PROSPECTUS
OCTOBER 28, 1998
Merrill Lynch Developing Capital Markets Fund, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
----------------
Merrill Lynch Developing Capital Markets Fund, Inc. (the "Fund") is a
non-diversified, open-end management investment company that seeks long-term
capital appreciation by investing in securities, principally equities, of
issuers in countries having smaller capital markets. This objective of the Fund
reflects the belief that investment opportunities may result from an evolving
long-term international trend favoring more market-oriented economies, a trend
that may especially benefit certain countries having smaller capital markets.
For more information on the Fund's investment objectives and policies, please
see "Investment Objective and Policies" on page 15. The Fund may employ a
variety of instruments and techniques to hedge against market and currency
risk. There can be no assurance that the Fund's investment objective will be
achieved. INVESTMENTS ON AN INTERNATIONAL BASIS INVOLVE CERTAIN RISK FACTORS.
SEE "RISK FACTORS AND SPECIAL CONSIDERATIONS."
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of
time the investor expects to hold the shares and other relevant circumstances.
See "Merrill Lynch Select Pricing(SM) System" on page 3.
Shares may be purchased directly from Merrill Lynch Funds Distributor (the
"Distributor"), a division of Princeton Funds Distributor, Inc. ("PFD"), P.O.
Box 9081, Princeton, New Jersey 08543-9081 [(609) 282-2800], or from securities
dealers that have entered into selected dealer agreements with the Distributor,
including Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch").
To permit the Fund to invest the net proceeds from the sale of its shares in an
orderly manner, the Fund may, from time to time, suspend the sale of its
shares, except for dividend reinvestments. The minimum initial purchase is
$1,000 and the minimum subsequent purchase is $50, except that for retirement
plans the minimum initial purchase is $100 and the minimum subsequent purchase
is $1, and for participants in certain fee-based programs the minimum initial
purchase is $250 and the minimum subsequent purchase is $50. Merrill Lynch may
charge its customers a processing fee (presently $5.35) for confirming
purchases and repurchases. Purchases and redemptions made directly through
Financial Data Services, Inc. (the "Transfer Agent") are not subject to the
processing fee. See "Purchase of Shares" and "Redemption of Shares."
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
This Prospectus is a concise statement of information about the Fund that
is relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated October 28, 1998 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission (the
"Commission") and is available, without charge, by calling or by writing the
Fund at the above telephone number or address. The Commission maintains a Web
site (http://www.sec.gov) that contains the Statement of Additional
Information, material incorporated by reference and other information regarding
the Fund. The Statement of Additional Information is hereby incorporated by
reference into this Prospectus.
----------------
Merrill Lynch Asset Management -- Manager
Merrill Lynch Funds Distributor -- Distributor
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(a)
---------------
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on
Purchases (as a percentage of offering price) ......... 5.25%(c)
Sales Charge Imposed on Dividend Reinvestments ......... None
Deferred Sales Charge (as a percentage
of original purchase price or
redemption proceeds, whichever is lower) .............. None(d)
Exchange Fee ........................................... None
ANNUAL FUND OPERATING EXPENSES (AS A
PERCENTAGE OF AVERAGE NET ASSETS):
Investment Advisory Fees(g) ............................ 1.00%
Rule 12b-l Fees(h):
Account Maintenance Fees .............................. None
Distribution Fees ..................................... None
Other Expenses:
Shareholder Servicing Costs(i) ........................ 0.21%
Other ................................................. 0.42%
-------
Total Other Expenses ............................... 0.63%
-------
Total Fund Operating Expenses .......................... 1.63%
=======
<CAPTION>
CLASS B(b) CLASS C CLASS D
-------------------------------- ---------------- ---------------
<S> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on
Purchases (as a percentage of offering price) ......... None None 5.25%(c)
Sales Charge Imposed on Dividend Reinvestments ......... None None None
Deferred Sales Charge (as a percentage
of original purchase price or
redemption proceeds, whichever is lower) .............. 4.0% during the first year, 1.0% for one None(d)
decreasing 1.0% annually year(f)
thereafter to 0.0% after the
fourth year(e)
Exchange Fee ........................................... None None None
ANNUAL FUND OPERATING EXPENSES (AS A
PERCENTAGE OF AVERAGE NET ASSETS):
Investment Advisory Fees(g) ............................ 1.00% 1.00% 1.00%
Rule 12b-l Fees(h):
Account Maintenance Fees .............................. 0.25% 0.25% 0.25%
Distribution Fees ..................................... 0.75% 0.75% None
(CLASS B SHARES CONVERT TO
CLASS D SHARES AUTOMATICALLY
AFTER APPROXIMATELY EIGHT
YEARS AND CEASE BEING SUBJECT
TO DISTRIBUTION FEES)
Other Expenses:
Shareholder Servicing Costs(i) ........................ 0.25% 0.26% 0.21%
Other ................................................. 0.42% 0.42% 0.42%
---- ---- -------
Total Other Expenses ............................... 0.67% 0.68% 0.63%
---- ---- -------
Total Fund Operating Expenses .......................... 2.67% 2.68% 1.88%
==== ==== =======
</TABLE>
- --------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders, certain retirement plans and participants in certain
fee-based programs. See "Purchase of Shares -- Initial Sales Charge
Alternatives -- Class A and Class D Shares" -- page 29 and "Shareholder
Services -- Fee-Based Programs" -- page 40.
(b) Class B shares convert to Class D shares automatically approximately eight
years after initial purchase. See "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares" -- page 31.
(c) Reduced for purchases of $25,000 and over, and waived for purchases of
Class A shares by certain retirement plans and participants in connection
with certain fee-based programs. Class A or Class D purchases of
$1,000,000 or more may not be subject to an initial sales charge. See
"Purchase of Shares -- Initial Sales Charge Alternatives -- Class A and
Class D Shares" -- page 29.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more that
are not subject to an initial sales charge may instead be subject to a
CDSC of 1.0% of amounts redeemed within the first year after purchase.
Such CDSC may be waived in connection with certain fee-based programs. A
0.75% sales charge for 401(k) purchases over $1,000,000 will apply. See
"Shareholder Services -- Fee-Based Programs" -- page 40.
(e) The CDSC may be modified in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" -- page 40.
(f) The CDSC may be waived in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" -- page 40.
(g) See "Management of the Fund -- Management and Advisory Arrangements" --
page 25.
(h) See "Purchase of Shares -- Distribution Plans" -- page 34.
(i) See "Management of the Fund -- Transfer Agency Services" -- page 26.
2
<PAGE>
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
--------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000 investment
including the maximum $52.50 initial sales charge (Class A and Class
D shares only) and assuming (1) the Total Fund Operating Expenses
for each class set forth on page 2; (2) a 5% annual return throughout
the periods; and (3) redemption at the end of the period (including any
applicable CDSC for Class B and Class C shares):
Class A ............................................................. $68 $101 $137 $ 236
Class B ............................................................. $67 $103 $142 $ 282*
Class C ............................................................. $37 $ 83 $142 $ 301
Class D ............................................................. $71 $108 $149 $ 261
An investor would pay the following expenses on the same $1,000
investment assuming no redemption at the end of the period:
Class A ............................................................. $68 $101 $137 $ 236
Class B ............................................................. $27 $ 83 $142 $ 282*
Class C ............................................................. $27 $ 83 $142 $ 301
Class D ............................................................. $71 $108 $149 $ 261
</TABLE>
- --------
* Assumes conversion to Class D shares approximately eight years after
purchase.
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The Example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Commission regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION
OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR
ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF
THE EXAMPLE. Class B and Class C shareholders who hold their shares for an
extended period of time may pay more in Rule 12b-1 distribution fees than the
economic equivalent of the maximum front-end sales charges permitted under the
Conduct Rules of the National Association of Securities Dealers, Inc. (the
"NASD"). Merrill Lynch may charge its customers a processing fee (presently
$5.35) for confirming purchases and repurchases. Purchases and redemptions made
directly through the Transfer Agent are not subject to the processing fee. See
"Purchase of Shares" and "Redemption of Shares."
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing(SM) System is used by more than
50 registered investment companies advised by Merrill Lynch Asset Management,
L.P. ("MLAM" or the "Manager") or its affiliate, Fund Asset Management, L.P.
("FAM"). Funds advised by MLAM or FAM that utilize the Merrill Lynch Select
Pricing(SM) System are referred to herein as "MLAM-advised mutual funds."
3
<PAGE>
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The CDSCs, distribution and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on Class D shares, are imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class nor have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of
shares will be calculated in the same manner at the same time and will differ
only to the extent that account maintenance and distribution fees and any
incremental transfer agency costs relating to a particular class are borne
exclusively by that class. Each class has different exchange privileges. See
"Shareholder Services -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the CDSCs and distribution fees with respect to the Class B and Class
C shares in that the sales charges and distribution fees applicable to each
class provide for the financing of the distribution of the shares of the Fund.
The distribution-related revenues paid with respect to a class will not be used
to finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing(SM) System that the investor
believes is most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase of
Shares."
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(1) FEE FEE FEATURE
- --------- ---------------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
A Maximum 5.25% initial No No No
sales charge(2)(3)
- ---------------------------------------------------------------------------------------------------------
B CDSC for a period of four 0.25% 0.75% B shares convert to
years, at a rate of 4.0% during D shares automatically
the first year, decreasing 1.0% after approximately
annually to 0.0%(4) eight years(5)
- ----------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.75% No
- ---------------------------------------------------------------------------------------------------------
D Maximum 5.25% initial 0.25% No No
sales charge(3)
- ----------------------------------------------------------------------------------------------------------
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs are imposed if the redemption occurs within
the applicable CDSC time period. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares -- Initial
Sales Charge Alternatives -- Class A and Class D Shares -- Eligible Class
A Investors."
(3) Reduced for purchases of $25,000 or more, and waived for purchases of Class
A shares by certain retirement plans and participants in connection with
certain fee-based programs. Class A and Class D share purchases of
$1,000,000 or more may not be subject to an initial sales charge but
instead may be subject to a 1.0% CDSC if redeemed within one year. Such
CDSC may be waived in connection with certain fee-based programs. A 0.75%
sales charge for 401(k) purchases over $1,000,000 will apply. See "Class
A" and "Class D" below.
(FOOTNOTES CONTINUED ON NEXT PAGE)
4
<PAGE>
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain
retirement plans was modified. Also, Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made have a ten-year
conversion period. If Class B shares of the Fund are exchanged for Class B
shares of another MLAM-advised mutual fund, the conversion period applicable
to the Class B shares acquired in the exchange will apply, and the holding
period for the shares exchanged will be tacked onto the holding period for
the shares acquired. (6) The CDSC may be waived in connection with certain
fee-based programs.
