are included in the
corresponding captions of the Statement of Operations, were as follows:
<TABLE>
<CAPTION>
Distribution and Transfer and
Shareholder Servicing Fees Administrative Services Registration Fees

Class A Class B Class R Class A Class B Class R Class A Class B Class R

<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Principal International
Emerging Markets Fund, Inc. $26,567 $21,608 $ 5,878 $12,431 $3,105 $ 445 $10,446 $9,086 $15,389
Principal International Fund, Inc. 602,849 299,813 120,269 326,519 78,169 40,326 21,324 14,281 11,794
Principal International SmallCap Fund, Inc. 34,908 38,235 8,261 13,637 4,975 427 8,996 5,349 5,730
</TABLE>

The International Growth Funds value securities for which market quotations are
readily available at market value, which is determined using the last reported
sale price or, if no sales are reported, as is regularly the case for some
securities traded over-the-counter, the last reported bid price. When reliable
market quotations are not considered to be readily available, which may be the
case, for example, with respect to certain debt securities, preferred stocks and
foreign securities, the investments are valued by using prices, provided by
market makers or estimates of market values obtained from yield data and other
factors relating to instruments or securities with similar characteristics in
accordance with procedures established in good faith by each fund's Board of
Directors. Securities with remaining maturities of 60 days or less are valued at
amortized cost, which approximates market.

Generally, trading in foreign securities is substantially completed each day at
various times prior to the close of the New York Stock Exchange. The values of
such securities used in computing net asset value per share are usually
determined as of such times. Occasionally, events which affect the values of
such securities and foreign currency exchange rates may occur between the times
at which they are generally determined and the close of the New York Stock
Exchange and would therefore not be reflected in the computation of each fund's
net asset value. If events materially affecting the value of such securities
occur during such period, then these securities are valued at their fair value
as determined in good faith by the Manager under procedures established and
regularly reviewed by each fund's Board of Directors. To the extent each fund
invests in foreign securities listed on foreign exchanges which trade on days on
which the fund does not determine its net asset value, for example Saturdays and
other customary national U.S. holidays, each fund's net asset value could be
significantly affected on days when shareholders do not have access to the
International Growth Funds.

Certain securities issued by companies in emerging market countries may have
more than one quoted valuation at any given point in time, sometimes referred to
as a "local" price and a "premium" price. The premium price is often a
negotiated price which may not consistently represent a price at which a
specific transaction can be effected. It is the policy of the International
Growth Funds to value such securities at prices at which it is expected those
shares may be sold, and the manager or any sub-adviser is authorized to make
such determinations subject to such oversight by each fund's Board of Directors
as may occasionally be necessary.

The value of foreign securities in foreign currency amounts is expressed in U.S.
dollars at the closing daily rate of exchange. The identified cost of the
portfolio holdings is translated at approximate rates prevailing when acquired.
Income and expense amounts are translated at approximate rates prevailing when
received or paid, with daily accruals of such amounts reported at approximate
rates prevailing at the date of valuation. Since the carrying amount of the
foreign securities is determined based on the exchange rate and market values at
the close of the period, it is not practicable to isolate that portion of the
results of operations arising as a result of changes in the foreign exchange
rates from the fluctuations arising from changes in the market prices of
securities during the period.

The International Growth Funds record investment transactions generally one day
after the trade date, except for short-term investment transactions which are
recorded generally on the trade date. The identified cost basis has been used in
determining the net realized gain or loss from investment transactions and
unrealized appreciation or depreciation of investments. The International Growth
Funds record dividend income on the ex-dividend date, except dividend income
from foreign securities whereby the ex-dividend date has passed; such dividends
are recorded as soon as the International Growth Funds are informed of the
ex-dividend date. Interest income is recognized on an accrual basis.

Reported net realized foreign exchange gains or losses arise from sales of
foreign currencies, currency gains or losses realized between trade and
settlement dates on security transactions, and the difference between the amount
of dividends and foreign withholding taxes recorded on the books and the U.S.
dollar equivalent of the amounts actually received or paid. Net unrealized
appreciation on translation of assets and liabilities in foreign currencies
arise from changes in the exchange rate relating to assets and liabilities,
other than investments in securities, purchased and held in non-U.S. denominated
currencies.

The International Growth Funds may, pursuant to an exemptive order issued by the
Securities and Exchange Commission, transfer uninvested funds into a joint
trading acount. The order permits the International Growth Funds' cash balances
to be deposited into a single joint account along with the cash of other
registered investment companies managed by Principal Management Corporation
(formerly known as Princor Management Corporation) (the "Manager"). These
balances may be invested in one or more short-term instruments.

Dividends and distributions to shareholders are recorded on the ex-dividend
date. Dividends and distributions to shareholders from net investment income and
net realized gain from investments and foreign currency transactions are
determined in accordance with federal income tax regulations, which may differ
from generally accepted accounting principles. Permanent book and tax basis
differences are reclassified within the capital accounts based on their federal
tax-basis treatment; temporary differences do not require reclassification.
Reclassifications made for Principal International Emerging Markets Fund, Inc.
and Principal International SmallCap Fund, Inc. for the year ended October 31,
1998 aggregated $75,696 and $181,352 respectively. Other reclassifications made
for the periods ended October 31, 1998 and 1997 were not material.

Note 2 -- Federal Income Taxes

At October 31, 1998, Principal International Emerging Markets Fund, Inc. had net
capital loss carryforwards of approximately $72,000 which expires in 2005 and
$1,350,000 which expires in 2006.

Note 3 -- Management Agreement and Transactions With Affiliates

The International Growth Funds have agreed to pay investment advisory and
management fees to Principal Management Corporation (wholly owned by Princor
Financial Services Corporation, a subsidiary of Principal Life Insurance
Company) computed at an annual percentage rate of each fund's average daily net
assets. The annual rate used in this calculation for the International Growth
Funds is as follows:

<TABLE>
<CAPTION>
Net Asset Value of Funds
(in millions)

First Next Next Next Over
$100 $100 $100 $100 $400

<S> <C> <C> <C> <C> <C>
Principal International Emerging Markets Fund, Inc. 1.25% 1.20% 1.15% 1.10% 1.05%
Principal International Fund, Inc. 0.75% 0.70% 0.65% 0.60% 0.55%
Principal International SmallCap Fund, Inc. 1.20% 1.15% 1.10% 1.05% 1.00%
</TABLE>

The International Growth Funds also reimburse the Manager for transfer and
administrative services, including the cost of accounting, data processing,
supplies and other services rendered.

<TABLE>
<CAPTION>
Class A Class B

<S> <C> <C>
Principal International Emerging Markets Fund, Inc. $ 111,414 $ 2,911
Principal International Fund, Inc. 1,271,429 97,586
Principal International SmallCap Fund, Inc. 185,226 11,813
</TABLE>

No brokerage commissions were paid by the International Growth Funds to Princor
Financial Services Corporation during the periods. Brokerage commissions were
paid to other affiliates by the following funds:
<TABLE>
<CAPTION>
Year Ended Periods Ended
October 31, 1998 October 31, 1997

<S> <C> <C>
Principal International Emerging Markets Fund, Inc. $ 4,730 $ 1,586
Principal International Fund, Inc. 138,499 20,595
Principal International SmallCap Fund, Inc. 6,610 1,502
</TABLE>

The International Growth Funds bear distribution and shareholder servicing fees
with respect to Class A shares computed at an annual rate of up to .25% of the
average daily net assets attributable to Class A shares of each fund. Each of
the International Growth Funds adopted a distribution plan with respect to Class
B shares that provides for distribution and shareholder servicing fees computed
at an annual rate of up to 1.00% of the average daily net assets attributable to
Class B shares of each fund. Each of the International Growth Funds adopted a
distribution plan with respect to Class R shares that provides for distribution
and shareholder servicing fees computed at an annual rate of up to .75% of the
average daily net assets attributable to Class R shares of each fund.
Distribution and shareholder servicing fees are paid to Princor Financial
Services Corporation; a portion of the fees are subsequently remitted to retail
dealers. Pursuant to the distribution agreements, fees unused by the principal
underwriter at the end of the fiscal year are returned to the International
Growth Funds.

Class A Class B Class R

<S> <C> <C> <C>
Principal International Emerging Markets Fund, Inc. 400,000 300,000 300,000
Principal International Fund, Inc. 8,948,596 167 144
Principal International SmallCap Fund, Inc. 400,000 300,000 300,000
</TABLE>

Note 4 -- Investment Transactions

For the year ended October 31, 1998, the cost of investment securities purchased
and proceeds from investment securities sold (not including short-term
investments and U.S. government securities) by the International Growth Funds
were as follows:
<TABLE>
<CAPTION>
Purchases Sales

<S> <C> <C>
Principal International Emerging Markets Fund, Inc. $ 10,650,789 $ 5,255,733
Principal International Fund, Inc. 160,865,537 133,077,387
Principal International SmallCap Fund, Inc. 24,647,135 18,690,336
</TABLE>

At October 31, 1998, net unrealized appreciation (depreciation) of investments
by the International Growth Funds was composed of the following:

<TABLE>
<CAPTION>
Net Unrealized
Gross Unrealized Appreciation (Depreciation)
Appreciation (Depreciation) of Investments

<S> <C> <C> <C>
Principal International Emerging Markets Fund, Inc. $ 914,650 $ (4,653,225) $(3,738,575)
Principal International Fund, Inc. 75,054,616 (33,731,603) 41,323,013
Principal International SmallCap Fund, Inc. 1,545,687 (2,816,771) (1,271,084)
</TABLE>

At October 31, 1998, the International Growth Funds held the following
securities which were purchased in a private placement transaction and may
require registration, or an exemption therefrom, in order to effect a sale in
the ordinary course of business.
<TABLE>
<CAPTION>
Value at Value as a
Date of October 31, Percentage of
Security Description Acquisition Cost 1998 Net Assets

<S> <C> <C> <C> <C> <C>
Principal International Al Ahram Beverages Co. ADR 8/21/97 $ 56,100 $ 61,710 .48%
Emerging Markets Fund, Inc. 4/14/98 12,050 11,220 .09
9/28/98 19,350 16,830 .13
Bank Handlowy GDR 8/14/97 50,200 45,600 .35
2/23/98 31,100 22,800 .18
4/2/98 16,625 11,400 .09
4/21/98 16,100 11,400 .09
Banque Libanaise le Commerce
SAL ADR 8/14/97 115,250 86,250 .68
2/19/98 7,440 6,900 .05
Banque Marocaine du Commerce
Exterieur 8/15/97 87,600 116,800 .91
Eesti Uhispank GDR 3/24/98 79,750 25,375 .20
4/2/98 15,250 5,075 .04
Industrial Credit & Investment Corp.
of India ADR 8/14/97 137,750 41,800 .32
10/7/97 31,400 11,000 .09
10/20/97 33,400 11,000 .09
11/10/97 15,000 5,500 .04
12/4/97 10,750 5,500 .04
12/17/97 18,675 9,900 .08
1/13/98 13,975 7,150 .06
6/5/98 13,000 5,500 .04
7/14/98 14,365 7,150 .06
8/28/98 20,988 12,650 .10
Mol Magyar Olaj-Es Gazipari ADR 3/20/98 $150,000 $111,801 .87%
4/14/98 16,250 11,180 .09
5/20/98 13,800 11,180 .09
8/4/98 11,950 8,944 .07
9/2/98 18,113 20,124 .16
9/23/98 20,570 24,596 .19
Paints & Chemical Industries
Co. GDR 9/26/97 149,225 116,522 .92
9/26/97 5,745 5,505 .04
10/20/97 11,700 9,175 .07
10/30/97 19,750 18,350 .14
12/4/97 12,155 11,928 .09
1/23/98 3,450 3,670 .03
4/14/98 14,788 11,928 .09
7/20/98 21,390 21,102 .17
9/1/98 17,040 22,020 .17
Pick Szeged RT GDR 7/7/98 26,510 18,257 .14
7/8/98 27,280 18,257 .14
7/14/98 12,950 8,299 .06
9/2/98 20,400 24,896 .20
9/23/98 14,490 24,896 .20
10/22/98 14,200 16,597 .13
10/27/98 20,410 21,576 .17
Reliance Industries GDR 8/14/97 72,000 30,450 .24
10/24/97 22,125 10,150 .08
12/12/97 21,750 15,225 .12
1/2/98 17,535 10,658 .08
1/13/98 12,750 8,628 .07
4/6/98 13,800 7,612 .06
7/14/98 13,050 9,135 .07
Tata Engineering & Locomotive
Ltd. Co. GDR 8/14/97 71,250 15,209 .12
10/1/97 19,000 5,070 .04
10/20/97 18,900 5,070 .04
12/30/97 7,650 2,282 .02
Videsh Sanchar Nigam Ltd. GDR 8/14/97 132,800 84,000 .66
11/18/97 28,250 21,000 .16
12/2/97 14,250 10,500 .08
12/12/97 10,720 8,400 .07
1/2/98 15,235 11,550 .09
1/13/98 13,620 12,600 .10
3/5/98 10,440 8,400 .07
4/3/98 21,038 17,850 .14
6/5/98 19,800 18,900 .15
7/14/98 11,750 10,500 .08
7/30/98 10,875 10,500 .08
9/28/98 16,688 15,750 .12

1,428,752 11.18
</TABLE>
<TABLE>
<CAPTION>
Value at Value as a
Date of October 31, Percentage of
Security Description Acquisition Cost 1998 Net Assets

<S> <C> <C> <C> <C> <C>
Principal International Fokus Bank 10/9/95 $ 557,692 $1,033,640 .29%
Fund, Inc. 12/17/96 797,392 1,033,640 .29
Kemira OY 12/13/96 610,584 411,838 .11
12/20/96 1,478,458 963,700 .27
2/26/97 1,162,586 831,912 .23
4/8/97 615,051 494,205 .14
4/9/97 41,573 32,947 .01

4,801,882 1.34

Principal International Bure Investment Aktiebolaget AB 8/14/97 46,173 52,963 .25
SmallCap Fund, Inc. 8/18/97 46,092 52,963 .25
8/22/97 8,101 9,268 .04
6/25/98 104,616 84,740 .39
8/5/98 32,121 29,129 .13
8/27/98 34,931 35,750 .16
10/19/98 38,867 42,370 .20
10/20/98 12,055 13,240 .06
Computacenter PLC 5/21/98 188,072 130,342 .60
5/21/98 22,261 21,219 .10
9/28/98 32,653 30,312 .14
10/2/98 64,456 61,382 .28
Industrial & Financial Systems 8/14/97 1,752 3,786 .02
8/18/97 10,528 22,720 .11
10/9/97 26,974 37,867 .17
10/30/97 53,442 75,734 .35
11/12/97 91,032 132,534 .61
Newsquest PLC 10/16/97 227,052 222,735 1.03
11/13/97 35,652 34,604 .16
8/26/98 49,359 43,752 .20

1,137,410 5.25
</TABLE>

The International Growth Funds' investments are with various issuers in various
industries. The Schedules of Investments contained herein summarize
concentrations of credit risk by issuer and industry.

Note 5 -- Foreign Currency Contracts

At October 31, 1998, Principal International Emerging Markets Fund, Inc. and
Principal International Fund, Inc. owned forward contracts to sell Hong Kong
Dollars ("HKD") at specified future dates at fixed exchange rates. Forward
foreign currency contracts are valued at the forward rate, and are
marked-to-market daily. The change in market value is recorded by each fund as
an unrealized gain or loss. When the contract is closed, each fund records a
realized gain or loss equal to the difference between the value of the contract
at the time it was opened and the value at the time it was closed.
<TABLE>
<CAPTION>
Value at
Contracts In Exchange Settlement October 31, Net Unrealized
to Deliver For Date 1998 (Depreciation)
<S> <C> <C> <C> <C> <C>
Principal International

Emerging Markets Fund, Inc. 3,575,000 HKD $ 440,000 3/1/99 $ 459,040 $(19,040)
Principal International Fund, Inc. 16,818,750 HKD 2,070,000 3/1/99 2,159,575 (89,575)
</TABLE>

The use of forward foreign currency contracts does not eliminate fluctuations in
underlying prices of each fund's portfolio securities, but it does establish a
rate of exchange that can be achieved in the future. Although forward foreign
currency contracts limit the risk of loss due to a decline in the value of the
hedged currency, they also limit any potential gain that might result should the
value of the currency increase. In addition, each fund could be exposed to risks
if the counterparties to the contracts are unable to meet the terms of their
contracts.

Note 6 -- Capital Share Transactions

Transactions in Capital Stock by fund were as follows:
<TABLE>
<CAPTION>
Principal Principal
International Principal International
Emerging Markets International SmallCap
Fund, Inc. Fund, Inc. Fund, Inc.
<S> <C> <C> <C>
Year Ended October 31, 1998:
Shares sold:
Class A ......................................... 620,056 6,434,705 770,054
Class B ......................................... 169,453 1,480,411 260,731
Class R ......................................... 87,602 1,035,347 47,319
Shares issued in reinvestment of dividends and distributions:
Class A ........................................... -- 1,012,117 --
Class B ........................................... -- 95,849 --
Class R ......................................... -- 36,589 --
Shares redeemed:
Class A ......................................... (110,092) (4,688,589) (216,075)
Class B ......................................... (43,618) (672,121) (79,482)
Class R ......................................... (53,356) (400,191) (17,457)

Net Increase 670,045 4,334,117 765,090

Periods Ended October 31, 1997:
Shares sold:
Class A ......................................... 608,541 10,828,384 624,104
Class B ......................................... 389,744 2,259,005 489,175
Class R ......................................... 303,043 1,249,248 302,174
Shares issued in reinvestment of dividends and distributions:
Class A ........................................... -- 1,075,120 --
Class B ........................................... -- 85,277 --
Class R ......................................... -- 9,208 --
Shares redeemed:
Class A ......................................... (844) (2,929,702) (707)
Class B ......................................... (13,468) (638,189) (9,721)
Class R ......................................... -- (118,068) (585)

Net Increase 1,287,016 11,820,283 1,404,440
</TABLE>

Note 7 -- Line of Credit

The International Growth Funds participate with other funds and portfolios
managed by Principal Management Corporation in an unsecured joint line of credit
with a bank, which allows the funds to borrow up to $60,000,000, collectively.
Borrowings are made solely to facilitate the handling of unusual and/or
unanticipated short-term cash requirements. Interest is charged to each fund,
based on its borrowings, at a rate equal to the Fed Funds Rate plus .50%.
Additionally, a commitment fee is charged at the annual rate of .08% on the
average unused portion of the line of credit. The commitment fee is allocated
among the participating funds and portfolios in proportion to their average net
assets during each quarter. At October 31, 1998, the Principal International
SmallCap Fund, Inc. had an outstanding borrowing of $85,000 at an annual rate of
5.93%. No other International Growth Fund had outstanding borrowings at October
31, 1998 under the line of credit.

Note 8 -- Year 2000 Problem (Unaudited)

Like other mutual funds, financial and business organizations and individuals
around the world, the International Growth Funds could be adversely affected if
the computer systems used by the Manager and other service providers do not
properly process and calculate date-related information and data from and after
January 1, 2000. This is commonly known as the "Year 2000 Problem." The Manager
is taking steps it believes are reasonably designed to address the Year 2000
Problem with respect to computer systems it uses and to obtain reasonable
assurances that comparable steps are being taken by each fund's other major
service providers. At this time, however there can be no assurance that these
steps will be sufficient to avoid any adverse impact to the funds.

Note 9 -- Euro Conversion (Unaudited)

The planned introduction of a new European currency, the euro, may result in
uncertainties for European securities in the markets in which they trade and
with respect to the operation of each of the International Growth Funds'
portfolios. Currently, the euro is expected to be introduced on January 1, 1999
by eleven European countries that are members of the European Economic and
Monetary Union ("EMU"). The introduction of the euro will require the
redenomination of European debt and equity securities over a period of time,
which may result in various accounting differences and/or tax treatments that
otherwise would not likely occur. Additional questions are raised by the fact
that certain other EMU members, including the United Kingdom, will not
officially be implementing the euro on January 1, 1999. If the introduction of
the euro does not take place as planned, there could be negative effects, such
as severe currency fluctuations and market disruptions.

The Manager is actively working to address euro-related issues and understands
that other key service providers are taking similar steps. At this time,
however, no one knows precisely what the degree of impact will be. To the extent
that the market impact or effect on a portfolio holding is negative, it could
hurt the fund's performance.

GROWTH FUNDS (INTERNATIONAL)

PRINCIPAL INTERNATIONAL EMERGING MARKETS FUND, INC.

Shares
Held Value

Common Stocks (85.92%)

Air Transportation, Scheduled (0.28%)
Cintra SA De Cv Ser'anpv 73,000 $ 35,336

Bakery Products (0.58%)
Nong Shim Co., Ltd. 1,600 74,576

Beer, Wine & Distilled Beverages (1.45%)
South African Breweries Ltd. 9,531 184,849

Beverages (8.18%)
Al Ahram Beverages Co. ADR 3,200(a) 89,760
Embotelladora Andina ADR, Series A 9,800 130,463
PanAmerican Beverages ADR 9,100 184,275
Fomento Economico Mexicano ADR 10,550 274,959
Pepsi-Gemex SA De Cv GDR 11,400 74,100
Quilmes Industrial Quines SA ADR 31,900 293,081

1,046,638
Blast Furnace & Basic Steel
Products (1.29%)
Hylsamex SA, Class B 36,100 49,428
Tubos De Acero De Mexico ADR 13,600 115,600

165,028
Cable & Other Pay TV Services (1.44%)
Ceske Radiokomunikace GDR 6,050(b) 184,525

Central Reserve Depositories (0.78%)
Banco Santiago SA ADR 7,300 99,462

Chemicals & Allied Products (0.81%)
Sarantis SA 8,980 103,351

Commercial Banks (5.61%)
Banco Portugues Do Atlantico 5,900(b) 118,341
Banco Rio De La Plata ADR 16,900 152,100
Bank Handlowy GDR 8,000(a) 91,200
Banque Libanaise Le Commerce SAL ADR 5,400(a) 93,150
Banque Marocaine du Commerce Exterieur 4,800(a) 116,880
Big Bank Gdanski SA 111,995 115,395
Eesti Uhispank GDR 6,000(a)(b) 30,450

717,516
Communications Equipment (2.25%)
ECI Telecommunications Ltd. ADR 8,700 288,187

Computer & Data Processing
Services (1.02%)
Tecnomatix Technologies Ltd. ADR 9,000(b) 130,500

Computer & Office Equipment (2.42%)
Orbotech Ltd. ADR 7,100(b) 248,500
Sindo Ricoh Co. 2,000 60,479

308,979
Construction & Related Machinery (0.87%)
Barlow Ltd. 23,458 110,812

Consumer Products (2.89%)
Rothmans Industries Ltd. 43,000 217,875
Souza Cruz SA 12,100 82,163
Tabak AS 300 70,337

370,375
Crude Petroleum & Natural Gas (1.47%)
Mol Magyar Olaj-Es Gazipari ADR 8,400(a) 187,825

Deep Sea Foreign Transportation of
Freight (0.11%)
Noble Group Ltd. ADR 98,000(b) 14,210

Drugs (1.32%)
Teva Pharmaceutical ADR 4,300 169,581

Eating & Drinking Places (1.00%)
Cafe De Coral Holdings Ltd. 373,000 127,608

Electric Services (3.43%)
Companhia Paranaense De Enersis ADR 20,400 158,100
Electricidade De Portugal SA 5,700 143,407
Enersis SA ADR 6,600 137,775

439,282
Electrical Industrial Apparatus (0.33%)
Guangdong Kelon Electric Holdings 50,000 42,603

Electronic Components &
Accessories (3.19%)
Elec & Eltek International ADR 34,500 172,500
Varitronix 90,000 170,798
Wong Circuits Holdings Ltd. ADR 80,000 65,200

408,498
Electronic Distribution
Equipment (3.87%)
Tadiran Ltd. ADR 4,900 144,244
Techtronic Industries Co. 1,164,000 219,396
Vtech Holdings Ltd. 35,000 131,261

494,901
Engines & Turbines (0.59%)
First Tractor Co. Ltd. 242,000 76,543

Federal & Federally Sponsored
Credit (0.92%)
Industrial Credit & Investment
Corp. of India ADR 21,300(a) 117,150

Fire, Marine & Casualty Insurance (0.45%)
Alfa, Series A 21,700 57,237

Foreign Banks, Branches &
Agencies (1.13%)
Bank Leumi Le - Israel 55,000 70,054
Credicorp Ltd. ADR 11,050 74,587

144,641
Furniture & Home Furnishing
Stores (0.58%)
Grupo Elektra SA CPO 175,000 74,683

Grocery Stores (1.19%)
Blue Square Chain Investments &
Property Ltd. 11,900(b) 151,571

Holding Offices (1.62%)
The India Fund, Inc. ADR 33,400(b)$ 206,662

Measuring & Controlling Devices (2.24%)
IDT Holdings Singapore Ltd. ADR 195,000 149,175
Moulin International Holding 1,230,000 136,561

285,736
Meat Products (1.04%)
Pick Szeged RT GDR 16,000(a) 132,778

Medical Instruments & Supplies (1.70%)
Medison Co. 19,600 216,876

Metal Cans & Shipping Containers (0.62%)
Colep 9,100(b) 78,746

Miscellaneous Electrical Equipment &
Supplies (1.28%)
G.P. Batteries International 74,500 163,804

Miscellaneous Food & Kindred
Products (0.90%)
Thai Union Frozen Products 28,000 115,067

Miscellaneous Investing (1.07%)
Banco Latino Americano
De Exportaciones 6,300 136,631

Miscellaneous Non-Durable (1.90%)
Desc SA ADR 12,900 243,487

Miscellaneous Textile Goods (2.07%)
Esprit Holdings Ltd. 466,000 172,960
Reliance Industries GDR 18,100(a) 91,858

264,818
Motor Vehicles & Equipment (0.22%)
Tata Engineering & Locomotive Ltd.
Co. GDR 10,900(a) 27,631

Newspapers (0.62%)
Investec-Consultadoria Internacional SA 2,000 78,935

Oil & Gas Field Services (0.17%)
Gulf Indonesia Resources Ltd. ADR 2,200(b) 21,725

Paints & Allied Products (1.72%)
Paints & Chemical Industries Co. GDR 24,000(a) 220,200

Paperboard Containers & Boxes (0.69%)
Hung Hing Print Group 228,000 88,304

Petroleum Refining (3.99%)
Sasol Ltd. 41,100 201,110
YPF Sociedad Anonima ADR 10,700 309,631

510,741
Search & Navigation Equipment (1.70%)
Elbit Systems Ltd. ADR 18,800 217,375

Security Brokers & Dealers (0.00%)
Peregrine Investment Holdings 62,000(c) --

Security & Commodity Exchanges (0.71%)
OTK Holdings Ltd. ADR 146,000 91,090

Services, NEC (0.92%)
IDT International 900,000 $ 117,351

Telephone Communications (11.29%)
Compania Anonima Telefonos De
Venezuela ADR 4,200 65,100
Compania De Telecomunicacion De
Chile ADR 7,400 162,338
Global Telesystems Group, Inc. ADR 5,400(b) 216,338
Hellenic Telecommunication 7,811 177,578
Matav RT ADR 9,000 241,875
Telec De Sao Paulo SA 200,000(b) 21,880
Telecommunicacoes Brasileiras SA ADR 2,200 167,063
Telefonica De Argentina ADR 4,900 162,006
Videsh Sanchar Nigam Ltd. GDR 21,900(a)(b) 229,950

1,444,128

Total Common Stocks 10,988,552

Preferred Stocks (6.70%)

Cement, Hydraulic (1.56%)
Titan Cement Co. 3,700 199,578

Central Reserve Depositories (0.43%)
Banco Ganadero SA ADR 7,700 55,344

Electric Services (1.05%)
Centrais Electricas De Santa Catarina 247,000 134,591

Industrial Inorganic Chemicals (0.27%)
Fertilizantes Fosfatados Fosfertil NPV 13,800,000 34,012

Telephone Communication (3.39%)
Telemig Celular 1,300,000(b) 12,206
Telesp Celular SA 1,290,000(b) 62,723
Telecomunicacoes De Minus Gerais 1,220,000 36,808
Telec De Sao Paulo SA 1,940,000(b) 322,013

433,750

Total Preferred Stocks 857,275

Principal
Amount Value

Commercial Paper (7.43%)

Federal & Federally Sponsored
Credit (7.43%)
Federal National Mortgage Association;
5.45%; 11/2/1998 $949,569 $ 949,856

Total Portfolio Investments (100.05%) 12,795,683

Liabilities, net of cash, receivables and
other assets (-0.05%) (5,778)

Total Net Assets (100.00%) $12,789,905

(a) Restricted security - See Note 4 to the financial statements.
(b) Non-income producing security - No dividend paid during the period.
(c) Peregrine Investment Holdings has filed a plan of liquidation.

Principal International Emerging Markets Fund, Inc.
Investments by Country

Total Percentage of
Country Value Total Value

Argentina $ 916,819 7.17%
Brazil 1,031,560 8.06
Chile 530,038 4.14
China 119,145 0.93
Colombia 55,344 0.43
Czech Republic 471,200 3.68
Egypt 309,960 2.42
Estonia 30,450 0.24
Greece 480,507 3.76
Hong Kong 1,164,238 9.10
Hungary 562,477 4.40
India 673,252 5.26
Indonesia 21,725 0.17
Israel 1,420,012 11.10
Korea, Republic of 351,932 2.75
Lebanon 93,150 0.73
Mexico 1,109,106 8.67
Morocco 116,880 0.91
Panama 136,631 1.07
Peru 74,587 0.58
Poland 206,595 1.61
Portugal 419,428 3.28
Singapore 782,763 6.12
South Africa 587,861 4.59
Thailand 115,067 0.90
United States 949,856 7.42
Venezuela 65,100 0.51

Total $12,795,683 100.00%

PRINCIPAL INTERNATIONAL FUND, INC.

