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 March 1, 1999.
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
Fund Description................................................. 3
Tax-Exempt Cash Management Fund.................................. 4
Investment Strategies and Related Risks.......................... 6
Fees and Expenses of the Fund.................................... 6
Pricing of Fund Shares........................................... 7
How To Sell Shares............................................... 7
How To Exchange Shares........................................... 10
Dividends and Distributions...................................... 11
Management, Organization and Capital Structure................... 12
General Information about the Fund Account....................... 13
Financial Highlights............................................. 16
FUND DESCRIPTION
In the description for the 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 the 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 on the following page is intended to help you compare
the cost of investing in this fund with the cost of investing in other mutual
funds. The example assumes you invest $10,000 in the Fund for the time periods
indicated. The example also assumes 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 the Fund are listed with
the Fund. Backed by their staff of experienced securities analysts, they provide
the Fund with professional investment management.
Principal Management Corporation serves as the manager for the Principal Mutual
Funds.
Fund Performance
Included in the Fund's description is a bar chart. The bar chart shows changes
in the Fund's performance from year to year. It provides an indication of the
risks involved when you invest.
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 Tax-Exempt 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.
PRINCIPAL TAX-EXEMPT CASH MANAGEMENT FUND, INC.
Principal 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 current interest income exempt from federal
income tax as is consistent with stability of principal and maintenance of
liquidity.
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.
Other securities in which the Fund may invest 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:
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 duration.
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.
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 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.
"1989" 5.9
"1990" 5.39
"1991" 4.08
"1992" 2.59
"1993" 1.92
"1994" 2.29
"1995" 3.28
"1996" 2.86
"1997" 2.81
"1998" 2.9
The 7-day yield ending on December 31, 1998 for Class A shares is 2.74%. To
obtain the Fund's current yield information, please call 1-800-247-4123.
Fund Operating Expenses
Class A
-------
Management Fees*....................... 0.49%
12b-1 Fees............................. None
Other Expenses......................... 0.31%
Total Fund Operating Expenses 0.80%
* The Manager voluntarily waived certain fees and expenses during
the fiscal year ended October 31, 1998. After waiver, the Class A
share management fee paid was 0.41% (total expenses 0.72%).
Examples**
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Class A $83 $259 $450 $1,002
** The Examples assume 1) an investment of $10,000, 2) a 5%
annual return and 3) expenses the same as the most recent
fiscal year expenses.
Day-to-day Fund management:
Since September 1989 Manager: Steve Schneider, CFA. Investment Manager -
Securities Investment of Principal Capital
Management since 1989.
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
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.
HOW TO BUY SHARES
Shares of the Fund are no longer offered for sale.
HOW 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).
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 Fund shares that were sold were acquired by conversion of Class B shares.
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 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:
sell a fixed number of sales ($25 initial minimum amount), or
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.
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.
HOW TO EXCHANGE SHARES
Shares of the Fund may be exchanged into:
o Class A shares of other Principal Mutual Funds.
o 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.
o 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.
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.
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.
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.
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 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 $5.9 billion. The Manager's address is Principal
Financial Group, Des Moines, Iowa 50392-0200.
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. following authorization by their boards of directors, and
the Manager will propose a transaction to the shareholders of the Principal
Tax-Exempt Cash Management Fund.
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. The transaction will not dilute the value of your shares.
In addition, the Principal Tax-Exempt Bond Fund will offer to exchange its Class
A shares without a sales charge for your shares of the Tax-Exempt Cash
Management Fund or shares of the Cash Management Fund issued in exchange for
those shares. The Exchange offer will commence on the day after the shareholders
approve the proposed transaction and will continue until June 1, 1999.
In anticipation of shareholder 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.
Shareholders of the Tax-Exempt Cash Management Fund will vote on the proposed
transaction at a shareholder meeting called for that purpose.
GENERAL INFORMATION ABOUT THE 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
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 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 LLP.
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 shareholder's address of record.
Year 2000 Readiness Disclosure
The business operations of the Fund depends 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 Fund's 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
Fund's portfolio and operational area could be impacted, included securities
pricing, dividend and interest payments, shareholder account servicing and
reporting functions. In addition, the 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 the 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 the Fund's securities will decrease the 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 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
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 changes were made to the names of
the Money Market Funds:
Former Fund Name
Princor Tax-Exempt Cash Management Fund, Inc.
New Fund Name
Principal Tax-Exempt Cash Management Fund, Inc.
