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SUPPLEMENT DATED SEPTEMBER 9, 1997
TO PROSPECTUS DATED JULY 21, 1997
U.S. EQUITY PLUS PORTFOLIO
A PORTFOLIO OF THE
MORGAN STANLEY INSTITUTIONAL FUND, INC. (THE "FUND")
P.O. BOX 2798
BOSTON, MASSACHUSETTS
02208-2798
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The Prospectus is being amended and supplemented to: (i) reflect changes to
the parent of the investment adviser, administrator and the distributor; and
(ii) detail the Portfolio's revised investment policies with respect to certain
derivative instruments. The Prospectus is amended and supplemented as follows:
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On May 31, 1997, Morgan Stanley Group Inc. and Dean Witter, Discover & Co.
merged to form Morgan Stanley, Dean Witter, Discover & Co. Prior thereto, Morgan
Stanley Group Inc. was the direct parent of Morgan Stanley Asset Management Inc.
(the "Adviser") and Morgan Stanley & Co. Incorporated ("Morgan Stanley"). The
Adviser and Morgan Stanley are now subsidiaries of Morgan Stanley, Dean Witter,
Discover & Co.
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After the section entitled "WHEN-ISSUED AND DELAYED DELIVERY SECURITIES" on
pages 9-10, the following sections are inserted:
DERIVATIVE INSTRUMENTS
The Portfolio is permitted to invest in various derivative
instruments for both hedging and non-hedging purposes. Derivatives
instruments include options, futures and options on futures, structured
investments and structured notes, caps, floors, collars and swaps.
Additionally, the Portfolio may invest in other derivative instruments
that are developed over time if their use would be consistent with the
objectives of the Portfolio. The Portfolio will limit its use of
derivative instruments to 33 1/3% of its total assets measured by the
aggregate notional amount of outstanding derivative instruments. The
Portfolio's investments in forward foreign currency contracts and
derivatives used for hedging purposes are not subject to the limit
described above.
The Portfolio may use derivative instruments under a number of
different circumstances to further its investment objectives. The
Portfolio may use derivatives when doing so provides more liquidity than
the direct purchase of the securities underlying such derivatives. For
example, the Portfolio may purchase derivatives to quickly gain exposure
to a market in response to changes in the Portfolio's investment policy
or upon the inflow of investable cash or when the derivative provides
greater liquidity than the underlying securities market. The Portfolio
may also use derivatives when it is restricted from directly owning the
underlying securities due to foreign investment restrictions or other
reasons or when doing so provides a price advantage over purchasing the
underlying securities directly, either because of a pricing differential
between the derivatives and securities markets or because of lower
transaction costs associated with the derivatives transaction.
Derivatives may also be used by the Portfolio for hedging purposes and
in other circumstances when the Portfolio's portfolio
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managers believe it advantageous to do so consistent with the
Portfolio's investment objective. The Portfolio will not, however, use
derivatives in a manner that creates leverage, except to the extent that
the use of leverage is expressly permitted by the Portfolio's investment
policies, and then only in a manner consistent with such policies.
Some of the derivative instruments in which the Portfolio may invest
and the risks related thereto are described in more detail below.
CAPS, FLOORS AND COLLARS
The Portfolio may invest in caps, floors and collars, which are
instruments analogous to options. In particular, a cap is the right to
receive the excess of a reference rate over a given rate and is
analogous to a put option. A floor is the right to receive the excess of
a given rate over a reference rate and is analogous to a call option.
Finally, a collar is an instrument that combines a cap and a floor. That
is, the buyer of a collar buys a cap and writes a floor, and the writer
of a collar writes a cap and buys a floor. The risks associated with
caps, floors and collars are similar to those associated with options.
In addition, caps, floors and collars are subject to risk of default by
the counterparty because they are privately negotiated instruments.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
The Portfolio may purchase and sell futures contracts and options on
futures contracts, including but not limited to securities index
futures, foreign currency exchange futures, interest rate futures
contracts and other financial futures. Futures contracts provide for the
sale by one party and purchase by another party of a specified amount of
a specific security, instrument or basket thereof, at a specific future
date and at a specified price. An option on a futures contract is a
legal contract that gives the holder the right to buy or sell a
specified amount of futures contracts at a fixed or determinable price
upon the exercise of the option.