CLASS A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares of the Fund are offered to a limited group of investors and also
will be issued upon reinvestment of dividends on outstanding Class A
shares. Investors that currently own Class A shares of the Fund in a
shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Other eligible investors include certain
retirement plans and participants in certain fee-based programs. In
addition, Class A shares will be offered at net asset value to Merrill
Lynch & Co., Inc. ("ML & Co.") and its subsidiaries (the term
"subsidiaries," when used herein with respect to ML & Co., includes
MLAM, FAM and certain other entities directly or indirectly wholly
owned and controlled by ML & Co.) and their directors and employees and
to members of the Boards of MLAM-advised mutual funds. The maximum
initial sales charge of 5.25% is reduced for purchases of $25,000 and
over, and waived for purchases by certain retirement plans and
participants in connection with certain fee-based programs. Purchases
of $1,000,000 or more may not be subject to an initial sales charge but
if the initial sales charge is waived, such purchases may be subject to
a 1.0% CDSC if the shares are redeemed within one year after purchase.
Such CDSC may be waived in connection with certain fee-based programs.
A 0.75% sales charge for 401(k) purchases over $1,000,000 will apply.
Sales charges also are reduced under a right of accumulation that takes
into account the investor's holdings of all classes of all MLAM-advised
mutual funds. See "Purchase of Shares -- Initial Sales Charge
Alternatives -- Class A and Class D Shares."
CLASS B: Class B shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25% and
an ongoing distribution fee of 0.75% of the Fund's average net assets
attributable to the Class B shares, as well as a CDSC if they are
redeemed within four years of purchase. Such CDSC may be modified in
connection with certain fee-based programs. Approximately eight years
after issuance, Class B shares will convert automatically into Class D
shares of the Fund, which are subject to an account maintenance fee but
no distribution fee; Class B shares of certain other MLAM-advised
mutual funds into which exchanges may be made convert to Class D shares
automatically after approximately ten years. If Class B shares of the
Fund are exchanged for Class B shares of another MLAM-advised mutual
fund, the conversion period applicable to the Class B shares acquired
in the exchange will apply, and the holding period for the shares
exchanged will be tacked onto the holding period for the shares
acquired. Automatic conversion of Class B shares into Class D shares
will occur at least once a month on the basis of the relative net asset
values of the shares of the two classes on the conversion date, without
the imposition of any sales load, fee or other charge. Conversion of
Class B shares to Class D shares will not be deemed a purchase or sale
of the shares for Federal income tax purposes. Shares purchased through
reinvestment of dividends on Class B shares also will convert
automatically to Class D shares. The conversion period for dividend
reinvestment shares, and the conversion and holding periods for certain
retirement plans, are modified as described under "Purchase of Shares
-- Deferred Sales Charge Alternatives -- Class B and Class C Shares --
Conversion of Class B Shares to Class D Shares."
CLASS C: Class C shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25% and
an ongoing distribution fee of 0.75% of the Fund's average net
5
<PAGE>
assets attributable to Class C shares. Class C shares are also subject
to a 1.0% CDSC if they are redeemed within one year after purchase.
Such CDSC may be waived in connection with certain fee-based programs.
Although Class C shares are subject to a CDSC for only one year (as
compared to four years for Class B shares), Class C shares have no
conversion feature and, accordingly, an investor who purchases Class C
shares will be subject to distribution fees that will be imposed on
Class C shares for an indefinite period subject to annual approval by
the Fund's Board of Directors and regulatory limitations.
CLASS D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.25% of the
Fund's average net assets attributable to Class D shares. Class D
shares are not subject to an ongoing distribution fee or any CDSC when
they are redeemed. The maximum initial sales charge of 5.25% is reduced
for purchases of $25,000 and over. Purchases of $1,000,000 or more may
not be subject to an initial sales charge, but if the initial sales
charge is waived such purchases may be subject to a 1.0% CDSC if the
shares are redeemed within one year after purchase. Such CDSC may be
waived in connection with certain fee-based programs. The schedule of
initial sales charges and reductions for Class D shares is the same as
the schedule for Class A shares, except that there is no waiver for
purchases in connection with certain fee-based programs. Class D shares
also will be issued upon conversion of Class B shares as described
above under "Class B." See "Purchase of Shares -- Initial Sales Charge
Alternatives -- Class A and Class D Shares."
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing(SM) System that the investor believes is most beneficial under his or
her particular circumstances.
INITIAL SALES CHARGE ALTERNATIVES. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative
particularly attractive because similar sales charge reductions are not
available with respect to the CDSCs imposed in connection with purchases of
Class B and Class C shares. Investors not qualifying for reduced initial sales
charges who expect to maintain their investment for an extended period of time
also may elect to purchase Class A or Class D shares, because over time the
accumulated ongoing account maintenance and distribution fees on Class B or
Class C shares may exceed the initial sales charge and, in the case of Class D
shares, the account maintenance fee. Although some investors that previously
purchased Class A shares may no longer be eligible to purchase Class A shares
of other MLAM-advised mutual funds, those previously purchased Class A shares,
together with Class B, Class C and Class D share holdings, will count toward a
right of accumulation that may qualify the investor for reduced initial sales
charges on new initial sales charge purchases. In addition, the ongoing Class B
and Class C account maintenance and distribution fees will cause Class B and
Class C shares to have higher expense ratios, pay lower dividends and have
lower total returns than the initial sales charge shares. The ongoing Class D
account maintenance fees will cause Class D shares to have a higher expense
ratio, pay lower dividends and have a lower total return than Class A shares.
DEFERRED SALES CHARGE ALTERNATIVES. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the
benefit of putting all of the investor's dollars to work from the time the
investment is made. The deferred sales charge alternatives may be particularly
appealing to investors who do not qualify for a reduction in initial sales
charges. Both Class B and Class C shares are subject to ongoing account
maintenance fees and distribution fees; however, the ongoing account
maintenance and distribution fees potentially
6
<PAGE>
may be offset to the extent any return is realized on the additional funds
initially invested in Class B or Class C shares. In addition, Class B shares
will be converted into Class D shares of the Fund after a conversion period of
approximately eight years, and thereafter investors will be subject to lower
ongoing fees.
Certain investors may elect to purchase Class B shares if they determine
it to be most advantageous to have all their funds invested initially and
intend to hold their shares for an extended period of time. Investors in Class
B shares should take into account whether they intend to redeem their shares
within the CDSC period and, if not, whether they intend to remain invested
until the end of the conversion period and thereby take advantage of the
reduction in ongoing fees resulting from the conversion into Class D shares.
Other investors, however, may elect to purchase Class C shares if they
determine that it is advantageous to have all their assets invested initially
and they are uncertain as to the length of time they intend to hold their
assets in MLAM-advised mutual funds. Although Class C shareholders are subject
to a shorter CDSC period at a lower rate, they forgo the Class B conversion
feature, making their investment subject to account maintenance and
distribution fees for an indefinite period of time. In addition, while both
Class B and Class C distribution fees are subject to the limitations on
asset-based sales charges imposed by the NASD, the Class B distribution fees
are further limited under a voluntary waiver of asset-based sales charges. See
"Purchase of Shares -- Limitations on the Payment of Deferred Sales Charges."
7
<PAGE>
CONSOLIDATED FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with the annual audits of the consolidated financial statements of
the Fund by Deloitte & Touche LLP, independent auditors. Consolidated financial
statements and the independent auditors' report thereon for the fiscal year
ended June 30, 1998, appear in the annual report of the Fund for the fiscal
year ended June 30, 1998 (the "Annual Report") and are incorporated by
reference into the Statement of Additional Information. Further information
about the performance of the Fund is contained in the Annual Report, which may
be obtained, without charge, by calling or by writing the Fund at the telephone
number or address on the front cover of this Prospectus.
The following per share data and ratios have been derived from information
provided in the Fund's audited consolidated financial statements.
<TABLE>
<CAPTION>
CLASS A SHARES
----------------------------------------------------
FOR THE YEAR ENDED JUNE 30,
----------------------------------------------------
1998++ 1997++ 1996++ 1995
------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period ...................... $ 17.23 $ 15.05 $ 13.35 $ 14.61
-------- ------- -------- --------
Investment income -- net ................................. .08 .36 .23 .24
Realized and unrealized gain (loss) on investments and
foreign currency transactions -- net .................... (6.18) 2.21 1.71 (.40)
-------- ------- -------- --------
Total from investment operations .......................... (6.10) 2.57 1.94 (.16)
-------- ------- -------- --------
Less dividends and distributions:
Investment income -- net ................................. (.12) (.28) (.24) (.04)
In excess of investment income -- net .................... (.09) -- -- --
Realized gain on investments -- net ...................... -- (.11) -- (.60)
In excess of realized gain on investments -- net ......... (.48) -- -- (.46)
-------- -------- -------- --------
Total dividends and distributions ......................... (.69) (.39) (.24) (1.10)
-------- -------- -------- --------
Net asset value, end of period ............................ $ 10.44 $ 17.23 $ 15.05 $ 13.35
======== ======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share ........................ (36.00)% 17.66% 14.82% (1.67)%
======== ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses .................................................. 1.63% 1.53% 1.54% 1.62%
======== ======== ======== ========
Investment income (loss) -- net ........................... .53% 2.32% 1.66% 1.56%
======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) .................. $219,422 $471,790 $342,884 $350,081
======== ======== ======== ========
Portfolio turnover ........................................ 98.16% 86.68% 71.01% 63.37%
======== ======== ======== ========
<CAPTION>
CLASS A SHARES
-------------------------------------------------------------------
FOR THE PERIOD
SEPTEMBER 1,
FOR THE YEAR ENDED JUNE 30,
--------------------------------------------------- 1989+ to JUNE 30,
1994 1993++ 1992 1991 1990
------------ ------------ ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period ...................... $ 11.62 $ 11.92 $ 10.43 $ 11.58 $ 9.60
-------- -------- -------- -------- ---------
Investment income -- net ................................. .11 .12 .15 .24 .24
Realized and unrealized gain (loss) on investments and
foreign currency transactions -- net .................... 3.23 .42 1.59 (.75) 1.88
-------- -------- -------- -------- ---------
Total from investment operations .......................... 3.34 .54 1.74 (.51) 2.12
-------- -------- -------- -------- ---------
Less dividends and distributions:
Investment income -- net ................................. (.07) (.14) (.17) (.15) (.13)
In excess of investment income -- net .................... -- -- -- -- --
Realized gain on investments -- net ...................... (.28) (.70) (.08) (.49) (.01)
In excess of realized gain on investments -- net ......... -- -- -- -- --
-------- -------- -------- -------- ----------
Total dividends and distributions ......................... (.35) (.84) (.25) (.64) (.14)
-------- -------- -------- -------- ----------
Net asset value, end of period ............................ $ 14.61 $ 11.62 $ 11.92 $ 10.43 $ 11.58
======== ======== ======== ======== ==========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share ........................ 28.73% 5.17% 17.02% (4.45)% 22.29%#
======== ======== ======== ======== ==========
RATIOS TO AVERAGE NET ASSETS:
Expenses .................................................. 1.46% 1.71% 1.64% 1.77% 1.71%*
======== ======== ======== ======== ==========
Investment income (loss) -- net ........................... .63% (.04)% 1.73% 1.98% 2.69%*
======== ======== ======== ======== ==========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) .................. $401,996 $142,285 $126,417 $111,947 $ 104,033
======== ======== ======== ======== ==========
Portfolio turnover ........................................ 66.85% 91.72% 71.05% 84.74% 64.53%
======== ======== ======== ======== ==========
</TABLE>
- -------
+ Commencement of operations.