(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
Principal Tax-Exempt Cash Management Fund, Inc.:
<S> <C> <C> <C> <C>
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>
(c) Total return is calculated without the front-end sales charge or contingent
deferred sales charge.
Additional information about the fund is available in the Statement of
Additional Information dated March 1, 1999 and which is part of this prospectus.
Information about the fund's investments is also available in the fund's annual
and semi-annual reports to shareholders. In the fund's annual report, you will
find a discussion of the market conditions and investment strategies that
significantly affected the fund's performance during its last fiscal year. 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 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
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 March 1, 1999
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
March 1, 1999 and shareholder report are 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..................................................... 5
Income-Oriented Funds .................................................... 8
Money Market Funds........................................................ 11
Funds' Investments........................................................ 14
Management of the Fund.................................................... 25
Manager and Sub-Advisor................................................... 29
Cost of Manager's Services................................................ 29
Brokerage on Purchases and Sales of Securities............................ 32
How to Purchase Shares.................................................... 35
Offering Price of Funds' Shares........................................... 37
Distribution Plan......................................................... 42
Determination of Net Asset Value of Funds' Shares ........................ 45
Performance Calculation................................................... 46
Tax Treatment of Funds, Dividends and Distributions ..................... 51
General Information and History........................................... 53
Financial Statements ..................................................... 53
Appendix A................................................................ 54
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 "CERTAIN 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.
- ----------------------------------- ------------------------------------
INCOME-ORIENTED FUNDS GROWTH-ORIENTED
PRINCIPAL LIMITED DOMESTIC FUNDS
TERM BOND FUND PRINCIPAL UTILITIES FUND
... for investors seeking a high ... for investors seeking current
level of current income combined income and long-term growth of
with a relative high level of stability income and capital from securities
of principal by investing in issued by public utilities
fixed-income securities with companies.
maturities of 5 years or less.
- ----------------------------------- ------------------------------------
PRINCIPAL GOVERNMENT PRINCIPAL REAL ESTATE FUND
SECURITIES INCOME FUND ... for investors seeking long-term
... for investors seeking a high capital growth and current income
level of current income, liquidity, from securities of companies
and relative safety from a portfolio primarily engaged in the real estate
emphasizing GNMA securities. industry.
- ----------------------------------- ------------------------------------
PRINCIPAL PRINCIPAL
BOND FUND BALANCED FUND
... for investors seeking high ... for investors seeking total
current income from a portfolio of return from a flexible portfolio of
higher quality bonds. common stocks, corporate bonds
and money market securities.
- ----------------------------------- ------------------------------------
PRINCIPAL TAX-EXEMPT PRINCIPAL
BOND FUND BLUE CHIP FUND
... for investors seeking a high ... for investors seeking growth
level of current income exempt of capital and growth of income
from federal income tax, consis- from stocks of well capitalized,
tent with preservation of capital. established companies.
(Income may be subject to Alternative
Minimum Tax for some investors.)
- ----------------------------------- ------------------------------------
PRINCIPAL HIGH PRINCIPAL CAPITAL
YIELD FUND ACCUMULATION FUND
... for investors seeking higher ... for investors seeking long-
current income from a portfolio of term capital appreciation, with
lower or non-rated fixed-income growth of income as a secondary
securities. objective.
- ----------------------------------- ------------------------------------
MONEY MARKET FUNDS PRINCOR
PRINCIPAL CASH GROWTH FUND
MANAGEMENT FUND ... for investors seeking long-
... for investors seeking income, term growth opportunities from a
liquidity, and the stability of common stock portfolio.
money market securities.
PRINCIPAL TAX-EXEMPT CASH
MANAGEMENT FUND
... for investors seeking income,
liquidity, and the stability of
money market securities with tax
advantages.
- ----------------------------------- -------------------------------------
GROWTH-ORIENTED INTERNATIONAL FUNDS PRINCIPAL MIDCAP FUND
PRINCIPAL INTERNATIONAL FUND ... for investors seeking long-term
... for investors seeking growth capital growth from securities
from common stocks of companies of emerging and other growth-oriented
domiciled in any of the major companies.
nations of the world.
- ----------------------------------- -------------------------------------
PRINCIPAL INTERNATIONAL PRINCIPAL SMALLCAP FUND
SMALLCAP FUND ...for investors seeking long-term
...for investors seeking long-term growth of capital from a portfolio
growth from equities from of investment securities issued by
non-United States companies with companies domiciled in the United
small market capitalization. States with comparatively smaller
market capitalization.