The Portfolio may sell securities index futures contracts and/or
options thereon in anticipation of or during a market decline to attempt
to offset the decrease in market value of investments in its portfolio,
or purchase securities index futures in order to gain market exposure.
Subject to applicable laws, the Portfolio may engage in transactions in
securities index futures contracts (and options thereon) which are
traded on a recognized securities or futures exchange, or may purchase
or sell such instruments in the over-the-counter market. There currently
are limited securities index futures and options on such futures in many
countries, particularly emerging countries. The nature of the strategies
adopted by the Adviser, and the extent to which those strategies are
used, may depend on the development of such markets.
The Portfolio may engage in transactions involving foreign currency
exchange futures contracts. Such contracts involve an obligation to
purchase or sell a specific currency at a specified future date and at a
specified price. The Portfolio may engage in such transactions to hedge
their respective holdings and commitments against changes in the level
of future currency rates or to adjust their exposure to a particular
currency.
The Portfolio may engage in transactions in interest rate futures
transactions. Interest rate futures contracts involve an obligation to
purchase or sell a specific debt security, instrument or basket thereof
at a specified future date at a specified price. The value of the
contract rises and falls inversely with
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changes in interest rates. The Portfolio may engage in such transactions
to hedge its holdings of debt instruments against future changes in
interest rates.
Financial futures are futures contracts relating to financial
instruments, such as U.S. Government securities, foreign currencies, and
certificates of deposit. Such contracts involve an obligation to
purchase or sell a specific security, instrument or basket thereof at a
specified future date at a specified price. Like interest rate futures
contracts, the value of financial futures contracts rises and falls
inversely with changes in interest rates. The Portfolio may engage in
financial futures contracts for hedging and non-hedging purposes.
Under rules adopted by the Commodity Futures Trading Commission, the
Portfolio may enter into futures contracts and options thereon for both
hedging and non-hedging purposes, provided that not more than 5% of the
Portfolio's total assets at the time of entering the transaction are
required as margin and option premiums to secure obligations under such
contracts relating to non-hedging activities.
Gains and losses on futures contracts and options thereon depend on
the Adviser's ability to predict correctly the direction of securities
prices, interest rates and other economic factors. Other risks
associated with the use of futures and options are (i) imperfect
correlation between the change in market value of investments held by
the Portfolio and the prices of futures and options relating to
investments purchased or sold by the Portfolio, and (ii) possible lack
of a liquid secondary market for a futures contract and the resulting
inability to close a futures position. The risk that the Portfolio will
be unable to close out a futures position or options contract will be
minimized by only entering into futures contracts or options
transactions for which there appears to be a liquid exchange or
secondary market. The risk of loss in trading on futures contracts in
some strategies can be substantial, due both to the low margin deposits
required and the extremely high degree of leverage involved in futures
pricing.
OPTIONS TRANSACTIONS
The Portfolio may seek to increase its return or may hedge its
portfolio investments through options transactions with respect to
securities, instruments, indices or baskets thereof in which the
Portfolio may invest, as well as with respect to foreign currency.
Purchasing a put option gives the Portfolio the right to sell a
specified security, currency or basket of securities or currencies at
the exercise price until the expiration of the option. Purchasing a call
option gives the Portfolio the right to purchase a specified security,
currency or basket of securities or currencies at the exercise price
until the expiration of the option.
The Portfolio also may write (i.e., sell) put and call options on
investments held in its portfolio, as well as with respect to foreign
currency. When the Portfolio has written an option, it receives a
premium, which increases the Portfolio's return on the underlying
security or instrument in the event the option expires unexercised or is
closed out at a profit. However, by writing a call option, the Portfolio
will limit its opportunity to profit from an increase in the market
value of the underlying security or instrument above the exercise price
of the option for as long as the Portfolio's obligation as writer of the
option continues. The Portfolio may only write options that are
"covered." A covered call option means that so long as the Portfolio is
obligated as the writer of the option, it will earmark or segregate
sufficient liquid assets to cover its obligations under the option or
own (i) the underlying security or instrument subject to the option,
(ii) securities or instruments convertible or exchangeable
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without the payment of any consideration into the security or instrument
subject to the option, or (iii) a call option on the same underlying
security with a strike price no higher than the price at which the
underlying instrument was sold pursuant to a short option position.