++ Based on average shares outstanding.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
8
<PAGE>
CONSOLIDATED FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
CLASS B SHARES
-------------------------------------------------------
FOR THE
PERIOD
JULY 1,
FOR THE YEAR
ENDED JUNE 30, 1994+
--------------------------------------- TO JUNE 30,
1998++ 1997++ 1996++ 1995
------------- ------------ ------------ ---------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period .......................... $ 17.04 $ 14.90 $ 13.24 $ 14.54
-------- -------- -------- --------
Investment income (loss) -- net .............................. (.07) .19 .09 .08
Realized and unrealized gain (loss) on investments and foreign
currency transactions -- net ................................ (6.08) 2.20 1.69 (.32)
-------- -------- -------- --------
Total from investment operations .............................. (6.15) 2.39 1.78 (.24)
-------- -------- -------- --------
Less dividends and distributions:
Investment income -- net ..................................... (.07) (.14) (.12) --
In excess of investment income -- net ........................ (.06) -- -- --
Realized gain on investments -- net .......................... -- (.11) -- (.60)
In excess of realized gain on investments -- net ............. (.48) -- -- (.46)
-------- -------- -------- ---------
Total dividends and distributions ............................. (.61) (.25) (.12) (1.06)
-------- -------- -------- ---------
Net asset value, end of period ................................ $ 10.28 $ 17.04 $ 14.90 $ 13.24
======== ======== ======== =========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share ............................ (36.68)% 16.39% 13.63% ( 2.22)%#
======== ======== ======== =========
RATIOS TO AVERAGE NET ASSETS:
Expenses ...................................................... 2.67% 2.57% 2.56% 2.79%*
======== ======== ======== =========
Investment income (loss) -- net ............................... (.53)% 1.22% .65% 1.01%*
======== ======== ======== =========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) ...................... $164,929 $398,468 $302,183 $ 162,774
======== ======== ======== =========
Portfolio turnover ............................................ 98.16% 86.68% 71.01% 63.37%
======== ======== ======== =========
<CAPTION>
CLASS C SHARES
-----------------------------------------------------
FOR THE
PERIOD
OCTOBER 21,
FOR THE YEAR
ENDED JUNE 30, 1994+
------------------------------------- TO JUNE 30,
1998++ 1997++ 1996++ 1995
------------- ----------- ----------- ---------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period .......................... $ 16.99 $ 14.87 $ 13.22 $ 16.71
--------- -------- -------- ---------
Investment income (loss) -- net .............................. (.07) .18 .09 .08
Realized and unrealized gain (loss) on investments and foreign
currency transactions -- net ................................ (6.08) 2.20 1.70 (2.50)
--------- -------- -------- ----------
Total from investment operations .............................. (6.15) 2.38 1.79 (2.42)
--------- -------- -------- ----------
Less dividends and distributions:
Investment income -- net ..................................... (.07) (.15) (.14) (.01)
In excess of investment income -- net ........................ (.05) -- -- --
Realized gain on investments -- net .......................... -- (.11) -- (.60)
In excess of realized gain on investments -- net ............. (.48) -- -- (.46)
--------- -------- -------- ----------
Total dividends and distributions ............................. (.60) (.26) (.14) (1.07)
--------- -------- -------- ----------
Net asset value, end of period ................................ $ 10.24 $ 16.99 $ 14.87 $ 13.22
========= ======== ======== ==========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share ............................ (36.69)% 16.37% 13.68% (14.97)%#
========= ======== ======== ==========
RATIOS TO AVERAGE NET ASSETS:
Expenses ...................................................... 2.68% 2.58% 2.56% 2.96%*
========= ======== ======== ==========
Investment income (loss) -- net ............................... (.51)% 1.19% .67% 1.32%*
========= ======== ======== ==========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) ...................... $ 32,339 $ 71,769 $ 46,983 $ 18,573
========= ======== ======== ==========
Portfolio turnover ............................................ 98.16% 86.68% 71.01% 63.37%
========= ======== ======== ==========
</TABLE>
- -------
+ Commencement of operations.
++ Based on average shares outstanding.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
9
<PAGE>
CONSOLIDATED FINANCIAL HIGHLIGHTS (CONCLUDED)
<TABLE>
<CAPTION>
CLASS D SHARES
-------------------------------------
FOR THE YEAR
ENDED JUNE 30,
-------------------------------------
1998++ 1997++ 1996++
------------- ----------- -----------
<S> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period ..................................................... $ 17.19 $ 15.02 $ 13.33
--------- -------- --------
Investment income -- net ................................................................ .04 .32 .21
Realized and unrealized gain (loss) on investments and foreign currency transactions -- (6.15) 2.20 1.69
--------- -------- --------
net
Total from investment operations ......................................................... (6.11) 2.52 1.90
--------- -------- --------
Less dividends and distributions:
Investment income -- net ................................................................ (.11) (.24) (.21)
In excess of investment income -- net ................................................... (.08) -- --
Realized gain on investments -- net ..................................................... -- (.11) --
In excess of realized gain on investments -- net ........................................ (.48) -- --
--------- -------- --------
Total dividends and distributions ........................................................ (.67) (.35) (.21)
--------- -------- --------
Net asset value, end of period ........................................................... $ 10.41 $ 17.19 $ 15.02
========= ======== ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share ....................................................... (36.13%) 17.30% 14.55%
========= ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses ................................................................................. 1.88% 1.78% 1.76%
========= ======== ========
Investment income -- net ................................................................. .28% 2.06% 1.48%
========= ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) ................................................. $ 31,686 $ 73,686 $ 57,821
========= ======== ========
Portfolio turnover ....................................................................... 98.16% 86.68% 71.01%
========= ======== ========
<CAPTION>
CLASS D SHARES
---------------
FOR THE
PERIOD
OCTOBER 21,
1994+
TO JUNE 30,
1995
---------------
<S> <C>
INCREASE (DECREASE) IN NET ASSET VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period ..................................................... $ 16.77
---------
Investment income -- net ................................................................ .13
Realized and unrealized gain (loss) on investments and foreign currency transactions -- (2.48)
----------
net
Total from investment operations ......................................................... (2.35)
----------
Less dividends and distributions:
Investment income -- net ................................................................ (.03)
In excess of investment income -- net ................................................... --
Realized gain on investments -- net ..................................................... (.60)
In excess of realized gain on investments -- net ........................................ (.46)
----------
Total dividends and distributions ........................................................ (1.09)
----------
Net asset value, end of period ........................................................... $ 13.33
==========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share ....................................................... (14.49)%#
==========
RATIOS TO AVERAGE NET ASSETS:
Expenses ................................................................................. 2.19%*
==========
Investment income -- net ................................................................. 2.10%*
==========
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands) ................................................. $ 21,899
==========
Portfolio turnover ....................................................................... 63.37%
==========
</TABLE>
- -------
+ Commencement of operations.
++ Based on average shares outstanding.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
10
<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
RESTRICTIONS ON FOREIGN INVESTMENT. Some countries prohibit or impose
substantial restrictions on investments in their capital markets, particularly
their equity markets, by foreign entities such as the Fund. As illustrations,
certain countries require governmental approval prior to investments by foreign
persons, or limit the amount of investment by foreign persons in a particular
company, or limit the investment by foreign persons to only a specific class of
securities of a company which may have less advantageous terms than securities
of the company available for purchase by nationals. There can be no assurance
that the Fund will be able to obtain required governmental approvals in a
timely manner. In addition, changes to restrictions on foreign ownership of
securities subsequent to the Fund's purchase of such securities may have an
adverse effect on the value of such securities. Certain countries may restrict
investment opportunities in issuers or industries deemed important to national
interests.
A number of countries, such as South Korea, Taiwan and Thailand, have
authorized the formation of closed-end investment companies to facilitate
indirect foreign investment in their capital markets. In accordance with the
Investment Company Act, the Fund may invest up to 10% of its total assets in
securities of closed-end investment companies. This restriction on investments
in securities of closed-end investment companies may limit opportunities for
the Fund to invest indirectly in certain smaller capital markets. Shares of
certain closed-end investment companies may at times be acquired only at market
prices representing premiums to their net asset values. If the Fund acquires
shares in closed-end investment companies, shareholders would bear both their
proportionate share of expenses in the Fund and, indirectly, the expenses of
such closed-end investment companies. The Fund also may seek, at its own cost,
to create its own investment entities under the laws of certain countries.
In some countries, banks or other financial institutions may constitute a
substantial number of the leading companies or the companies with the most
actively traded securities. Also, the Investment Company Act restricts the
Fund's investments in any equity security of an issuer which, in its most
recent fiscal year, derived more than 15% of its revenues from "securities
related activities," as defined by the rules thereunder. These provisions may
also restrict the Fund's investments in certain foreign banks and other
financial institutions.
INTERNATIONAL INVESTING IN COUNTRIES WITH SMALLER CAPITAL MARKETS.
Foreign investments in smaller capital markets involve risks not involved in
domestic investment, including fluctuations in foreign exchange rates, future
political and economic developments, different legal systems and the existence
or possible imposition of exchange controls or other foreign or U.S.
governmental laws or restrictions applicable to such investments. These risks
are often heightened for investments in smaller capital markets. Development of
a capital market depends on a number of factors, including the country's success
in political, economic and social reforms.
Because the Fund will invest in securities denominated or quoted in
currencies other than the U.S. dollar, changes in foreign currency exchange
rates may affect the value of securities in the portfolio and the unrealized
appreciation or depreciation of investments insofar as U.S. investors are
concerned. Foreign currency exchange rates are determined by forces of supply
and demand in the foreign exchange markets. These forces are, in turn, affected
by international balance of payments and other economic and financial
conditions, government intervention, speculation and other factors.
A number of European countries have agreed to enter into the European
Economic and Monetary Union ("EMU") in an effort to reduce trade barriers
between themselves and eliminate fluctuations in their currencies. EMU
establishes a single European currency (the "euro"), which will be introduced
on January 1, 1999 and is expected to replace the existing national currencies
of all initial EMU participants by July 1, 2002. Upon introduction of the euro,
certain securities (beginning with government and corporate bonds) will be
redenominated in the
11
<PAGE>
euro. Thereafter, these securities will trade and make dividend and other
payments only in euros. Like other investment companies and business
organizations, including the companies in which the Fund invests, the Fund
could be adversely affected if the euro, or EMU as a whole, does not take
effect as planned; if a participating country withdraws from EMU; or if the
computing, accounting and trading systems used by the Fund's service providers,
or by other entities with which the Fund or its service providers do business,
are not capable of recognizing the euro as a distinct currency beginning with
euro conversion.
With respect to certain countries, there may be the possibility of
expropriation of assets, confiscatory taxation, high rates of inflation,
political or social instability or diplomatic developments which could affect
investment in those countries. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as
growth of gross domestic product, rates of inflation, capital reinvestment,
resources, self-sufficiency and balance of payments position. In addition,
certain foreign investments may be subject to foreign withholding taxes. These
risks are often heightened for investments in smaller capital markets.