Shares
Held Value

Common Stocks (93.28%)

Advertising (1.75%)
WPP Group PLC 1,295,000 $ 6,354,407

Beverages (0.87%)
PanAmerican Beverages ADR 156,300 3,165,075

Blast Furnace & Basic Steel
Products (0.31%)
Tubos De Acero De Mexico ADR 132,000 1,122,000
Central Reserve Depositories (2.62%)
National Westminster Bank 329,931 5,511,549
Union Bank of Norway 209,660 3,981,603

9,493,152
Commercial Banks (14.01%)
Bank of Ireland 428,239 7,896,075
Barclays PLC 146,594 3,147,327
BG Bank 106,000 6,145,237
Fokus Bank 240,000(a) 2,067,280
Istituto Mobiliare Italiano 413,000 6,353,066
Merita PLC Class A 1,187,670 6,364,546
National Australia Bank Ltd. 326,437 4,306,363
Royal Bank of Canada Montreal Quebec 143,000 6,572,426
Svenska Handelsbanken Class A 30,000 1,260,736
Svenska Handelsbanken AB Free 172,750 6,640,948

50,754,004
Communications Equipment (2.06%)
ECI Telecommunications Ltd. ADR 225,000 7,453,125

Communications Services, NEC (1.10%)
Koninklijke KPN NV 102,780 3,995,245

Computer & Office Equipment (1.24%)
Orbotech Ltd. ADR 128,200(b) 4,487,000

Concrete, Gypsum & Plaster
Products (1.78%)
Lafarge SA 63,000 6,439,591

Consumer Products (5.36%)
Imasco Ltd. 413,457 7,750,840
Imperial Tobacco Group PLC 303,500 3,123,332
Societe Nationale D'Exploitation
Industrielle Des Tabacs et
Allumettes 43,750 2,598,133
Swedish Match Co. 1,688,000 5,938,445

19,410,750
Copper Ores (0.96%)
Trelleborg AB Class B 379,000 3,466,672

Deep Sea Foreign
Transportation of Freight (0.58%)
Van Ommeren NV 64,841 2,100,406

Drugs (5.62%)
Elan Corp. PLC ADR 75,000(b) 5,254,688
Novartis AG 4,423 7,969,999
Pharmacia & Upjohn, Inc. 135,000 7,146,562

20,371,249
Electrical Goods (1.28%)
Smiths Industries PLC 344,000 4,623,184

Electronic Components &
Accessories (1.22%)
Elec & Eltek International ADR 757,400 3,787,000
Varitronix 340,000 645,236

4,432,236
Electronic Distribution
Equipment (2.31%)
Phillips Electronics 157,100 8,361,050

Engines & Turbines (1.20%)
RHI AG 89,000 2,787,906
Scapa Group PLC 835,400 1,559,937

4,347,843
Farm & Garden Machinery (0.81%)
New Holland NV 231,000 2,916,375

Finance Services (0.50%)
Takefuji Corp. 34,000 $ 1,811,948

Gas Production & Distribution (0.79%)
Omv AG 30,600 2,870,363

Hose, Belting, Gaskets & Packing (0.55%)
Phoenix AG 94,000 1,986,503

Industrial Inorganic Chemicals (0.76%)
Kemira OY 332,000(a) 2,734,602

Investment Offices (1.40%)
AMVESCAP PLC 671,400 5,076,644

Life Insurance (1.03%)
QBE Insurance Group Ltd. 946,390 3,721,878

Meat Products (5.79%)
Danisco AS 120,000 6,632,853
Orkla ASA Class A 111,000 1,874,591
Orkla ASA Class B 349,600 5,216,491
Unilever NV 97,800 7,257,722

20,981,657
Miscellaneous Chemical Products (1.52%)
Hoechst AG 132,000 5,507,382

Miscellaneous Converted
Paper Products (1.64%)
Bunzl PLC 1,285,000 5,939,500

Miscellaneous Food & Kindred
Products (1.03%)
Greencore Group PLC 991,000 3,734,168

Miscellaneous Non-Durable Goods (2.93%)
Desc S.A. Class B 3,140,000 2,878,597
Diageo PLC 716,179 7,736,044

10,614,641
Miscellaneous Textile Goods (0.73%)
Esprit Holdings Ltd. 7,082,000 2,628,550

Miscellaneous Transportation
Equipment (0.79%)
Autoliv, Inc. 86,000 2,843,375

Motor Vehicles & Equipment (1.98%)
E.C.I.A. Equipment & Composants 20,000 3,797,098
Mayflower Corp. PLC 1,557,000 3,389,765

7,186,863
Newspapers (0.77%)
Publishing & Broadcasting Ltd. 710,000 2,805,479

Oil & Gas Field Services (0.94%)
Eni Spa 571,000 3,398,392

Paperboard Containers & Boxes (0.93%)
Buhrmann NV 187,200 3,357,754

Personnel Supply Services (1.02%)
Vedior NV 144,265 3,676,767

Petroleum Refining (5.25%)
Repsol Petroleo SA 155,400 7,785,649
Sasol Ltd. 751,000 3,674,784
YPF Sociedad Anonima ADR 261,000 7,552,688

19,013,121
Plastic Materials & Synthetics (0.96%)
Astra AB 222,466 $ 3,486,320

Pulp Mills (2.38%)
Lassila & Tikanoja Ltd. OY 164,000 3,906,006
Upm-Kymmene OY 196,980 4,711,043

8,617,049
Radio & Television Broadcasting (0.91%)
Mirror Group PLC 1,351,000 3,291,971

Security Brokers & Dealers (0.00%)
Peregrine Investment Holdings 2,289,000(b)(c) --

Soap, Cleaners & Toilet Goods (3.29%)
Benckiser NV Class B 98,650 5,593,598
Reckitt & Colman PLC 367,297 6,329,515

11,923,113
Special Industry Machinery (1.55%)
Cookson Group 2,673,200 5,596,018

Sugar & Confectionery Products (2.35%)
Nestle 4,004 8,516,047

Telephone Communications (6.41%)
Nokia Corp. Class A ADR 62,000 5,769,875
Swisscom AG 10,600(b) 3,593,106
Telecom Corp. of New Zealand Ltd. 1,395,000 5,723,645
Telecom Italia-DI 1,617,200 8,154,110

23,240,736

Total Common Stocks 337,854,205

Preferred Stock (0.70%)

Commercial Banks (0.70%)
National Australia Bank
ECU Convertible 96,000 2,538,000

Principal
Amount Value

Commercial Paper (7.74%)

Business Credit Institutions (3.19%)
General Electric Capital Corp.;
5.18%; 11/3/1998 $ 5,750,000 $ 5,748,345
5.45%; 11/6/1998 5,805,000 5,800,606

11,548,951
Personal Credit Institutions (4.55%)
Ford Motor Credit Co.;
5.15%; 11/4/1998 6,035,000 6,032,410
Household Finance Corp.;
5.10%; 11/2/1998 10,440,000 10,438,521

16,470,931

Total Commercial Paper (7.74%) 28,019,882

Total Portfolio Investments (101.72%) 368,412,087

Liabilities, net of cash, receivables
and other assets (-1.72%) (6,239,752)

Total Net Assets (100.00%) $362,172,335

(a)Restricted security - See Note 4 to the financial statements.
(b)Non-income producing security - No dividend paid during the period.
(c)Peregrine Investment Holdings has filed a plan of liquidation.

Principal International Fund, Inc.
Investments by Country

Total Percentage of
Country Value Total Value

Argentina $ 7,552,687 2.05%
Australia 13,371,720 3.63
Austria 5,658,268 1.54
Canada 14,323,266 3.89
Denmark 12,778,090 3.47
Finland 23,486,072 6.37
France 12,834,822 3.48
Germany 7,493,885 2.03
Hong Kong 3,273,786 0.89
Israel 11,940,125 3.24
Italy 17,905,568 4.86
Japan 1,811,948 0.49
Mexico 7,165,672 1.95
Netherlands 37,258,918 10.11
New Zealand 5,723,645 1.55
Norway 13,139,965 3.57
Singapore 3,787,000 1.03
South Africa 3,674,784 1.00
Spain 7,785,649 2.11
Sweden 23,636,496 6.42
Switzerland 20,079,153 5.45
United Kingdom 78,564,123 21.32
United States 35,166,445 9.55

Total $368,412,087 100.00%

PRINCIPAL INTERNATIONAL SMALLCAP FUND, INC.

Shares
Held Value

Common Stocks (80.44%)

Advertising (2.42%)
Industrial & Financial Systems 28,800(a)(b)$272,641
United Group Ltd. 170,000 252,826

525,467
Air Transportation, Scheduled (1.34%)
Ryanair Holdings PLC ADR 9,900(a) 290,812

Airports, Flying Fields
& Services (3.63%)
Aeroporti Di Roma 29,400 183,952
Auckland International Airport Ltd 394,500(a) 409,355
Virgin Express Holdings ADR 23,800(a) 193,375

786,682
Central Reserve Depositories (1.09%)
Union Bank of Norway 12,420 235,865

Commercial Banks (1.38%)
Banco Pastor SA 5,600 298,818

Communications Equipment (1.08%)
Research In Motion Ltd. 67,900(a)$ 234,825

Computer & Data Processing
Services (4.64%)
Computacenter PLC 32,100(a)(b) 243,255
Computershare Ltd. 63,900 270,386
Equant ADR 4,000(a) 175,000
Intentia International AB 3,800(a) 101,601
Merkantildata ASA 21,500 215,816

1,006,058
Computer & Office Equipment (1.21%)
Orbotech Ltd. ADR 7,500(a) 262,500

Drugs (1.44%)
Fabrica Espanola De Productos 20,760 312,616

Electric Services (2.99%)
Independent Energy Holdings ADR 36,400(a) 245,700
Vestas Wind Systems 8,300(a) 402,085

647,785
Electrical Industrial Apparatus (0.47%)
Doncasters PLC ADR 7,300(a) 102,200

Electrical Work (1.25%)
Internatio-Muller NV 2,200 53,007
Telesystem International
Wireless, Inc. 20,800(a) 217,820

270,827
Electronic Components &
Accessories (0.41%)
Elec & Eltek International ADR 17,900 89,500

Electronic Distribution
Equipment (3.67%)
C/TAC NV 14,500(a) 308,993
Techtronic Industries Co. 1,447,000 272,737
Vtech Holdings Ltd. 57,000 213,768

795,498
Engines & Turbines (0.49%)
RHI AG 3,400 106,504

Fabricated Rubber Products, NEC (1.50%)
Semperit AG Holding 3,000 324,405

Grocery Stores (0.35%)
Superdiplo SA 2,900(a) 74,907

Hose, Belting, Gaskets & Packing (2.01%)
Phoenix AG 20,600 435,340

Hotels & Motels (0.66%)
Choice Hotels Scandinavia 110,000(a) 143,245

Household Furniture (0.68%)
Ekornes ASA 16,000 146,500

Investment Offices (0.68%)
Tyndall Australia Ltd. 121,442 146,604

Life Insurance (1.01%)
Scor SA 3,800 217,871

Measuring & Controlling Devices (0.53%)
Sensonor ASA 59,900(a) 113,755

Meat Products (0.93%)
Perkins Foods PLC 89,360 201,281

Medical Instruments & Supplies (1.12%)
Cochlear Ltd. 47,900 241,611

Metalworking Machinery (2.11%)
Mikron Holding AG 2,200 458,166

Miscellaneous Amusement, Recreation
Services (1.89%)
Tab Ltd. 215,500(a) 408,999

Miscellaneous Business Services (0.38%)
Enator AB 3,400 81,772

Miscellaneous Electrical Equipment &
Supplies (2.41%)
Kaba Holding AG, Class B 1,080 522,416

Miscellaneous Food & Kindred
Products (1.25%)
Greencore Group PLC 72,100 271,679

Miscellaneous Manufacturers (1.06%)
Docdata NV 13,600(a) 229,376

Miscellaneous Non-Durable Goods (2.66%)
Austria Tabakwerke AG 8,200 577,063

Miscellaneous Plastics Products,
NEC (1.06%)
Airspray NV 7,700(a) 230,463

Miscellaneous Primary Metal
Products (0.00%)
YBM Magnex International, Inc. 28,300(a) 183

Miscellaneous Transportation
Services (0.53%)
ASG AB, Class B 5,500 114,688

Motor Vehicles & Equipment (1.40%)
E.C.I.A. Equipment & Composants 1,100 208,840
Mayflower Corp. PLC 43,000 93,616

302,456
Newspapers (1.39%)
Newsquest PLC 75,700(b) 301,091

Non-Classifiable Establishments (1.48%)
Bure Investment Aktiebolaget AB 24,200(b) 320,423

Non-Residential Building
Construction (0.54%)
Algeco 1,200 116,396

Oil & Gas Field Services (2.49%)
Cie Generale De Geophysique 800(a) 51,828
Cie Generale De Geophysique ADR 2,500(a) 33,125
Det Sondenfjelds-Norske
Dampskibsselska 9,400(a) 133,247
Hydralift ASA, A Shares 19,000(a) 118,557
Hydralift ASA, B Shares 3,800(a) 21,907
Petrolia Drilling ASA 75,300(a) 179,772

538,436
Personnel Supply Services (2.47%)
Dis Deutshcer Industries Service AG 3,100 $ 150,678
Unique International NV 13,700 383,637

534,315
Pulp Mills (2.73%)
Lassila & Tikanoja Ltd. OY 14,800 352,493
Miquel Y Costas 7,300 237,961

590,454
Real Estate Agents & Managers (1.27%)
Tornet Fastighet 21,500 275,046

Sanitary Services (1.81%)
De Sammensluttede Vognmand AS 4,500 393,111

Security Brokers & Dealers (4.18%)
AOT NV 29,200 362,718
Kempen & Co. NV 8,212 448,484
Van Der Moolen Holdings 1,365 95,376

906,578
Services To Buildings (0.72%)
Spotless Group Ltd. 71,000 156,842

Special Industry Machinery (1.09%)
Aixtron 1,400 237,112

Telephone Communication (7.80%)
Aapt Ltd. 71,400(a) 142,175
Esat Telecom Group PLC ADR 8,000(a) 242,000
Esprit Telecom Group PLC ADR 20,900(a) 376,200
Global Telesystems Group, Inc. ADR 6,700(a) 268,419
Metronet Communications ADR, Class B 28,800(a) 662,400

1,691,194
Trusts (0.74%)
NHP PLC 62,040(a) 160,004

Total Common Stocks 17,429,739

Principal
Amount Value

Commercial Paper (18.48%)

Federal & Federally Sponsored
Credit (18.48%)
Federal Home Loan Mortgage Corporation;
4.74%; 11/4/1998 $2,004,208 $2,004,208
Federal National Mortgage Association;
5.45%; 11/2/1998 1,999,697 1,999,697

Total Commercial Paper 4,003,905

Total Portfolio Investments (98.92%) 21,433,644

Cash and receivables, net of liabilities (1.08%) 233,598

Total Net Assets (100.00%) $21,667,242

(a) Non-income producing security - No dividend paid during the period.
(b) Restricted security - See Note 4 to the financial statements.

Principal International SmallCap Fund, Inc.
Investments by Country

Total Percentage of
Country Value Total Value

Australia $1,619,443 7.56%
Austria 1,007,971 4.70
Belgium 193,375 0.90
Canada 1,115,228 5.20
Czech Republic 268,419 1.25
Denmark 795,196 3.71
Finland 352,493 1.64
France 628,060 2.93
Germany 823,131 3.84
Hong Kong 486,505 2.27
Ireland 532,812 2.49
Israel 262,500 1.22
Italy 183,952 0.86
Netherlands 2,287,055 10.67
New Zealand 409,355 1.91
Norway 1,308,664 6.11
Singapore 89,500 0.42
Spain 924,301 4.31
Sweden 1,166,171 5.44
Switzerland 980,583 4.57
United Kingdom 1,995,025 9.31
United States 4,003,905 18.69

Total $21,433,644 100.00%

FINANCIAL HIGHLIGHTS

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

Total from Investment Operations (1.75) (1.22)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $6.54 $8.29

Total Return(b)........................................ (21.11)% (10.18)%(c)

Total from Investment Operations (1.76) (1.23)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $6.52 $8.28

PRINCIPAL INTERNATIONAL EMERGING MARKETS FUND, INC.
Class R shares 1998 1997(a)
- --------------------------------------------------------------------------------
Net Asset Value, Beginning of Period................... $8.28 $9.51
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.04) (.01)
Net Realized and Unrealized Gain (Loss) on Investments (1.71) (1.22)

Total from Investment Operations (1.75) (1.23)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $6.53 $8.28

Total Return(b)........................................ (21.14)% 10.29)%(c)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $2,202 $2,510
Ratio of Expenses to Average Net Assets............. 3.47% 2.20%(d)
Ratio of Net Investment Income (Operating Loss)
to Average Net Assets............................. (.60)% (.51)%(d)
Portfolio Turnover Rate............................. 45.2% 21.4%(d)

See accompanying notes.
Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):
<TABLE>
<CAPTION>

PRINCIPAL INTERNATIONAL FUND, INC.(e)
Class A shares 1998 1997 1996 1995 1994
- -------------------------------------------------------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period................... $9.33 $8.14 $7.28 $7.44 $6.85
Income from Investment Operations:
Net Investment Income............................... .13 .09 .10 .08 .01
Net Realized and Unrealized Gain (Loss) on Investments .04 1.52 1.17 (.02) .64

Total from Investment Operations .17 1.61 1.27 .06 .65

Less Dividends and Distributions:
Dividends from Net Investment Income................ (.10) (.11) (.08) (.03) (.02)
Distributions from Capital Gains.................... (.20) (.31) (.33) (.19) (.04)

Total Dividends and Distributions (.30) (.42) (.41) (.22) (.06)

Net Asset Value, End of Period......................... $9.20 $9.33 $8.14 $7.28 $7.44

Total Return(b)........................................ 1.93% 20.46% 18.36% 1.03% 9.60%

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $302,757 $281,158 $172,276 $126,554 $115,812
Ratio of Expenses to Average Net Assets............. 1.25% 1.39% 1.45% 1.63% 1.74%
Ratio of Net Investment Income to Average Net Assets 1.45% 1.25% 1.43% 1.10% .10%
Portfolio Turnover Rate............................. 38.7% 26.6% 23.8% 35.4% 13.2%
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL INTERNATIONAL FUND, INC.(e)
Class B shares 1998 1997 1996 1995(f)
- ------------------------------------------------------------------- ---- ---- ----
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period................... $9.26 $8.07 $7.24 $6.71
Income from Investment Operations:
Net Investment Income............................... .07 .03 .03 .05
Net Realized and Unrealized Gain (Loss) on Investments .04 1.51 1.15 .51

Total from Investment Operations .11 1.54 1.18 .56

Less Dividends and Distributions:
Dividends from Net Investment Income................ (.03) (.04) (.02) (.03)
Distributions from Capital Gains.................... (.20) (.31) (.33) --

Total Dividends and Distributions (.23) (.35) (.35) (.03)

Net Asset Value, End of Period......................... $9.14 $9.26 $8.07 $7.24

Total Return(b)........................................ 1.27% 19.62% 17.16% 9.77%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $41,676 $33,842 $15,745 $3,908
Ratio of Expenses to Average Net Assets............. 1.91% 2.17% 2.28% 2.19%(d)
Ratio of Net Investment Income to Average Net Assets .77% .42% .64% .58%(d)
Portfolio Turnover Rate............................. 38.7% 26.6% 23.8% 35.4%(d)
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL INTERNATIONAL FUND, INC.(e)
Class R shares 1998 1997 1996(g)
- ------------------------------------------------------------------- ---- ----
<S> <C> <C> <C>
Net Asset Value, Beginning of Period................... $9.27 $8.12 $7.48
Income from Investment Operations:
Net Investment Income............................... .06 .07 .01
Net Realized and Unrealized Gain (Loss) on Investments .04 1.47 .63

Total from Investment Operations .10 1.54 .64

Less Dividends and Distributions:
Dividends from Net Investment Income................ (.04) (.08) --
Distributions from Capital Gains.................... (.20) (.31) --

Total Dividends and Distributions (.24) (.39) --

Net Asset Value, End of Period......................... $9.13 $9.27 $8.12

Total Return(b)........................................ 1.13% 19.65% 9.29%(c)

Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $17,739 $11,773 $1,057
Ratio of Expenses to Average Net Assets............. 2.01% 2.10% 1.59%(d)
Ratio of Net Investment Income to Average Net Assets .67% .44% .78%(d)
Portfolio Turnover Rate............................. 38.7% 26.6% 23.8%(d)
</TABLE>

See accompanying notes.

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

PRINCIPAL INTERNATIONAL SMALLCAP FUND, INC.
Class A shares 1998 1997(a)
- --------------------------------------------------------------------------------
<S> <C> <C>
Net Asset Value, Beginning of Period................... $9.96 $10.04
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.07) (.01)
Net Realized and Unrealized Gain (Loss) on Investments .10 (.07)

Total from Investment Operations .03 (.08)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $9.99 $9.96

Total from Investment Operations .01 (.08)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $9.97 $9.96

PRINCIPAL INTERNATIONAL SMALLCAP FUND, INC.
Class R shares 1998 1997(a)
- --------------------------------------------------------------------------------
<S> <C> <C>
Net Asset Value, Beginning of Period................... $9.96 $10.04
Income from Investment Operations:
Net Investment Income (Operating Loss).............. (.07) (.01)
Net Realized and Unrealized Gain (Loss) on Investments .12 (.07)

Total from Investment Operations .05 (.08)
Less Dividends and Distributions:
Dividends from Net Investment Income................ -- --
Distributions from Capital Gains.................... -- --

Total Dividends and Distributions -- --

Net Asset Value, End of Period......................... $10.01 $9.96

Total Return(b)........................................ .50% .50%(c)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............ $3,317 $3,004
Ratio of Expenses to Average Net Assets............. 2.51% 2.15%(d)
Ratio of Net Investment Income (Operating Loss) to
Average Net Assets................................ (.68)% (.54)%(d)
Portfolio Turnover Rate............................. 99.8% 10.4%(d)

</TABLE>

See accompanying notes.

Notes to Financial Highlights

(a) Period from August 29, 1997, date Class A and Class B shares first offered
to the public and Class R shares first offered to eligible purchasers,
through October 31, 1997. Principal International Emerging Markets Fund,
Inc. and Principal International SmallCap Fund, Inc. classes of shares
recognized net investment income as follows for the period from the initial
purchase of shares on August 14, 1997, through August 28, 1997, none of
which was distributed to the sole shareholder, Principal Life Insurance
Company. Principal International Emerging Markets Fund, Inc. and Principal
International SmallCap Fund, Inc. incurred unrealized gains (losses) on
investments during the initial interim period as follows. This represents
Class A, Class B and Class R share activities prior to the initial public
offering of all classes of shares of each fund.

Per Share
Net Investment
Income

Principal International Emerging Markets Fund, Inc.:
Class A $.01 $(.50)
Class B .01 (.50)
Class R .01 (.50)

Principal International SmallCap Fund, Inc.:
Class A .01 .03
Class B .01 .03
Class R .01 .03

(b) Total return is calculated without the front-end sales charge or contingent
deferred sales charge.

(d) Computed on an annualized basis.

(e) Effective January 1, 1998, Princor World Fund, Inc. changed its name to
Principal International Fund, Inc.

(g) Period from February 29, 1996, date Class R shares first offered to
eligible purchasers, through October 31, 1996. Principal International
Fund, Inc. Class R shares recognized no net investment income for the
period from the initial purchase by Principal Management Corporation of
Class R shares on February 27, 1996, through February 28, 1996.
Additionally, Class R shares incurred unrealized gains on investments of
$.02 per share during the initial interim period. This represents Class R
share activities of the fund prior to the intial offering of Class R
shares.

<TABLE>
<CAPTION>
October 31, 1998

STATEMENTS OF ASSETS AND LIABILITIES

Principal Principal Government
Bond Securities Income
INCOME FUNDS Fund, Inc. Fund, Inc.

<S> <C> <C>
Investment in securities -- at cost............................... $170,474,225 $282,353,179
------------ ------------
------------ ------------

Assets
Investment in securities -- at value (Note 4)..................... $179,472,476 $291,952,706
Cash ............................................................ 2,035 3,852
Receivables:
Interest....................................................... 3,094,436 1,547,275
Investment securities sold..................................... -- --
Capital Stock sold............................................. 492,795 518,797
Other assets...................................................... 3,589 17,027
------------ ------------

Total Assets 183,065,331 294,039,657
Liabilities
Accrued expenses.................................................. 141,357 189,849
Payables:
Investment securities purchased................................ -- 9,113,438
Capital Stock reacquired....................................... 181,310 754,994
Indebtedness (Note 6)............................................. -- --
------------ ------------

Total Liabilities 322,667 10,058,281
------------ ------------

Net Assets Applicable to Outstanding Shares....................... $182,742,664 $283,981,376
------------ ------------
------------ ------------

Net Assets Consist of:
Capital Stock..................................................... $ 157,709 $ 244,238
Additional paid-in capital........................................ 173,027,577 275,891,834
Accumulated undistributed (overdistributed)
net investment income.......................................... 33,837 254,305
Accumulated net realized gain (loss) on investment transactions .. 525,290 (2,008,528)
Net unrealized appreciation (depreciation) of investments......... 8,998,251 9,599,527
------------ ------------
Total Net Assets $182,742,664 $283,981,376
------------ ------------
------------ ------------

Capital Stock (par value: $.01 a share):
Shares authorized................................................. 100,000,000 100,000,000

Net Asset Value Per Share:
Class A: Net Assets............................................... $148,081,417 $251,455,080
Shares issued and outstanding............................ 12,778,833 21,617,045
Net asset value per share................................ $11.59 $11.63
Maximum offering price per share(a)...................... $12.17 $12.21
------ ------
------ ------
Class B: Net Assets .............................................. $22,465,556 $24,369,677
Shares issued and outstanding............................ 1,940,097 2,100,344
Net asset value per share(b)............................. $11.58 $11.60
------ ------
------ ------
Class R: Net Assets............................................... $12,195,691 $8,156,619
Shares issued and outstanding............................ 1,051,897 706,374
Net asset value per share................................ $11.59 $11.55
------ ------
------ ------

<FN>
(a)Maximum offering price is equal to net asset value plus a front-end
sales charge of 4.75% (1.50% with respect to Principal Limited Term Bond
Fund, Inc.) of the offering price or 4.99% of the net asset value (1.52%
of net asset value with respect to Principal Limited Term Bond Fund,
Inc.)
(b)Redemption price per share is equal to net asset value less any
applicable contingent deferred sales charge.
</FN>
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
October 31, 1998

STATEMENTS OF ASSETS AND LIABILITIES

Principal Principal Principal
High Yield Limited Term Bond Tax-Exempt Bond
INCOME FUNDS Fund, Inc. Fund, Inc. Fund, Inc.

<S> <C> <C> <C>
Investment in securities -- at cost............................... $49,663,453 $30,883,301 $197,560,741
----------- ----------- ------------
----------- ----------- ------------

Assets
Investment in securities -- at value (Note 4)..................... $45,353,447 $31,044,504 $212,152,700
Cash ............................................................ 27,865 2,016 4,376
Receivables:
Interest....................................................... 1,150,194 351,223 3,989,442
Investment securities sold..................................... -- 16,695 --
Capital Stock sold............................................. 56,589 8,210 423,276
Other assets...................................................... 2,036 -- 7,512
----------- ----------- ------------

Total Assets 46,590,131 31,422,648 216,577,306
Liabilities
Accrued expenses.................................................. 66,187 24,664 138,975
Payables:
Investment securities purchased................................ 1,643,916 -- --
Capital Stock reacquired....................................... 145,226 27,279 34,426
Indebtedness (Note 6)............................................. -- -- 120,000
----------- ----------- ------------

Total Liabilities 1,855,329 51,943 293,401
---------- ----------- ------------

Net Assets Applicable to Outstanding Shares....................... $44,734,802 $31,370,705 $216,283,905
----------- ----------- ------------
----------- ----------- ------------

Net Assets Consist of:
Capital Stock..................................................... $ 58,731 $ 31,575 $ 171,819
Additional paid-in capital........................................ 50,862,953 31,196,899 201,351,447
Accumulated undistributed (overdistributed)
net investment income.......................................... (48,931) 24,590 83,391
Accumulated net realized gain (loss) on investment transactions .. (1,827,945) (43,562) 85,289
Net unrealized appreciation (depreciation) of investments......... (4,310,006) 161,203 14,591,959
----------- ----------- ------------
Total Net Assets $44,734,802 $31,370,705 $216,283,905
----------- ----------- ------------
----------- ----------- ------------

Capital Stock (par value: $.01 a share):
Shares authorized................................................. 100,000,000 100,000,000 100,000,000

Net Asset Value Per Share:
Class A: Net Assets............................................... $33,473,629 $27,631,893 $204,864,505
Shares issued and outstanding............................ 4,384,993 2,781,690 16,275,214
Net asset value per share................................ $7.63 $9.93 $12.59
Maximum offering price per share(a)...................... $8.01 $10.08 $13.22
----- ------ ------
----- ------ ------
Class B: Net Assets .............................................. $8,526,963 $1,704,891 $11,419,400
Shares issued and outstanding............................ 1,124,088 170,914 906,696
Net asset value per share(b)............................. $7.59 $9.98 $12.59
----- ------ ------
----- ------ ------
Class R: Net Assets............................................... $2,734,210 $2,033,921 N/A
Shares issued and outstanding............................ 363,981 204,914 N/A
Net asset value per share................................ $7.51 $9.93 N/A
----- ----- ------
----- ----- ------

STATEMENTS OF OPERATIONS

Principal Principal Government
Bond Securities Income
INCOME FUNDS Fund, Inc. Fund, Inc.