- ----------------------------------- -------------------------------------
PRINCIPAL INTERNATIONAL EMERGING *These illustrations represent
MARKETS FUND comparative relationships only with
... for investors seeking long-term regard to the investment objectives
growth of capital from securities sought by the funds. Relative
issued in emerging market income, stability and growth may
countries. vary among the funds with certain
- ----------------------------------- market conditions. In "no way should
the illustrations be construed as
projected relative performance 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:
(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); 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 the Fund may invest not more than 25% of the value of its total
assets in a single 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.
(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) 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:
(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) 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.
(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.
(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 "CERTAIN
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.
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 Contracts
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 Contracts. 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 Contracts. 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 may 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. Each
participation interest is backed by an irrevocable letter of credit or guarantee
of a bank. Banks will retain a service and letter of credit fee and a fee for
issuing repurchase commitments in an amount equal to the excess of the interest
paid on the Municipal Obligations over the negotiated yield at which the
instruments were purchased by the Funds. 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. 13731 Bay Hill Court, Clive, 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.)
<TABLE>
<CAPTION>
COMPENSATION TABLE*
fiscal year ended October 31, 1998
Director Compensation from Each Principal Fund Compensation from Fund Complex
-------- ------------------------------------- ------------------------------
<S> <C> <C> <C>
James D. Davis $21,450 $50,775
Pamela A. Ferguson 20,100 43,950
Richard W. Gilbert 21,450 48,825
Barbara A. Lukavsky 21,450 50,775
Richard G. Peebler** 21,000 44,400
<FN>
* None of the Funds provide retirement benefits for any of the directors.
** Richard G. Peebler received $1,200 from each of the Principal Funds. In
addition, he received fees as a result of services on the Executive
Committee of the following funds:
</FN>
</TABLE>
Principal Capital Value Fund, Inc. $225
Principal Growth Fund, Inc. 225
Principal International Fund, Inc. 150
rincipal International Emerging Markets Fund, Inc. 75
Principal International SmallCap Fund, Inc. 75
Principal MidCap Fund, Inc. 150
As of February 12, 1999, Principal Life Insurance Company, a life insurance
company organized in 1879 under the laws of Iowa, its subsidiaries and
affiliates owned of record a percentage of the outstanding voting shares of each
Fund:
% of Outstanding
Fund Shares Owned
---- ----------------
Balanced Fund 0.17%
Blue Chip Fund 0.86
Bond Fund 0.62
Capital Value Fund 23.73
Cash Management Fund 8.70
Government Securities Income Fund 0.04
Growth Fund 0.41
High Yield Fund 7.37
International Emerging Markets Fund 47.31
International Fund 23.00
International SmallCap Fund 43.91
Limited Term Bond Fund 31.30
MidCap Fund 0.65
Real Estate Fund 69.38
SmallCap Fund 22.56
Tax-Exempt Bond Fund 0.05
Tax-Exempt Cash Management Fund 3.94
Utilities Fund 0.25
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.
As of February 16, 1999, the following shareholders of the Funds owned 5% or
more of the outstanding shares of the Funds:
<TABLE>
<CAPTION>
Percentage
Name Address of Ownership
---- ------- ------------
<S> <C> <C>
Principal Cash Management Fund, Inc.
Class A
Delaware Charter Guarantee & Trust Co. PO Box 8704 8.8%
Attn: Thomas R. Kline, CFO Wilmington, DE 19899-8704
Class B
Fahnestock & Co, Inc. FBO 125 Broad Street 6.1
Wassberg Gallagher & Stalter New York, MO 64111
Principal High Yield Fund, Inc.
Class R
Principal Life Insurance Company Custodian 1313 Little Blue Heron Ct. 6.2
IRA of William Flatley Naples, FL 34108-3311
Principal International Emerging Markets Fund, Inc.
Class R
Principal Life Insurance Company Custodian RR 4 6.7
Roth Conversion IRA of Gordon F. Reabe, Jr. Lake Lotawana, MO 64086-9804
Principal Limited Term Bond Fund, Inc.
Class B
Everen Securities, Inc. A/C 111 East Kilbourn Avenue 5.7
Meramec Valley Mutual Insurance Co. Milwaukee, MO 63023-0100
Class R
Principal Life Insurance Company Custodian 4164 Salt Works Rd 5.3
Rollover IRA of Medina, NY 14103-9555
Ronald E. Levine
Principal Life Insurance Company Custodian 349 W State St. 7.1
Rollover IRA of South Elgin, IL 60177-1930
Alvin Horn
Principal Tax-Exempt Bond Fund, Inc.