Certain developing countries are especially large debtors. Investment in
debt obligations ("sovereign debt obligations") issued or guaranteed by
developing governments or their agencies and instrumentalities ("foreign
governmental entities") involves a high degree of risk. The foreign
governmental entity that controls the replacement of sovereign debt obligations
may not be willing or able to repay the principal and/or interest when due in
accordance with the terms of such obligations. A foreign governmental entity's
willingness or ability to repay principal and interest due in a timely manner
may be affected by, among other factors, its cash flow situation, the relative
size of the debt service burden to the economy as a whole, the foreign
governmental entity's dependence on expected disbursements from third parties,
the foreign governmental entity's policy toward the International Monetary Fund
and the political constraints to which a foreign governmental entity may be
subject.
Foreign governmental entities may default on their sovereign debt
obligations. Foreign holders of sovereign debt obligations (including the Fund)
may be requested to participate in the rescheduling of such debt and to extend
further loans to foreign governmental entities. In the event of a default by a
foreign governmental entity, the Fund may have few or no effective legal
remedies.
Foreign governmental entities may be dependent on expected disbursements
from foreign governments, multilateral agencies and others abroad to reduce
principal and interest arrearage on their debt. The commitment on the part of
these governments, agencies and others to make such disbursements may be
conditioned on a foreign governmental entity's implementation of economic
reforms and/or economic performance and the timely service of such debtor's
obligations. Failure to implement such reforms, achieve such levels of economic
performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entities, which may further impair such debtor's ability or
willingness to service its debt on a timely basis.
Most of the securities held by the Fund are not registered with the
Commission, nor are the issuers thereof subject to the reporting requirements
of such agency. Accordingly, there may be less publicly available information
about an issuer in a smaller capital market than would be available about a
U.S. company, and it may not be subject to accounting, auditing and financial
reporting standards and requirements comparable to those to which U.S.
companies are subject. As a result, traditional investment measurements, such
as price/earnings ratios, as used in the United States, may not be applicable
in certain capital markets.
Smaller capital markets, while often growing in trading volume, typically
have substantially less volume than U.S. markets, and securities in many
smaller capital markets are less liquid and their prices may be more volatile
than securities of comparable U.S. companies. Brokerage commissions, custodial
services and other costs relating to investment in smaller capital markets are
generally more expensive than in the United States. Such
12
<PAGE>
markets have different clearance and settlement procedures, and in certain
markets there have been times when settlements have been unable to keep pace
with the volume of securities transactions, making it difficult to conduct such
transactions. Further, satisfactory custodial services for investment
securities may not be available in some countries having smaller capital
markets, which may result in the Fund incurring additional costs and delays in
transporting and holding custody of such securities outside such countries.
Delays in settlement could result in temporary periods when assets of the Fund
are uninvested and no return is earned thereon. The inability of the Fund to
make intended security purchases due to settlement problems could cause the
Fund to miss attractive investment opportunities. Inability to dispose of a
portfolio security due to settlement problems could result either in losses to
the Fund due to subsequent declines in value of the portfolio security or, if
the Fund has entered into a contract to sell the security, could result in
possible liability to the purchaser. There is generally less government
supervision and regulation of exchanges, brokers and issuers in countries
having smaller capital markets than there is in the United States. For example,
there may be no comparable provisions under certain foreign laws to insider
trading and similar laws intended to protect investors with respect to
securities transactions consummated in the United States. Further, brokerage
commissions and other transaction costs on foreign securities exchanges
generally are higher than in the United States.
As a result, management of the Fund may determine that, notwithstanding
otherwise favorable investment criteria, it may not be practicable or
appropriate to invest in a particular country. The Fund may invest in countries
in which foreign investors, including management of the Fund, have had no or
limited prior experience. Due to its emphasis on securities of issuers located
in smaller capital markets and the potential for substantial volatility in many
of those countries' markets, the Fund should be considered as a vehicle for
diversification and not as a balanced investment program.
HEDGING STRATEGIES. The Fund may engage in various portfolio strategies in
seeking to hedge its portfolio against movements in the equity markets,
interest rates and exchange rates between currencies by the use of options,
futures and options on futures. Utilization of options and futures transactions
involves the risk of imperfect correlation in movements in the price of options
and futures and movements in the price of the securities, interest rates or
currencies which are the subject of the hedge. Options and futures transactions
in foreign markets are also subject to the risk factors associated with foreign
investments generally, as discussed above. There can be no assurance that a
liquid secondary market for options and futures contracts will exist at any
specific time.
NO RATING CRITERIA FOR DEBT SECURITIES. The Fund has established no rating
criteria for the debt securities in which it may invest, and such securities
may not be rated at all for creditworthiness. Securities rated in the medium to
lower rating categories of nationally recognized statistical rating
organizations and unrated securities of comparable quality are predominately
speculative with respect to the capacity to pay interest and repay principal in
accordance with the terms of the security and generally involve a greater
volatility of price than securities in higher rating categories. The Fund does
not intend to purchase debt securities that are in default or which the Manager
believes will be in default.
BORROWING. As a non-fundamental investment restriction, the Fund may not
borrow amounts in excess of 20% of its total assets (taken at market value) and
then only from banks as a temporary measure for extraordinary or emergency
purposes, including to meet redemptions or to settle securities transactions.
In addition, the Fund will not purchase securities while borrowings exceed 5%
of its total assets, except (a) to honor prior commitments or (b) to exercise
subscription rights when outstanding borrowings have been obtained exclusively
for settlements of other securities transactions. The purchase of securities
while borrowings are outstanding will have the effect of leveraging the Fund.
Such leveraging increases the Fund's exposure to capital risk, and borrowed
funds are subject to interest costs which will reduce net income.
13
<PAGE>
NON-DIVERSIFIED STATUS. As a non-diversified investment company, the Fund
may invest a larger percentage of its assets in individual issuers than a
diversified investment company. In this regard, the Fund is not subject to the
general limitation that it not invest more than 5% of its total assets in the
securities of any one issuer. To the extent the Fund makes investments in
excess of 5% of its assets in a particular issuer, its exposure to credit and
market risks associated with that issuer is increased.
LIMITATIONS ON SHARE TRANSACTIONS. The Fund is designed for long-term
investors. To permit the Fund to invest the net proceeds from the sale of its
shares in an orderly manner, the Fund may, from time to time, suspend the sale
of its shares, except for dividend reinvestments. The Fund also reserves the
right to limit the number of its shares that may be purchased by a person
during a specified period of time or in the aggregate.
FEES AND EXPENSES. The management fee (at the annual rate of 1.00% of the
Fund's average daily net assets) and other operating expenses of the Fund may
be higher than the management fees and operating expenses of other mutual funds
managed by the Manager and other investment advisers. Limitations on the growth
of the Fund could adversely affect its operating expense ratio.
SUITABILITY. The economic benefit from an investment in the Fund depends
upon many factors beyond the control of the Fund, the Manager and its
affiliates. Because of its emphasis on securities of issuers in countries
having smaller capital markets, the Fund should be considered as a vehicle for
diversification and not as a balanced investment program. The suitability for
any particular investor of a purchase of shares of the Fund will depend upon,
among other things, such investor's investment objectives and such investor's
ability to accept the risks of investing in such markets, including the risk of
a loss of principal.
14
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The Fund is a non-diversified, open-end management investment company. The
investment objective of the Fund is to seek long-term capital appreciation by
investing in securities, principally equities, of issuers in countries having
smaller capital markets. Except for Temporary Investments as discussed and
defined below, all of the Fund's assets will consist of direct or indirect
investments in countries having smaller capital markets. The investment
objective of the Fund described above is a fundamental policy of the Fund and
may not be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities, as defined in the Investment Company Act
of 1940, as amended (the "Investment Company Act"). It is currently expected
that under normal conditions at least 65% of the Fund's net assets will be
invested in equity securities. The Fund may employ a variety of investments and
techniques to hedge against market and currency risk. There can be no assurance
that the Fund's investment objective will be achieved.
For purposes of its investment objective, the Fund considers countries
having smaller capital markets to be all countries other than the four
countries having the largest equity market capitalizations. Currently, these
four countries are Japan, the United Kingdom, the United States and Germany.
The Fund will at all times, except during defensive periods, maintain
investments in at least three countries having smaller capital markets.
The Fund seeks to benefit from economic and other developments in smaller
capital markets. The investment objective of the Fund reflects the belief that
investment opportunities may result from an evolving long-term international
trend favoring more market-oriented economies, a trend that may especially
benefit certain countries having smaller capital markets. This trend may be
facilitated by local or international political, economic or financial
developments that could benefit the capital markets of such countries. Certain
such countries, particularly so-called "emerging" countries which may be in the
process of developing more market-oriented economies, may experience relatively
high rates of economic growth. Other countries, although having relatively
mature smaller capital markets, may also be in a position to benefit from local
or international developments encouraging greater market orientation and
diminishing governmental intervention in economic affairs.
Many investors, particularly individuals, lack the information, capability
or inclination to invest in countries having smaller capital markets. It also
may not be permissible for such investors to invest directly in certain such
markets. Unlike many intermediary investment vehicles, such as closed-end
investment companies that invest in a single country, the Fund intends to
diversify investment risk among the capital markets of a number of countries.
The Fund will not necessarily seek to diversify investments on a geographical
basis or on the basis of the level of economic development of any particular
country.
Because of the general illiquidity of the capital markets in some
countries, the Fund may invest in a relatively small number of leading or
actively traded companies in a country's capital markets in the expectation
that the investment experience of the securities of such companies will
substantially represent the investment experience of the country's capital
markets as a whole.
The Fund also may invest in debt securities of issuers in countries having
smaller capital markets. Capital appreciation in debt securities may arise as a
result of a favorable change in relative foreign exchange rates, in relative
interest rate levels, or in the creditworthiness of issuers. In accordance with
its investment objective, the Fund will not seek to benefit from anticipated
short-term fluctuations in currency exchange rates. The Fund may, from time to
time, invest in debt securities with relatively high yields (as compared to
other debt securities meeting the Fund's investment criteria), notwithstanding
that the Fund may not anticipate that such securities will experience
substantial capital appreciation. Such income can be used, however, to offset
the operating expenses of the Fund.
15
<PAGE>
The Fund may invest in debt securities issued or guaranteed by foreign
governments (including foreign states, provinces and municipalities) or their
agencies and instrumentalities ("governmental entities"), issued or guaranteed
by international organizations designated or supported by multiple foreign
governmental entities (which are not obligations of foreign governments) to
promote economic reconstruction or development ("supranational entities"), or
issued by foreign corporations or financial institutions.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the
Asian Development Bank and the Inter-American Development Bank. The
governmental members, or "stockholders," usually make initial capital
contributions to the supranational entity and in many cases are committed to
make additional capital contributions if the supranational entity is unable to
repay its borrowings.