<S> <C> <C>
Net Investment Income
Interest income.................................................... $11,618,838 $18,885,184

Expenses:
Management and investment advisory fees (Note 3)................ 782,241 1,239,644
Distribution and shareholder servicing fees (Notes 1 and 3)..... 539,213 692,648
Transfer and administrative services (Notes 1 and 3)............ 482,817 499,207
Registration fees (Note 1)...................................... 53,167 37,239
Custodian fees ................................................. 2,786 10,837
Auditing and legal fees ........................................ 8,973 7,377
Directors' fees ................................................ 7,335 7,348
Other .......................................................... 11,664 20,798
----------- -----------
Total Gross Expenses 1,888,196 2,515,098
Less: Management and investment
advisory fees waived......................................... 172,366 --
----------- -----------
Total Net Expenses 1,715,830 2,515,098
----------- -----------
Net Investment Income 9,903,008 16,370,086

Net Realized and Unrealized Gain (Loss) on Investments
Net realized gain (loss) from investment transactions.............. 598,317 242,270
Change in unrealized appreciation/depreciation
of investments ................................................. 1,323,899 2,717,566
----------- -----------
Net Realized and Unrealized
Gain (Loss) on Investments 1,922,216 2,959,836
----------- -----------

Net Increase (Decrease) in Net Assets
Resulting from Operations $11,825,224 $19,329,922
----------- -----------
----------- -----------
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
Year Ended October 31, 1998

STATEMENTS OF OPERATIONS

Principal Principal Principal
High Yield Limited Term Bond Tax-Exempt Bond
INCOME FUNDS Fund, Inc. Fund, Inc. Fund, Inc.

<S> <C> <C> <C>
Net Investment Income
Interest income.................................................... $ 4,371,633 $1,788,479 $11,754,268

Expenses:
Management and investment advisory fees (Note 3)................ 287,858 133,825 974,740
Distribution and shareholder servicing fees (Notes 1 and 3)..... 197,857 50,768 530,667
Transfer and administrative services (Notes 1 and 3)............ 217,020 90,187 199,780
Registration fees (Note 1)...................................... 49,117 38,997 49,540
Custodian fees ................................................. 2,728 2,366 2,666
Auditing and legal fees ........................................ 6,527 4,740 6,784
Directors' fees ................................................ 7,347 7,348 7,359
Other .......................................................... 4,343 4,483 16,905
----------- ---------- -----------
Total Gross Expenses 772,797 332,714 1,788,441
Less: Management and investment
advisory fees waived......................................... -- 100,270 --
----------- ---------- -----------
Total Net Expenses 772,797 232,444 1,788,441
----------- ---------- -----------
Net Investment Income 3,598,836 1,556,035 9,965,827

Net Realized and Unrealized Gain (Loss) on Investments
Net realized gain (loss) from investment transactions.............. 148,393 (2,668) 919,377
Change in unrealized appreciation/depreciation
of investments ................................................. (5,300,030) 172,616 2,567,043
----------- ---------- -----------
Net Realized and Unrealized
Gain (Loss) on Investments (5,151,637) 169,948 3,486,420
----------- ---------- -----------

Net Increase (Decrease) in Net Assets
Resulting from Operations $(1,552,801) $1,725,983 $13,452,247
----------- ---------- -----------
----------- ---------- -----------
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
Years Ended October 31

STATEMENTS OF CHANGES IN NET ASSETS

Principal Principal Government
Bond Securities Income
INCOME FUNDS Fund, Inc. Fund, Inc.

1998 1997 1998 1997

<S> <C> <C> <C> <C>
Operations
Net investment income............................................ $ 9,903,008 $ 8,629,236 $ 16,370,086 $ 16,566,061
Net realized gain (loss) from investment transactions ........... 598,317 921,121 242,270 (776,007)
Change in unrealized appreciation/depreciation
of investments................................................ 1,323,899 3,176,634 2,717,566 7,674,729
------------ ------------ ------------ ------------
Net Increase (Decrease) in Net Assets
Resulting from Operations 11,825,224 12,726,991 19,329,922 23,464,783

Dividends and Distributions to Shareholders
From net investment income:
Class A....................................................... (8,430,036) (8,447,557) (15,088,625) (16,727,976)
Class B....................................................... (977,376) (648,042) (1,071,553) (797,919)
Class R....................................................... (530,322) (193,972) (334,428) (127,873)
Excess distribution of net investment income:
Class A....................................................... -- -- -- --
Class B....................................................... -- -- -- --
Class R....................................................... -- -- -- --
------------ ------------ ------------ ------------
Total Dividends and Distributions (9,937,734) (9,289,571) (16,494,606) (17,653,768)

Capital Share Transactions (Note 5)
Shares sold:
Class A....................................................... 41,289,926 27,360,904 39,967,883 31,378,780
Class B....................................................... 10,554,095 6,449,151 10,634,274 6,564,032
Class R....................................................... 8,716,511 6,016,081 4,770,310 3,952,066
Shares issued in reinvestment of dividends and distributions:
Class A....................................................... 6,299,889 5,936,473 12,166,316 13,338,406
Class B....................................................... 833,944 523,092 882,934 644,830
Class R....................................................... 524,979 193,561 329,918 127,615
Shares redeemed:
Class A....................................................... (27,535,115) (23,209,507) (53,118,031) (59,260,515)
Class B....................................................... (2,514,110) (1,891,456) (2,741,242) (3,726,468)
Class R....................................................... (3,120,947) (948,686) (1,161,190) (510,669)
------------ ------------ ------------ ------------
Net Increase (Decrease) in Net Assets from
Capital Share Transactions 35,049,172 20,429,613 11,731,172 (7,491,923)
------------ ------------ ------------ ------------
Total Increase (Decrease) 36,936,662 23,867,033 14,566,488 (1,680,908)

Net Assets
Beginning of year................................................ 145,806,002 121,938,969 269,414,888 271,095,796
------------ ------------ ------------ ------------
End of year (including undistributed (overdistributed) net
investment income as set forth below)......................... $182,742,664 $145,806,002 $283,981,376 $269,414,888
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------

Undistributed (Overdistributed) Net Investment Income........... $ 33,837 $ 68,563 $ 254,30 $ 447,772
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------

See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
Years Ended October 31

STATEMENTS OF CHANGES IN NET ASSETS

Principal Principal
High Yield Limited Term Bond
INCOME FUNDS Fund, Inc. Fund, Inc.

1998 1997 1998 1997

<S> <C> <C> <C> <C>
Operations
Net investment income............................................ $ 3,598,836 $ 3,025,285 $ 1,556,035 $ 1,200,046
Net realized gain (loss) from investment transactions ........... 148,393 1,000,035 (2,668) (30,744)
Change in unrealized appreciation/depreciation
of investments................................................ (5,300,030) 221,232 172,616 99,272
----------- ----------- ----------- -----------
Net Increase (Decrease) in Net Assets
Resulting from Operations (1,552,801) 4,246,552 1,725,983 1,268,574

Dividends and Distributions to Shareholders
From net investment income:
Class A....................................................... (2,856,403) (2,851,339) (1,431,290) (1,227,443)
Class B....................................................... (571,855) (305,236) (53,434) (14,695)
Class R....................................................... (189,231) (76,561) (78,892) (27,342)
Excess distribution of net investment income:
Class A....................................................... (50,532) -- -- --
Class B....................................................... (10,117) -- -- --
Class R....................................................... (3,347) -- -- --
----------- ----------- ----------- -----------
Total Dividends and Distributions (3,681,485) (3,233,136) (1,563,616) (1,269,480)

Capital Share Transactions (Note 5)
Shares sold:
Class A....................................................... 11,927,135 12,193,322 12,780,385 6,544,078
Class B....................................................... 4,358,175 4,993,786 1,373,038 580,621
Class R....................................................... 1,736,594 1,904,286 1,710,613 847,672
Shares issued in reinvestment of dividends and distributions:
Class A....................................................... 1,574,414 1,195,770 1,358,983 1,161,005
Class B....................................................... 427,433 195,332 42,187 8,758
Class R....................................................... 191,997 76,523 77,461 27,342
Shares redeemed:
Class A....................................................... (14,350,135) (4,508,255) (7,216,941) (4,380,863)
Class B....................................................... (1,816,211) (825,099) (344,198) (78,682)
Class R....................................................... (839,238) (149,618) (370,918) (355,461)
----------- ----------- ----------- -----------
Net Increase (Decrease) in Net Assets from
Capital Share Transactions 3,210,164 15,076,047 9,410,610 4,354,470
----------- ----------- ----------- -----------
Total Increase (Decrease) (2,024,122) 16,089,463 9,572,977 4,353,564

Net Assets
Beginning of year................................................ 46,758,924 30,669,461 21,797,728 17,444,164
----------- ----------- ----------- -----------
End of year (including undistributed (overdistributed) net
investment income as set forth below)......................... $44,734,802 $46,758,924 $31,370,705 $21,797,728
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------

Undistributed (Overdistributed) Net Investment Income........... $ (48,931) $ 33,718 $ 24,590 $ 25,655
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
Years Ended October 31

STATEMENTS OF CHANGES IN NET ASSETS

Principal
Tax-Exempt Bond
INCOME FUNDS Fund, Inc.

1998 1997

<S> <C> <C>
Operations
Net investment income............................................ $ 9,965,827 $ 10,171,880
Net realized gain (loss) from investment transactions ........... 919,377 818,662
Change in unrealized appreciation/depreciation
of investments................................................ 2,567,043 5,658,545
------------ ------------
Net Increase (Decrease) in Net Assets
Resulting from Operations 13,452,247 16,649,087

Dividends and Distributions to Shareholders
From net investment income:
Class A....................................................... (9,655,683) (10,615,003)
Class B....................................................... (408,929) (312,381)
Class R....................................................... N/A N/A
Excess distribution of net investment income:
Class A....................................................... -- --
Class B....................................................... -- --
Class R....................................................... -- --
------------ ------------
Total Dividends and Distributions (10,064,612) (10,927,384)

Capital Share Transactions (Note 5)
Shares sold:
Class A....................................................... 30,673,603 24,107,825
Class B....................................................... 4,178,912 2,704,384
Class R....................................................... N/A N/A
Shares issued in reinvestment of dividends and distributions:
Class A....................................................... 6,533,809 7,156,854
Class B....................................................... 306,980 214,928
Class R....................................................... N/A N/A
Shares redeemed:
Class A....................................................... (28,581,284) (30,946,309)
Class B....................................................... (1,005,105) (1,143,685)
Class R....................................................... N/A N/A
------------ ------------
Net Increase (Decrease) in Net Assets from
Capital Share Transactions 12,106,915 2,093,997
------------ ------------
Total Increase (Decrease) 15,494,550 7,815,700

Net Assets
Beginning of year................................................ 200,789,355 192,973,655
------------ ------------
End of year (including undistributed (overdistributed) net
investment income as set forth below)......................... $216,283,905 $200,789,355
------------ ------------
------------ ------------

Undistributed (Overdistributed) Net Investment Income........... $ 83,391 $ 191,601
------------ ------------
------------ ------------

See accompanying notes.
</TABLE>
NOTES TO FINANCIAL STATEMENTS

Principal Bond Fund, Inc.
Principal Government Securities Income Fund, Inc.
Principal High Yield Fund, Inc.
Principal Limited Term Bond Fund, Inc.
Principal Tax-Exempt Bond Fund, Inc.

Note 1 -- Significant Accounting Policies

Principal Bond Fund, Inc., Principal Government Securities Income Fund, Inc.,
Principal High Yield Fund, Inc., Principal Limited Term Bond Fund, Inc. and
Principal Tax-Exempt Bond Fund, Inc. (the "Income Funds") are registered under
the Investment Company Act of 1940, as amended, as open-end diversified
management investment companies and operate in the mutual fund industry.

Effective January 1, 1998, the following changes were made to the names of the
Income Funds:

<TABLE>
<CAPTION>
Former Fund Name New Fund Name
---------------- -------------
<S> <C> <C>
Princor Bond Fund, Inc. Principal Bond Fund, Inc.
Princor Government Securites Income Fund, Inc. Principal Government Securities Income Fund, Inc.
Princor High Yield Fund, Inc. Principal High Yield Fund, Inc.
Princor Limited Term Bond Fund, Inc. Principal Limited Term Bond Fund, Inc.
Princor Tax-Exempt Bond Fund, Inc. Principal Tax-Exempt Bond Fund, Inc.
</TABLE>

Class A shares generally are sold with an initial sales charge based on
declining rates and certain purchases may be subject to a contingent deferred
sales charge ("CDSC"). Class B shares are sold without an initial sales charge,
but are subject to a declining CDSC on certain redemptions made within six years
of purchase. Class R shares are sold without an initial sales charge and are not
subject to a CDSC. Class B shares and Class R shares bear a higher ongoing
distribution fee than Class A shares. Class B shares automatically convert into
Class A shares, based on relative net asset value (without a sales charge) after
seven years. Class R shares automatically convert into Class A shares, based on
relative net asset value (without a sales charge) after four years. All classes
of shares for each fund represent interests in the same portfolio of
investments, and will vote together as a single class except where otherwise
required by law or as determined by each of the Income Funds' respective Board
of Directors. In addition, the Board of Directors of each fund declares separate
dividends on each class of shares.

The Income Funds allocate daily all income, expenses (other than class-specific
expenses) and realized and unrealized gains or losses to each class of shares
based upon the relative proportion of the value of shares outstanding of each
class. Expenses specifically attributable to a particular class are charged
directly to such class. Class-specific expenses charged to each class during the
year ended October 31, 1998, which are included in the corresponding captions of
the Statement of Operations, were as follows:

<TABLE>
<CAPTION>
Distribution and Transfer and
Shareholder Servicing Fees Administrative Services Registration Fees
-------------------------- ------------------------- --------------------------
Class A Class B Class R Class A Class B Class R Class A Class B Class R
-------- -------- ------- -------- ------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Principal Bond Fund, Inc. $311,884 $157,212 $70,117 $103,059 $26,545 $14,181 $12,906 $10,861 $8,660
Principal Government Securities Income Fund, Inc. 491,907 154,126 46,615 161,187 21,608 8,023 12,562 9,470 9,315
Principal High Yield Fund, Inc. 92,573 85,322 19,962 35,188 12,133 5,166 11,749 10,526 7,860
Principal Limited Term Bond Fund, Inc. 36,351 5,062 9,355 6,718 1,484 2,244 10,987 8,429 8,290
Principal Tax-Exempt Bond Fund, Inc. 464,545 66,122 N/A 53,011 3,387 N/A 23,416 13,979 N/A
</TABLE>

The Income Funds value securities for which market quotations are readily
available at market value, which is determined using the last reported sale
price or, if no sales are reported, as is regularly the case for some securities
traded over-the-counter, the last reported bid price. When reliable market
quotations are not considered to be readily available, which may be the case,
for example, with respect to certain debt securities and preferred stocks, the
investments are valued by using prices provided by market makers or estimates of
market values obtained from yield data and other factors relating to instruments
or securities with similar characteristics in accordance with procedures
established in good faith by each fund's Board of Directors. Securities with
remaining maturities of 60 days or less are valued at amortized cost, which
approximates market.

The Income Funds record investment transactions generally one day after the
trade date, except for short-term investment transactions which are recorded
generally on the trade date. The identified cost basis has been used in
determining the net realized gain or loss from investment transactions and
unrealized appreciation or depreciation of investments. Interest income is
recognized on an accrual basis.

The Income Funds may, pursuant to an exemptive order issued by the Securities
and Exchange Commission, transfer uninvested funds into a joint trading account.
The order permits the Income Funds' cash balances to be deposited into a single
joint account along with the cash of other registered investment companies
managed by Principal Management Corporation (formerly known as Princor
Management Corporation) (the "Manager"). These balances may be invested in one
or more short-term instruments.

Note 2 -- Federal Income Taxes

At October 31, 1998, the Income Funds had approximate net capital loss
carryforwards as follows:

<TABLE>
<CAPTION>
Principal
Government Principal Principal
Securities Income High Yield Limited Term Bond
Net Capital Loss Carryforwards Expire In: Fund, Inc. Fund, Inc. Fund, Inc.
---------------------------------------- ----------------- ---------- -----------------
<S> <C> <C> <C>
1999 $ - $ 429,000 $ -
2000 - 561,000 -
2001 - 409,000 -
2002 157,000 323,000 -
2003 1,075,000 106,000 -
2004 - - 4,000
2005 776,000 - 31,000
2006 - - 9,000
---------- ---------- -------
$2,008,000 $1,828,000 $44,000
---------- ---------- -------
---------- ---------- -------
</TABLE>

Note 3 -- Management Agreement and Transactions With Affiliates

The Income Funds have agreed to pay investment advisory and management fees to
Principal Management Corporation [wholly owned by Princor Financial Services
Corporation, a subsidiary of Principal Life Insurance Company (formerly known as
Principal Mutual Life Insurance Company)] computed at an annual percentage rate
of each fund's average daily net assets. The annual rate used in this
calculation for the Income Funds is as follows:

<TABLE>
<CAPTION>
Net Asset Value of Funds
(in millions)
---------------------------------------------------------------------------
First Next Next Next Over
$100 $100 $100 $100 $400
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Principal Bond Fund, Inc. 0.50% 0.45% 0.40% 0.35% 0.30%
Principal Government Securities Income Fund, Inc. 0.50 0.45 0.40 0.35 0.30
Principal High Yield Fund, Inc. 0.60 0.55 0.50 0.45 0.40
Principal Limited Term Bond Fund, Inc. 0.50 0.45 0.40 0.35 0.30
Principal Tax-Exempt Bond Fund, Inc. 0.50 0.45 0.40 0.35 0.30
</TABLE>

The Income Funds also reimburse the Manager for transfer and administrative
services, including the cost of accounting, data processing, supplies and other
services rendered.

The Manager voluntarily waives a portion of its fee for some of the Income
Funds. The waivers are in amounts that maintain total operating expenses for
each fund within certain limits. The limits are expressed as a percentage of
average daily net assets attributable to each class on an annualized basis
during the reporting period. The amounts waived and the operating expense
limits, which were maintained at or below those shown, are as follows:

<TABLE>
<CAPTION>
Amount
Waived
-----------------------------------------------
Year Ended Year Ended Expense
October 31, 1998 October 31, 1997 Limit
---------------- ---------------- -------
<S> <C> <C> <C>
Principal Bond Fund, Inc.
Class A $121,092 $41,526 0.95%
Class B 26,130 8,982 1.70
Class R 25,144 10,427 1.45
Principal Limited Term Bond Fund, Inc.
Class A 76,952 46,271 0.90
Class B 11,537 6,528 1.25
Class R 11,781 6,831 1.50
</TABLE>

The Manager intends to continue its voluntary waiver and, if necessary, pay
expenses normally payable by Principal Limited Term Bond Fund, Inc. through
October 31, 1999. Effective November 1, 1998, the expense limits were increased
to 1.00%, 1.35% and 1.60%, for Class A, Class B and Class R shares,
respectively. The Manager ceased its waiver of expenses for Principal Bond Fund,
Inc. on October 31, 1998.

Princor Financial Services Corporation, as principal underwriter, receives
proceeds of any CDSC on certain Class A and Class B share redemptions. The
charge is based on declining rates which for Class A shares begin at .75%, and
for Class B shares at 4.00% (.25% and 1.25% for Principal Limited Term Bond
Fund, Inc., respectively), of the lesser of the current market value or the cost
of shares being redeemed. Princor Financial Services Corporation also retains
sales charges on sales of Class A shares based on declining rates which begin at
4.75% of the offering price (1.50% for Principal Limited Term Bond Fund, Inc.).
The aggregate amount of these charges retained, by fund, for the year ended
October 31, 1998 were as follows:

Class A Class B
-------- --------
Principal Bond Fund, Inc. $852,533 $35,337
Principal Government Securities Income Fund, Inc. 805,031 41,791
Principal High Yield Fund, Inc. 300,230 34,925
Principal Limited Term Bond Fund, Inc. 75,772 1,419
Principal Tax-Exempt Bond Fund, Inc. 643,073 24,683

No brokerage commissions were paid by the Income Funds to affiliated broker
dealers during the year.

The Income Funds bear distribution and shareholder servicing fees with respect
to Class A shares computed at an annual rate of up to .25% (.15% for the
Principal Limited Term Bond Fund, Inc.) of the average daily net assets
attributable to Class A shares of each fund. Each of the Income Funds adopted a
distribution plan with respect to Class B shares that provides for distribution
and shareholder servicing fees computed at an annual rate of up to 1.00% of the
average daily net assets attributable to Class B shares of each fund (.50% for
the Principal Limited Term Bond Fund, Inc.). Each of the Income Funds, with the
exception of Principal Tax-Exempt Bond Fund, Inc., adopted a distribution plan
with respect to Class R shares that provides for distribution and shareholder
servicing fees computed at an annual rate of up to .75% of the average daily net
assets attributable to Class R shares of each fund. Distribution and shareholder
servicing fees are paid to Princor Financial Services Corporation; a portion of
the fees are subsequently remitted to retail dealers. Pursuant to the
distribution agreements, fees unused by the principal underwriter at the end of
the fiscal year are returned to the Income Funds.

<TABLE>
<CAPTION>
Class A Class B Class R
--------- ------- -------
<S> <C> <C> <C>
Principal Bond Fund, Inc. 178,252 124 104
Principal Government Securities Income Fund, Inc. 94,035 122 103
Principal High Yield Fund, Inc. 396,345 174 5,053
Principal Limited Term Bond Fund, Inc. 1,171,382 117 4,731
Principal Tax-Exempt Bond Fund, Inc. 92,517 113 N/A
</TABLE>

Note 4 -- Investment Transactions

For the year ended October 31, 1998, the cost of investment securities purchased
and proceeds from investment securities sold (not including short-term
investments and U. S. government securities) by the Income Funds were as
follows:

Purchases Sales
----------- -----------
Principal Bond Fund, Inc. $59,929,649 $23,024,436
Principal High Yield Fund, Inc. 32,903,766 30,183,099
Principal Limited Term Bond Fund, Inc. 12,957,730 6,012,923
Principal Tax-Exempt Bond Fund, Inc. 25,434,992 13,567,920

At October 31, 1998, net unrealized appreciation (depreciation) of investments
by the Income Funds was composed of the following:

<TABLE>
<CAPTION>
Gross Unrealized Net Unrealized
----------------------------------- Appreciation (Depreciation)
Appreciation (Depreciation) of Investments
------------ -------------- ---------------------------
<S> <C> <C> <C>
Principal Bond Fund, Inc. $ 9,764,858 $ (766,607) $ 8,998,251
Principal Government Securities Income Fund, Inc. 9,701,127 (101,600) 9,599,527
Principal High Yield Fund, Inc. 485,117 (4,795,123) (4,310,006)
Principal Limited Term Bond Fund, Inc. 387,785 (226,582) 161,203
Principal Tax-Exempt Bond Fund, Inc. 14,607,775 (15,816) 14,591,959
</TABLE>

The Income Funds may trade portfolio securities on a "to-be-announced" (TBA)
basis. In a TBA transaction, the fund commits to purchase or sell securities for
which all specific information is not known at the time of the trade. Securities
purchased on a TBA basis are not settled until they are delivered to the fund,
normally 15 to 30 days later. These transactions are subject to market
fluctuations and their current value is determined in the same manner as for
other portfolio securities. As of October 31, 1998, Principal Government
Securities Income Fund, Inc. had TBA purchase commitments involving securities
with a face amount of $9,000,000, cost of $9,113,438 and market value of
$9,092,817. The fund has set aside investment securities and other assets in
excess of the commitments to serve as collateral.

Note 4 -- Investment Transactions (Continued)

At October 31, 1998, the Income Funds held the following securities which may
require registration under the Securities Act of 1933, or an exemption
therefrom, in order to effect a sale in the ordinary course of business.
<TABLE>
<CAPTION>
Value at Value as a
Date of October 31, Percentage of
Security Description Acquisition Cost 1998 Net Assets
-------------------------------- ----------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Principal Bond Fund, Inc. John Hancock Mutual Life
Insurance Co. Surplus Notes 1/8/97 $2,396,100 $2,616,117 1.43%

Principal High Yield Fund, Inc. BE Aerospace Senior Subordinated
Notes 10/28/98 750,000 768,750 1.72
Cenargo International PLC
First Mortgage Notes 10/22/98 1,305,000 1,305,000 2.92
Qwest Communications International
Senior Notes 10/28/98 893,916 920,250 2.06
---------- -----
2,994,000 6.70
Principal Limited Term Bond Fund, Inc. Orix Credit Alliance, Inc.
Medium-Term Notes 11/8/96 850,000 850,704 2.71

Principal Tax-Exempt Bond Fund, Inc. Eddyville, Iowa, IDR Ref. Bonds,
Cargill, Inc. Project 1/11/95 859,910 1,050,000 .49
</TABLE>
The Income Funds' investments are with various issuers in various industries.
The Schedules of Investments contained herein summarize concentrations of credit
risk by issuer and industry.

Note 5 -- Capital Share Transactions

Transactions in Capital Stock by fund were as follows:

<TABLE>
<CAPTION>
Principal Principal Principal
Bond Government Securities High Yield
Fund, Inc. Income Fund, Inc. Fund, Inc.
---------- --------------------- ----------
Year Ended October 31, 1998:
Shares sold:
<S> <C> <C> <C>
Class A ......................................... 3,558,782 3,449,728 1,429,263
Class B ......................................... 911,403 919,042 520,583
Class R............................................ 751,757 414,918 208,702
Shares issued in reinvestment of dividends and
distributions:
Class A ........................................... 544,557 1,053,198 190,004
Class B ........................................... 72,083 76,520 51,887
Class R............................................ 45,324 28,745 23,509
Shares redeemed:
Class A ......................................... (2,379,170) (4,587,595) (1,722,188)
Class B ......................................... (216,720) (237,166) (222,473)
Class R............................................ (268,084) (100,699) (101,674)
--------- --------- ---------
Net Increase 3,019,932 1,016,691 377,613
--------- --------- ---------
--------- --------- ---------

</TABLE>
<TABLE>
<CAPTION>
Principal Principal Principal
Bond Government Securities High Yield
Fund, Inc. Income Fund, Inc. Fund, Inc.
---------- --------------------- ----------
Year Ended October 31, 1997:
Shares sold:
<S> <C> <C> <C>
Class A ......................................... 2,460,201 2,799,875 1,440,198
Class B ......................................... 581,347 585,099 591,875
Class R............................................ 542,993 354,800 227,035
Shares issued in reinvestment of dividends and
distributions:
Class A ........................................... 534,855 1,189,680 141,482
Class B ........................................... 47,159 57,621 23,153
Class R............................................ 17,417 11,432 9,113
Shares redeemed:
Class A ......................................... (2,091,860) (5,287,652) (532,170)
Class B ......................................... (170,486) (332,061) (97,891)
Class R............................................ (84,604) (45,744) (17,821)
--------- --------- ---------
Net Increase (Decrease) 1,837,022 (666,950) 1,784,974
--------- --------- ---------
--------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>

Principal Principal
Limited Term Bond Tax-Exempt Bond
Fund, Inc. Fund, Inc.
----------------- ---------------
Year Ended October 31, 1998:
Shares sold:
<S> <C> <C>
Class A ......................................... 1,291,180 2,447,392
Class B ......................................... 138,167 333,971
Class R............................................ 173,119 N/A
Shares issued in reinvestment of dividends and distributions:
Class A ......................................... 137,689 522,117
Class B ......................................... 4,256 24,507
Class R............................................ 7,859 N/A
Shares redeemed:
Class A ......................................... (729,920) (2,279,032)
Class B ......................................... (34,626) (80,155)
Class R............................................ (37,539) N/A
--------- ---------
Net Increase 950,185 968,800
--------- ---------
--------- ---------

</TABLE>
<TABLE>
<CAPTION>

Year Ended October 31, 1997:
Shares sold:
<S> <C> <C>
Class A ......................................... 666,459 1,983,441
Class B ......................................... 58,936 222,542
Class R............................................ 86,576 N/A
Shares issued in reinvestment of dividends and distributions:
Class A ......................................... 118,478 589,808
Class B ......................................... 892 17,694
Class R............................................ 2,797 N/A
Shares redeemed:
Class A ......................................... (445,740) (2,541,274)
Class B ......................................... (7,993) (93,935)
Class R............................................ (36,339) N/A
--------- ---------

Net Increase 444,066 178,276
--------- ---------
--------- ---------
</TABLE>

Note 6 -- Line of Credit

The Income Funds participate with other funds and portfolios managed by
Principal Management Corporation in an unsecured joint line of credit with a
bank, which allows the funds to borrow up to $60,000,000, collectively.
Borrowings are made solely to facilitate the handling of unusual and/or
unanticipated short-term cash requirements. Interest is charged to each fund,
based on its borrowings, at a rate equal to the Fed Funds Rate plus .50%.
Additionally, a commitment fee is charged at the annual rate of .08% on the
average unused portion of the line of credit. The commitment fee is allocated
among the participating funds and portfolios in proportion to their average net
assets during each quarter. At October 31, 1998, Principal Tax-Exempt Bond Fund,
Inc. had an outstanding borrowing of $120,000 at an annual rate of 5.93%. No
other Income Fund had outstanding borrowings at October 31, 1998 under the line
of credit.