By writing (or selling) a put option, the Portfolio incurs an
obligation to buy the security or instrument underlying the option from
the purchaser of the put at the option's exercise price at any time
during the option period, at the purchaser's election. The Portfolio may
also write options that may be exercised by the purchaser only on a
specific date. The Portfolio that has written a put option will earmark
or segregate sufficient liquid assets to cover its obligations under the
option or will own a put option on the same underlying security with an
equal or higher strike price.
The Portfolio may engage in transactions in options which are traded
on recognized exchanges or over-the-counter. There currently are limited
options markets in many countries, particularly emerging countries such
as Latin American countries, and the nature of the strategies adopted by
the Adviser and the extent to which those strategies are used will
depend on the development of such options markets. The primary risks
associated with the use of options are (i) imperfect correlation between
the change in market value of investments held, purchased or sold by the
Portfolio and the prices of options relating to such investments, and
(ii) possible lack of a liquid secondary market for an option.
STRUCTURED NOTES
Structured Notes are derivatives on which the amount of principal
repayment and/or interest payments is based upon the movement of one or
more factors. These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and
LIBOR) and stock indices such as the S&P 500 Index. In some cases, the
impact of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The Portfolio may use
structured notes to tailor its investments to the specific risks and
returns the Adviser wishes to accept while avoiding or reducing certain
other risks.
SWAPS -- SWAP CONTRACTS
Swaps and Swap Contracts are derivatives in the form of a contract
or other similar instrument in which two parties agree to exchange the
returns generated by a security, instrument, basket or index thereof for
the returns generated by another security, instrument, basket thereof or
index. The payment streams are calculated by reference to a specific
security, index or instrument and an agreed upon notional amount. The
relevant indices include but are not limited to, currencies, fixed
interest rates, prices and total return on interest rate indices, fixed
income indices, stock indices and commodity indices (as well as amounts
derived from arithmetic operations on these indices). For example, the
Portfolio may agree to swap the return generated by a fixed income index
for the return generated by a second fixed income index. The currency
swaps in which the Portfolio may enter will generally involve an
agreement to pay interest streams in one currency based on a specified
index in exchange for receiving interest streams denominated in another
currency. Such swaps may involve initial and final exchanges that
correspond to the agreed upon notional amount.
The Portfolio will usually enter into swaps on a net basis, i.e.,
the two return streams are netted out in a cash settlement on the
payment date or dates specified in the instrument, with the Portfolio
receiving or paying, as the case may be, only the net amount of the two
returns. The Portfolio's obligations under a swap agreement will be
accrued daily (offset against any amounts owing to the
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Portfolio) and any accrued, but unpaid, net amounts owed to a swap
counterparty will be covered by the maintenance of a segregated account
consisting of cash or liquid securities. The Portfolio will not enter
into any swap agreement unless the counterparty meets the rating
requirements set forth in guidelines established by the Fund's Board of
Directors.
Interest rate and total rate of return swaps do not involve the
delivery of securities, other underlying assets, or principal.
Accordingly, the risk of loss with respect to interest rate and total
rate of return swaps is limited to the net amount of payments that the
Portfolio is contractually obligated to make. If the other party to an
interest rate or total rate of return swap defaults, the Portfolio's
risk of loss consists of the net amount of payments that the Portfolio
is contractually entitled to receive. In contrast, currency swaps may
involve the delivery of the entire principal value of one designated
currency in exchange for the other designated currency. Therefore, the
entire principal value of a currency swap may be subject to the risk
that the other party to the swap will default on its contractual
delivery obligations. If there is a default by the counterparty, the
Portfolio may have contractual remedies pursuant to the agreements
related to the transaction. The swaps market has grown substantially in
recent years with a large number of banks and investment banking firms
acting both as principals and as agents utilizing standardized swap
documentation. As a result, the swaps market has become relatively
liquid. Swaps that include caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than "traditional"
swaps.
The use of swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Adviser is incorrect
in its forecasts of market values, interest rates, and currency exchange
rates, the investment performance of the Portfolio would be less
favorable than it would have been if this investment technique were not
used.
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