The Fund has established no rating criteria for the debt securities in
which it may invest, and such securities may not be rated at all for
creditworthiness. High yield/high risk securities are predominately speculative
with respect to the capacity to pay interest and repay principal in accordance
with the terms of the security and generally involve a greater volatility of
price than securities in higher rating categories. See "Investment Objective
and Policies" in the Statement of Additional Information for additional
information regarding ratings of debt securities. In purchasing such
securities, the Fund will rely on the Manager's judgment, analysis and
experience in evaluating the creditworthiness of an issuer of such securities.
The Manager will take into consideration, among other things, the issuer's
financial resources, its sensitivity to economic conditions and trends, its
operating history, the quality of the issuer's management and regulatory
matters. The Fund does not intend to purchase debt securities that are in
default or which the Manager believes will be in default.
For purposes of the Fund's investment objective, an issuer ordinarily will
be considered to be located in the country where the primary trading market of
its securities is located. The Fund, however, may consider a company to be
located in countries having smaller capital markets, without reference to its
domicile or to the primary trading market of its securities, when at least 50%
of its non-current assets, capitalization, gross revenues or profits in any one
of the two most recent fiscal years represents (directly or indirectly through
subsidiaries) assets or activities located in such countries. The Fund also may
consider closed-end investment companies to be located in the country or
countries in which they primarily make their portfolio investments.
The Fund reserves the right, as a temporary defensive measure or to
provide for redemptions or in anticipation of investment in countries having
smaller capital markets, to hold cash or cash equivalents (in U.S. dollars or
foreign currencies) and short-term securities, including money market
securities ("Temporary Investments"). The Fund may invest in the securities of
foreign issuers in the form of American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs"), Global Depositary Receipts ("GDRs") or other
securities convertible into securities of foreign issuers. The Fund may invest
in unsponsored ADRs. The issuers of unsponsored ADRs are not obligated to
disclose material information in the United States, and therefore, there may
not be a correlation between such information and the market value of such
ADRs.
PORTFOLIO STRATEGIES INVOLVING OPTIONS AND FUTURES
The Fund may engage in various portfolio strategies to hedge its portfolio
against adverse movements in equity, debt and currency markets. The Fund has
authority to purchase and write (I.E., sell) covered put and call options on
its portfolio securities, purchase put and call options on securities and
engage in transactions in stock index options, stock index futures and
financial futures, and related options on such futures. The Fund may also
16
<PAGE>
deal in forward foreign exchange transactions and foreign currency options and
futures, and related options on such futures. Each of these portfolio
strategies is described below. Although certain risks are involved in options
and futures transactions (as discussed below and in "Risk Factors in Options
and Futures Transactions" below), the Manager believes that, because the Fund
will engage in options and futures transactions only for hedging purposes, the
options and futures portfolio strategies of the Fund will not subject the Fund
to the risks frequently associated with the speculative use of options and
futures transactions. While the Fund's use of hedging strategies is intended to
reduce the volatility of the net asset value of its shares, the net asset value
of the Fund's shares will fluctuate. There can be no assurance that the Fund's
hedging transactions will be effective. Furthermore, the Fund will only engage
in hedging activities from time to time and will not necessarily engage in
hedging transactions in all the smaller capital markets in which the Fund is
invested at any given time. Also, the Fund may not necessarily be engaging in
hedging activities when movements in any particular equity, debt and currency
markets occur. Reference is made to the Statement of Additional Information for
further information concerning these strategies.
WRITING COVERED OPTIONS. The Fund is authorized to write (I.E., sell)
covered call options on the securities in which it may invest and to enter into
closing purchase transactions with respect to certain of such options. A
covered call option is an option where the Fund, in return for a premium, gives
another party a right to buy specified securities owned by the Fund at a
specified future date and price set at the time of the contract. The principal
reason for writing call options is to attempt to realize, through the receipt
of premiums, a greater return than would be realized on the securities alone.
By writing covered call options, the Fund gives up the opportunity, while the
option is in effect, to profit from any price increase in the underlying
security above the option exercise price. In addition, the Fund's ability to
sell the underlying security will be limited while the option is in effect
unless the Fund effects a closing purchase transaction. A closing purchase
transaction cancels out the Fund's position as the writer of an option by means
of an offsetting purchase of an identical option prior to the expiration of the
option it has written. Covered call options serve as a partial hedge against
the price of the underlying security declining.
The Fund also may write put options which give the holder of the option
the right to sell the underlying security to the Fund at the stated exercise
price. The Fund will receive a premium for writing a put option which increases
the Fund's return. The Fund writes only covered put options, which means that
so long as the Fund is obligated as the writer of the option, it will, through
its custodian, have deposited and maintained cash, cash equivalents, U.S.
Government securities or other liquid securities denominated in U.S. dollars or
non-U.S. currencies with a securities depository with a value equal to or
greater than the exercise price of the underlying securities. By writing a put,
the Fund will be obligated to purchase the underlying security at a price that
may be higher than the market value of that security at the time of exercise
for as long as the option is outstanding. The Fund may engage in closing
transactions in order to terminate put options that it has written. The Fund
will not write put options if the aggregate value of the obligations underlying
puts shall exceed 50% of the Fund's net assets.
PURCHASING OPTIONS. The Fund is authorized to purchase put options to
hedge against a decline in the market value of its securities. By buying a put
option the Fund has a right to sell the underlying security at the stated
exercise price, thus limiting the Fund's risk of loss through a decline in the
market value of the security until the put option expires. The amount of any
appreciation in the value of the underlying security will be partially offset
by the amount of the premium paid for the put option and any related
transaction costs. Prior to its expiration, a put option may be sold in a
closing sale transaction and profit or loss from the sale will depend on
whether the amount received is more or less than the premium paid for the put
option plus the related transaction costs. A closing sale transaction cancels
out the Fund's position as the purchaser of an option by means of an offsetting
sale of an identical option prior to the expiration of the option it has
purchased. In certain circumstances, the
17
<PAGE>
Fund may purchase call options on securities held in its portfolio on which it
has written call options or on securities which it intends to purchase. The
Fund will not purchase options on securities (including stock index options
discussed below) if as a result of such purchase, the aggregate cost (premiums
paid) of all outstanding options on securities held by the Fund would exceed 5%
of the market value of the Fund's total assets.
STOCK OR OTHER FINANCIAL INDEX FUTURES AND OPTIONS. The Fund is authorized
to engage in transactions in stock or other financial index options and
futures, and related options on such futures. The Fund may purchase or write
put and call options on stock or other financial indices to hedge against the
risks of market-wide stock price movements in the securities in which the Fund
invests. Options on indices are similar to options on securities except that on
settlement, the parties to the contract pay or receive an amount of cash equal
to the difference between the closing value of the index on the relevant
valuation date and the exercise price of the option times a specified multiple.
The Fund may invest in stock or other financial index options based on a broad
market index, E.G., the S&P 500 Index, or based on a narrow index representing
an industry or market segment, E.G., the AMEX Oil & Gas Index.
The Fund may also purchase and sell stock index futures contracts and
financial futures contracts ("futures contracts") as a hedge against adverse
changes in the market value of its portfolio securities as described below. A
futures contract is an agreement between two parties that obligates the
purchaser of the futures contract to buy and the seller of a futures contract
to sell a security for a set price on a future date. Unlike most other futures
contracts, a stock index futures contract does not require actual delivery of
securities but results in cash settlement based upon the difference in value of
the index between the time the contract was entered into and the time of its
settlement. The Fund may effect transactions in stock index futures contracts
in connection with the equity securities in which it invests and in financial
futures contracts in connection with the debt securities in which it invests.
Transactions by the Fund in stock index futures and financial futures are
subject to limitation as described below under "Restrictions on the Use of
Futures Transactions."
The Fund is authorized to sell futures contracts in anticipation of or
during a market decline to attempt to offset the decrease in market value of
the Fund's securities portfolio that might otherwise result. When the Fund is
not invested or fully invested in any particular securities markets and
anticipates a significant market advance, it may purchase futures in order to
gain rapid market exposure that may in part or entirely offset increases in the
cost of securities that the Fund intends to purchase. As such purchases are
made, an equivalent amount of futures contracts will be terminated by
offsetting sales. The Manager does not consider purchases of futures contracts
to be a speculative practice under these circumstances. It is anticipated that,
in a substantial majority of these transactions, the Fund will purchase such
securities upon termination of the long futures position, whether the long
position is the purchase of a futures contract or the purchase of a call option
or the writing of a put option on a future, but under unusual circumstances
(E.G., the Fund experiences a significant amount of redemptions), a long
futures position may be terminated without the corresponding purchase of
securities.
The Fund also has authority to purchase and write call and put options on
futures contracts (including financial futures) and stock indices in connection
with its hedging activities. Generally, these strategies are utilized under the
same market and market sector conditions (I.E., conditions relating to specific
types of investments) in which the Fund enters into futures transactions. The
Fund may purchase put options or write call options on futures contracts and
stock indices rather than selling the underlying futures contract in
anticipation of a decrease in the market value of its securities. Similarly,
the Fund may purchase call options, or write put options on futures contracts
and stock indices, as a substitute for the purchase of such futures to hedge
against the increased cost resulting from an increase in the market value of
securities which the Fund intends to purchase.
18
<PAGE>
The Fund is also authorized to engage in options and futures transactions
on U.S. and foreign exchanges and in options in the over-the-counter markets
("OTC options"). In general, exchange-traded contracts are third-party
contracts (I.E., performance of the parties' obligations is guaranteed by an
exchange or clearing corporation) with standardized strike prices and
expiration dates. OTC options transactions are two-party contracts with prices
and terms negotiated by the buyer and seller. See "Restrictions on OTC Options"
below for information as to restrictions on the use of OTC options.
FOREIGN CURRENCY HEDGING. The Fund has authority to deal in forward
foreign exchange among currencies of the different countries in which it will
invest and multinational currency units as a hedge against possible variations
in the foreign exchange rates among these currencies. This is accomplished
through contractual agreements to purchase or sell a specified currency at a
specified future date and price set at the time of the contract. The Fund's
dealings in forward foreign exchange will be limited to hedging involving
either specific transactions or portfolio positions. Transaction hedging is the
purchase or sale of forward foreign currency with respect to specific
receivables or payables of the Fund accruing in connection with the purchase
and sale of its portfolio securities, the sale and redemption of shares of the
Fund or the payment of dividends and distributions by the Fund. Position
hedging is the sale of forward foreign currency with respect to portfolio
security positions denominated or quoted in such foreign currency. The Fund has
no limitation on transaction hedging. If the Fund enters into a position
hedging transaction, the Fund's custodian will place cash or liquid securities
in a separate account of the Fund in an amount equal to the value of the Fund's
total assets committed to the consummation of such forward contract. If the
value of the securities placed in the separate account declines, additional
cash or liquid securities will be placed in the account so that the value of
the account will equal the amount of the Fund's commitment with respect to such
contracts. Hedging against a decline in the value of a currency does not
eliminate fluctuations in the prices of portfolio securities or prevent losses
if the prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the
currency at a price above the devaluation level it anticipates.