Note 7 -- Year 2000 Problem (Unaudited)

Like other mutual funds, financial and business organizations and individuals
around the world, the Income Funds could be adversely affected if the computer
systems used by the Manager and other service providers do not properly process
and calculate date-related information and data from and after January 1, 2000.
This is commonly known as the "Year 2000 Problem." The Manager is taking steps
it believes are reasonably designed to address the Year 2000 Problem with
respect to computer systems it uses and to obtain reasonable assurances that
comparable steps are being taken by each fund's other major service providers.
At this time, however there can be no assurance that these steps will be
sufficient to avoid any adverse impact to the funds.
SCHEDULES OF INVESTMENTS

INCOME FUNDS

PRINCIPAL BOND FUND, INC.
- --------------------------------------------------------------------------------
Principal
Amount Value
- --------------------------------------------------------------------------------

Bonds (95.93%)

Air Transportation, Scheduled (1.52%)
Federal Express Corp. 1994 Pass
Through Cert., Series A310-A3;
8.40%; 3/23/2010 $1,500,000 $ 1,727,070
Federal Express Corp. Pass Through
Cert.; 7.58%; 7/2/2019 1,000,000 1,053,140
------------
2,780,210
Aircraft & Parts (0.59%)
Textron, Inc. Medium-Term
Notes, Series C;
9.80%; 1/11/2000 500,000 525,083
9.55%; 3/19/2001 500,000 547,864
------------
1,072,947
Beverages (1.23%)
Joseph E. Seagram & Sons
Guaranteed Debentures;
8.38%; 2/15/2007 1,000,000 1,096,735
8.88%; 9/15/2011 1,000,000 1,145,888
------------
2,242,623
Cable & Other Pay TV Services (2.56%)
CSC Holdings, Inc. Senior Notes;
7.25%; 7/15/2008 2,000,000 1,952,500
Tele-Communications, Inc.
Notes; 7.25%; 8/1/2005 2,000,000 2,157,958
Senior Debentures; 7.88%; 8/1/2013 500,000 574,273
------------
4,684,731
Cash Grains (1.46%)
Aktiebolaget SKF Senior Notes;
7.63%; 7/15/2003 2,500,000 2,662,782

Combination Utility Services (3.43%)
MidAmerican Energy Co.
Medium-Term Notes;
6.38%; 6/15/2006 3,000,000 3,103,770
PG Energy, Inc. First Mortgage
Bonds; 8.38%; 12/1/2002 500,000 548,778
Public Service Electric & Gas
Medium-Term Notes;
8.16%; 5/26/2009 1,250,000 1,483,441
Puget Sound Power & Light Co.
1st Mortgage Medium-Term Notes,
Series A; 7.75%; 2/1/2007 1,000,000 1,126,546
------------
6,262,535
Commercial Banks (2.51%)
NationsBank Corp. Subordinated
Notes; 6.38%; 2/15/2008 4,500,000 4,584,298

Computer & Office Equipment (1.64%)
Seagate Technology, Inc. Senior Notes;
7.37%; 3/1/2007 3,000,000 2,992,296

Construction & Related
Machinery (0.72%)
Caterpillar, Inc. Global Debentures;
9.38%; 8/15/2011 $1,000,000 $ 1,309,876

Consumer Products (0.86%)
Philip Morris Cos. Notes;
6.80%; 12/1/2003 500,000 527,894
RJR Nabisco Capital Corp. Senior
Notes; 8.75%; 4/15/2004 1,000,000 1,039,660
------------
1,567,554
Copper Ores (1.91%)
Asarco, Inc.
Debentures; 7.88%; 4/15/2013 2,000,000 2,232,498
Notes; 7.38%; 2/1/2003 1,200,000 1,254,737
------------
3,487,235
Crude Petroleum & Natural Gas (0.30%)
Occidental Petroleum Corp.
Medium-Term Notes;
9.73%; 6/15/2001 500,000 545,423

Department Stores (2.97%)
Harcourt General, Inc. Subordinated
Notes; 9.50%; 3/15/2000 400,000 416,543
Fred Meyer, Inc. Senior Notes;
7.38%; 3/1/2005 2,000,000 2,107,422
J.C. Penney Co., Inc. Debentures;
7.13%; 11/15/2023 1,000,000 994,879
Sears Roebuck Co.
Medium-Term Notes;
9.05%; 2/6/2012 500,000 631,657
9.12%; 2/13/2012 1,000,000 1,269,854
------------
5,420,355
Drug Stores & Proprietary
Stores (1.11%)
Rite Aid Corp. Senior Debentures;
6.88%; 8/15/2013 2,000,000 2,030,400

Electric Services (2.89%)
Commonwealth Edison Co.
Debentures; 6.95%; 7/15/2018 1,000,000 994,401
Ohio Edison Co. First Mortgage
Bonds; 8.25%; 4/1/2002 2,000,000 2,167,752
Southern California Edison Co.
Notes; 6.38%; 1/15/2006 1,000,000 1,047,965
Toledo Edison Co. Debentures;
8.70%; 9/1/2002 1,000,000 1,078,551
------------
5,288,669
Engines & Turbines (0.57%)
Brunswick Corp. Debentures;
7.38%; 9/1/2023 1,000,000 1,047,797

Fabricated Rubber Products,
NEC (0.96%)
M. A. Hanna Co. Senior Notes;
9.38%; 9/15/2003 1,500,000 1,751,452

Farm & Garden Machinery (1.48%)
Case Corp. Notes; 7.25%; 1/15/2016 1,000,000 1,066,703
Tenneco, Inc. Notes;
10.08%; 2/1/2001 500,000 550,446
8.08%; 10/1/2002 1,000,000 1,088,692
------------
2,705,841
Federal & Federally Sponsored
Credit (4.25%)
Fannie Mae Benchmark Notes;
5.75%; 4/15/2003 $2,500,000 $ 2,593,278
5.75%; 6/15/2005 5,000,000 5,166,290
------------
7,759,568
General Government, NEC (2.58%)
Ontario Hydro Debentures;
7.45%; 3/31/2013 2,000,000 2,307,420
Province of Saskatchewan, Canada
Global Notes; 8.00%; 2/1/2013 2,000,000 2,410,320
------------
4,717,740
General Industrial Machinery (0.56%)
Timken Company Medium-Term
Notes; 6.20%; 1/15/2008 1,000,000 1,030,679

Gold & Silver Ores (0.68%)
Placer Dome, Inc. Notes;
7.13%; 6/15/2007 1,250,000 1,239,191

Grain Mill Products (0.58%)
Ralston Purina Co. Debentures;
7.75%; 10/1/2015 1,000,000 1,068,831

Grocery Stores (2.74%)
American Stores Co. Bond;
8.00%; 6/1/2026 2,500,000 2,727,230
Food Lion, Inc.
Medium-Term Notes;
8.67%; 8/28/2006 1,000,000 1,173,464
Notes; 7.55%; 4/15/2007 1,000,000 1,103,438
------------
5,004,132
Highway & Street Construction (1.33%)
Foster Wheeler Corp. Notes;
6.75%; 11/15/2005 2,500,000 2,423,840

Household Furniture (1.27%)
Masco Corp. Debentures;
7.13%; 8/15/2013 2,000,000 2,328,388

Industrial Inorganic Chemicals (1.60%)
Dow Chemical Co.
Debentures; 7.38%; 3/1/2023 1,000,000 1,033,692
Medium-Term Notes;
7.75%; 9/15/2020 1,000,000 1,108,036
FMC Corp. Senior Notes;
6.38%; 9/1/2003 750,000 777,000
------------
2,918,728
Life Insurance (1.43%)
John Hancock Mutual Life Insurance
Co. Surplus Notes; 7.38%; 2/15/2024 2,500,000(a) 2,616,117

Machinery, Equipment, & Supplies (0.14%)
AAR Corp. Notes; 7.25%; 10/15/2003 250,000 262,699

Management & Public Relations (0.57%)
Servicemaster Co. Ltd. Notes;
6.95%; 8/15/2007 1,000,000 1,050,249

Millwork, Plywood & Structural
Members (0.41%)
Georgia-Pacific Corp.
Debentures; 9.50%; 12/1/2011 $ 600,000 $ 741,187

Miscellaneous Amusement, Recreation
Service (1.01%)
Circus Circus Enterprises Senior
Notes; 6.45%; 2/1/2006 2,000,000 1,854,484

Miscellaneous Chemical
Products (1.85%)
Ferro Corp. Senior Debentures;
7.63%; 5/1/2013 1,100,000 1,254,591
Smith International, Inc. Senior
Notes; 7.00%; 9/15/2007 2,025,000 2,134,615
------------
3,389,206
Miscellaneous Investing (2.57%)
BRE Properties, Inc. Notes;
7.20%; 6/15/2007 2,000,000 1,859,490
First Industrial LP Medium-Term
Notes; 7.00%; 12/1/2006 1,500,000 1,521,584
Weingarten Realty Investors
Medium-Term Notes;
7.29%; 5/23/2005 1,250,000 1,312,487
------------
4,693,561
Miscellaneous Metal Ores (1.02%)
Cyprus Amax Minerals Notes;
7.38%; 5/15/2007 1,100,000 1,126,989
Cyprus Minerals Co. Notes;
10.13%; 4/1/2002 650,000 734,176
------------
1,861,165
Motor Vehicles & Equipment (1.91%)
Ford Motor Co. Debentures;
7.50%; 8/1/2026 1,000,000 1,083,040
8.90%; 1/15/2032 1,000,000 1,266,700
General Motors Corp. Global
Medium-Term Notes;
8.88%; 5/15/2003 1,000,000 1,135,622
------------
3,485,362
Newspapers (1.36%)
News America Holdings, Inc.
Guaranteed Senior Notes;
8.50%; 2/15/2005 2,250,000 2,486,373

Oil & Gas Field Services (1.72%)
Petroleum Geo-Services ASA Notes;
7.50%; 3/31/2007 2,500,000 2,651,430
R&B Falcon Senior Notes;
6.75%; 4/15/2005 500,000 496,301
------------
3,147,731
Operative Builders (1.34%)
Pulte Corp.
Senior Notes; 8.38%; 8/15/2004 500,000 534,255
Notes; 7.63%; 10/15/2017 2,000,000 1,922,658
------------
2,456,913
Paper & Paper Products (1.55%)
Boise Cascade Office Products Corp.;
7.05%; 5/15/2005 3,000,000 2,827,413

Paper Mills (3.37%)
Bowater, Inc. Debentures;
9.50%; 10/15/2012 $1,000,000 $ 1,283,206
9.38%; 12/15/2021 1,500,000 1,876,892
Champion International Corp.
Notes; 9.88%; 6/1/2000 750,000 795,869
Chesapeake Corp. Notes;
9.88%; 5/1/2003 1,000,000 1,161,728
James River Corp. Notes;
6.70%; 11/15/2003 1,000,000 1,040,837
------------
6,158,532
Paperboard Mills (0.99%)
Federal Paper Board Co., Inc.
Debentures; 8.88%; 7/1/2012 1,500,000 1,808,773

Personal Credit Institutions (3.46%)
Commercial Credit Co. Notes;
6.75%; 7/1/2007 2,000,000 2,097,726
General Motors Acceptance Corp.
Global Notes; 8.50%; 1/1/2003 2,000,000 2,220,296
Household Finance Corp. Notes
5.88%; 11/1/2002 2,000,000 2,004,206
------------
6,322,228
Petroleum & Petroleum
Products (2.19%)
Enron Corp. Notes; 9.13%; 4/1/2003 3,500,000 3,993,213

Petroleum Refining (5.59%)
Ashland, Inc. Medium-Term Notes;
7.71%; 5/11/2007 500,000 547,940
Ashland Oil, Inc. Medium-Term Notes;
7.73%; 7/15/2013 750,000 840,044
7.72%; 7/15/2013 1,000,000 1,119,109
Mapco, Inc. Medium-Term Notes;
8.48%; 8/5/2013 1,000,000 1,215,732
Sun Co., Inc.
Debentures; 9.00%; 11/1/2024 2,000,000 2,466,540
Notes; 7.13%; 3/15/2004 300,000 319,688
Tosco Corp. Notes; 7.25%; 1/1/2007 2,500,000 2,600,445
Ultramar Credit Corp. Guaranteed
Notes; 8.63%; 7/1/2002 1,000,000 1,107,646
------------
10,217,144
Plastic Materials & Synthetics (0.29%)
Geon Co. Notes; 6.88%; 12/15/2005 500,000 526,310

Pulp Mills (1.57%)
ITT Rayonier, Inc. Notes;
7.50%; 10/15/2002 1,875,000 2,013,248
International Paper Co.
Medium-Term Notes;
9.70%; 8/15/2000 800,000 860,503
------------
2,873,751
Railroads (1.92%)
Union Pacific Corp.
Debentures; 7.00%; 2/1/2016 2,500,000 2,443,493
Notes; 7.25%; 11/1/2008 1,000,000 1,064,144
------------
3,507,637
Real Estate Operators & Lessor (0.67%)
First Industrial, L.P. Notes;
7.60%; 5/15/2007 $1,250,000 $ 1,216,978

Refrigeration & Service
Machinery (0.87%)
Westinghouse Electric Corp.
Global Notes; 8.88%; 6/1/2001 1,500,000 1,590,775

Rental of Railroad Cars (1.50%)
GATX Capital Corp. Medium-Term Notes;
Series B; 9.50%; 1/10/2002 1,500,000 1,676,900
Series C; 6.86%; 10/13/2005 1,000,000 1,063,177
------------
2,740,077
Rubber & Plastics Footwear (1.40%)
Reebok International Ltd. Debentures;
6.75%; 9/15/2005 2,500,000 2,562,185

Sanitary Services (1.87%)
Laidlaw, Inc.
Notes; 7.70%; 8/15/2002 1,000,000 1,050,411
Senior Notes; 7.88%; 4/15/2005 750,000 805,202
WMX Technologies, Inc. Notes;
7.00%; 10/15/2006 1,500,000 1,568,724

3,424,337
Security Brokers & Dealers (2.77%)
Bear Stearns Cos., Inc.
Senior Notes; 7.00%; 3/1/2007 2,500,000 2,546,030
Lehman Brothers, Inc. Senior
Subordinated Notes;
7.38%; 1/15/2007 2,545,000 2,524,518
------------
5,070,548
Telephone Communication (5.59%)
Airtouch Communications, Inc. Notes;
6.65%; 5/1/2008 2,500,000 2,574,360
GTE Corp. Notes; 6.36%; 4/15/2006 2,500,000 2,621,327
Sprint Corp. Notes; 8.13%; 7/15/2002 1,500,000 1,647,923
Worldcom, Inc. Notes;
7.75%; 4/1/2007 3,000,000 3,372,759
------------
10,216,369
Variety Stores (0.70%)
Dayton-Hudson Corp. Debentures;
9.25%; 8/15/2011 1,000,000 1,272,728
------------

Total Bonds 175,302,166

Asset-Backed Securities (1.72%)

Security Brokers & Dealers (1.72%)
Merrill Lynch Mortgage Investors, Inc.
Collateralized Mortgage-Backed
Security, Series 95-C3, 7.37%*
Class C; 12/26/2025 3,000,000 3,150,900

Commercial Paper (0.56%)

Personal Credit Institutions (0.56%)
Investment in Joint Trade Account;
Associates Corp.; 5.72%; 11/2/1998 1,019,410 1,019,410
------------
Total Portfolio Investments (98.21%) 179,472,476

- --------------------------------------------------------------------------------
Value
- --------------------------------------------------------------------------------

Cash and receivables, net of liabilities (1.79%) $ 3,270,188
------------
Total Net Assets (100.00%) $182,742,664
------------
------------

(a)Restricted security - See Note 4 to the financial statements.
* Variable rate (monthly)

PRINCIPAL GOVERNMENT SECURITIES INCOME
FUND, INC.

- --------------------------------------------------------------------------------
Description of Issue
- ------------------------------------------ Principal
Type Rate Maturity Amount Value
- --------------------------------------------------------------------------------
Government National Mortgage Association (GNMA)
Certificates (101.50%)

GNMA I 6.00% 10/15/2023-1/20/2028 $14,658,308 $ 14,523,206
GNMA I 6.50 9/15/2023-12/1/2028 71,781,437 72,574,692
GNMA I 7.00 10/15/2022-5/15/2028 78,090,120 79,924,836
GNMA I 7.25 9/15/2025-10/15/2025 4,468,787 4,569,960
GNMA I 7.50 4/15/2017-10/15/2027 41,113,811 42,373,522
GNMA I 8.00 8/15/2016-2/15/2022 9,279,703 9,685,315
GNMA II 6.00 1/20/2024-8/20/2028 51,693,537 50,848,092
GNMA II 6.50 3/20/2024-3/20/2027 13,679,743 13,729,548
------------

Total GNMA Certificates 288,229,171

- --------------------------------------------------------------------------------
Principal
Amount Value
- --------------------------------------------------------------------------------

Federal Agency Short-Term Obligation (1.31%)
Investment in Joint Trade Account;
Federal National Mortgage
Association; 5.45%; 11/2/1998 $3,723,535 $ 3,723,535
------------

Total Portfolio Investments (102.81%) 291,952,706

Liabilities, net of cash, receivables and
other assets (-2.81%) (7,971,330)
------------

Total Net Assets (100.00%) $283,981,376
------------
------------

PRINCIPAL HIGH YIELD FUND, INC.

- --------------------------------------------------------------------------------
Principal
Amount Value
- --------------------------------------------------------------------------------

Bonds (95.07%)

Advertising (3.57%)
Lamar Advertising Co.
Senior Subordinated Notes;
9.63%; 12/1/2006 $1,500,000 $ 1,597,500

Aircraft & Parts (1.72%)
BE Aerospace Senior Subordinated
Notes; 9.50%; 11/1/2008 $ 750,000(a) $ 768,750

Cable & Other Pay TV Services (10.28%)
CSC Holdings, Inc. Senior Notes;
7.25%; 7/15/2008 1,500,000 1,464,375
Century Communications Senior Notes;
8.75%; 10/1/2007 900,000 929,250
Fox/Liberty Networks LLC Senior Notes;
8.88%; 8/15/2007 1,500,000 1,451,250
Jones Intercable, Inc. Senior Notes;
9.63%; 3/15/2002 700,000 756,000
-----------
4,600,875
Cogeneration - Small Power
Producer (3.50%)
AES Corp. Senior Subordinated
Notes; 8.38%; 8/15/2007 800,000 744,000
Calpine Corp. Senior Notes;
8.75%; 7/15/2007 800,000 820,000
-----------
1,564,000
Communications Equipment (3.10%)
FWT, Inc. Senior Subordinated
Notes; 9.88%; 11/15/2007 800,000 466,000
Qwest Communications International
Senior Notes; 7.50%; 11/1/2008 900,000(a) 920,250
-----------
1,386,250
Communication Services, NEC (2.73%)
Level 3 Communications, Inc.
Senior Notes; 9.13%; 5/1/2008 1,300,000 1,222,000

Computer & Data Processing
Services (2.01%)
DecisionOne Corp. Senior Subordinated
Notes; 9.75%; 8/1/2007 1,500,000 900,000

Crude Petroleum & Natural Gas (4.61%)
Chesapeake Energy Corp. Senior
Notes, Series A; 9.63%; 5/1/2005 1,500,000 1,275,000
Ocean Energy, Inc. Senior Subordinated
Notes; 8.88%; 7/15/2007 800,000 788,000
-----------
2,063,000
Eating & Drinking Places (5.07%)
Cafeteria Operators L. P. Senior Secured
Notes; 12.00%; 12/31/2001 1,500,000 1,413,750
Foodmaker, Inc. Senior Subordinated
Notes; 8.38%; 4/15/2008 900,000 852,750
-----------
2,266,500
Electric Services (1.89%)
York Power Funding Ltd. Senior Secured
Bonds; 12.00%; 10/30/2007 900,000 843,750

Finance Services (1.70%)
DVI, Inc. Senior Notes;
9.88%; 2/1/2004 800,000 760,000

Forest Products (1.11%)
Doman Industries Ltd. Senior Notes;
8.75%; 3/15/2004 700,000 497,000

Fuel Dealers (1.50%)
Petroleum Heat & Power Co., Inc.
Senior Subordinated Debentures;
12.25%; 2/1/2005 700,000 672,000

Funeral Service & Crematories (0.62%)
Loewen Group International, Inc.;
8.25%; 10/15/2003 $ 350,000 $ 276,500

Grocery Stores (1.75%)
Marsh Supermarkets Senior
Subordinated Notes;
8.88%; 8/1/2007 800,000 784,000

Heavy Construction, Except
Highway (3.12%)
Mastec, Inc. Senior Subordinated
Notes; 7.75%; 2/1/2008 1,500,000 1,395,000

Hotels & Motels (2.97%)
HMH Properties, Inc. Senior Notes;
7.88%; 8/1/2008 750,000 725,625
John Q. Hammons Hotels, L.P. &
Finance Corp. First Mortgage
Notes; 8.88%; 2/15/2004 700,000 602,000
-----------
1,327,625
Industrial Inorganic Chemicals (0.30%)
PT. Tri Polyta Indonesia TBK
Guaranteed Secured Notes;
11.38%; 12/1/2003 800,000(b) 136,000

Men's & Boys' Clothing Stores (0.95%)
Edison Brothers Stores, Inc. Senior
Notes; 11.00%; 9/26/2007 700,000 427,000

Miscellaneous Amusement, Recreation
Service (3.49%)
Rio Hotel & Casino, Inc. Senior
Subordinated Notes;
9.50%; 4/15/2007 700,000 759,500
Station Casinos, Inc. Senior
Subordinated Notes, Series B;
9.63%; 6/1/2003 800,000 800,000
-----------
1,559,500
Miscellaneous Equipment Rental &
Leasing (3.14%)
Rental Service Corp. Senior Subordinated
Notes; 9.00%; 5/15/2008 1,500,000 1,402,500

Miscellaneous Metal Ores (2.62%)
Glencore Nickel Priority Ltd.
Senior Secured Notes;
9.00%; 12/1/2014 1,500,000 1,170,000

Miscellaneous Shopping Goods
Stores (1.89%)
Zale Corp. Senior Notes;
8.50%; 10/1/2007 900,000 846,000

Newspapers (1.86%)
Hollinger International Publishing, Inc.
Senior Subordinated Notes;
9.25%; 3/15/2007 $ 800,000 $ 834,000

Nursing & Personal Care Facilities (1.63%)
Integrated Health Services, Inc. Senior
Subordinated Notes; 9.25%; 1/15/2008 800,000 728,000

Oil & Gas Field Services (1.56%)
Dawson Production Services
Senior Notes; 9.38%; 2/1/2007 700,000 700,000

Paper Mills (0.96%)
Indah Kiat Finance Mauritius Ltd.
Guaranteed Senior Notes;
10.00%; 7/1/2007 800,000 430,000

Personal Credit Institutions (1.18%)
MacSaver Financial Services, Inc.
Notes; 7.60%; 8/1/2007 800,000 527,793

Petroleum Refining (1.51%)
Crown Central Petroleum Corp.
Senior Notes; 10.88%; 2/1/2005 700,000 677,250

Pulp Mills (1.57%)
Pen-Tab Industries, Inc. Senior
Subordinated Notes; 10.88%; 2/1/2007 800,000 704,000

Radio & Television Broadcasting (1.72%)
Antenna TV S.A. Senior Notes;
9.00%; 8/1/2007 900,000 767,250

Retail Stores, NEC (1.83%)
Cole National Group, Inc.
Senior Subordinated Notes;
9.88%; 12/31/2006 800,000 820,000

Search & Navigation Equipment (0.94%)
AMRESCO, Inc. Senior Subordinated
Notes; 10.00%; 3/15/2004 700,000 420,000

Telephone Communication (13.75%)
Comcast Cellular Holdings Senior Notes;
9.50%; 5/1/2007 1,500,000 1,545,000
Intermedia Communications, Inc. Senior
Notes; 8.50%; 1/15/2008 800,000 756,000
Lenfest Communications Senior Notes;
8.38%; 11/1/2005 800,000 836,000
NEXTLINK Communications, Inc.
Senior Notes; 9.00%; 3/15/2008 800,000 728,000
Rogers Cablesystems, Ltd. Senior
Secured Second Priority Notes;
9.63%; 8/1/2002 750,000 800,625
Rogers Cantel, Inc. Senior Secured
Debentures; 9.75%; 6/1/2016 700,000 710,500
Vanguard Cellular Systems, Inc. Senior
Debentures; 9.38%; 4/15/2006 700,000 773,500
-----------
6,149,625
Water Transportation of Freight,
NEC (2.92%)
Cenargo International PLC First Mortgage
Notes; 9.75%; 6/15/2008 $1,500,000(a) $ 1,305,000
-----------

Total Bonds 42,528,668

Commercial Paper (6.31%)

Business Credit Institutions (1.41%)
American Express Credit Corp.;
5.05%; 11/2/1998 310,000 309,956
General Electric Capital Corp.;
5.10%; 11/2/1998 320,000 319,955
-----------
629,911
Personal Credit Institutions (4.91%)
Investment in Joint Trade Account,
Associates Corp; 5.72%; 11/2/1998 2,194,868 2,194,868
-----------

Total Commercial Paper 2,824,779
-----------

Total Portfolio Investments (101.38%) 45,353,447

Liabilities, net of cash, receivables and
other assets (-1.38%) (618,645)
-----------

Total Net Assets (100.00%) $44,734,802
-----------
-----------

(a)Restricted security - See Note 4 to the financial statements.
(b)Non-income producing security - Security in default.

PRINCIPAL LIMITED TERM BOND FUND, INC.

- --------------------------------------------------------------------------------
Principal
Amount Value
- --------------------------------------------------------------------------------

Bonds (61.34%)

Business Credit Institutions (9.36%)
CIT Group Holdings
Senior Medium-Term Notes;
6.38%; 10/1/2002 $1,000,000 $ 1,019,533
Ford Motor Credit Co. Notes;
7.50%; 1/15/2003 1,000,000 1,065,888
Orix Credit Alliance, Inc.
Medium-Term Notes;
6.46%; 5/17/1999 850,000(a) 850,704
-----------
2,936,125
Combination Utility Services (3.53%)
Consolidated Edison Co. Debentures,
Series 93-B; 6.50%; 2/1/2001 824,000 851,245
Pacificorp First Mortgage Medium-Term
Notes; 9.50%; 5/20/1999 250,000 255,550
-----------
1,106,795
Commercial Banks (1.06%)
Lehman Large Loan Class A1,
Series 1997-LLI; 6.79%; 6/12/2004 317,722 331,025

Department Stores (5.25%)
J. C. Penney Co., Inc. Notes;
9.05%; 3/1/2001 $1,000,000 $ 1,077,980
Sears Roebuck Acceptance Corp.
Medium-Term Notes, Series II;
6.69%; 8/13/2001 450,000 466,955
Sears Roebuck Co. Medium-Term
Notes; 6.46%; 5/12/2000 100,000 101,278
-----------
1,646,213
Finance Services (4.87%)
Aetna Services, Inc. Notes;
6.38%; 8/15/2003 500,000 518,663
Lehman Brothers, Inc. Senior
Subordinated Notes;
7.25%; 4/15/2003 1,000,000 1,009,355
-----------
1,528,018
Federal & Federally Sponsored
Credit (0.97%)
Federal Home Loan Mortgage
Corporation Debentures;
6.57%; 2/27/2007 130,000 141,055
Federal National Mortgage
Association Medium-Term Notes;
6.70%; 6/19/2007 150,000 163,837
-----------
304,892
General Industrial Machinery (3.39%)
Timken Co. Medium-Term Notes;
7.30%; 8/13/2002 1,000,000 1,064,405

Miscellaneous Investing (0.96%)
United Dominion Realty Trust
Notes; 7.25%; 4/1/1999 300,000 300,114

Mortgage Bankers & Brokers (2.76%)
Countrywide Funding Corp.
Medium-Term Notes;
6.05%; 3/1/2001 860,000 867,377

Motor Vehicles & Equipment (1.75%)
General Motors Corp. Medium-Term
Notes; 9.20%; 7/2/2001 500,000 548,645

Paper Mills (3.28%)
International Paper Co. Notes;
7.00%; 6/1/2001 1,000,000 1,030,053

Paperboard Mills (3.46%)
Temple-Inland, Inc. Notes;
9.00%; 5/1/2001 1,000,000 1,084,663

Personal Credit Institutions (11.62%)
American General Finance Corp.
Medium-Term Notes, Series D;
7.46%; 3/28/2000 350,000 359,675
Notes; 7.25%; 4/15/2000 701,000 721,253
Associates Corp. of North America
Notes; 5.75%; 10/15/2003 1,000,000 1,004,350
Chrysler Financial Corp.
Medium-Term Notes;
8.45%; 1/28/2000 500,000 517,709
General Motors Acceptance Corp.
Notes; 6.63%; 10/1/2002 1,000,000 1,041,056
-----------
3,644,043
Plumbing & Heating, Except
Electric (3.42%)
Masco Corp. Notes; 6.13%; 9/15/2003 $1,035,000 $ 1,073,625

Security Brokers & Dealers (3.39%)
Merrill Lynch & Co., Inc. Notes;
6.55%; 8/1/2004 1,030,000 1,064,886

Telephone Communication (2.27%)
Nynex Capital Funding Medium-Term
Notes, Series A; 9.40%; 6/1/2000 670,000 711,927
-----------

Total Bonds 19,242,806

- --------------------------------------------------------------------------------
Description of Issue
- ---------------------------------- Principal
Type Rate Maturity Amount Value
- --------------------------------------------------------------------------------

Federal Home Loan Mortgage Corporation (FHLMC)
Certificates (11.71%)

FHLMC 7.00% 12/1/2022 $ 719,438 $ 731,920
FHLMC 7.00 3/1/2028 993,337 1,009,796
FHLMC 7.25 12/1/2007 493,439 499,287
FHLMC 8.00 12/1/2011 242,965 251,502
FHLMC 8.00 10/1/2022 230,115 237,727
FHLMC 8.25 1/1/2012 86,170 88,058
FHLMC 8.50 1/1/2000 437,643 443,529
FHLMC 8.50 4/1/2000 90,095 91,307
FHLMC 9.00 9/1/2009 303,768 320,958
-----------

Total FHLMC Certificates 3,674,084

Federal National Mortgage Association (FNMA)
Certificates (6.81%)

FNMA 6.00 7/1/2028 1,000,000 987,890
FNMA 8.00 10/1/2006 119,371 121,758
FNMA 8.00 5/1/2027 337,982 349,402
FNMA 8.50 5/1/2022 286,588 298,966
FNMA 9.00 2/1/2025 356,057 376,787
-----------

Total FNMA Certificates 2,134,803

Government National Mortgage Association (GNMA)
Certificates (8.95%)

GNMA I 6.50 6/15/2028 991,200 1,002,193
GNMA I 6.50 9/15/2028 998,617 1,009,691
GNMA I 9.00 7/15/2017 76,258 81,600
GNMAII 6.00 7/20/2028 496,764 488,692
GNMAII 8.00 1/20/2016 216,224 224,529

Total GNMA Certificates 2,806,705

Asset-Backed Securities (8.92%)

Motor Vehicles & Equipment (3.15%)
GMAC Commercial Mortgage
Securities, Inc. Mortgage Pass-Through
Certificates, Series 1998-C2, Class C;
6.50%; 8/15/2008 $1,000,000 $ 987,730

Personal Credit Institutions (1.18%)
Union Acceptance Corp. 1996-B Auto
Trust Pass-Through Certificates,
Class A; 6.45%; 7/8/2003 366,453 370,924

Mortgage Pass Thru Securities (4.59%)
J.P. Morgan Commercial Mortgage
Finance Corp. Mortgage
Pass-Through, Series 97-C5,
Class A-2; 7.06%; 9/15/2029 1,360,000 1,441,097
-----------

Total Asset-Backed Securities 2,799,751

Commercial Paper (1.23%)

Personal Credit Institutions (1.23%)
Investment in Joint Trade Account;
Associates Corp.; 5.72%; 11/2/1998 386,355 386,355
-----------

Total Portfolio Investments (98.96%) 31,044,504

Cash, receivables and other assets,
net of liabilities (1.04%) 326,201
-----------

Total Net Assets (100.00%) $31,370,705
-----------
-----------

(a)Restricted security - See Note 4 to the financial statements.