Class B
Allan S. Noddle The Grand Oudezijds Voorburgawal 197 8.9
Amsterdam Netherlands 1012 Ex
Netherlands
Principal Tax-Exempt Cash Management Fund, Inc.
Dolores A. Staples 1054 19th Street 7.0
West Des Moines, IA 50265-2339
</TABLE>
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, LLC
("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 $31 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>
John E. Aschenbrenner Director Director (Manager)
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 assets 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
Net Assets as of For Fiscal Year 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. The Manager compensates Invista for its sub-advisory services as provided
in the Sub-Advisory Agreement between Invista and the Manager. The Manager may
periodically reallocate management fees between itself and Invista.
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(1) 636,217(1) 534,366(1)
Capital Value Fund 2,349,118 2,031,143 1,671,502
Cash Management Fund 2,127,595(1) 2,864,916(1) 2,555,687(1)
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(3) N/A
International Fund 2,492,037 1,882,664 1,154,783
International SmallCap Fund 242,403 30,283(3) N/A
Limited Term Bond Fund 133,825(1) 97,039(1) 18,619(1)(2)
MidCap Fund 2,548,924 2,004,305 1,293,848
Real Estate Fund 87,653(4) N/A N/A
SmallCap Fund 147,083(4) N/A N/A
Tax-Exempt Bond Fund 974,740 941,387 888,967
Tax-Exempt Cash Management Fund 316,084(1) 499,606(1) 451,467(1)
Utilities Fund 531,644(1) 436,296(1) 375,780(1)
<FN>
(1) Before waiver.
(2) Period from February 29, 1996 (Date Operations Commenced) through
October 31, 1996.
(3) Period from August 29, 1997 (Date Operations Commenced) through October
31, 1997.
(4) Period from January 1, 1998 (Date Operations Commenced) through
October 31, 1998.
</FN>
</TABLE>
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(2) N/A
International Fund 1,168,106 906,359 598,305
International SmallCap Fund 153,320 4,283(2) N/A
Limited Term Bond Fund 90,187 44,634 32,982(1)
MidCap Fund 1,840,474 1,308,608 942,986
Real Estate Fund 76,546(3) N/A N/A
SmallCap Fund 199,807(3) N/A N/A
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
<FN>
(1) Period from February 13, 1996 (Date Operations Commenced) through
October 31, 1996.
(2) Period from August 14, 1997 (Date Operations Commenced) through October
31, 1997.
(3) Period from December 10, 1997 (Date Operations Commenced) through
October 31, 1998.
</FN>
</TABLE>
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 Capital Management, a subsidiary of 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 (Management Agreement) and
December 14, 1998 (Investment Service Agreement). 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.
<TABLE>
<CAPTION>
Total Brokerage Commissions Paid
--------------------------------------------------------------
Fund 1998 1997 1996
---- --------- --------- ---------
<S> <C> <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** N/A N/A
SmallCap Fund 46,957** N/A N/A
Utilities Fund 39,470 58,450 70,140
<FN>
* Period from August 14, 1997 (date operations commenced) through October
31, 1997.
**Period from January 1, 1998 (date operations commenced) through October
31, 1998.
</FN>
</TABLE>
Brokerage commissions paid to affiliates during the fiscal year 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>
<TABLE>
<CAPTION>
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>
<TABLE>
<CAPTION>
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 & Co. is affiliated with Morgan Stanley Asset Management, Inc.,
which acts as sub-advisor to two Accounts included in the Fund complex. On
December 1, 1998 Morgan Stanley Asset Management, Inc. changed its name to
Morgan Stanley Dean Witter Investment Management, Inc. but continues to do
business in certain instances using the name Morgan Stanley Asset Management.
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" ("AEBP") 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 as
Limited Term Bond Fund Limited Term Bond Fund % of Offering Price
---------------------- ---------------------- -------------------
Sales Charge as % of: Sales Charge as % of: All Funds Limited
Offering Amount Offering Amount Except Limited Term
Amount of Purchase Price Invested Price Invested Term Bond Fund Bond Fund
------------------ ----- -------- ----- -------- -------------- ---------
<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 1.01 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>
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:
Net Dealer Allowance as %
Offering Amount of Offering
Amount of Purchase Price Invested Price
------------------ ----- -------- -----
<S> <C> <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 0.00 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:
<TABLE>
<CAPTION>
Schedule 1
Amount Payable by Employer as a Percent
Amount of Plan Contributions* In each year of Plan Contributions
------------------------------------------- ---------------------------------------
<S> <C> <C>
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
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
<FN>
* 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.