The Fund is also authorized to purchase or sell listed or over-the-counter
("OTC") foreign currency options, foreign currency futures and related options
on foreign currency futures as a short or long hedge against possible
variations in foreign exchange rates. Such transactions may be effected with
respect to hedges on non-U.S. dollar denominated securities owned by the Fund,
sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund. As an illustration, the Fund may use such techniques to
hedge the stated value in U.S. dollars of an investment in a franc-denominated
security. In such circumstances, for example, the Fund may purchase a foreign
currency put option enabling it to sell a specified amount of francs for
dollars at a specified price by a future date. To the extent the hedge is
successful, a loss in the value of the franc relative to the dollar will tend
to be offset by an increase in the value of the put option. To offset, in whole
or in part, the cost of acquiring such a put option, the Fund may also sell a
call option which, if exercised, requires it to sell a specified amount of
francs for dollars at a specified price by a future date (a technique called a
"spread"). By selling such a call option in this illustration, the Fund gives
up the opportunity to profit without limit from increases in the relative value
of the franc to the dollar. The Manager believes that "spreads" of the type
which may be utilized by the Fund constitute hedging transactions and are
consistent with the policies described above.
Certain differences exist between these foreign currency hedging
instruments. Foreign currency options provide the holder thereof the right to
buy or sell a currency at a fixed price on a future date. A futures contract on
a foreign currency is an agreement between two parties to buy and sell a
specified amount of a currency for a set price on a future date. Futures
contracts and options on futures contracts are traded on boards of trade or
futures exchanges. The Fund will not speculate in foreign currency options,
futures or related options. Accordingly, the
19
<PAGE>
Fund will not hedge a currency substantially in excess of the market value of
securities which it has committed or anticipates to purchase which are
denominated in such currency and, in the case of securities which have been
sold by the Fund but not yet delivered, the proceeds thereof in its denominated
currency. The Fund may not incur potential net liabilities of more than 20% of
its total assets from foreign currency options, futures or related options.
RESTRICTIONS ON THE USE OF FUTURES TRANSACTIONS. Regulations of the
Commodity Futures Trading Commission ("CFTC") applicable to the Fund provide
that the futures trading activities described herein will not result in the
Fund being deemed a "commodity pool," as defined under such regulations, if the
Fund adheres to certain restrictions. In particular, the Fund may purchase and
sell futures contracts and options thereon (i) for bona fide hedging purposes
and (ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed
5% of the liquidation value of the Fund's portfolio, after taking into account
unrealized profits and unrealized losses on any such contracts and options.
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, an amount of cash and cash equivalents will be
deposited in a segregated account with the Fund's custodian so that the amount
so segregated, plus the amount of initial and variation margin held in the
account of its broker, equals the market value of the futures contract, thereby
ensuring that the use of such futures contract is unleveraged.
RESTRICTIONS ON OTC OPTIONS. The Fund will engage in OTC options,
including OTC stock index options, OTC foreign currency options and options on
foreign currency futures, only with member banks of the Federal Reserve System
and primary dealers in U.S. Government securities or with affiliates of such
banks or dealers that have capital of at least $50 million or whose obligations
are guaranteed by an entity having capital of at least $50 million or any other
bank or dealer having capital of at least $150 million or whose obligations are
guaranteed by an entity having capital of at least $150 million.
The staff of the Commission has taken the position that purchased OTC
options and the assets used as cover for written OTC options are illiquid
securities. Therefore, the Fund has adopted an investment policy pursuant to
which it will not purchase or sell OTC options (including OTC options on
futures contracts) if, as a result of such transaction, the sum of the market
value of OTC options currently outstanding which are held by the Fund, the
market value of the underlying securities covered by OTC call options currently
outstanding which were sold by the Fund and margin deposits on the Fund's
existing OTC options on futures contracts exceeds 15% of the total assets of
the Fund, taken at market value, together with all other assets of the Fund
which are illiquid or are not otherwise readily marketable. However, if the OTC
option is sold by the Fund to a primary U.S. Government securities dealer
recognized by the Federal Reserve Bank of New York and if the Fund has the
unconditional contractual right to repurchase such OTC option from the dealer
at a predetermined price, then the Fund will treat as illiquid such amount of
the underlying securities as is equal to the repurchase price less the amount
by which the option is "in-the-money" (I.E., current market value of the
underlying security minus the option's strike price). The repurchase price with
the primary dealers is typically a formula price which is generally based on a
multiple of the premium received for the option, plus the amount by which the
option is "in-the-money." This policy as to OTC options is not a fundamental
policy of the Fund and may be amended by the Directors of the Fund without the
approval of the Fund's shareholders. However, the Fund will not change or
modify this policy prior to the change or modification by the Commission staff
of its position.
RISK FACTORS IN OPTIONS AND FUTURES TRANSACTIONS. Utilization of options
and futures transactions to hedge the portfolio involves the risk of imperfect
correlation in movements in the price of options and futures and movements in
the price of the securities or currencies which are the subject of the hedge.
If the price of the options or futures moves more or less than the price of the
hedged securities or currencies, the Fund will experience
20
<PAGE>
a gain or loss which will not be completely offset by movements in the price of
the subject of the hedge. The successful use of options and futures also
depends on the Manager's ability to predict correctly price movements in the
market involved in a particular options or futures transaction. In addition,
options and futures transactions in foreign markets are subject to the risk
factors associated with foreign investments generally. See "Risk Factors and
Special Considerations."
The Fund intends to enter into options and futures transactions, on an
exchange or in the OTC market, only if there appears to be a liquid secondary
market for such options or futures, or in the case of OTC transactions, the
Manager believes the Fund can receive on each business day at least two
independent bids or offers (one of which will be from an entity other than a
party to the option) or which can be sold at a formula price provided for in
the OTC option agreement. As a result, it is expected that the Fund will enter
into exchange traded options and futures transactions only in the relatively
mature smaller capital markets such as Australia, Hong Kong or Sweden, which
have liquid secondary markets for such instruments. There can be no assurance,
however, that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures position. The inability
to close options and futures positions also could have an adverse impact on the
Fund's ability to hedge effectively its portfolio. There is also the risk of
loss by the Fund of margin deposits or collateral in the event of bankruptcy of
a broker with whom the Fund has an open position in an option, a futures
contract or related option.
The exchanges on which the Fund intends to conduct options transactions
generally have established limitations governing the maximum number of call or
put options on the same underlying security or currency (whether or not
covered) that may be written by a single investor, whether acting alone or in
concert with others (regardless of whether such options are written on the same
or different exchanges or are held or written on one or more accounts or
through one or more brokers). "Trading limits" are imposed on the maximum
number of contracts that any person may trade on a particular trading day. The
Manager does not believe that these trading and position limits will have any
adverse impact on the portfolio strategies for hedging the Fund's portfolio.
OTHER INVESTMENT POLICIES AND PRACTICES
NON-DIVERSIFIED STATUS. The Fund is classified as non-diversified within
the meaning of the Investment Company Act, which means that the Fund is not
limited by such Act in the proportion of its assets that it may invest in
securities of a single issuer. The Fund's investments will be limited, however,
in order to qualify for the special tax treatment afforded regulated investment
companies ("RICs") under the Internal Revenue Code of 1986, as amended (the
"Code"). See "Additional Information -- Taxes." To qualify, the Fund must
comply with certain requirements, including limiting its investments so that at
the close of each quarter of the taxable year (i) not more than 25% of the
market value of the Fund's total assets will be invested in the securities of a
single issuer, and (ii) with respect to 50% of the market value of its total
assets, not more than 5% of the market value of its total assets will be
invested in the securities of a single issuer, and the Fund will not own more
than 10% of the outstanding voting securities of a single issuer. Foreign
government securities (unlike U.S. Government securities) are not exempt from
the diversification requirements of the Code and the securities of each foreign
government issuer are considered to be the obligations of a single issuer. A
fund that elects to be classified as "diversified" under the Investment Company
Act must satisfy the foregoing 5% and 10% requirements with respect to 75% of
its total assets. To the extent the Fund assumes large positions in the
securities of a small number of issuers, the Fund's net asset value may
fluctuate to a greater extent than that of a diversified investment company as
a result of changes in the financial condition or in the market's assessment of
issuers, and the Fund may be more susceptible to any single economic, political
or regulatory occurrence than a diversified investment company.
21
<PAGE>
PORTFOLIO TRANSACTIONS. Since portfolio transactions may be effected on
foreign securities exchanges, the Fund may incur settlement delays on certain
of such exchanges. See "Risk Factors and Special Considerations." Where
possible, the Fund will deal directly with the dealers who make a market in the
securities involved except in those circumstances where better prices and
execution are available elsewhere. Such dealers usually are acting as principal
for their own account. On occasion, securities may be purchased directly from
the issuer. Such portfolio securities are generally traded on a net basis and
do not normally involve either brokerage commissions or transfer taxes.
Securities firms may receive brokerage commissions on certain portfolio
transactions, including options, futures and options on futures transactions
and the purchase and sale of underlying securities upon exercise of options.
The Fund has no obligation to deal with any broker in the execution of
transactions in portfolio securities. Under the Investment Company Act, persons
affiliated with the Fund, including Merrill Lynch, are prohibited from dealing
with the Fund as a principal in the purchase and sale of securities unless a
permissive order allowing such transactions is obtained from the Commission.
Affiliated persons of the Fund may serve as its broker in transactions
conducted on an exchange and in OTC transactions conducted on an agency basis.
In addition, consistent with the Conduct Rules of the NASD, the Fund may
consider sales of shares of the Fund as a factor in the selection of brokers or
dealers to execute portfolio transactions for the Fund. It is expected that the
majority of the shares of the Fund will be sold by Merrill Lynch. Costs
associated with transactions in foreign securities are generally higher than
with transactions in U.S. securities, although the Fund will endeavor to
achieve the best net results in effecting such transactions.
PORTFOLIO TURNOVER. The Manager will effect portfolio transactions without
regard to holding period, if, in its judgment, such transactions are advisable
in light of a change in circumstance in general market, economic or financial
conditions. As a result of its investment policies, the Fund may engage in a
substantial number of portfolio transactions. The portfolio turnover rate is
calculated by dividing the lesser of the Fund's annual sales or purchases of
portfolio securities (exclusive of purchases or sales of securities whose
maturities at the time of acquisition were one year or less) by the monthly
average value of the securities in the portfolio during the year. A high
portfolio turnover rate involves certain tax consequences and greater
transaction costs in the form of dealer spreads and brokerage commissions,
which are borne directly by the Fund.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS. The Fund may
purchase securities on a when-issued basis, and it may purchase or sell
securities for delayed delivery. These transactions occur when securities are
purchased or sold by the Fund with payment and delivery taking place in the
future to secure what is considered an advantageous yield and price to the Fund
at the time of entering into the transaction. Although the Fund has not
established any limit on the percentage of its assets that may be committed in
connection with such transactions, the Fund will maintain a segregated account
with its custodian of cash, cash equivalents, U.S. Government securities or
other liquid securities denominated in U.S. dollars or non-U.S. currencies in
an aggregate amount equal to the amount of its commitment in connection with
such purchase transactions.