PRINCIPAL TAX-EXEMPT BOND FUND, INC.

- --------------------------------------------------------------------------------
Principal
Amount Value
- --------------------------------------------------------------------------------

Long-Term Tax-Exempt Bonds (98.09%)

Alabama (2.40%)
Courtland, Alabama IDB IDR Series A
Bonds for Champion International;
7.20%; 12/1/2013 $3,815,000 $ 4,191,731
Phenix County, Alabama IDB
Environmental Improvement Rev.
Bonds, Mead Coated Board, Inc.,
Series B; 5.25%; 4/1/2028 1,000,000 991,250
------------
5,182,981
Arizona (1.97%)
Navajo County, Arizona Pollution
Control Corp. Rev. Ref. Bonds,
Arizona Public Service Co.,
Series 1993A; 5.88%; 8/15/2028 4,100,000 4,264,000

Arkansas (2.54%)
City of Blytheville, Arkansas Solid Waste
Recycling & Sewer Treatment Rev.
Bonds, Series 1992, Nucor Corp.
Project; 6.90%; 12/1/2021 $4,610,000 $ 4,984,563
Little River County Arkansas Rev.
Georgia Pacific Corp. Project;
5.60%; 10/1/2026 500,000 501,250
------------
5,485,813
California (4.58%)
ABAG Finance Authority for Nonprofit
Corp., Cert. of Participation,
Stanford University Hospital;
5.00%; 11/1/2004 750,000 797,813
5.50%; 11/1/2013 1,250,000 1,375,000
5.25%; 11/1/2020 1,750,000 1,824,375
California Pollution Control Funding
Authority Pollution Control Rev. Ref.
Bonds for San Diego Gas & Electric,
Series A; 5.90%; 6/1/2014 1,000,000 1,125,000
California Pollution Control Funding
Authority Rev. Bonds, Atlantic
Richfield Co. Project; 5.00%; 4/1/2008 2,500,000 2,609,375
City of Upland, California San Antonio
Comm. Hospital Cert. of Participation;
5.25%; 1/1/2004 2,080,000 2,173,600
------------
9,905,163
Colorado (2.60%)
City & County of Denver, Colorado
Airport System Rev. Bonds,
Series 1991D; 7.75%; 11/15/2013 3,185,000 4,108,650
Colorado Health Fac. Authority Rev.
Bonds for Sisters of Charity
Healthcare Systems, Series 1994;
5.25%; 5/15/2014 1,500,000 1,524,375
------------
5,633,025
Florida (1.10%)
Nassau County, Florida Pollution
Control Rev. Ref. Bonds; ITT
Rayonier, Inc. Project;
6.10%; 6/1/2005 1,000,000 1,065,000
7.65%; 6/1/2006 1,265,000 1,306,315
------------
2,371,315
Georgia (1.73%)
Fulco, Georgia Hospital Authority Rev.
Anticipation Cert. for St. Joseph's
Hospital of Atlanta, Inc.;
5.50%; 10/1/2014 2,000,000 2,202,500
Municipal Electric Authority of Georgia
Power Rev. Bonds, Series R;
7.30%; 1/1/2009 1,505,000 1,542,098
------------
3,744,598
Illinois (13.55%)
Chicago, Illinois Midway Airport Rev.
Bonds, Series A, MBIA Insured;
5.50%; 1/1/2011 1,500,000 1,603,125
5.50%; 1/1/2013 500,000 533,750
Chicago, Illinois O'Hare International
Airport Special Fac. Rev. Bonds for
American Airlines, Inc. Project-A;
7.88%; 11/1/2025 6,010,000 6,475,775
Chicago, Illinois O'Hare International
Airport Special Fac. Rev. Bonds for
Lufthansa German Airlines Project;
7.13%; 5/1/2018 $1,000,000 $ 1,076,250
City of Chicago, Illinois Adj. Rate Gas
Supply Rev. Bonds, Series 1985A,
Peoples Gas Light & Coke Project;
6.88%; 3/1/2015 2,800,000 3,062,500
Illinois Health Fac. Authority Ref. Rev.
Bonds for OSF Healthcare System;
5.75%; 11/15/2007 1,000,000 1,071,250
6.00%; 11/15/2010 500,000 538,750
6.00%; 11/15/2013 500,000 535,625
Illinois Health Fac. Authority Rev. Bonds,
Northwestern Memorial Hospital,
Series 1994A;
5.60%; 8/15/2006 500,000 539,375
5.75%; 8/15/2008 615,000 664,969
5.80%; 8/15/2009 840,000 906,150
6.10%; 8/15/2014 1,000,000 1,076,250
Illinois Health Fac. Authority Rev.
Bonds for Sarah Bush Lincoln
Health Center;
Series 1992; 7.25%; 5/15/2002 2,950,000 3,344,562
Series 1996B; 6.00%; 2/15/2011 1,000,000 1,087,500
Series 1996B; 5.50%; 2/15/2016 1,000,000 1,015,000
Illinois Health Fac. Authority Rev.
Bonds for South Suburban Hospital,
Series 1992;
7.00%; 2/15/2009 305,000 358,375
7.00%; 2/15/2018 720,000 888,300
Illinois Health Fac. Authority Rev. Ref.
Bonds for Advocate Healthcare,
Series A; 6.75%; 4/15/2012 2,000,000 2,314,950
Regional Transportation Authority,
Illinois General Obligation Bonds,
Series 1994A; 6.25%; 6/1/2015 2,000,000 2,212,500
------------
29,304,956
Indiana (7.52%)
City of Mount Vernon, Indiana
Pollution Control Rev. Bonds for
Southern Indiana Gas & Electric
Co. Project; 7.25%; 3/1/2014 700,000 748,125
City of Petersburg, Indiana Pollution
Control Rev. Bonds, for Indianapolis
Power & Light Co. Project,
Series 1993A; 6.10%; 1/1/2016 4,000,000 4,265,000
Indiana Health Fac. Financing Authority
Hospital Rev. Bonds, Clarian Health
Partners, Inc.; 5.50%; 2/15/2009 2,520,000 2,664,900
Indiana Health Fac. Financing
Authority Hospital Rev. Ref. Bonds,
Schneck Memorial Hospital,
Series 1998;
4.70%; 2/15/2006 500,000 504,375
5.13%; 2/15/2017 500,000 488,125
Indiana Health Fac. Financing
Authority Hospital Rev. Ref. Bonds,
Welborn Memorial Baptist Hospital,
Series 1993; 5.63%; 7/1/2023 1,860,000 1,885,575
Indiana (Continued)
Lawrenceburg, Indiana Pollution
Control Rev. Ref. Bonds, Indiana
Michigan Power Co. Project,
Series D; 7.00%; 4/1/2015 $1,000,000 $ 1,080,000
Series E; 5.90%; 11/1/2019 3,220,000 3,352,825
Warrick County, Indiana
Environmental Improvement Rev.
Bonds, Southern Indiana Gas &
Electric, Series 1993B;
6.00%; 5/1/2023 1,190,000 1,265,862

16,254,787
Iowa (2.96%)
City of Muscatine, Iowa Electric Rev.
Ref. Bonds, Series 1986;
6.00%; 1/1/2006 150,000 150,386
5.00%; 1/1/2007 1,575,000 1,576,102
Eddyville, Iowa IDR Ref. Bonds,
Cargill, Inc. Project; 5.63%; 12/1/2013 1,000,000(a) 1,050,000
Iowa Finance Authority Hospital Fac.
Ref. Rev. Bonds for Jennie
Edmundson Memorial Hospital;
7.40%; 11/1/2006 550,000 618,062
Iowa Finance Authority Hospital Fac.
Ref. Rev. Bonds, Iowa Health Systems,
Series A, MBIA Insured;
5.13%; 1/1/2028 3,000,000 3,015,000
------------
6,409,550
Kentucky (1.85%)
City of Ashland, Kentucky Sewage
and Solid Waste Rev. Bonds for
Ashland, Inc. Project, Series 1995;
7.13%; 2/1/2022 750,000 842,813
City of Ashland, Kentucky Solid
Waste Rev. Bonds for Ashland
Oil, Inc. Project, Series 1991;
7.20%; 10/1/2020 1,000,000 1,078,750
------------
1,921,563
Louisiana (0.97%)
St. Charles Parish, Louisiana Pollution
Control Rev. Bonds for Louisiana
Power & Light Co. Project;
7.50%; 6/1/2021 1,950,000 2,108,438

Maine (0.98%)
Skowhegan, Maine Pollution Control
Rev. Ref. Bonds for Scott Paper
Co. Project, Series 1993;
5.90%; 11/1/2013 2,000,000 2,122,500

Michigan (3.02%)
Detroit, Michigan LOC Dev. Financing
Authority Ref. Bonds, Senior Series A
Chrysler Corp; 5.20%; 5/1/2010 1,700,000 1,780,750
Michigan State Hospital Financing
Authority Hospital Rev. Bonds for
Detroit Medical Center, Series 1993B;
5.75%; 8/15/2013 $ 600,000 $ 628,500
5.50%; 8/15/2023 2,000,000 2,017,500
Michigan State Hospital Financing
Authority Rev. Ref. Bonds,
Daughters of Charity Hospital;
5.25%; 11/1/2015 1,000,000 1,020,000
Michigan State Hospital Financing
Authority Rev. Ref. Bonds,
Daughters of Charity Natl. Health
System; 5.50%; 11/1/2005 1,000,000 1,082,500
------------
6,529,250
Minnesota (0.73%)
City of Bass Brook, Minnesota Pollution
Control Rev. Ref. Bonds for
Minnesota Power & Light Project;
6.00%; 7/1/2022 1,500,000 1,578,750

Mississippi (0.23%)
Grenada County, Mississippi Rev. Ref.
Bonds, Georgia Pacific Corp. Project;
5.45%; 9/1/2014 500,000 502,500

Missouri (1.14%)
Missouri State Health & Educational
Fac. Authority Health Fac. Rev.
Bonds, BJC Health System,
Series 1994A; 6.75%; 5/15/2012 2,000,000 2,465,000

Montana (0.98%)
Forsyth, Montana Pollution Control
Rev. Ref. Bonds, Montana Power
Co., Colstrip Project, Series 1993A;
6.13%; 5/1/2023 2,000,000 2,127,500

Nebraska (2.20%)
Dawson County, Nebraska Sanitary &
Improvement General Obligation
Ref. Bonds; 5.55%; 2/1/2017 1,000,000 1,042,500
Nebraska Public Power Dist. Power
Supply System Rev. Bonds;
5.30%; 1/1/2002 1,000,000 1,046,250
5.40%; 1/1/2003 1,500,000 1,586,250
5.50%; 1/1/2004 1,000,000 1,077,500
------------
4,752,500
Nevada (1.84%)
Clark County, Nevada IDR Ref.
Bonds, Nevada Power Co. Project,
Series 1992C; 7.20%; 10/1/2022 3,600,000 3,969,000

New Mexico (1.08%)
City of Lordsburg, New Mexico
Pollution Control Rev. Bonds
for Phelps Dodge Corp. Project;
6.50%; 4/1/2013 2,150,000 2,340,813

North Carolina (3.46%)
Martin County, North Carolina
Industrial Fac. & Pollution Control
Finance Authority Solid Waste
Rev. Bonds, Weyerhaeuser;
5.65%; 12/1/2023 1,500,000 1,530,000
6.80%; 5/1/2024 2,000,000 2,230,000
North Carolina Medical Care Hospital
Rev. Bonds for Rex Hospital Project;
5.00%; 6/1/2023 $2,170,000 $ 2,129,312
Wake County, North Carolina
Industrial Fac. & Pollution Control
Finance Authority Rev. Bond,
Carolina Power & Light Co.;
6.90%; 4/1/2009 1,500,000 1,584,375
------------
7,473,687
North Dakota (0.96%)
Mercer County, North Dakota
Pollution Control Rev. Bonds,
Ottertail Power Co. Project,
Series 1991; 6.90%; 2/1/2019 1,950,000 2,086,500

Ohio (4.78%)
Cuyahoga County, Ohio Hospital
Rev. Bonds for Meridia Health
Systems, Series 1991;
7.25%; 8/15/2019 1,445,000 1,566,019
Lorain County, Ohio Hospital Ref.
Bonds, Humility Mary Health
Care, Series A; 5.90%; 12/15/2008 3,270,000 3,547,950
Ohio Air Quality Dev. Rev. Bonds,
Columbus Southern Power Co.
Project, Series 1985B;
6.25%; 12/1/2020 4,900,000 5,218,500
------------
10,332,469
Oklahoma (1.14%)
Tulsa Industrial Authority Rev. Bonds,
St. John Medical Center Project,
Series 1994;
6.25%; 2/15/2014 1,280,000 1,384,000
6.25%; 2/15/2017 1,000,000 1,077,500
------------
2,461,500
Rhode Island (1.44%)
Rhode Island State Industrial Facilities
Corp. Marine Term Rev. Bonds,
Mobil Oil Refining;
6.00%; 11/1/2014 2,900,000 3,113,875

South Carolina (4.68%)
Darlington County, South Carolina
Pollution Control Rev. Bonds for
Carolina Power & Light;
6.60%; 11/1/2010 1,000,000 1,098,750
Greenville Hospital System,
South Carolina Hospital Fac.
Rev. Ref. Bonds; 6.00%; 5/1/2020 230,000 259,037
Series C; 5.50%; 5/1/2016 2,500,000 2,575,000
Oconee County, South Carolina
Pollution Control Rev. Ref. Bonds,
Duke Energy Corp. Project, Series
1993; 5.80%; 4/1/2014 2,000,000 2,127,500
York County, South Carolina Exempt
Fac. Industrial Rev. Bonds for
Hoechst Celanese Project,
Series 1994; 5.70%; 1/1/2024 2,000,000 2,062,500
York County, South Carolina Pollution
Control Rev. Bonds, Bowater, Inc.
Project; 7.63%; 3/1/2006 1,700,000 1,995,375
------------
10,118,162
South Dakota (0.50%)
Pennington County, South Dakota
Pollution Control Rev. Ref. Bonds
for Black Hills Power & Light Co.
Project; 6.70%; 6/1/2010 $1,000,000 $ 1,085,000

Tennessee (0.96%)
County of Louden, Tennessee Industrial
Development Solid Waste;
6.20%; 2/1/2023 1,950,000 2,084,062

Texas (9.07%)
Brazos River Authority, Texas Rev.
Industrial Bonds Project-A Houston
Industries, Inc.; 5.13%; 5/1/2019 2,000,000 2,012,500
Cass County, Texas Industrial
Dev. Corp. Pollution Control
Rev. Bonds for International
Paper Co. - Series B
5.35%; 4/1/2012 3,750,000 3,867,187
Guadalupe-Blanco River Authority,
Texas Industrial Dev. Corp.
Pollution Control Rev. E I Du Pont
1982 Series A; 6.35%; 7/1/2022 2,500,000 2,728,125
IDC Port of Corpus Christi Rev. Ref.
Bonds, Port Fac. Rev. Bonds,
Valero Energy Corp.; 5.13%; 4/1/2009 1,000,000 1,010,000
Matagorda County, Texas
Navigational District No. 1 Pollution
Control Rev. Bonds for Central
Power & Light Co.;
7.50%; 12/15/2014 2,585,000 2,749,794
6.00%; 7/1/2028 1,000,000 1,060,000
Milam County, Texas Industrial Dev.
Corp. Pollution Control Rev. Ref.
Bonds, Alcoa Project;
5.65%; 12/1/2012 2,000,000 2,142,500
Red River Authority, Texas Pollution
Control Rev. Bonds, Hoechst
Celanese Corp. Project;
5.20%; 5/1/2007 2,825,000 2,934,469
Tarrant County, Texas Health Fac.
Dev. Corp., Harris Methodist Health
System Rev. Bonds; 5.90%; 9/1/2006 1,000,000 1,120,000
------------
19,624,575
Utah (0.91%)
Intermountain Power Agency, Utah
Power Supply, Rev. Ref. Bonds,
Series 1996D; 5.00%; 7/1/2021 2,000,000 1,967,500

Virginia (2.78%)
Albemarle County, Virginia IDA
Hospital Rev. Ref. Bonds, Martha
Jefferson Hospital; 5.50%; 10/1/2015 1,900,000 1,959,375
Bedford County, Virginia Industrial Dev.
Nekoosa Packing Corp., Georgia
Pacific; 5.60%; 12/1/2025 2,500,000 2,537,500
Chesapeake, Virginia IDA Rev. Ref.
Bonds for Cargill, Inc. Project;
5.88%; 3/1/2013 1,410,000 1,508,700
------------
6,005,575
Washington (2.96%)
City of Seattle, Washington Municipal
Light and Power Rev. Bonds;
1993; 5.10%; 11/1/2005 $1,950,000 $ 2,076,750
1994; 6.63%; 7/1/2016 1,000,000 1,147,500
1998; 4.88%; 6/1/2021 1,500,000 1,456,875
Washington Health Care Fac.
Authority Rev. Bonds; Series 1989,
Sisters of Providence;
7.88%; 10/1/1999 1,650,000 1,738,374
------------
6,419,499
West Virginia (6.69%)
Braxton County, West Virginia Solid
Waste Disposal Rev. Weyerhaeuser
Co.; 5.40%; 5/1/2025 2,000,000 2,015,000
Marshall County, West Virginia
Pollution Control Rev. Bonds
for Ohio Power Co. Project;
Series C; 6.85%; 6/1/2022 1,200,000 1,306,500
Series D; 5.90%; 4/1/2022 4,500,000 4,798,125
Pleasants County, West Virgina
Pollution Control Rev. Bonds
for Potomac Edison Co.;
6.15%; 5/1/2015 2,000,000 2,172,500
Putnam County, West Virginia
Pollution Control Rev. Bonds for
Appalachian Power Co. Project,
Series C; 6.60%; 7/1/2019 3,875,000 4,170,469
------------
14,462,594
Wisconsin (2.75%)
Kaukauna, Wisconsin Pollution
Control Rev. Ref. Bonds for
International Paper Co. Project,
Series A; 5.40%; 5/1/2004 3,610,000 3,772,450
Wisconsin Health & Educational
Fac. Authority Rev. Bonds;
Series 1995; Franciscan Skemp
Medical Center, Inc.;
5.88%; 11/15/2010 1,000,000 1,086,250
6.13%; 11/15/2015 1,000,000 1,085,000
------------
5,943,700
------------

Total Portfolio Investments (98.09%) 212,152,700

Cash, receivables and other assets,
net of liabilities (1.91%) 4,131,205
------------

Total Net Assets (100.00%) $216,283,905
------------
------------

(a)Restricted security - See Note 4 to the financial statements.

FINANCIAL HIGHLIGHTS

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

Distributions from Capital Gains...................... -- -- -- (.01) (.01)
------ ------ ------ ------ ------
Total Dividends and Distributions (.72) (.81) (.76) (.79) (.79)
------ ------ ------ ------ ------
Net Asset Value, End of Period........................... $11.59 $11.44 $11.17 $11.42 $10.27
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total Return(c).......................................... 7.76% 10.15% 4.74% 19.73% (6.01)%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $148,081 $126,427 $113,437 $106,962 $88,801
Ratio of Expenses to Average Net Assets(b)............ .95% .95% .95% .94% .95%
Ratio of Net Investment Income to Average Net Assets.. 6.19% 6.70% 6.85% 7.26% 7.27%
Portfolio Turnover Rate............................... 15.2% 12.8% 3.4% 5.1% 8.9%
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL BOND FUND, INC.(a)
Class B shares 1998 1997 1996 1995(f)
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $11.42 $11.15 $11.41 $10.19
Income from Investment Operations:
Net Investment Income(b).............................. .63 .67 .67 .63
Net Realized and Unrealized Gain (Loss) on Investments .16 .31 (.25) 1.19
------ ------ ------ ------
Total from Investment Operations .79 .98 .42 1.82
Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.63) (.71) (.68) (.60)
Distributions from Capital Gains...................... -- -- -- --
------ ------ ------ ------
Total Dividends and Distributions (.63) (.71) (.68) (.60)
------ ------ ------ ------
Net Asset Value, End of Period........................... $11.58 $11.42 $11.15 $11.41
------ ------ ------ ------
------ ------ ------ ------
Total Return(c).......................................... 7.04% 9.20% 3.91% 17.98%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $22,466 $13,403 $7,976 $2,708
Ratio of Expenses to Average Net Assets(b)............ 1.67% 1.70% 1.69% 1.59%(e)
Ratio of Net Investment Income to Average Net Assets.. 5.45% 5.92% 6.14% 6.30%(e)
Portfolio Turnover Rate............................... 15.2% 12.8% 3.4% 5.1%(e)
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL BOND FUND, INC.(a)
Class R shares 1998 1997 1996(g)
---- ---- ----
<S> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $11.43 $11.16 $11.27
Income from Investment Operations:
Net Investment Income(b).............................. .63 .71 .51
Net Realized and Unrealized Gain (Loss) on Investments .16 .30 (.13)
------ ------ ------
Total from Investment Operations .79 1.01 .38
Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.63) (.74) (.49)
Distributions from Capital Gains...................... -- -- --
------ ------ ------
Total Dividends and Distributions (.63) (.74) (.49)
------ ------ ------
Net Asset Value, End of Period........................... $11.59 $11.43 $11.16
------ ------ ------
------ ------ ------
Total Return(c).......................................... 7.05% 9.49% 3.75%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $12,196 $5,976 $525
Ratio of Expenses to Average Net Assets(b)............ 1.45% 1.45% 1.28%(e)
Ratio of Net Investment Income to Average Net Assets.. 5.66% 6.11% 6.51%(e)
Portfolio Turnover Rate............................... 15.2% 12.8% 3.4%(e)

See accompanying notes.
</TABLE>

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

<TABLE>
<CAPTION>
PRINCIPAL GOVERNMENT SECURITIES INCOME FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $11.51 $11.26 $11.31 $10.28 $11.79
Income from Investment Operations:
Net Investment Income................................. .70 .70 .70 .71 .69
Net Realized and Unrealized Gain (Loss) on Investments .12 .29 (.05) 1.02 (1.40)
------ ------ ------ ------ ------
Total from Investment Operations .82 .99 .65 1.73 (.71)
Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.70) (.74) (.70) (.70) (.68)
Distributions from Capital Gains...................... -- -- -- -- (.12)
------ ------ ------ ------ ------
Total Dividends and Distributions (.70) (.74) (.70) (.70) (.80)
------ ------ ------ ------ ------
Net Asset Value, End of Period........................... $11.63 $11.51 $11.26 $11.31 $10.28
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total Return(c).......................................... 7.38% 9.23% 6.06% 17.46% (6.26)%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $251,455 $249,832 $259,029 $261,128 $249,438
Ratio of Expenses to Average Net Assets............... .86% .84% .81% .87% .95%
Ratio of Net Investment Income to Average Net Assets.. 6.07% 6.19% 6.31% 6.57% 6.35%
Portfolio Turnover Rate............................... 17.1% 10.8% 25.9% 10.1% 24.8%
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL GOVERNMENT SECURITIES INCOME FUND, INC.(a)
Class B shares 1998 1997 1996 1995(f)
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $11.50 $11.23 $11.29 $10.20
Income from Investment Operations:
Net Investment Income................................. .62 .64 .61 .56
Net Realized and Unrealized Gain (Loss) on Investments .12 .29 (.05) 1.07
------ ------ ------ ------
Total from Investment Operations .74 .93 .56 1.63
Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.64) (.66) (.62) (.54)
Distributions from Capital Gains...................... -- -- -- --
------ ------ ------ ------
Total Dividends and Distributions (.64) (.66) (.62) (.54)
------ ------ ------ ------
Net Asset Value, End of Period........................... $11.60 $11.50 $11.23 $11.29
------ ------ ------ ------
------ ------ ------ ------
Total Return(c).......................................... 6.60% 8.65% 5.17% 16.07%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $24,370 $15,431 $11,586 $4,699
Ratio of Expenses to Average Net Assets............... 1.57% 1.39% 1.60% 1.53%(e)
Ratio of Net Investment Income to Average Net Assets.. 5.43% 5.63% 5.53% 5.68%(e)
Portfolio Turnover Rate............................... 17.1% 10.8% 25.9% 10.1%(e)
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL GOVERNMENT SECURITIES INCOME FUND, INC.(a)
Class R shares 1998 1997 1996(g)
---- ---- ----
<S> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $11.42 $11.21 $11.27
Income from Investment Operations:
Net Investment Income................................. .61 .64 .47
Net Realized and Unrealized Gain (Loss) on Investments .13 .24 (.08)
------ ------ ------
Total from Investment Operations .74 .88 .39
Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.61) (.67) (.45)
Distributions from Capital Gains...................... -- -- --
------ ------ ------
Total Dividends and Distributions (.61) (.67) (.45)
------ ------ ------
Net Asset Value, End of Period........................... $11.55 $11.42 $11.21
------ ------ ------
------ ------ ------
Total Return(c).......................................... 6.66% 8.19% 3.76%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $8,156 $4,152 $481
Ratio of Expenses to Average Net Assets............... 1.64% 1.79% 1.18%(e)
Ratio of Net Investment Income to Average Net Assets.. 5.39% 5.21% 5.84%(e)
Portfolio Turnover Rate............................... 17.1% 10.8% 25.9%(e)

See accompanying notes.
</TABLE>

FINANCIAL HIGHLIGHTS (Continued)

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.64) (.73) (.70) (.65) (.65)
Excess Distribution of Net Investment Income(i)....... (.01) -- -- -- --
------ ------ ------ ------ ------
Total Dividends and Distributions (.65) (.73) (.70) (.65) (.65)
------ ------ ------ ------ ------
Net Asset Value, End of Period........................... $7.63 $8.52 $8.27 $8.06 $7.83
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total Return(c).......................................... (3.18)% 12.33% 11.88% 11.73% 1.45%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $33,474 $38,239 $28,432 $23,396 $19,802
Ratio of Expenses to Average Net Assets............... 1.40% 1.22% 1.26% 1.45% 1.46%
Ratio of Net Investment Income to Average Net Assets.. 7.71% 7.99% 8.49% 8.71% 7.82%
Portfolio Turnover Rate............................... 65.9% 39.2% 18.8% 40.3% 27.2%
</TABLE>

Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.57) (.65) (.63) (.50)
Excess Distribution of Net Investment Income(i)....... (.01) -- -- --
---- ---- ---- ----
Total Dividends and Distributions (.58) (.65) (.63) (.50)
---- ---- ---- ----
Net Asset Value, End of Period........................... $7.59 $8.47 $8.22 $8.05
---- ---- ---- ----
---- ---- ---- ----
Total Return(c).......................................... (3.93)% 11.31% 10.46% 12.20%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $8,527 $6,558 $2,113 $633
Ratio of Expenses to Average Net Assets............... 2.34% 2.13% 2.38% 2.10%(e)
Ratio of Net Investment Income to Average Net Assets.. 6.78% 7.03% 7.39% 7.78%(e)
Portfolio Turnover Rate............................... 65.9% 39.2% 18.8% 40.3%(e)
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL HIGH YIELD FUND, INC.(a)
Class R shares 1998 1997 1996(g)
---- ---- ----
<S> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $8.40 $8.20 $8.21
Income from Investment Operations:
Net Investment Income................................. .57 .62 .46
Net Realized and Unrealized Gain (Loss) on Investments (.87) .26 (.03)
------ ------ ------
Total from Investment Operations (.30) .88 .43

Less Dividends and Distributions:
Dividends from Net Investment Income................. (.58) (.68) (.44)
Excess Distribution of Net Investment Income(i)....... (.01) -- --
------ ------ ------
Total Dividends and Distributions (.59) (.68) (.44)
------ ------ ------
Net Asset Value, End of Period........................... $7.51 $8.40 $8.20
------ ------ ------
------ ------ ------
Total Return(c).......................................... (3.97)% 11.14% 5.60%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $2,734 $1,961 $124
Ratio of Expenses to Average Net Assets............... 2.28% 2.42% 1.59%(e)
Ratio of Net Investment Income to Average Net Assets.. 6.84% 6.70% 7.84%(e)
Portfolio Turnover Rate............................... 65.9% 39.2% 18.8%(e)

See accompanying notes.
</TABLE>

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

<TABLE>
<CAPTION>
PRINCIPAL LIMITED TERM BOND FUND, INC.(a)
Class A shares 1998 1997 1996(h)
---- ---- ----
<S> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $9.88 $9.89 $9.90
Income from Investment Operations:
Net Investment Income(b).............................. .57 .61 .38
Net Realized and Unrealized Gain (Loss) on Investments .06 .03 (.04)
------ ------ ------
Total from Investment Operations .63 .64 .34

PRINCIPAL LIMITED TERM BOND FUND, INC.(a)
Class B shares 1998 1997 1996(h)
---- ---- ----
Net Asset Value, Beginning of Period..................... $9.90 $9.89 $9.90
Income from Investment Operations:
Net Investment Income(b).............................. .54 .56 .36
Net Realized and Unrealized Gain (Loss) on Investments .06 .04 (.05)
------ ------ ------
Total from Investment Operations .60 .60 .31

PRINCIPAL LIMITED TERM BOND FUND, INC.(a)
Class R shares 1998 1997 1996(g)
---- ---- ----
Net Asset Value, Beginning of Period..................... $9.85 $9.88 $9.90
Income from Investment Operations:
Net Investment Income(b).............................. .52 .54 .36
Net Realized and Unrealized Gain (Loss) on Investments .07 .03 (.06)
------ ------ ------
Total from Investment Operations .59 .57 .30

Less Dividends from Net Investment Income................ (.51) (.60) (.32)
------ ------ ------
Net Asset Value, End of Period........................... $9.93 $9.85 $9.88
------ ------ ------
------ ------ ------
Total Return(c).......................................... 6.12% 6.01% 3.24%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $2,034 $606 $83
Ratio of Expenses to Average Net Assets(b)............ 1.44% 1.48% 1.40%(e)
Ratio of Net Investment Income to Average Net Assets.. 5.21% 5.60% 5.64%(e)
Portfolio Turnover Rate............................... 23.8% 17.4% 16.5%(e)

See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
FINANCIAL HIGHLIGHTS (Continued)

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):

PRINCIPAL TAX-EXEMPT BOND FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $12.38 $12.04 $11.98 $10.93 $12.62
Income from Investment Operations:
Net Investment Income................................. .60 .63 .64 .65 .64
Net Realized and Unrealized Gain (Loss) on Investments .22 .39 .07 1.05 (1.54)
------ ------ ------ ------ ------
Total from Investment Operations .82 1.02 .71 1.70 (.90)

Less Dividends and Distributions:
Dividends from Net Investment Income.................. (.61) (.68) (.65) (.65) (.63)
Distributions from Capital Gains...................... -- -- -- -- (.16)
------ ------ ------ ------ ------
Total Dividends and Distributions (.61) (.68) (.65) (.65) (.79)
------ ------ ------ ------ ------
Net Asset Value, End of Period........................... $12.59 $12.38 $12.04 $11.98 $10.93
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total Return(c)......................................... 6.76% 8.71% 6.08% 16.03% (7.41)%
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands).............. $204,865 $193,007 $187,180 $179,715 $171,425
Ratio of Expenses to Average Net Assets............... .83% .79% .78% .83% .91%
Ratio of Net Investment Income to Average Net Assets.. 4.83% 5.14% 5.34% 5.67% 5.49%
Portfolio Turnover Rate............................... 6.6% 8.9% 9.8% 17.6% 20.6%
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL TAX-EXEMPT BOND FUND, INC.(a)
Class B shares 1998 1997 1996 1995(f)
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period..................... $12.39 $12.02 $11.96 $10.56
Income from Investment Operations:
Net Investment Income................................. .53 .55 .55 .50
Net Realized and Unrealized Gain (Loss) on Investments .20 .40 .06 1.38
------ ------ ------ ------
Total from Investment Operations .73 .95 .61 1.88
Less Dividends and Distributions:
Dividends from Net Investment Income................. (.53) (.58) (.55) (.48)
Distributions from Capital Gains..................... -- -- -- --
------ ------ ------ ------
Total Dividends and Distributions (.53) (.58) (.55) (.48)
------ ------ ------ ------
Net Asset Value, End of Period........................... $12.59 $12.39 $12.02 $11.96
------ ------ ------ ------
------ ------ ------ ------

See accompanying notes.
</TABLE>

Notes to Financial Highlights

(a) Effective January 1, 1998, the following changes were made to the names of
the Income Funds:

Principal Bond Fund, Inc.:
<S> <C> <C> <C> <C>
Class A 1998 $.70 1.04% $121,092
1997 .74 .98 41,256
1996 .76 .97 22,536
1995 .77 1.02 86,018
1994 .77 1.09 120,999

Class B 1998 .62 1.81 26,130
1997 .66 1.79 8,982
1996 .67 1.79 5,874
1995(f) .62 1.62(e) 300

Class R 1998 .61 1.72 25,144
1997 .69 1.78 10,427
1996(g) .51 1.28(e) 3

Principal Limited Term Bond Fund, Inc.:
Class A 1998 .55 1.13 76,952
1997 .59 1.15 46,271
1996(h) .37 1.16(e) 22,716

Class B 1998 .47 2.36 11,537
1997 .46 3.82 6,528
1996(h) .34 1.94(e) 259

Class R 1998 .46 2.22 11,781
1997 .43 2.95 6,831
1996(g) .35 1.79(e) 60
</TABLE>

(d) Total return amounts have not been annualized.

(e) Computed on an annualized basis.

(g) Period from February 29, 1996, date Class R shares first offered to eligible
purchasers, through October 31, 1996. The Income Funds' Class R shares
recognized no net investment income for the period from the initial purchase
by Principal Management Corporation of Class R shares on February 27, 1996
through February 28, 1996. Certain of the Income Funds' Class R shares
incurred unrealized losses on investments during the initial interim period
as follows. This represents Class R share activities of each fund prior to
the initial offering of Class R shares:

Per Share
Unrealized (Loss)
-----------------
Principal Bond Fund, Inc. $(.03)
Principal Government Securities Income Fund, Inc. (.03)
Principal Limited Term Bond Fund, Inc. (.02)

(h) Period from February 29, 1996, date shares first offered to the public,
through October 31, 1996. With respect to Class A shares, net investment
income, aggregating $.02 per share for the period from the initial purchase
of shares on February 13, 1996 through February 28, 1996, was recognized,
none of which was distributed to its sole shareholder, Principal Life
Insurance Company during the period. Additionally, Class A shares incurred
unrealized losses on investments of $.12 per share during the initial
interim period. With respect to Class B shares, no net investment income was
recognized for the period from initial purchase of shares on February 27,
1996 through February 28, 1996. Additionally, Class B shares incurred
unrealized losses on investments of $.02 per share during the initial
interim period. This represents Class A share and Class B share activities
of the fund prior to the initial public offering of both classes of shares.

(i) Dividends and distributions which exceed investment income and net realized
gains for financial reporting purposes but not for tax purposes are reported
as dividends in excess of net investment income or distributions in excess
of net realized gains on investments. To the extent distributions exceed
current and accumulated earnings and profits for federal income tax
purposes, they are reported as tax return of capital distributions.

October 31, 1998

STATEMENTS OF ASSETS AND LIABILITIES

Principal Cash Principal Tax-Exempt
Management Cash Management
MONEY MARKET FUNDS Fund, Inc. Fund, Inc.

<S> <C> <C>
Assets
Investment in securities -- at value
(approximates cost) (Note 1)........... $302,343,330 $25,980,002
Cash............................. 3,612,026 225,388
Receivables:
Interest .............................. 515,251 101,150
Capital Stock sold..................... 4,602,478 99,633
Other assets.............................. 20,112 3,051

Total Assets 311,093,197 26,409,224

Liabilities
Accrued expenses.......................... 325,723 68,910
Payables:
Investment securities purchased........ 891,093 --
Capital Stock reacquired............... 282,796 --
Indebtedness (Note 5)..................... 660,000 --

Total Liabilities 2,159,612 68,910

Net Assets Applicable to
Outstanding Shares ..................... $308,933,585 $26,340,314

Net Assets Consist of:
Capital Stock............................. $ 3,089,336 $ 263,403
Additional paid-in capital................ 305,844,249 26,076,911

Total Net Assets $308,933,585 $26,340,314

Capital Stock (par value: $.01 a share):
Shares authorized......................... 2,000,000,000 1,000,000,000

Net Asset Value Per Share:
Class A: Net Assets....................... $294,917,447 $26,340,314
Shares issued and outstanding.... 294,917,447 26,340,314
Net asset value per share........ $1.000 $1.000

Class B: Net Assets....................... $3,602,364 N/A
Shares issued and outstanding.... 3,602,364 N/A
Net asset value per share(a)..... $1.000 N/A

Class R: Net Assets....................... $10,413,774 N/A
Shares issued and outstanding.... 10,413,774 N/A
Net asset value per share........ $1.000 N/A

<FN>
(a) Redemption price per share is equal to net asset value less any
applicable contingent deferred sales charge.
</FN>
See accompanying notes.
</TABLE>

Year Ended October 31, 1998

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
Principal Cash Principal Tax-Exempt
Management Cash Management
MONEY MARKET FUNDS Fund, Inc. Fund, Inc.

<S> <C> <C>
Net Investment Income
Interest income......................... $31,537,294 $2,252,397

Expenses:
Management and investment
advisory fees (Note 3)............ 2,127,595 316,084
Distribution and shareholder
servicing fees (Notes 1 and 3).... 26,477 --
Transfer and administrative
services (Notes 1 and 3).......... 854,575 147,850
Registration fees (Note 1)........... 93,333 21,065
Custodian fees....................... 12,811 7,760
Auditing and legal fees.............. 4,411 8,271
Directors' fees...................... 7,303 7,304
Other................................ 52,070 5,911

Total Gross Expenses 3,178,575 514,245
Less: Management and investment
advisory fees waived.............. 1,343 59,049

Total Net Expenses 3,177,232 455,196

Net Investment Income $28,360,062 $1,797,201

See accompanying notes.
</TABLE>

Years Ended October 31, Except as Noted

STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Principal Cash Principal Tax-Exempt
Management Cash Management
MONEY MARKET FUNDS Fund, Inc. Fund, Inc.

1998 1997 1998 1997
<S> <C> <C> <C> <C>
Operations
Net investment income .................. $ 28,360,062 $ 39,246,307 $ 1,797,201 $ 2,962,416

Dividends to Shareholders from Net
Investment Income:
Class A.............................. (28,008,033) (39,078,437) (1,797,101) (2,961,821)
Class B.............................. (70,945) (33,816) (100)(a) (595)
Class R .................... (281,084) (134,054) N/A N/A

Total Dividends (28,360,062) (39,246,307) (1,797,201) (2,962,416)

Capital Share Transactions (Note 4)
Shares sold:
Class A.............................. 2,363,859,504 3,393,711,785 192,888,810 372,738,780
Class B.............................. 5,040,642 3,168,600 -- --
Class R ..................... 11,918,726 6,448,386 N/A N/A

Shares issued in reinvestment of dividends:
Class A.............................. 26,466,497 38,790,163 1,669,792 2,914,790
Class B.............................. 66,630 29,671 85(a) 595
Class R ...................... 273,695 129,398 N/A N/A

Shares redeemed:
Class A.............................. (2,931,480,148) (3,291,392,367) (267,157,398) (375,196,233)
Class B.............................. (2,497,006) (2,725,899) (27,749)(a) --
Class R ............................. (6,074,611) (3,921,162) N/A N/A

Net Increase (Decrease) in Net Assets
from Capital Share Transactions (532,426,071) 144,238,575 (72,626,460) 457,932

Total Increase (Decrease) (532,426,071) 144,238,575 (72,626,460) 457,932

Net Assets
Beginning of year....................... 841,359,656 697,121,081 98,966,774 98,508,842

End of year ............................ $ 308,933,585 $ 841,359,656 $ 26,340,314 $ 98,966,774

<FN>
(a)For the period November 1, 1997 through December 29, 1997 (date Class B
operations ceased).
</FN>

See accompanying notes.
</TABLE>

NOTES TO FINANCIAL STATEMENTS

Principal Cash Management Fund, Inc.
Principal Tax-Exempt Cash Management Fund, Inc.

Note 1 -- Significant Accounting Policies

Principal Cash Management Fund, Inc. and Principal Tax-Exempt Cash Management
Fund, Inc. (the "Money Market Funds") are registered under the Investment
Company Act of 1940, as amended, as open-end diversified management investment
companies and operate in the mutual fund industry.

On December 29, 1997, Principal Tax-Exempt Cash Management Fund, Inc. ceased
offering Class B shares. All outstanding Class B shares were redeemed at that
date.

Effective January 1, 1998, the following changes were made to the names of the
Money Market Funds:
<TABLE>
<CAPTION>
Former Fund Name New Fund Name
<S> <C>
Princor Cash Management Fund, Inc. Principal Cash Management Fund, Inc.
Princor Tax-Exempt Cash Management Fund, Inc. Principal Tax-Exempt Cash Management Fund, Inc.
</TABLE>

A significant portion of the shares issued by Principal Cash Management Fund,
Inc. and Principal Tax-Exempt Cash Management Fund, Inc. Class A shares has been
issued through Principal Financial Securities, Inc. ("PFS"), a previously
affiliated broker-dealer. PFS was sold in January, 1998. Subsequent to the sale,
assets of PFS clients of approximately $536 million and $62 million were
redeemed from Principal Cash Management Fund, Inc. Class A shares and Principal
Tax-Exempt Cash Management Fund, Inc. Class A shares, respectively.

Shares of the Money Market Funds are sold at net asset value; no sales charge
applies to purchases of the Money Market Funds. Certain purchases of Class A
shares of the Money Market Funds may be subject to a contingent deferred sales
charge ("CDSC") if redeemed within eighteen months of purchase. Principal Cash
Management Fund, Inc. Class B shares are sold without an initial sales charge,
but are subject to a declining CDSC on certain redemptions made within six years
of purchase. Principal Cash Management Fund, Inc. Class R shares are sold
without an initial sales charge and are not subject to a CDSC. Class B and Class
R shares bear a higher ongoing distribution fee than Class A shares. Class B
shares automatically convert into Class A shares based on relative net asset
value (without a sales charge) after seven years. Class R shares automatically
convert into Class A shares based on relative net asset value (without a sales
charge) after four years. All classes of the Principal Cash Management Fund,
Inc. represent interests in the same portfolio of investments and will vote
together as a single class except where otherwise required by law or as
determined by each of the Money Market Funds' respective Board of Directors. In
addition, the Board of Directors of each fund declares separate dividends on
each class of shares.

The Money Market Funds allocate daily all income, expenses (other than
class-specific expenses), and realized gains or losses to each class of shares
based upon the relative proportion of the number of settled shares outstanding
of each class. Expenses specifically attributable to a particular class are
charged directly to such class. Class-specific expenses charged to each class
during the periods ended October 31, 1998, which are included in the
corresponding captions of the Statement of Operations, were as follows:
<TABLE>
<CAPTION>
Distribution and Transfer and
Shareholder Servicing Fees Administrative Services Registration Fees

Class A Class B Class R Class A Class B Class R Class A Class B Class R

<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Principal Cash Management Fund, Inc. N/A $5,456 $21,021 $378,811 $1,048 $4,135 $18,993 $10,330 $8,762
Principal Tax-Exempt Cash Management Fund, Inc. N/A -- N/A 25,610 6 N/A 11,091 933 N/A
</TABLE>

The Money Market Funds value their securities at amortized cost, which
approximates market. Under the amortized cost method, a security is valued by
applying a constant yield to maturity of the difference between the principal
amount due at maturity and the cost of the security to the fund.

The Money Market Funds record investment transactions generally on the trade
date. The identified cost basis has been used in determining the net realized
gain or loss from investment transactions. Interest income is recognized on an
accrual basis.

The Money Market Funds may, pursuant to an exemptive order issued by the
Securities and Exchange Commission, transfer uninvested funds into a joint
trading acount. The order permits the Money Market Funds' cash balances to be
deposited into a single joint account along with the cash of other registered
investment companies managed by Principal Management Corporation (formerly known
as Princor Management Corporation) (the "Manager"). These balances may be
invested in one or more short-term instruments.

The Money Market Funds declare all net investment income and any realized gains
and losses from investment transactions as dividends daily to shareholders of
record as of that day. Dividends and distributions to shareholders from net
investment income and net realized gain from investments are determined in
accordance with federal income tax regulations, which may differ from generally
accepted accounting principles. Permanent book and tax basis differences are
reclassified within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification.
Reclassifications made for the years ended October 31, 1998 and 1997 were not
material.

The Money Market Funds' investments are with various issuers in various
industries. The Schedules of Investments contained herein summarize
concentrations of credit risk by issuer and industry.

Note 2 -- Federal Income Taxes

Note 3 -- Management Agreement and Transactions With Affiliates

The Money Market Funds have agreed to pay investment advisory and management
fees to Principal Management Corporation [wholly owned by Princor Financial
Services Corporation, a subsidiary of Principal Life Insurance Company (formerly
known as Principal Mutual Life Insurance Company)] computed at an annual
percentage rate of each fund's average daily net assets. The annual rate used in
this calculation for the Money Market Funds are as follows:

<TABLE>
Net Asset Value of Funds
(in millions)
<CAPTION>
First Next Next Next Over
$100 $100 $100 $100 $400

<S> <C> <C> <C> <C> <C>
Principal Cash Management Fund, Inc. 0.50% 0.45% 0.40% 0.35% 0.30%
Principal Tax-Exempt Cash Management Fund, Inc. 0.50% 0.45% 0.40% 0.35% 0.30%
</TABLE>

The Money Market Funds also reimburse the Manager for transfer and
administrative services, including the cost of accounting, data processing,
supplies and other services rendered.

Note 3 -- Management Agreement and Transactions With Affiliates (Continued)

The Manager voluntarily waived a portion of its fee for the Money Market Funds.
The waivers are in amounts that maintain total operating expenses for each fund
within certain limits. The limits are expressed as a percentage of average net
assets attributable to each class on an annualized basis during the reporting
period. The amounts waived and the operating expense limits which were
maintained at or below those shown, are as follows:
<TABLE>
Amount
Waived
<CAPTION>

Year
Ended
October 31, 1998, Year Ended Expense
Except as Noted October 31, 1997 Limit
<S> <C> <C> <C>
Principal Cash Management Fund, Inc.
Class A $ -- (a) $ -- 0.75%
Class B 1,343(a) 5,492 1.50
Class R -- (a) 2,441 1.25(b)
Principal Tax-Exempt Cash Management Fund, Inc.
Class A 58,145 27,978 0.75
Class B 904(c) 5,807 1.50(c)

<FN>
(a) For the period November 1, 1997 through February 28, 1998 (date waivers
ceased).
(b) For the period March 1, 1996 through March 2, 1997, the expense limit was
1.50%.
(c) For the period November 1, 1997 through December 29, 1997 (date Class B
operations ceased).
</FN>
</TABLE>

The manager ceased its waiver of expenses for Principal Cash Management Fund,
Inc. on March 1, 1998. The manager ceased its waiver of expenses for Principal
Tax-Exempt Cash Management Fund, Inc. on October 31, 1998.

Princor Financial Services Corporation, as principal underwriter, receives
proceeds of any CDSC on certain Class A and Class B share redemptions. The
charge is based on declining rates which for Class A shares begin at .75%, and
for Class B shares at 4.00%, of the lesser of the current market value or the
cost of shares being redeemed. The aggregate amount of these charges retained by
Princor Financial Services Corporation for the year ended October 31, 1998, was
$1,646 and $17,525 for Principal Cash Management Fund, Inc. for Class A and
Class B shares, respectively. There were no charges retained by Princor
Financial Services Corporation for Principal Tax-Exempt Cash Management Fund,
Inc.

No brokerage commissions were paid by the Money Market Funds to affiliated
broker dealers during the year.

Principal Cash Management Fund, Inc. adopted a distribution plan with respect to
Class B shares that provides for distribution and shareholder servicing fees
computed at an annual rate of up to 1.00% of the average daily net assets
attributable to Class B shares of the fund. The Fund also adopted a distribution
plan with respect to Class R shares that provides for distribution and
shareholder servicing fees computed at an annual rate of up to .75% of the
average daily net assets attributable to Class R shares of the fund.
Distribution and shareholder servicing fees are paid to Princor Financial
Services Corporation; a portion of the fees are subsequently remitted to retail
dealers. Pursuant to the distribution agreements, fees unused by the principal
underwriter at the end of the fiscal year are returned to Principal Cash
Management Fund, Inc. There are no distribution or shareholder servicing fees
with respect to Class A shares.

At October 31, 1998, Principal Life Insurance Company, subsidiaries of Principal
Life Insurance Company, benefit plans sponsored on behalf of Principal Life
Insurance Company and several joint ventures (in each of which a subsidiary of
Principal Life Insurance Company is a participant) owned shares of the Money
Market Funds as follows:
<TABLE>
<CAPTION>
Class A Class B Class R
<S> <C> <C> <C>
Principal Cash Management Fund, Inc. 29,297,308 30,462 28,126
Principal Tax-Exempt Cash Management Fund, Inc. 1,028,457 N/A N/A
</TABLE>

Note 4 -- Capital Share Transactions

Transactions in Capital Stock by fund were as follows:
<TABLE>
<CAPTION>
Principal Cash Principal Tax-Exempt
Management Cash Management
Fund, Inc. Fund, Inc.
<S> <C> <C>
Periods Ended October 31, 1998:
Shares sold:
Class A .......................................... 2,363,859,504 192,888,810
Class B ......................................... 5,040,642 --
Class R .......................................... 11,918,726 N/A
Shares issued in reinvestment of dividends:
Class A ........................................... 26,466,497 1,669,792
Class B ........................................... 66,630 85
Class R .......................................... 273,695 N/A
Shares redeemed:
Class A ......................................... (2,931,480,148) (267,157,398)
Class B ......................................... (2,497,006) (27,749)
Class R .......................................... (6,074,611) N/A

Net Decrease (532,426,071) (72,626,460)

Year Ended October 31, 1997:
Shares sold:
Class A .......................................... 3,393,711,785 372,738,780
Class B ......................................... 3,168,600 --
Class R .......................................... 6,448,386 N/A
Shares issued in reinvestment of dividends:
Class A ........................................... 38,790,163 2,914,790
Class B ........................................... 29,671 595
Class R .......................................... 129,398 N/A
Shares redeemed:
Class A ......................................... (3,291,392,367) (375,196,233)
Class B ......................................... (2,725,899) --
Class R .......................................... (3,921,162) N/A

Net Increase 144,238,575 457,932
</TABLE>

Note 5 -- Line of Credit

The Money Market Funds participate with other funds and portfolios managed by
Principal Management Corporation in an unsecured joint line of credit with a
bank, which allows the funds to borrow up to $60,000,000, collectively.
Borrowings are made solely to facilitate the handling of unusual and/or
unanticipated short-term cash requirements. Interest is charged to each fund,
based on its borrowings, at a rate equal to the Fed Funds Rate plus .50%.
Additionally, a commitment fee is charged at the annual rate of .08% on the
average unused portion of the line of credit. The commitment fee is allocated
among the participating funds and portfolios in proportion to their average net
assets during each quarter. At October 31, 1998, Principal Cash Management Fund,
Inc. had an outstanding borrowing of $660,000 at an annual rate of 5.93%.

Note 6 -- Year 2000 Problem (Unaudited)

Like other mutual funds, financial and business organizations and individuals
around the world, the Money Market Funds could be adversely affected if the
computer systems used by the Manager and other service providers do not properly
process and calculate date-related information and data from and after January
1, 2000. This is commonly known as the "Year 2000 Problem." The Manager is
taking steps it believes are reasonably designed to address the Year 2000
Problem with respect to computer systems it uses and to obtain reasonable
assurances that comparable steps are being taken by each fund's other major
service providers. At this time, however there can be no assurance that these
steps will be sufficient to avoid any adverse impact to the funds.

SCHEDULES OF INVESTMENTS

PRINCIPAL CASH MANAGEMENT FUND, INC.