</FN>
</TABLE>
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 "How 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
or to satisfy substantially equal periodic payment calculation 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.
As principal underwriter, Princor received underwriting fees from the sale of
shares for the periods indicated 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(2) N/A
International Fund 1,369,016 1,524,740 951,553
International SmallCap Fund 197,039 38,421(2) N/A
Limited Term Bond Fund 77,191 50,773 56,766(1)
MidCap Fund 2,447,638 2,152,664 2,112,480
Real Estate Fund 53,280(3) N/A N/A
SmallCap Fund 398,391(3) 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
<FN>
(1)Period from February 29, 1996 (Date Operations Commenced) through
October 31, 1996.
(2)Period from August 29, 1997 (Date Operations Commenced) through
October 31, 1997.
(3)Period from January 1, 1998 (Date Operations Commenced) through
October 31, 1998.
</FN>
</TABLE>
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
------------
Prospectus and Registered
Shareholder Salaries Representative
Amount Report Sales & Sales Service Total
Fund Retained Printing Brochures Overhead Materials Fees Expenditures
---- -------- -------------- --------- ---------- -------------- -------- ------------
<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
------------
Prospectus and Registered
Shareholder Salaries Representative
Amount Report Sales & Sales Service Total
Fund Retained Printing Brochures Overhead Materials Fees Commissions Expenditures
---- ----------- -------------- --------- --------- -------------- ------- ----------- ------------
<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
------------
Prospectus and Registered
Shareholder Representative Underwriter's
Amount Report Sales Sales Service Salaries and Total
Fund Retained Printing Brochures Materials Fees Overhead Expenditures
---- ----------- -------------- --------- -------------- -------- ------------- ------------
<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 each 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(1)
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)(3) N/A
International Fund (2.86) 8.93 9.97
International SmallCap Fund (4.41) (3.36)(3) N/A
Limited Term Bond Fund 4.98 5.76(4) N/A
MidCap Fund (14.02) 12.25 14.58
Real Estate Fund (19.43)(5) N/A N/A
SmallCap Fund (19.90)(5) N/A N/A
Tax-Exempt Bond Fund 1.74 4.74 7.27
Utilities Fund 25.89 10.40 11.56(2)
<FN>
(1)Period beginning March 1, 1991 and ending October 31, 1998.
(2)Period beginning December 16, 1992 and ending October 31, 1998.
(3)Period beginning August 29, 1997 and ending October 31, 1998.
(4)Period beginning February 29, 1996 and ending October 31, 1998.
(5)Period beginning December 31, 1997 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
---- ------ ------
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)(4) N/A
SmallCap Fund (19.51)(4) 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.
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 Fund14.77 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)(3) N/A
SmallCap Fund (15.75)(3) 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:
Yield as of October 31, 1998
----------------------------
Fund Class A Class B Class R
---- ------- ------- -------
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
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% 28.0%
5.61 5.23 36.0
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
---- ------- ------- -------
Cash Management Fund 4.92% 4.23% 4.50%
Tax-Exempt Cash Management Fund 2.53 N/A N/A
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
---- ------- ------- -------
Cash Management Fund 5.04% 4.31% 4.60%
Tax-Exempt Cash Management Fund 2.56 N/A N/A
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 A Tax-Rate
------- ------- --------
3.51% 3.56% 28.0%
3.95 4.00 36.0
4.19 4.24 39.6
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.
(chart)
Year 6% 8% 10%
0 $10,000 $10,000 $10,000
20 $32,071 $46,610 $67,275
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 4.99%
(monthly average six-month CD rate for the month of October, 1998, as reported
in the Federal Reserve Bulletin) and an inflation rate of 1.5% (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 $(105).
($10,000 x 4.99%) / 2 = $250 Interest for six-month period
- 70 Federal income taxes (28%)
- 75 Inflation's impact on invested
principal $(10,000 x 1.5%) / 2
($105) 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:
<TABLE>
<CAPTION>
Old Fund Name New Fund Name
------------- -------------
<S> <C> <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.