STANDBY COMMITMENT AGREEMENTS. The Fund may from time to time enter into
standby commitment agreements. Such agreements commit the Fund, for a stated
period of time, to purchase a stated amount of a fixed income security or a
stated number of shares of equity securities that may be issued and sold to the
Fund at the option of the issuer. The price and coupon of the security is fixed
at the time of the commitment. At the time of entering into the agreement the
Fund is paid a commitment fee, regardless of whether or not the security is
ultimately issued, which is typically approximately 0.5% of the aggregate
purchase price of the security that the Fund has committed to purchase. The
Fund will enter into such agreements only for the purpose of investing in the
security underlying the commitment at a yield and price that is considered
advantageous to the Fund. The Fund will not enter into a standby commitment
with a remaining term in excess of 45 days and will limit its investment in
such commitments so that the aggregate purchase price of the securities subject
to such commitments, together
22
<PAGE>
with the value of portfolio securities subject to legal restrictions on resale,
will not exceed 15% of its assets taken at the time of acquisition of such
commitment or security. The Fund will at all times maintain a segregated
account with its custodian of cash, cash equivalents, U.S. Government
securities or other liquid securities denominated in U.S. dollars or non-U.S.
currencies in an aggregate amount equal to the purchase price of the securities
underlying the commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued, and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance
of the security underlying the commitment is at the option of the issuer, the
Fund may bear the risk of a decline in the value of such security and may not
benefit from an appreciation in the value of the security during the commitment
period.
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued, and the value of the security will
thereafter be reflected in the calculation of the Fund's net asset value. The
cost basis of the security will be adjusted by the amount of the commitment
fee. In the event the security is not issued, the commitment fee will be
recorded as income on the expiration date of the standby commitment.
REPURCHASE AGREEMENTS; PURCHASE AND SALE CONTRACTS. The Fund may invest in
securities pursuant to repurchase agreements or purchase and sale contracts.
Under a repurchase agreement, the seller agrees, upon entering into the
contract with the Fund, to repurchase a security (typically a security issued
or guaranteed by the U.S. Government) at a mutually agreed upon time and price,
thereby determining the yield during the term of the agreement. This results in
a fixed yield for the Fund insulated from fluctuations in the market value of
the underlying security during such period, although, to the extent the
repurchase agreement is not denominated in U.S. dollars, the Fund's return may
be affected by currency fluctuations. Repurchase agreements may be entered into
only with financial institutions which (i) have, in the opinion of the Manager,
substantial capital relative to the Fund's exposure, or (ii) have provided the
Fund with a third-party guaranty or other credit enhancement. A purchase and
sale contract is similar to a repurchase agreement, but purchase and sale
contracts, unlike repurchase agreements, allocate interest on the underlying
security to the purchaser during the term of the agreement. In all instances,
the Fund takes possession of the underlying securities when investing in
repurchase agreements or purchase and sale contracts. Nevertheless, if the
seller were to default on its obligation to repurchase a security under a
repurchase agreement or purchase and sale contract and the market value of the
underlying security at such time was less than the Fund had paid to the seller,
the Fund would realize a loss. The Fund may not invest more than 15% of its
total assets in repurchase agreements or purchase and sale contracts maturing
in more than seven days, together with all other illiquid securities.
LENDING OF PORTFOLIO SECURITIES. The Fund may from time to time lend
securities from its portfolio, with a value not exceeding 33 1/3% of its total
assets, to banks, brokers and other financial institutions and receive
collateral in cash or securities issued or guaranteed by the U.S. Government.
Such collateral will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. This limitation is a
fundamental policy, and it may not be changed without the approval of the
holders of a majority of the Fund's outstanding voting securities, as defined
in the Investment Company Act. During the period of such a loan, the Fund
receives the income on the loaned securities and receives either the income on
the collateral or other compensation, I.E., negotiated loan premium or fee, for
entering into the loan and thereby increases its yield. Such loans are
terminable at any time, and the borrower, after notice, will be required to
return borrowed securities within five business days. In the event that the
borrower defaults on its obligation to return borrowed securities, because of
23
<PAGE>
insolvency or otherwise, the Fund could experience delays and costs in gaining
access to the collateral and could suffer a loss to the extent that the value
of the collateral falls below the market value of the borrowed securities.
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that
are described in the Statement of Additional Information. Investment
restrictions and policies which are fundamental policies may not be changed
without the approval of the holders of a majority of the Fund's outstanding
voting securities (which for this purpose and under the Investment Company Act
means the lesser of (a) 67% of the shares represented at a meeting at which
more than 50% of the outstanding shares are represented or (b) more than 50% of
the outstanding shares). Among its fundamental policies, the Fund may not
invest more than 25% of its total assets, taken at market value at the time of
each investment, in the securities of issuers in any particular industry
(excluding the U.S. Government and its agencies or instrumentalities).
Investment restrictions and policies that are non-fundamental policies may be
changed by the Board of Directors without shareholder approval. As a
non-fundamental policy, the Fund may not borrow amounts in excess of 20% of its
total assets (taken at market value) and then only from banks as a temporary
measure for extraordinary or emergency purposes, including to meet redemptions
or to settle securities transactions. In addition, the Fund will not purchase
securities while borrowings exceed 5% of its total assets, except (a) to honor
prior commitments, or (b) to exercise subscription rights where outstanding
borrowings have been obtained exclusively for settlement of other securities
transactions. The purchase of securities while borrowings are outstanding will
have the effect of leveraging the Fund. Such leveraging or borrowing increases
the Fund's exposure to capital risk, and borrowed funds are subject to interest
costs which will reduce net income.
As a non-fundamental policy, the Fund will not invest in securities which
cannot be readily resold because of legal or contractual restrictions or which
cannot otherwise be marketed, redeemed or put to the issuer or a third party,
including repurchase agreements and purchase and sale contracts maturing in
more than seven days, if, regarding all such securities, more than 15% of its
total assets taken at market value would be invested in such securities.
Notwithstanding the foregoing, the Fund may purchase without regard to this
limitation securities that are not registered under the Securities Act of 1933,
as amended (the "Securities Act"), but that can be offered and sold to
"qualified institutional buyers" under Rule 144A under the Securities Act,
provided that the Fund's Board of Directors continuously determines, based on
the trading markets for the specific Rule 144A security, that it is liquid. The
Board of Directors may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of restricted securities. The
Board has determined that securities which are freely tradeable in their
primary market offshore should be deemed liquid. The Board, however, will
retain sufficient oversight and be ultimately responsible for the
determinations.
24
<PAGE>
MANAGEMENT OF THE FUND
BOARD OF DIRECTORS
The Board of Directors of the Fund consists of seven individuals, six of
whom are not "interested persons" of the Fund as defined in the Investment
Company Act. The Board of Directors of the Fund is responsible for the overall
supervision of the operations of the Fund and performs the various duties
imposed on the directors of investment companies by the Investment Company Act.
The Directors of the Fund are:
ARTHUR ZEIKEL* -- Chairman of the Manager and its affiliate, FAM; Chairman
and Director of Princeton Services, Inc. ("Princeton Services"); and Executive
Vice President of ML & Co.
DONALD CECIL -- Special Limited Partner of Cumberland Associates (an
investment partnership).
ROLAND M. MACHOLD -- Retired Director of the State of New Jersey Division
of Investment.
EDWARD H. MEYER -- Chairman of the Board, President and Chief Executive
Officer of Grey Advertising Inc.
CHARLES C. REILLY -- Self-employed financial consultant; former President
and Chief Investment Officer of Verus Capital, Inc.; and former Senior Vice
President of Arnhold and S. Bleichroeder, Inc.
RICHARD R. WEST -- Dean Emeritus, New York University Leonard N. Stern
School of Business Administration.
EDWARD D. ZINBARG -- Former Executive Vice President of The Prudential
Insurance Company of America.
--------
* Interested person, as defined in the Investment Company Act, of the Fund.
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager acts as the Fund's investment adviser. The Manager is owned and
controlled by ML & Co., a financial services holding company and the parent of
Merrill Lynch. The Asset Management Group of ML & Co.(which includes the
Manager) acts as the manager for more than 100 registered investment companies
and offers portfolio management services to individuals and institutions. As of
September 1998, the Asset Management Group had a total of approximately $467
billion in investment company and other portfolio assets under management. This
amount includes assets managed for certain affiliates of the Manager.
The Fund has entered into a management agreement with the Manager (the
"Management Agreement"). The Management Agreement provides that, subject to the
direction of the Board of Directors of the Fund, the Manager is responsible for
the actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Manager,
subject to review by the Board of Directors.
The Manager provides the portfolio manager for the Fund, who considers
analyses from various sources (including brokerage firms with which the Fund
does business), makes the necessary decisions and places transactions
accordingly. The Manager is also obligated to perform certain administrative
and management services for the Fund and is obligated to provide all of the
office space, facilities, equipment and personnel necessary to perform its
duties under the Management Agreement.
The Fund pays the Manager a monthly fee at the annual rate of 1.00% of the
average daily net assets of the Fund. This fee is higher than that of most
mutual funds, including most other mutual funds managed by the Manager, but
management of the Fund believes this fee is justified by the additional
investment research and analysis required in connection with investing in
smaller capital markets. For the fiscal year ended June 30, 1998, the fee paid
by the Fund to the Manager was $7,818,489 (based upon average net assets of
approximately $781.8 million).
25
<PAGE>
The Manager has also entered into a sub-advisory agreement with Merrill
Lynch Asset Management U.K. Limited ("MLAM U.K."), a wholly-owned, indirect
subsidiary of ML & Co. and an affiliate of the Manager, pursuant to which the
Manager pays MLAM U.K. a fee for providing investment advisory services to the
Manager with respect to the Fund computed at a rate to be determined from time
to time between the Manager and MLAM U.K., but in no event in excess of the
amount the Manager actually receives for providing services to the Fund
pursuant to the Management Agreement. MLAM U.K. has offices at Milton Gate, 1
Moor Lane, London EC2Y 9HA, England. For the fiscal year ended June 30, 1998,
MLAM U.K. received no fees pursuant to the sub-advisory agreement.
A. Grace Pineda, Senior Vice President of the Fund, is the Fund's
Portfolio Manager. Ms. Pineda has been a First Vice President of the Manager
since 1997 and Senior Portfolio Manager of the Manager and its corporate
predecessors since 1989. Ms. Pineda was a Vice President of the Manager and its
corporate predecessors from 1989 to 1997. Ms. Pineda has been primarily
responsible for the day-to-day management of the Fund's investment portfolio
since September 1989.
The Fund pays certain expenses incurred in its operations, including,
among other things, taxes; expenses for legal and auditing services; costs of
printing proxies, shareholder reports, prospectuses and statements of
additional information. Accounting services are provided to the Fund by the
Manager, and the Fund reimburses the Manager for its costs in connection with
such services. For the fiscal year ended June 30, 1998, the Fund reimbursed the
Manager $168,374 for accounting services. For the same period, the ratio of
total expenses to average net assets for Class A, Class B, Class C and Class D
shares was 1.63%, 2.67%, 2.68% and 1.88%, respectively.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics under Rule
17j-1 of the Investment Company Act that incorporates the Code of Ethics of the
Manager (together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Manager and, as described below,
impose additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Manager include a ban on acquiring any securities in a "hot" initial public
offering and a prohibition from profiting on short-term trading in securities.