Principal
Amount Value

Commercial Paper (88.64%)

Asset-Backed Securities (15.46%)
CXC, INC.;
5.47%; 11/16/1998 $2,750,000 $ 2,743,732
5.50%; 11/23/1998 4,250,000 4,235,715
5.15%; 12/9/1998 1,800,000 1,790,215
5.18%; 1/25/1999 6,000,000 5,926,617
Ciesco L.P.;
5.43%; 11/2/1998 2,750,000 2,749,585
5.38%; 12/9/1998 1,500,000 1,491,490
Corporate Asset Funding Co.;
5.49%; 11/6/1998 5,000,000 4,996,188
5.35%; 11/19/1998 2,100,000 2,094,383
5.23%; 11/25/1998 5,300,000 5,281,432
Corporate Receivables Corp.;
5.45%; 11/4/1998 2,300,000 2,298,964
5.25%; 12/3/1998 5,000,000 4,976,666
5.55%; 12/17/1998 5,000,000 4,966,458
Receivables Capital Corp.;
5.30%; 11/12/1998 4,175,000 4,168,239

47,719,684

Business Credit Institutions (8.23%)
Aon Corp.;
5.32%; 11/2/1998 3,300,000 3,299,512
5.38%; 11/6/1998 2,500,000 2,498,132
5.53%; 11/9/1998 1,025,000 1,023,740
5.45%; 11/16/1998 3,900,000 3,891,144
CIT Group Holding, Inc.;
5.18%; 12/31/1998 4,000,000 3,965,467
General Electric Capital Corp.;
5.07%; 12/31/1998 1,700,000 1,685,635
5.44%; 1/15/1999 1,500,000 1,483,000
5.43%; 2/19/1999 1,000,000 983,408
5.45%; 3/8/1999 825,000 809,138
5.44%; 3/9/1999 1,100,000 1,078,724
5.42%; 3/12/1999 2,500,000 2,450,693
5.45%; 3/19/1999 1,100,000 1,077,019
5.42%; 4/16/1999 1,225,000 1,194,385

25,439,997
Combination Utility Services (0.55%)
Citizens Utilities Co.;
5.25%; 11/24/1998 1,700,000 1,694,298

Commercial Banks (5.54%)
J.P. Morgan & Co., Inc.;
5.47%; 11/10/1998 4,000,000 3,994,530
5.42%; 11/18/1998 3,500,000 3,491,042
5.25%; 12/7/1998 4,500,000 4,476,375
5.25%; 12/8/1998 2,225,000 2,212,994
5.50%; 12/21/1998 500,000 496,181
Norwest Corp.;
5.20%; 12/16/1998 2,450,000 2,434,075

17,105,197
Crude Petroleum & Natural Gas (1.22%)
Chevron Oil Funance Co.;
5.20%; 11/4/1998 $ 825,000 $ 824,643
Chevron U.K. Investment PLC;
4.90%; 3/18/1999 3,000,000 2,944,058

3,768,701
Cutlery, Handtools &
Hardware (0.32%)
Stanley Works; 5.49%;
11/19/1998 1,000,000 997,255

Department Stores (4.65%)
Sears Roebuck Acceptance Corp.;
5.51%; 11/23/1998 2,000,000 1,993,266
5.40%; 12/11/1998 2,250,000 2,236,500
5.38%; 12/16/1998 1,500,000 1,489,913
5.38%; 12/18/1998 1,700,000 1,688,059
5.17%; 1/22/1999 2,300,000 2,272,915
5.12%; 1/29/1999 3,250,000 3,208,862
5.10%; 2/1/1999 1,500,000 1,480,450

14,369,965
Drugs (2.88%)
Receivables Capital Corp.;
5.37%; 11/3/1998 786,000 785,766
5.36%; 11/9/1998 1,775,000 1,772,886
5.22%; 11/25/1998 700,000 697,564
5.15%; 1/13/1999 4,250,000 4,205,617
5.21%; 1/21/1999 1,468,000 1,450,791

8,912,624
Electric Services (1.51%)
CommEd Fuel Co., Inc.;
5.30%; 11/17/1998 3,625,000 3,616,461
Tampa Electric Co.;
5.22%; 12/14/1998 1,050,000 1,043,453

4,659,914
Insurance Agents, Brokers &
Services (1.32%)
Marsh & McLennan Cos.;
5.45%; 2/26/1999 4,150,000 4,076,493

Investment Offices (4.83%)
Morgan Stanley Group, Inc.;
5.50%; 11/20/1998 4,240,000 4,227,692
5.20%; 1/22/1999 2,000,000 1,976,311
5.30%; 2/25/1999 2,775,000 2,727,609
4.90%; 3/26/1999 2,000,000 1,960,528
4.93%; 4/1/1999 2,500,000 2,448,303
4.84%; 4/23/1999 1,625,000 1,587,204

14,927,647
Life Insurance (2.09%)
American General Corp.;
5.42%; 11/18/1998 1,500,000 1,496,161
5.08%; 12/08/1998 2,000,000 1,989,558
5.06%; 12/14/1998 3,000,000 2,981,868

6,467,587
Miscellaneous Electrical Equipment &
Supplies (0.63%)
General Electric Co.;
5.09%; 11/30/1998 1,950,000 1,942,004

Miscellaneous Investing (4.65%)
Delaware Funding Corp.;
5.19%; 11/17/1998 $3,500,000 $ 3,491,927
5.20%; 11/18/1998 2,175,000 2,169,659
5.45%; 11/20/1998 3,000,000 2,991,371
5.24%; 12/1/1998 2,750,000 2,737,992
5.15%; 12/22/1998 3,000,000 2,978,112

14,369,061
Miscellaneous Manufacturers (3.25%)
Dover Corp.;
5.45%; 11/13/1998 4,750,000 4,741,371
5.47%; 11/13/1998 3,500,000 3,493,618
5.22%; 1/14/1999 1,810,000 1,790,579

10,025,568
Mortgage Bankers & Brokers (3.61%)
Countrywide Home Loan, Inc.;
5.48%; 11/24/1998 4,500,000 4,484,245
5.45%; 11/30/1998 2,750,000 2,737,927
5.22%; 2/12/1999 4,000,000 3,940,260

11,162,432
Personal Credit Institutions (16.57%)
Associates First Capital Corp.;
5.42%; 11/4/1998 400,000 399,819
5.25%; 11/5/1998 1,975,000 1,973,848
5.30%; 11/5/1998 975,000 974,426
5.29%; 12/1/1998 3,000,000 2,986,775
5.20%; 12/23/1998 5,500,000 5,458,689
Avco Financial Services, Inc.;
5.25%; 12/21/1998 1,750,000 1,737,240
Comoloco, Inc.;
5.46%; 12/18/1998 1,500,000 1,489,308
5.47%; 12/18/1998 1,000,000 992,859
5.44%; 1/15/1999 1,000,000 988,667
5.51%; 1/25/1999 1,000,000 986,990
5.53%; 2/9/1999 1,500,000 1,476,958
5.50%; 2/23/1999 1,500,000 1,473,875
5.44%; 3/8/1999 1,000,000 980,809
5.42%; 5/14/1999 1,200,000 1,164,951
4.72%; 5/20/1999 2,500,000 2,434,444
4.62%; 7/23/1999 1,250,000 1,207,650
Ford Motor Credit Co.;
5.16%; 12/4/1998 1,925,000 1,915,895
General Motors Acceptance Corp.;
5.51%; 11/6/1998 2,600,000 2,598,010
5.11%; 1/15/99 1,350,000 1,335,628
Household Finance Corp.;
5.10%; 11/3/1998 700,000 699,802
5.10%; 11/9/1998 1,075,000 1,074,694
5.15%; 12/30/1998 3,000,000 2,974,679
5.08%; 2/26/1999 2,000,000 1,966,980
Norwest Financial, Inc.;
5.10%; 2/2/1999 4,375,000 4,317,359
5.14%; 2/5/1999 500,000 493,147
5.07%; 3/12/1999 1,525,000 1,496,865
5.45%; 4/5/1999 1,000,000 976,535
5.40%; 5/7/1999 1,500,000 1,457,925
Transamerica Finance Corp.;
5.50%; 11/10/1998 3,175,000 3,170,634

51,205,461
Retail Stores, NEC (0.84%)
Toys 'R' Us, Inc.;
5.20%; 11/25/1998 2,600,000 2,590,986

Security Brokers & Dealers (10.49%)
Bear Stearns Cos., Inc.;
5.51%; 11/19/1998 $5,625,000 $ 5,609,503
5.14%; 12/2/1998 5,000,000 4,977,869
Goldman Sachs Group L.P.;
5.50%; 11/20/1998 2,850,000 2,841,727
5.50%; 11/24/1998 1,625,000 1,619,290
5.10%; 3/19/1999 2,500,000 2,451,125
Merrill Lynch & Co., Inc.;
5.09%; 12/4/1998 3,900,000 3,881,826
5.11%; 12/10/1998 6,150,000 6,115,981
5.48%; 2/9/1999 1,000,000 984,778
5.45%; 2/23/1999 1,000,000 982,742
5.46%; 4/1/1999 2,000,000 1,954,197
5.45%; 4/9/1999 1,000,000 975,929

32,394,967

Total Commercial Paper 273,829,841

Bonds (9.23%)

Beverages (0.12%)
Pepsico, Inc. Debentures;
7.63%; 11/1/1998 375,000 375,000

Business Credit Institutions (2.53%)
American Express Credit Corp.
Debentures; 8.50%; 6/15/1999 490,000 497,865
CIT Group Holdings, Inc.
Medium-Term Notes;
5.88%; 11/9/1998 750,000 750,014
Senior Notes;
6.38%; 5/21/1999 1,000,000 1,003,097
John Deere Capital Corp.
Notes; 6.30%; 6/1/1999 800,000 802,071
Ford Motor Credit Co.
Debentures; 8.88%; 6/15/1999 500,000 509,150
Notes; 5.63%; 12/15/1998 2,000,000 1,999,621
5.63%;1/15/1999 540,000 539,750
8.00%; 1/15/1999 200,000 200,835
7.25%; 5/15/1999 1,500,000 1,510,879

7,813,282
Consumer Products (0.57%)
Philip Morris Co., Inc. Notes;
7.75%; 5/1/1999 1,735,000 1,753,203

Department Stores (0.16%)
Sears Roebuck Acceptance Corp.
Medium-Term Notes;
6.38%; 2/16/1999 500,000 500,839

Electric Services (0.42%)
Southern California Edison Co.
1st Ref. Mortgage Bonds;
7.50%; 4/15/1999 1,300,000 1,311,608

Life Insurance (1.42%)
Transamerica Financial Corp.
Senior Notes;
6.80%; 3/15/1999 4,365,000 4,381,222

Miscellaneous Equipment Rental &
Leasing (0.63%)
International Lease Finance Corp. Notes;
5.75%; 1/15/1999 $1,205,000 $ 1,205,504
7.50%; 3/1/1999 750,000 753,985

1,959,489
Mortgage Bankers & Brokers (0.11%)
Xerox Credit Corp. Debentures;
10.00%; 4/1/1999 325,000 330,394

Motor Vehicles & Equipment (0.69%)
General Motors Acceptance Corp.
Debentures; 8.40%; 10/15/1999 1,690,000 1,739,239
Notes; 8.63%; 6/15/1999 400,000 407,610

2,146,849
Personal Credit Institutions (2.58%)
American General Finance Corp.
Notes; 7.70%; 10/15/1999 475,000 486,205
Senior Notes; 6.88%; 7/1/1999 400,000 402,753
Associates Corp. of North America
Senior Notes;
6.25%; 3/15/1999 1,250,000 1,252,128
7.25%; 9/1/1999 315,000 318,791
Avco Financial Services, Inc.
Senior Notes;
7.25%; 7/15/1999 2,560,000 2,585,558
8.50%; 10/15/1999 650,000 668,461
Household Finance Corp. Notes;
7.75%; 6/1/1999 1,200,000 1,213,045
8.95%; 9/15/1999 250,000 257,888
Norwest Financial, Inc. Senior Notes;
6.25%; 3/15/1999 755,000 756,774

7,941,603

Total Bonds 28,513,489

Total Portfolio Investments (97.87%) 302,343,330

Cash, receivables and other assets,
net of liabilities (2.13%) 6,590,255

Total Net Assets (100.00%) $308,933,585

PRINCIPAL TAX-EXEMPT CASH MANAGEMENT
FUND, INC.

Principal
Amount Value

Short-Term Tax-Exempt Bonds (98.63%)

Alaska (3.13%)
Alaska Industrial Dev. & Export
Authority, IDB Current Ref. Bonds,
Series 1988A; LOC Bank of America;
Lot #6; 3.20%; 11/8/1998*; 7/1/2001 $380,000 $380,002
Lot #7; 3.20%; 11/8/1998*; 7/1/2001 95,000 95,000
Lot #8; 3.20%; 11/8/1998*; 7/1/2005 145,000 145,000
Lot #9; 3.20%; 11/8/1998*; 7/1/2005 205,000 205,000

825,002
Arizona (3.80%)
Chandler County, Arizona, IDA, F/R
Monthly IDR, Parsons Municipal
Services, Series 1983; LOC
Bank of America;
3.45%; 11/15/1998*; 12/15/2009 1,000,000 1,000,000

Colorado (4.36%)
City of Thornton, Colorado, F/R
Monthly IDR, Service Merchandise
Co., Inc., Series 1984; LOC CIBC;
3.40%; 11/15/1998*; 12/15/1999 100,000 100,000
South Denver Metropolis District,
City & County of Denver, Colorado,
General Obligation Bonds, Series
1985; LOC Barclays Bank;
3.70%; 11/30/1998**; 12/1/2005 1,050,000 1,050,000

1,150,000
Georgia (4.55%)
Hapeville, Georgia, Dev. Authority,
Adj. Tender IDR Bonds, Hapeville
Hotel Ltd., Partnership Project
Series 1985; LOC Deutch Bank
Corp.; 3.70%; 11/2/1998*; 11/1/2015 1,200,000 1,200,000

Illinois (11.01%)
City of Burbank, Illinois, F/R Monthly
IDR, Service Merchandise Co., Inc.,
Series 1984; LOC CIBC;
3.40%; 11/15/1998*; 9/15/2024 1,000,000 1,000,000
City of Galesburg, Illinois, Knox College
Project, Series 1996; LOC LaSalle
National Bank;
3.10%; 11/8/1998*; 3/1/2031 600,000 600,000
City of Naperville, Illinois, Economic
Dev. Rev. Bonds, Service Merchandise
Co., Inc.; LOC CIBC;
3.40%; 11/15/1998*; 11/30/2024 1,300,000 1,300,000

2,900,000
Iowa (9.87%)
City of Storm Lake, Iowa, Private
College Rev. Bonds, Buena Vista
College, Series 1993; LOC Norwest
Bank Minnesota, N. A.;
3.20%; 11/8/1998*; 12/1/2003 $ 500,000 $ 500,000
Iowa Finance Authority Housing H/Care,
Rev. Bonds, Wesley Project, Series 1997;
LOC Norwest Bank Minnesota, N.A.;
3.20%; 11/8/1998*; 4/1/2005 500,000 500,000
Iowa Higher Education Loan Authority
Fac., Rev. Bonds, St. Ambrose, Series
1997; LOC Norwest Bank Minnesota,
N.A.; 3.20%; 11/8/1998* 2/1/2007 500,000 500,000
Woodbury County, Iowa, Education Fac.
Rev. Bonds, Siouxland, Series 1996;
LOC Firstar Bank Milwaukee, N.A.;
3.15%; 11/8/1998*; 11/1/2016 500,000 500,000
Woodbury County, Iowa, Education Fac.
Rev. Bonds, Siouxland, Series 1997;
LOC Norwest Bank Minnesota, N.A.;
3.20%; 11/8/1998*; 5/1/2016 600,000 600,000

2,600,000
Louisiana (3.80%)
Jefferson Parish, Louisiana, IDB Rev.
Ref. Bonds, George J. Achel, Sr.
Project, Series 1986; LOC Barclays
Bank; 3.20%; 11/8/1998*; 12/1/20041,000,000 1,000,000

Maryland (0.49%)
Montgomery County, Maryland, F/R
Monthly IDA, Information Systems
& Networks; LOC NationsBank, N.A.;
3.65%; 11/8/1998*; 4/1/2014 130,000 130,000

Michigan (1.12%)
Township of Cornell, Michigan,
The Economic Dev. Corp.,
Environmental Improvement
Rev. Ref. Bonds, Series 1986,
Mead Escanaba Paper Co. Project;
LOC Bank of America;
3.60%; 11/2/1998*; 11/1/2016 295,000 295,000

Minnesota (3.80%)
City of Coon Rapids, Minnesota
Rev. Bonds for Health Central
System, Series 1985; LOC Norwest
Bank Minnesota, N.A.;
3.15%; 11/8/1998*; 8/1/2015 500,000 500,000
City of Rochester, Minnesota, Health Care
Fac. Rev. Bonds, Mayo Foundation/
Mayo Medical Center, Adj. Tender,
Series 1992C;
3.35%; 11/16/1998**; 11/15/2021 250,000 250,000
3.50%; 12/8/1998**; 11/15/2021 250,000 250,000

1,000,000
Nebraska (3.80%)
Lincoln Electric System
Commercial Paper Notes;
3.35%; 11/3/1998 500,000 500,000
3.35%; 1/22/1999 500,000 500,000

1,000,000
New Hampshire (3.80%)
New Hampshire IDA, F/R Monthly 1983
Hudson, Oerlikon-Buhrle USA/Balzers;
LOC UBS AG;
3.50%; 11/8/1998*; 7/1/2013 $1,000,000 $1,000,000

New York (6.64%)
New York State Energy Research &
Dev. Authority for New York State
Electric & Gas Corp.; Series 1985-D;
LOC UBS AG;
3.80%; 12/1/1998**; 12/1/2015 750,000 750,000
New York State Energy Research &
Dev. Authority Pollution Control
Rev. Bonds, Long Island Lighting
Co.; Series 1985B; LOC Deutsche
Bank; 3.58%; 3/1/1999**; 3/1/2016 1,000,000 1,000,000

1,750,000
North Carolina (4.21%)
University of North Carolina
Foundation, Inc., Series 1989;
LOC NationsBank, N.A.;
3.15%; 11/8/1998*; 10/1/2009 1,110,000 1,110,000

Ohio (4.94%)
Toledo-Lucas County, Ohio, Port
Fac. Ref. Rev. Bonds, CSX
Transport Project, Series 1992;
LOC Bank of Nova Scotia;
3.25%; 11/6/1998**; 12/15/2021 500,000 500,000
3.15%; 1/19/1999**; 12/15/2021 500,000 500,000
Village of Evendale, Ohio, SHV Real
Estate Income Project;
LOC ABN-AMRO;
3.00%; 11/8/1998*; 9/1/2015 300,000 300,000

1,300,000
Pennsylvania (6.07%)
Bucks County, Pennsylvania, IDA SHV
Real Estate, Inc. Project, Series 1985;
LOC ABN-AMRO Bank;
3.15%; 11/8/1998*; 7/1/2015 600,000 600,000
Delaware County, Pennsylvania, Fac.
Rev. Tax & Rev. Anticipation Notes,
Series 1985; Guaranteed by United
Parcel Service;
3.60%; 11/2/1998*; 12/1/2015 1,000,000 1,000,000

1,600,000
Tennessee (1.90%)
Knox, Tennessee, IDB F/R Monthly
IDR 1983, Service Merchandise Co.,
Inc.; LOC CIBC;
3.40%; 11/15/1998*; 12/15/2008 500,000 500,000

Texas (14.12%)
Coppell, Texas, Industrial Dev. Corp.,
IDA 1984, Minyard Properties
Project; LOC Citibank;
3.30%; 11/8/1998*; 12/1/2001 870,000 870,000
Grapevine, Texas, Industrial Dev. Corp.,
American Airlines;
LOC Morgan Guaranty;
Series 1984 B3;
3.65%; 11/2/1998*; 12/1/2024 $ 800,000 $ 800,000
Series 1984 B4;
3.65%; 11/2/1998*; 12/1/2024 400,000 400,000
3.65%; 11/2/1998*; 12/1/2024 100,000 100,000
Lone Star Airport Improvement Authority,
American Airlines, Series 1984;
LOC Royal Bank of Canada;
Series 1984 A2;
3.65%; 11/2/1998*; 12/1/2014 100,000 100,000
Series 1984 A5;
3.65%; 11/2/1998*; 12/1/2014 100,000 100,000
Series 1984 B1;
3.65%; 11/2/1998*; 12/1/2014 800,000 800,000
Series 1984 B5;
3.65%; 11/2/1998*; 12/1/2014 400,000 400,000
Montgomery County, Texas, Industrial
Dev. Corp. Ref. Bonds,
Series 1986A; Dal-Tile Corp.
Project; LOC Credit Suisse;
3.20%; 11/8/1998*; 12/1/2003 150,000 150,000

3,720,000
West Virginia (3.80%)
Putnam County, West Virginia, F/R
Monthly IDR 1981, FMC Corp.
Project; LOC Bank of New York;
3.60%; 11/8/1998*; 10/1/2011 1,000,000 1,000,000

Wyoming (3.42%)
Lincoln County, Wyoming, Pollution
Control Ref. Bonds, Pacificorp
Project, Series 1991; LOC
UBS AG;
3.35%; 11/5/1998**; 1/1/2016 500,000 500,000
3.20%; 3/11/1999**; 1/1/2016 400,000 400,000

900,000

Total Portfolio Investments (98.63%) 25,980,002

Cash, receivables and other assets,
net of liabilities (1.37%) 360,312

Total Net Assets (100.00%) $26,340,314

* Demand Date
** Put Date

FINANCIAL HIGHLIGHTS

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31 (except as noted):
<TABLE>
<CAPTION>
PRINCIPAL CASH MANAGEMENT FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
- -------------------------------------------------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.................... $1.000 $1.000 $1.000 $1.000 $1.000
Income from Investment Operations:
Net Investment Income(b)............................. .051 .050 .049 .052 .033
Net Realized and Unrealized Gain (Loss) on Investments -- -- -- -- --

Total from Investment Operations .051 .050 .049 .052 .033

Less Dividends From Net Investment Income............... (.051) (.050) (.049) (.052) (.033)

Net Asset Value, End of Period.......................... $1.000 $1.000 $1.000 $1.000 $1.000

Total from Investment Operations .042 .041 .041 .041

Less Dividends from Net Investment Income............... (.042) (.041) (.041) (.041)

Net Asset Value, End of Period.......................... $1.000 $1.000 $1.000 $1.000

PRINCIPAL CASH MANAGEMENT FUND, INC.(a)
Class R shares 1998 1997 1996(h)
- -------------------------------------------------------- ---- ---- ----
Net Asset Value, Beginning of Period.................... $1.000 $1.000 $1.000
Income from Investment Operations:
Net Investment Income(b)............................. .046 .044 .030
Net Realized and Unrealized Gain (Loss) on Investments -- -- --

Total from Investment Operations .046 .044 .030

Less Dividends from Net Investment Income............... (.046) (.044) (.030)

Net Asset Value, End of Period.......................... $1.000 $1.000 $1.000

Total Return(c)......................................... 4.56% 4.16% 2.97%(d)
Ratio/Supplemental Data:
Net Assets, End of Period (in thousands)............. $10,414 $4,296 $1,639
Ratio of Expenses to Average Net Assets(b)........... 1.05%(e) 1.26% .99%(f)
Ratio of Net Investment Income to Average Net Assets. 4.62% 4.40% 4.41%(f)

See accompanying notes.
</TABLE>

Selected data for a share of Capital Stock outstanding throughout each year
ended October 31:
<TABLE>
<CAPTION>

PRINCIPAL TAX-EXEMPT CASH MANAGEMENT FUND, INC.(a)
Class A shares 1998 1997 1996 1995 1994
- -------------------------------------------------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period.................... $1.000 $1.000 $1.000 $1.000 $1.000

Net Investment Income from Operations(b)................ .028 .029 .029 .032 .021

Less Dividends from Net Investment Income............... (.028) (.029) (.029) (.032) (.021)

Net Asset Value, End of Period.......................... $1.000 $1.000 $1.000 $1.000 $1.000

See accompanying notes.
</TABLE>

Notes to Financial Highlights

(a) Effective January 1, 1998, the following changes were made to the names of
the Money Market Funds:

<TABLE>
<CAPTION>
Former Fund Name New Fund Name
<S> <C>
Princor Cash Management Fund, Inc. Principal Cash Management Fund, Inc.
Princor Tax-Exempt Cash Management Fund, Inc. Principal Tax-Exempt Cash Management Fund, Inc.
</TABLE>

Class B 1998(e) .041 1.49 1,343
1997 .036 2.14 5,492
1996 .029 3.94 6,140
1995(g) .041(f) 1.63(f) 104

Class R 1998(e) .046 1.05 --
1997 .043 1.34 2,441

Principal Tax-Exempt Cash Management Fund, Inc.:
Class A 1998 .026 .81 58,145
1997 .029 .73 27,978
1996 .028 .77 69,107
1995 .031 .84 138,574
1994 .019 .85 150,515
</TABLE>

(d) Total return amounts have not been annualized.

(e) Management fee waivers apply to November 1, 1997 through February 28, 1998.

(f) Computed on an annualized basis.

(g) Period from December 9, 1994, date Class B shares first offered to the
public, through October 31, 1995.

(h) Period from February 29, 1996, date Class R shares first offered to
eligible purchasers, through October 31, 1996.

The Boards of Directors and Shareholders
Principal Balanced Fund, Inc.
Principal Blue Chip Fund, Inc.
Principal Capital Value Fund, Inc.
Principal Growth Fund, Inc.
Principal MidCap Fund, Inc.
Principal Real Estate Fund, Inc.
Principal SmallCap Fund, Inc.
Principal Utilities Fund, Inc.
Principal International Emerging Markets Fund, Inc.
Principal International Fund, Inc.
Principal International SmallCap Fund, Inc.
Principal Bond Fund, Inc.
Principal Government Securities Income Fund, Inc.
Principal High Yield Fund, Inc.
Principal Limited Term Bond Fund, Inc.
Principal Tax-Exempt Bond Fund, Inc.
Principal Cash Management Fund, Inc.
Principal Tax-Exempt Cash Management Fund, Inc.

We have audited the accompanying statements of assets and liabilities, including
the schedules of investments, of The Principal Domestic Growth Funds
(comprising, respectively, Principal Balanced Fund, Inc., Principal Blue Chip
Fund, Inc., Principal Capital Value Fund, Inc., Principal MidCap Fund, Inc.,
Principal Growth Fund, Inc., Principal Real Estate Fund, Inc., Principal
SmallCap Fund, Inc. and Principal Utilities Fund, Inc.), The Principal
International Growth Funds (comprising, respectively, Principal International
Emerging Markets Fund, Inc., Principal International Fund, Inc. and Principal
International SmallCap Fund, Inc.), The Principal Income Funds (comprising,
respectively, Principal Bond Fund, Inc., Principal Government Securities Income
Fund, Inc., Principal High Yield Fund, Inc., Principal Limited Term Bond Fund,
Inc. and Principal Tax-Exempt Bond Fund, Inc.) and The Principal Money Market
Funds (comprising, respectively, Principal Cash Management Fund, Inc. and
Principal Tax-Exempt Cash Management Fund, Inc.) as of October 31, 1998, and the
related statements of operations, statements of changes in net assets and
financial highlights for each of the periods indicated therein. These financial
statements and financial highlights are the responsibility of the Funds'
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights. Our procedures included confirmation of
securities owned as of October 31, 1998, by correspondence with the custodians
and brokers. As to securities relating to uncompleted transactions, we performed
other audit 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
audits provide a reasonable basis for our opinion.

In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of each
of the respective funds constituting The Principal Domestic Growth Funds, The
Principal International Growth Funds, The Principal Income Funds and The
Principal Money Market Funds at October 31, 1998, and the results of their
operations, the changes in their net assets and the financial highlights for
each of the periods indicated therein, in conformity with generally accepted
accounting principles.

/S/ ERNST & YOUNG LLP

Des Moines, Iowa
November 25, 1998

Information for federal income tax purposes is presented as an aid to
shareholders in reporting the dividend distributions shown below. Shareholders
should consult a tax adviser on how to report these distributions for state and
local purposes.
<TABLE>
<CAPTION>

Periods Ended October 31, 1998

Per Share Per Share
Income Dividend Distributions Capital Gain Distributions

Total
Total Dividends
Payable Per Total Deductible Payable Long- Short- Capital Gain and
Date Share Dividends Percentage* Date Term** Term*** Distributions Distributions

Principal Balanced
Fund, Inc.
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
A Shares 12/24/97 $.0850 23.48% 12/04/97 $ .7849 $.2432
3/24/98 .0900 25.92%
6/24/98 .0950 25.36%
9/24/98 .1050 26.71%
$.3750 $1.0281 $1.4031
B Shares 12/24/97 $.0548 23.48% 12/04/97 $ .7849 $.2432
3/24/98 .0595 25.92%
6/24/98 .0646 25.36%
9/24/98 .0776 26.71%
$.2565 $1.0281 $1.2846
R Shares 12/24/97 $.0610 23.48% 12/04/97 $ .7849 $.2432
3/24/98 .0672 25.92%
6/24/98 .0724 25.36%
9/24/98 .0841 26.71%
$.2847 $1.0281 $1.3128

Principal Blue Chip
Fund, Inc.
A Shares 12/24/97 $.0500 76.14% 12/04/97 $2.0241 .0569
3/24/98 .0475 87.31%
6/24/98 .0107 75.81%
9/24/98 .0100 79.61%
$.1182 $2.081 $ 2.6267
B Shares 12/24/97 $.0133 76.14% 12/04/97 $2.0241 .0569
3/24/98 .0089 87.31%
6/24/98 -- 00.00%
9/24/98 -- 00.00%
$.0222 $2.081 $ 2.1032
R Shares 12/24/97 $.0226 76.14% 12/04/97 $2.0241 .0569
3/24/98 .0190 87.31%
6/24/98 -- 00.00%
9/24/98 -- 00.00%
$.0416 $2.081 $ 2.1226

Principal Capital
Value Fund, Inc.
A Shares 12/24/97 $.2665 93.49% 12/04/97 $2.0601 $.4121
6/24/98 .2600 92.93%
$.5265 $2.4722 $2.9987
B Shares 12/24/97 $.1388 93.49% 12/04/97 $2.0601 $.4121
6/24/98 .1187 92.93%
$.2575 $2.4722 $2.7297
R Shares 12/24/97 $.1557 93.49% 12/04/97 $2.0601 $.4121
6/24/98 .1363 92.93%
$.2920 $2.4722 $2.7642

Principal Growth
Fund, Inc.
A Shares 12/24/97 $.1825 55.31% 12/04/97 $1.4891
6/24/98 .1600 44.42%
$.3425 $ 1.4891 $ 1.8316
B Shares 12/24/97 $.0593 55.31% 12/04/97 $1.4891
06/24/98 .0297 44.42%
$.0890 $ 1.4891 $ 1.5781
R Shares 12/24/97 $.0154 55.31% 12/04/97 $1.4891
06/24/98 -- 00.00%
$.0154 $ 1.4891 $ 1.5045

Principal
International
Fund, Inc.
A Shares 12/24/97 $.1030 00.00% 12/04/97 $.2006 $.0000
$.1030 $ .2006 $ .3036
B Shares 12/24/97 $.0347 00.00% 12/04/97 $.2006 $.0000
$.0347 $ .2006 $ .2353
R Shares 12/24/97 $.0421 00.00% 12/04/97 $.2006 $.0000
$.0421 $ .2006 $ .2427

Principal MidCap
Fund, Inc.
A Shares 12/04/97 $1.0450 $.0540
$1.0990 $1.0990
B Shares 12/04/97 $1.0450 $.0540
$1.0990 $1.0990
R Shares 12/04/97 $1.0450 $.0540
$1.0990 $1.0990

Principal Real
Estate Fund, Inc.
A Shares 3/24/98 $.0550 00.00%
6/24/98 .0700 00.00%
9/24/98 .0800 00.00%
$.2050 $.2050
B Shares 3/24/98 $.0513 00.00%
6/24/98 .0651 00.00%
9/24/98 .0755 00.00%
$.1919 $.1919
R Shares 3/24/98 $.0530 00.00%
6/24/98 .0686 00.00%
9/24/98 .0809 00.00%
$.2025 $.2025
</TABLE>

Foreign Taxes Paid

Principal International Fund, Inc. makes an election under the Internal
Revenue Code Section 853 to pass through foreign taxes paid by the fund to
its shareholders. The total amount of foreign taxes passed through to
shareholders for the year ended October 31, 1998 totals $0.0290 per share for
Principal International Fund, Inc. This information is given to meet certain
requirements of the Internal Revenue Code and should not be used by
shareholders for preparing their income tax returns. For tax return
preparation purposes, please refer to the information supplied with the 1099
form you receive from the fund's transfer agent.

<TABLE>
<CAPTION>
Period Ended October 31, 1998

Per Share Per Share
Income Dividend Distributions Capital Gain Distributions
Total
Total Dividends
Payable Per Total Deductible Payable Long- Short- Capital Gain and
Date Share Dividends Percentage* Date Term** Term*** Distributions Distributions

Principal Utilities
Fund, Inc.
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
A Shares 12/24/97 $.1350 95.80%
3/24/98 .1100 95.72%
6/24/98 .1000 98.75%
9/24/98 .0900 91.87%
$.4350 $ .4350
B Shares 12/24/97 $.1091 95.80%
3/24/98 .0836 95.72%
6/24/98 .0727 98.75%
9/24/98 .0629 91.87%
$.3283 $ .3283
R Shares 12/24/97 $.1097 95.80%
3/24/98 .0826 95.72%
6/24/98 .0719 98.75%
9/24/98 .0621 91.87%
$.3263 $ .3263

<FN>
* Percent qualifying for deduction by shareholders who are corporations.
** Taxable as long-term capital gain.
*** Taxable at ordinary income rates.
</FN>
</TABLE>

Ordinary Income Dividends

The Funds paid the following per share income dividends on the dates indicated:

Per Share Dividends/Payable Date
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>

Fund 11/24/97 12/24/97 1/23/98 2/24/98 3/24/98 4/24/98 5/22/98 6/24/98 7/24/98 8/24/98 9/24/98 10/23/98

Principal Bond Fund, Inc.
Class A $.0613 $.0613 $.0588 $.0588 $.0588 $.0588 $.0588 $.0588 $.0600 $.0600 $.0600 $.0600
Class B .0537 .0537 .0514 .0514 .0514 .0514 .0514 .0514 .0529 .0529 .0529 .0529
Class R .0542 .0542 .0512 .0512 .0512 .0512 .0512 .0512 .0533 .0533 .0533 .0533

Principal Government
Securities Income
Fund, Inc.
Class A .0575 .0588 .0588 .0588 .0588 .0588 .0588 .0588 .0588 .0588 .0588 .0588
Class B .0507 .0535 .0535 .0535 .0535 .0535 .0535 .0535 .0535 .0535 .0535 .0535
Class R .0500 .0510 .0510 .0510 .0510 .0510 .0510 .0510 .0510 .0510 .0510 .0510

Principal High Yield
Fund, Inc.
Class A .0563 .0563 .0563 .0563 .0550 .0550 .0550 .0525 .0525 .0525 .0513 .0513
Class B .0500 .0500 .0500 .0489 .0489 .0489 .0489 .0466 .0466 .0466 .0456 .0456
Class R .0517 .0517 .0517 .0497 .0497 .0497 .0497 .0472 .0472 .0472 .0456 .0456

Principal Limited Term Bond
Fund, Inc.
Class A .0500 .0500 .0500 .0500 .0500 .0475 .0475 .0475 .0475 .0475 .0475 .0450
Class B .0452 .0452 .0452 .0452 .0452 .0425 .0425 .0425 .0425 .0425 .0425 .0401
Class R .0462 .0462 .0431 .0431 .0431 .0410 .0410 .0410 .0410 .0410 .0410 .0390

Principal Tax-Exempt Bond
Fund, Inc.*
Class A .0513 .0513 .0513 .0513 .0513 .0513 .0513 .0500 .0500 .0500 .0500 .0500
Class B .0446 .0446 .0446 .0446 .0446 .0446 .0446 .0437 .0437 .0437 .0437 .0437

<FN>
* Dividends from the Principal Tax-Exempt Bond Fund, Inc. were exempt from
federal income taxation for non-corporate shareholders.
</FN>
</TABLE>

FEDERAL INCOME TAX INFORMATION (Continued)

Ordinary Income Dividends

The Funds paid the following per share income dividends on the dates indicated:
<TABLE>
<CAPTION>

Per Share Dividends/Payable Date

Fund 11/20/97 12/19/97 1/20/98 2/20/98 3/20/98 4/20/98 5/20/98 6/19/98 7/20/98 8/20/98 9/18/98 10/20/98

Principal Cash Management
Fund, Inc.
Class A $.0043 $.0044 $.0043 $.0046 $.0040 $.0040 $.0041 $.0043 $.0040 $.0043 $.0043 $.0042
Class B .0036 .0037 .0036 .0038 .0033 .0031 .0034 .0037 .0034 .0035 .0036 .0035
Class R .0038 .0039 .0038 .0041 .0035 .0036 .0037 .0039 .0036 .0040 .0040 .0038

Principal Tax-Exempt Cash
Management Fund, Inc.*
Class A .0026 .0026 .0024 .0024 .0019 .0023 .0026 .0026 .0022 .0023 .0023 .0023
Class B** .0019 .0019 .0005*** -- -- -- -- -- -- -- -- --

<FN>
* Dividends from Principal Tax-Exempt Cash Management Fund, Inc. were exempt
from federal income taxation for non-corporate shareholders.

** On December 29, 1997, Principal Tax-Exempt Cash Management Fund, Inc.
ceased offering Class B shares. All outstanding Class B shares were
redeemed at that date.

*** Dividends declared on Principal Tax-Exempt Cash Management Fund, Inc. Class
B shares from December 21, 1997 through December 29, 1997 (date operations
ceased).
</FN>
</TABLE>

PRINCIPAL MUTUAL FUNDS

Principal Life Insurance Company has sponsored the development of a number of
mutual funds. The funds which make up the Principal Mutual Funds and a brief
description of their respective investment objectives are provided below. For
more complete information about any of the funds, including charges and
expenses, obtain a prospectus from Princor Financial Services Corporation, The
Principal Financial Group, Des Moines, Iowa 50392-0200 (telephone
1-800-247-4123). Please read it carefully before you invest or send money.

DOMESTIC GROWTH FUNDS INVESTMENT OBJECTIVE

Principal Balanced Fund, Inc. To seek the generation of a total
return consisting of current
income and capital appreciation
while assuming reasonable risks in
furtherance of this objective.

Principal Blue Chip Fund, Inc. To seek growth of capital and growth
of income by investing primarily in
common stocks of well capitalized,
established companies.

Principal Capital Value Fund, Inc. To seek long-term capital
appreciation and a secondary
objective of growth of investment
income.

Principal Growth Fund, Inc. To seek growth of capital with
realization of current income
incidental to the objective of growth
of capital.

Principal MidCap Fund, Inc. To seek capital appreciation by
investing primarily in securities
of emerging and other growth-oriented
companies.

Principal Real Estate Fund, Inc. To seek the generation of total
return by investing primarily in
equity securities of companies
principally engaged in the real
estate industry.

Principal SmallCap Fund, Inc. To seek long-term growth of capital
by investing primarily in equity
securities of companies with
comparatively smaller market
capitalizations.

Principal Utilities Fund, Inc. To seek current income and long-term
growth of income and capital by
investing primarily in equity and
fixed income securities of companies
in the public utilities industry.

INTERNATIONAL GROWTH FUNDS

Principal International To seek long-term growth of capital
Emerging Markets by investing primarily in equity
Fund, Inc. securities of issuers in emerging
market countries.

Principal International Fund, Inc. To seek long-term growth of capital
by investing in a portfolio of equity
securities of companies domiciled in
any of the nations of the world.

Principal International SmallCap To seek long-term growth of capital
Fund, Inc. by investing primarily in equity
securities of non-United States
companies with comparatively
smaller market capitalizations.

INCOME FUNDS

Principal Bond Fund, Inc. To seek as high a level of income as
is consistent with preservation of
capital and prudent investment risk.

Principal Government Securities To seek a high level of current
Income Fund, Inc. income, liquidity and safety of
principal.

Principal High Yield Fund, Inc. To seek high current income.
Capital growth is a secondary
objective when consistent with
seeking high current income.

Principal Limited Term Bond To seek a high level of current
Fund, Inc. income consistent with a relatively
high level of principal stability by
investing in a portfolio of
securities with a dollar weighted
average maturity of five years or
less.

Principal Tax-Exempt Bond To seek as high a level of current
Fund, Inc. income exempt from federal taxation
as is consistent with preservation
of capital.

MONEY MARKET FUNDS

Principal Cash Management To seek as high a level of current
Fund, Inc. income available from short-term
securities as is considered
consistent with preservation of
principal and maintenance of
liquidity by investing in a portfolio
of money market instruments.

Principal Tax-Exempt Cash To seek, through investment in a
Management Fund, Inc. professionally-managed portfolio of
high quality short-term Municipal
Obligations, as high a level of
current interest income exempt from
federal income tax as is consistent
with stability of principal and
maintenance of liquidity.

PRINCIPAL FAMILY OF MUTUAL FUNDS
MULTIPLE CLASS DISTRIBUTION PLAN

Princor Financial Services Corporation ("The Distributor"), Princor Management
Corporation ("Adviser") and each of the funds listed on Exhibit 1 (the "Fund or
Funds") seek to allow each of the Funds to issue multiple separate classes of
shares under this Multiple Class Distribution Plan (the "Plan") in reliance upon
Rule 18f-3 of the Investment Company Act of 1940.

This Plan enables each Fund to offer certain investors the option of purchasing
shares subject to: (i) a conventional front-end sales charge ("Class A shares")
or (ii) a contingent deferred sales charge ("Class B shares"). The Plan also
permits each Fund, except Princor Tax Exempt Cash Management Fund, Inc., to
offer distributees of retirement plans administered by Principal Mutual Life
Insurance Company, and other classes of customers identified from time-to-time
by the Funds' management, a class of shares that is not subject to either a
front-end or contingent deferred sales charge ("Class R shares"). Each Class
represents an interest in the same portfolio of investments of a Fund.

SALES CHARGES

Class A shares

Class A shares of the Money Market Funds are sold to the public at net
asset value; no sales charge applies to purchases of the Money Market Funds.
Class A shares of the Growth- Oriented and Income-Oriented Funds, except the
Limited Term Bond Fund, are sold to the public at the net asset value plus a
sales charge which ranges from a high 4.75% to a low of 0% of the offering price
(equivalent to a range of 4.99% to 0% of the net amount invested) according to
the schedule below. Class A shares of the Limited Term Bond Fund are sold to the
public at the net asset value plus a sales charge which ranges from a high of
1.50% to a low of 0% of the offering price according to the schedule below. An
investor who purchases $1 million or more of Class A shares does not pay a sales
charge at the time of purchase. However, a redemption of such shares occurring
within 18 months from the date of purchase will be subject to a contingent
deferred sales charge ("CDSC") at the rate of .75% (.25% for the Limited Term
Bond Fund) of the lesser of the value of the shares redeemed (exclusive of
reinvested dividend and capital gain distributions) or the total cost of such
shares. Shares subject to the CDSC which are exchanged into another Princor Fund
will continue to be subject to the CDSC until the original 18 month period
expires. However, no CDSC is payable with respect to the redemptions of Class A
shares to fund a Princor 401(a) or Princor 401(k) retirement plan, except
redemptions resulting from the termination of the plan or transfer of plan
assets. Certain purchases of Class A shares qualify for reduced sales charges.

<TABLE>
<CAPTION>
Sales Charge for
All Funds Except Sales Charge for Dealer Allowance
Limited Term Bond Fund Limited Term Bond Fund as % of Offering
Sales Charge as % of: Sales Charge as % of: All Funds

Offering Amount Offering Amount Except Limited Limited Term
Amount of Purchase Price Invested Price Invested Term Bond Fund Bond Fund
------------------ ----- -------- ----- -------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Less than $50,000 4.75% 4.99% 1.50% 1.52% 4.00% 1.25%
$50,000 but less than $100,000 4.25% 4.44% 1.25% 1.27% 3.75% 1.00%
$100,000 but less than $250,000 3.75% 3.90% 1.00% 1.01% 3.25% 0.75%
$250,000 but less than $500,000 2.50% 2.56% 0.75% 0.76% 2.00% 0.50%
$500,000 but less than $1,000,000 1.50% 1.52% 0.50% 0.50% 1.25% 0.25%
$1,000,000 or more No Sales Charge 0.00% No Sales Charge 0.00% 0.75% 0.25%
</TABLE>

Class B shares

Class B shares are sold without an initial sales charge, although a
CDSC will be imposed on shares redeemed within six years of purchase. The
following types of shares may be redeemed without charge at any time: (i) shares
acquired by reinvestment of distributions and (ii) shares otherwise exempt from
the CDSC, as described below. Subject to the foregoing exclusions, the amount of
the charge is determined as a percentage of the lesser of the current market
value or the cost of the shares being redeemed. Therefore, when a share is
redeemed, any increase in its value above the initial purchase price is not
subject to any CDSC. The amount of the CDSC will depend on the number of years
shares have been owned and the dollar amount being redeemed, according to the
following table:

<TABLE>
<CAPTION>
====================================================================================================================================
Contingent Deferred Sales Charge
as a Percentage of
Dollar Amount Subject to Charge
====================================================================================================================================
==============================================
For Certain Sponsored Plans
Commenced After 2/1/1998
==============================================
------------------------ =====================
All Funds All Funds
Years Since Purchase Except Limited Term Limited Term Except Limited Term Limited Term
Payments Made Bond Fund Bond Fund Bond Fund Bond Fund
- ----- -------------- -------- ---------- ---- ---------- -------- ---------- ---- ---------
<S> <C> <C> <C> <C>
2 years or less 4.0% 1.25% 3.00% 0.75%
more than 2 years, up to 4 years 3.0% 0.75% 2.00% 0.50%
more than 4 years, up to 5 years 2.0% 0.50% 1.00% 0.25%
more than 5 years, up to 6 years 1.0% 0.25% None None
more than 6 years None None None None
==================================== ======================= ======================== ======================== =====================
</TABLE>

In determining whether a CDSC is payable on any redemption, the Fund
will first redeem shares not subject to any charge, and then shares held longest
during the six-year period. The CDSC will be waived on redemptions of Class B
shares in connection with the following types of transactions:

a. Shares redeemed due to a shareholder's death;

b. Shares redeemed due to the shareholder's disability, as defined in the
Internal Revenue Code of 1986 (the "Code"), as amended;

c. Shares redeemed from retirement plans to satisfy minimum distribution
rules under the Code;

d. Shares redeemed to pay surrender charges;

e. Shares redeemed to pay retirement plan fees;

f. Shares redeemed involuntarily from small balance accounts (values of
less than $300);

g. Shares redeemed through a systematic withdrawal plan that permits up
to 10% of the value of a shareholder's Class B shares of a particular
Fund on the last business day of December of each year to be withdrawn
automatically in equal monthly installments throughout the year;

h. Shares redeemed from a retirement plan to assure the plan complies
with Sections 401(k), 401(m), 408(k) and 415 of the Code; or

i. Shares redeemed from retirement plans qualified under Section 401(a)
of the Code due to the plan participant's death, disability,
retirement or separation from service after attaining age 55.

Class R shares

Class R shares are purchased without an initial sales charge or a
contingent deferred sales charge.

EXPENSE ALLOCATION

The Fund will pay to the distributor a distribution fee pursuant to the Fund's
Rule 12b-1 distribution plan at an annual rate of (i) up to .25% (.15% for
Princor Limited Term Bond Fund, Inc.) of the average daily net asset value of
the Class A shares; (ii) up to 1.00% (.50% for Princor Limited Term Bond Fund,
Inc.) of the average daily net asset value of the Class B shares; and (iii) up
to .75% of the average daily net asset value of Class R shares. For accounting
purposes, the classes of a Fund are identical except that the net asset value
and expenses each class will reflect the Distribution Plan expenses (if any) and
any Class Expenses, as defined below, attributable to the class. "Class
Expenses" are limited to: (i) transfer agency fees, as identified by the Funds'
transfer agent as being attributable to a specific class; (ii) blue sky
registration fees incurred with respect to a class of shares; (iii) Commission
registration fees incurred with respect to a class of shares; (iv) the expenses
of administrative personnel and services as required to provide services to the
shareholders of a specific class (depending on the type of service provided
administrative expenses are allocated to specific classes based on the relative
percentage of shareholder transactions and net asset values compared to the
total of both share classes); (v) litigation or other legal expenses or audit or
other accounting expenses relating solely to one class of shares (vi) Directors'
fees incurred as a result of issues relating to one class of shares; and (vii)
printing and postage expenses related to preparing and distributing materials
such as shareholder reports, prospectuses and proxies to current shareholders of
a given class.

Any additional incremental expenses not specifically identified above that are
subsequently identified and determined to be properly allocated to one class of
shares will not be so allocated unless and until approved by the Funds'
directors. Certain expenses may be allocated differently if their method of
imposition changes; thus, if a Class Expense of a Fund can no longer be
attributed to a class it will be allocated to the Fund as a whole.

The net asset value of all outstanding shares of each class is determined by
dividing the ending total net assets applicable to a specific class by the
number of shares outstanding relating to the class. Expenses are attributable to
each class of shares depending on the nature of the expenditure and are accrued
on a daily basis. These fall into two categories: (1) fund level expenses that
are attributable to each class that are allocated based on net assets at the
beginning of the day (i.e., legal, audit, etc.) and (2) certain class level
expenses that may have a different cost for one class versus the other (i.e.,
12b-1 fees). Because of the additional expenses that will be borne by the Class
B shares and Class R shares, the net income attributable to and the dividends
payable on Class B shares and Class R shares will be lower than the net income
attributable to and the dividends payable on Class A shares.

CONVERSION FEATURES

Class A shares. Class A shares do not convert into any other class of shares at
any time.

Class B shares. Class B shares will automatically convert to Class A shares,
based on relative net asset value on the first business day of the 85th month
(61st month for certain sponsored plans) after the purchase date. Class B shares
acquired by exchange from Class B shares of another Princor fund will convert
into Class A shares based on the time of the initial purchase. At the same time,
a pro rata portion of all shares purchased through reinvestment of dividends and
distributions would convert into Class A shares, with that portion determined by
the ratio that the shareholder's Class B shares converting into Class A shares
bears to the shareholder's total Class B shares that were not acquired through
dividends and distributions. The conversion of Class B to Class A shares is
subject to the continuing availability of a ruling from the Internal Revenue
Service or an opinion of counsel that such conversions will not constitute
taxable events for Federal tax purposes. There can be no assurance that such
ruling or opinion will be available, and the conversion of Class B shares to
Class A shares will not occur if such ruling or opinion is not available. In
such event, Class B shares would continue to be subject to higher expenses than
Class A shares for an indefinite period.

Class R shares. Class R shares will automatically convert to Class A shares,
based on relative net asset value, on the first business day of the 49th month
after the purchase date. Class R shares acquired by exchange from Class R shares
of another Princor fund will convert into Class A shares based on the time of
the initial purchase. At the same time, a pro rata portion of all shares
purchased through reinvestment of dividends and distributions would convert into
Class A shares, with that portion determined by the ratio that the shareholder's
Class R shares converting into Class A shares bears to the shareholder's total
Class R shares that were not acquired through dividends and distributions. The
conversion of Class R shares to Class A shares is subject to the continuing
availability of a ruling from the Internal Revenue Service or an opinion of
counsel that such conversions will not constitute taxable events for Federal tax
purposes. There can be no assurance that such ruling or opinion is not
available. In such event, Class R shares would continue to be subject to higher
expenses than Class A shares for an indefinite period.

EXCHANGE FEATURES

Class A shares. Class A shares of any Fund (except the Money Market Funds and
the Short Term Bond Fund) may be exchanged at the net asset value for Class A
shares of any other Princor Fund at any time.

Class A shares of the Limited Term Bond Fund may be exchanged at net asset value
for Class A shares of any Fund at any time three months after the purchase of
such shares.

The CDSC that might apply to certain Class A shares upon redemption will not
apply if these shares are exchanged for shares of another Fund. However, for
purposes of computing the CDSC on the shares acquired through this exchange, the
length of time the acquired shares have been owned by a shareholder will be
measured from the date the exchanged shares were purchased. The amount of the
CDSC will be determined by reference to the CDSC table to which the exchanged
shares were subject.

Class A shares of Princor Cash Management Fund or Princor Tax-Exempt Cash
Management Fund acquired by direct purchase may not be exchanged for other Class
A shares. However, Class A shares of these two Funds acquired by exchange of any
other Princor Fund shares, or by conversion of Class B or Class R shares, and
additional shares which have been purchased by reinvesting dividends earned on
such shares, may be exchanged for other Class A shares without a sales charge.
In addition, Class A shares of the Money Market Funds acquired by direct
purchase or reinvestment of dividends on such shares may be exchanged for Class
B shares of any Growth-Oriented or Income-Oriented Fund.

Class B shares. Class B shares for all Funds may be exchanged at net asset value
at any time for Class B shares of any Fund.

The CDSC that might apply to Class B shares upon redemption will not apply if
these shares are exchanged for shares of another Fund. However, for purposes of
computing the CDSC on the shares acquired through this exchange, the length of
time the acquired shares have been owned by a shareholder will be measured from
the date the exchanged shares were purchased. The amount of the CDSC will be
determined by reference to the CDSC table to which the exchanged shares were
subject.

Class R shares. Class R shares for all Funds may be exchanged at net asset value
at any time for Class R shares of any Fund. For purposes of computing the length
of time Class R shares acquired by the exchange are held prior to conversion to
Class A shares, the length of time the acquired shares have been owned by a
shareholder will be measured from the date the exchanged shares were purchased.

Exhibit 1

Principal Balanced Fund, Inc.
Principal Blue Chip Fund, Inc.
Principal Bond Fund, Inc.
Principal Capital Value Fund, Inc.
Principal Cash Management Fund, Inc.
Principal Government Securities Income Fund, Inc.
Principal Growth Fund, Inc.
Principal High Yield Fund, Inc.
Principal International Fund, Inc.
Principal International Emerging Markets Fund, Inc.
Principal International SmallCap Fund, Inc.
Principal Limited Term Bond Fund, Inc.
Principal MidCap Fund, Inc.
Principal Real Estate Fund, Inc.
Principal SmallCap Fund, Inc.
Principal Tax-Exempt Bond Fund, Inc.
Principal Tax-Exempt Cash Management Fund, Inc.
Principal Utilities Fund, Inc.

PRINCIPAL TAX-EXEMPT BOND FUND, INC.
DISTRIBUTION AND SHAREHOLDER SERVICING
PLAN AND AGREEMENT
CLASS R SHARES

PLAN AND AGREEMENT made as of the 12th day of December, 1995 and amended
as of March 9, 1998, by and between PRINCIPAL TAX-EXEMPT BOND FUND, INC., a
Maryland corporation (the "Fund"), and PRINCOR FINANCIAL SERVICES CORPORATION,
an Iowa corporation (the "Underwriter").

WHEREAS, Rule 12b-1 under the Investment Company Act of 1940 (the "Act"),
provides that a registered open-end management investment company may
participate in financing the distribution of securities of which it is the
issuer; and

WHEREAS, any payments made by the Fund in accordance with Rule 12b-1 must
be made pursuant to a written plan describing all material aspects of the
proposed financing of distribution; and

WHEREAS, the Underwriter acts as the underwriter for the Fund; and various
broker-dealers (the "Dealers"), including the Underwriter, sell shares of the
Fund and provide services to existing shareholders; and

WHEREAS, the Board of Directors of the Fund has determined that the Fund
should make direct payments to the Underwriter for transmission to Dealers
(including the Underwriter) in connection with selling Class R shares of the
Fund and the rendering of services to Class R shareholders and that such payment
should be separate from the investment advisory and management fee paid to
Princor Management Corporation; and

WHEREAS, the Board of Directors of the Fund has determined that there is a
reasonable likelihood that the adoption of the Plan will benefit the Fund and
its Class R shareholders;

NOW, THEREFORE, the following shall constitute the written Plan pursuant
to which the Fund shall participate in financing the distribution of its Class R
shares.

Section 1. The Fund is hereby authorized to make payments to the
Underwriter from that portion of its assets attributable to its Class R shares
for the purpose of reimbursing the Underwriter for expenses it incurs in
connection with sales of the Class R shares and to compensate the Underwriter
and other selling Dealers for (i) providing shareholder services to existing
Class R shareholders, including without limitation, furnishing information as to
the status of shareholder accounts, requests, responding to telephone and
written inquiries, and assisting shareholders with tax information and (ii)
rendering assistance in the distribution and promotion of the sale of Class R
shares to the public.

In consideration of the activities described above, the Fund shall pay the
Underwriter a fee after the end of each month at the annual rate of 0.75% of the
daily net asset value of the Fund's Class R shares. The Underwriter shall (A)
retain such amounts as are appropriate to (i) reimburse the Underwriter for
expenses it incurs in connection with sales of Class R shares, and (ii)
compensate the Underwriter for providing services and rendering assistance in
the distribution and promotion of the sale of Class R shares to the public, and
(B) remit such amounts as are appropriate to other Dealers in recognition of
their services and assistance as described above in the first paragraph of this
Section 1; provided however, the Underwriter shall not retain for itself or
remit to selling Dealers in recognition of the services provided to shareholders
an amount in excess of 0.25% annually of the daily net asset value of the Fund's
Class R shares. If the aggregate payments received by the Underwriter under this
Plan in any fiscal year exceed the expenditures made by the Underwriter in such
fiscal year for these purposes, the Underwriter shall promptly reimburse the
Fund for the amount of such excess.

Section 2. This Plan shall not take effect until it has been approved (1)
by a vote of at least a majority (as defined in the Act) of the outstanding
Class R shares of the Fund and (2) by votes of the majority of both (i) the
Board of Directors of the Fund, and (ii) those Directors of the Fund who, except
for their positions as Directors of the Fund, are not "interested persons" (as
defined in the Act) of the Fund and who have no direct or indirect financial
interest in the operation of this Plan or any agreements related to this Plan
(the "Disinterested Directors"), cast in person at a meeting called for the
purpose of voting on this Plan or such agreements.

Section 3. Unless sooner terminated pursuant to Section 5, this Plan shall
continue in effect for a period of twelve months from the date it takes effect
and thereafter shall continue in effect so long as such continuance is
specifically approved at least annually in the manner provided for approval of
this Plan in Section 2(2).

Section 4. A representative of the Underwriter shall provide to the Board
and the Board shall review at least quarterly a written report of the amounts so
expended and the purposes for which such expenditures were made.

Section 5. This Plan may be terminated at any time by vote of a majority
of the Disinterested Directors, or by vote of a majority (as defined in the Act)
of the Fund's outstanding Class R shares.

Section 6. Any agreement of the Fund related to this Plan shall be in
writing and shall provide:

A. That such agreement may be terminated at any time, without payment of
any penalty, 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 a vote of a
majority (as defined in the Investment Company Act of 1940) of the
Fund's outstanding Class R shares on not more than sixty days'
written notice to any other party to the agreement; and

B. That such agreement shall terminate automatically in the event of its
assignment.

Section 7. While the Plan is in effect, the selection and nomination of
Directors who are not interested persons (as defined in the Act) of the Fund
shall be committed to the discretion of the Directors who are not interested
persons.

Section 8. The Fund shall preserve copies of this Plan and any related
agreements and all reports made pursuant to Paragraph 4, for a period of not
less than six years from the date of the Plan, or the agreements or such report,
as the case may be, the first two years in an easily accessible place.

Section 9. This Plan may not be amended to increase materially the amount
of distribution expenses provided for in Section 1 hereof unless such amendment
is approved in the manner provided for initial approval in Section 2 hereof and
no other material amendment to this Plan shall be made unless approved in the
manner provided for initial approval in Section 2(2) hereof.

IN WITNESS WHEREOF, the parties hereto have executed and delivered this
Plan as of the first date written above.

PRINCIPAL TAX-EXEMPT BOND FUND, INC.

By: /s/ A. S. Filean
A. S. Filean, Vice President

PRINCOR FINANCIAL SERVICES CORPORATION

By: /s/ S. L. Jones
S. L. Jones, President

<ARTICLE> 6

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-END> OCT-31-1998
<INVESTMENTS-AT-COST> 25,980,002
<INVESTMENTS-AT-VALUE> 25,980,002
<RECEIVABLES> 200,783
<ASSETS-OTHER> 3,051
<OTHER-ITEMS-ASSETS> 225,388
<TOTAL-ASSETS> 26,409,224
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 68,910
<TOTAL-LIABILITIES> 68,910
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 26,340,314
<SHARES-COMMON-STOCK> 26,340,314
<SHARES-COMMON-PRIOR> 98,939,110
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 0
<NET-ASSETS> 26,340,314
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 2,252,397
<OTHER-INCOME> 0
<EXPENSES-NET> (455,196)
<NET-INVESTMENT-INCOME> 1,797,201
<REALIZED-GAINS-CURRENT> 0
<APPREC-INCREASE-CURRENT> 0
<NET-CHANGE-FROM-OPS> 0
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (1,797,101)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 192,888,810
<NUMBER-OF-SHARES-REDEEMED> (267,157,398)
<SHARES-REINVESTED> 1,669,792
<NET-CHANGE-IN-ASSETS> (72,626,460)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 316,084
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 514,245
<AVERAGE-NET-ASSETS> 63,746,858
<PER-SHARE-NAV-BEGIN> 1.000
<PER-SHARE-NII> .028
<PER-SHARE-GAIN-APPREC> 0
<PER-SHARE-DIVIDEND> (.028)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 1.000
<EXPENSE-RATIO> .72
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
<FN>
<F1>
Without the Manager's voluntary waiver of a portion of certain expenses
for this period, this fund would have had per share net investment income
of $.026 and a ratio of expenses to average net assets of .81%. The amount
waived was $58,145.
</FN>

</TABLE>