In addition, no employee may purchase or sell any security which at the time is
being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Manager. Furthermore, the Codes provide for trading "blackout periods" which
prohibit trading by investment personnel of the Fund within periods of trading
by the Fund in the same (or equivalent) security (15 or 30 days depending upon
the transaction).
TRANSFER AGENCY SERVICES
The Transfer Agent, which is a subsidiary of ML & Co., acts as the Fund's
transfer agent pursuant to a Transfer Agency, Dividend Disbursing Agency and
Shareholder Servicing Agency Agreement (the "Transfer Agency Agreement").
Pursuant to the Transfer Agency Agreement, the Transfer Agent is responsible
for the issuance, transfer and redemption of shares and the opening and
maintenance of shareholder accounts. Pursuant to the Transfer Agency Agreement,
the Transfer Agent receives an annual fee of up to $11.00 per Class A or Class
D account and up to $14.00 per Class B or Class C account, and is entitled to
reimbursement for certain transaction
26
<PAGE>
charges and out-of-pocket expenses incurred by the Transfer Agent under the
Transfer Agency Agreement. Additionally, a $.20 monthly closed account charge
will be assessed on all accounts that close during the calendar year.
Application of this fee will commence the month following the month the account
is closed. At the end of the calendar year, no further fees will be due. For
purposes of the Transfer Agency Agreement, the term "account" includes a
shareholder account maintained directly by the Transfer Agent and any other
account representing a beneficial interest of a person in the relevant share
class or a record keeping system, provided the record keeping system is
maintained by a subsidiary of ML & Co. For the fiscal year ended June 30, 1998,
the Fund paid the Transfer Agent $1,830,486 pursuant to the Transfer Agency
Agreement.
PURCHASE OF SHARES
The Distributor, an affiliate of both the Manager and Merrill Lynch, acts
as the distributor of the shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000 and the minimum subsequent purchase is $50,
except that for retirement plans, the minimum initial purchase is $100 and the
minimum subsequent purchase is $1, and for participants in certain fee-based
programs, the minimum initial purchase is $250 and the minimum subsequent
purchase is $50.
The Fund offers its shares in four classes at a public offering price
equal to the next determined net asset value per share plus sales charges
imposed either at the time of purchase or on a deferred basis depending upon
the class of shares selected by the investor under the Merrill Lynch Select
Pricing(SM) System, as described below. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase orders by the Distributor. As to purchase orders
received by securities dealers prior to the close of business on the New York
Stock Exchange (the "NYSE") (generally, the NYSE closes at 4:00 p.m., Eastern
time), which includes orders received after the close of business on the
previous day, the applicable offering price will be based on the net asset
value determined as of 15 minutes after the close of business on the NYSE on
that day, provided the Distributor in turn receives the order from the
securities dealer prior to 30 minutes after the close of business on the NYSE
on that day. If the purchase orders are not received by the Distributor prior
to 30 minutes after the close of business on the NYSE, such orders shall be
deemed received on the next business day. The Fund or the Distributor may
suspend the continuous offering of the Fund's shares at any time in response to
conditions in the securities markets or otherwise and may thereafter resume
such offering from time to time. Any order may be rejected by the Distributor
or the Fund. Neither the Distributor nor the dealers are permitted to withhold
placing orders to benefit themselves by a price change. Merrill Lynch may
charge its customers a processing fee (presently $5.35) to confirm a sale of
shares to such customers. Purchases made directly through the Transfer Agent
are not subject to the processing fee.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the
amount of the purchase, the length of time the investor expects to hold the
shares and other relevant circumstances. Shares of Class A and Class D are sold
to investors choosing the initial sales charge alternatives and shares of Class
B and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the investment
thereafter being subject to a CDSC and ongoing distribution fees. A discussion
of the factors that investors should consider in determining the method of
purchasing shares under the Merrill Lynch Select Pricing(SM) System is set forth
under "Merrill Lynch Select Pricing(SM) System" on page 3.
27
<PAGE>
Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The CDSCs, distribution and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on Class D shares, are imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges do not affect the net
asset value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares are
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Class B, Class C and Class D shares each have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class pursuant to which account maintenance and/or distribution fees are
paid (except that Class B shareholders may vote upon any material changes to
expenses charged under the Class D Distribution Plan). See "Distribution Plans"
below. Each class has different exchange privileges. See "Shareholder Services
- -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the CDSCs and distribution fees with respect to Class B and Class C shares
in that the sales charges and distribution fees applicable to each class
provide for the financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
Investors are advised that only Class A and Class D shares may be available for
purchase through securities dealers, other than Merrill Lynch, that are
eligible to sell shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System.
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(1) FEE FEE FEATURE
- ------- ---------------- ------------- ------------ ----------
<S> <C> <C> <C> <C>
A Maximum 5.25% initial No No No
sales charge(2)(3)
- ----------------------------------------------------------------------------------------------------------
B CDSC for a period of four years, 0.25% 0.75% B shares convert to
at a rate of 4.0% during the D shares automatically
first year, decreasing 1.0% after approximately
annually to 0.0%(4) eight years(5)
- ----------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.75% No
- ---------------------------------------------------------------------------------------------------------
D Maximum 5.25% initial 0.25% No No
sales charge(3)
- --------------------------------------------------------------------------------------------------------
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs may be imposed if the redemption occurs
within the applicable CDSC time period. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of
the shares being redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge Alternatives
-- Class A and Class D Shares -- Eligible Class A Investors."
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class
A shares by certain retirement plans and participants in connection with
certain fee-based programs. Certain Class A and Class D share purchases of
$1,000,000 or more may not be subject to an initial sales charge but
instead may be subject to a 1.0% CDSC if redeemed within one year. Such
CDSC may be waived in connection with certain fee-based programs. A 0.75%
sales charge for 401(k) purchases over $1,000,000 will apply.
(FOOTNOTES CONTINUED ON NEXT PAGE)
28
<PAGE>
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares, certain retirement
plans and certain fee-based programs may be modified. Also, Class B shares
of certain other MLAM-advised mutual funds into which exchanges may be
made have a ten-year conversion period. If Class B shares of the Fund are
exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the
exchange will apply, and the holding period for the shares exchanged will
be tacked onto the holding period for the shares acquired.
(6) The CDSC may be waived in connection with certain fee-based programs.
INITIAL SALES CHARGE ALTERNATIVES -- CLASS A AND CLASS D SHARES
INVESTORS CHOOSING THE INITIAL SALES CHARGE ALTERNATIVES WHO ARE ELIGIBLE
TO PURCHASE CLASS A SHARES SHOULD PURCHASE CLASS A SHARES RATHER THAN CLASS D
SHARES BECAUSE THERE IS AN ACCOUNT MAINTENANCE FEE IMPOSED ON CLASS D SHARES.
The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternatives is the next determined net asset
value plus varying sales charges (I.E., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES LOAD AS DISCOUNT TO
SALES LOAD AS PERCENTAGE* OF SELECTED DEALERS
PERCENTAGE OF THE THE NET AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE OFFERING PRICE INVESTED THE OFFERING PRICE
- ------------------------------------------ ------------------- ---------------- -------------------
<S> <C> <C> <C>
Less than $25,000......................... 5.25% 5.54% 5.00%
$25,000 but less than $50,000............. 4.75 4.99 4.50
$50,000 but less than $100,000............ 4.00 4.17 3.75
$100,000 but less than $250,000........... 3.00 3.09 2.75
$250,000 but less than $1,000,000......... 2.00 2.04 1.80
$1,000,000 and over**..................... 0.00 0.00 0.00
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on certain Class A and Class D
purchases of $1,000,000 or more, and on Class A purchases by certain
retirement plans and participants in connection with certain fee-based
programs. If the sales charge is waived in connection with a purchase of
$1,000,000 or more, such purchases may be subject to a 1.0% CDSC if the
shares are redeemed within one year after purchase. Such CDSC may be waived
in connection with certain fee-based programs. The charge will be assessed
on an amount equal to the lesser of the proceeds of redemption or the cost
of the shares being redeemed. A sales charge of 0.75% will be charged on
purchases of $1,000,000 or more of Class A or Class D shares by certain
employer-sponsored retirement or savings plans.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and
Class D shares of the Fund will receive a concession equal to most of the sales
charge, they may be deemed to be underwriters under the Securities Act. The
proceeds from the account maintenance fees are used to compensate the
Distributor and Merrill Lynch (pursuant to a sub-agreement) for providing
continuing account maintenance activities.
During the fiscal year ended June 30, 1998, the Fund sold 11,519,583 Class
A shares for aggregate net proceeds of $161,951,614. The gross sales charges
for the sale of Class A shares of the Fund for that year were $72,619, of which
$5,269 and $67,350 were received by the Distributor and Merrill Lynch,
respectively. For the fiscal year ended June 30, 1998, the Distributor received
no CDSCs with respect to redemptions within one year after purchase of Class A
shares purchased subject to a front-end sales charge waiver.
During the fiscal year ended June 30, 1998, the Fund sold 2,736,989 Class
D shares for aggregate net proceeds of $41,244,505. The gross sales charges for
the sale of Class D shares of the Fund for that year were $122,480, of which
$8,796 and $113,684 were received by the Distributor and Merrill Lynch,
respectively. For the fiscal year ended June 30, 1998, the Distributor received
no CDSCs with respect to redemptions within one year after purchase of Class D
shares purchased subject to a front-end sales charge waiver.
29
<PAGE>
ELIGIBLE CLASS A INVESTORS. Class A shares are offered to a limited group
of investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Certain employer-sponsored retirement or savings
plans, including eligible 401(k) plans, may purchase Class A shares of the Fund
at net asset value provided such plans meet the required minimum number of
eligible employees or required amount of assets advised by MLAM or any of its
affiliates. Class A shares are available at net asset value to corporate
warranty insurance reserve fund programs and U.S. branches of foreign owned
banking institutions provided that the program or the branch has $3 million or
more initially invested in MLAM-advised mutual funds. Also eligible to purchase
Class A shares at net asset value are participants in certain investment
programs including TMA(SM) Managed Trusts to which Merrill Lynch Trust Company
provides discretionary trustee services, collective investment trusts for which
Merrill Lynch Trust Company serves as trustee and purchases made in connection
with certain fee-based programs. In addition, Class A shares are offered at net
asset value to ML & Co. and its subsidiaries and their directors and employees
and to members of the Boards of MLAM-advised investment companies, including the
Fund. Certain persons who acquired shares of certain MLAM-advised closed-end
funds in their initial offerings who wish to reinvest the net proceeds from a
sale of their closed-end fund shares of common stock in shares of the Fund also
may purchase Class A shares of the Fund if certain conditions set forth in the
Statement of Additional Information are met. In addition, Class A shares of the
Fund and certain other MLAM-advised mutual funds are offered at net asset value
to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. and, if certain
conditions set forth in the Statement of Additional Information are met, to
shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch
High Income Municipal Bond Fund, Inc. who wish to reinvest the net proceeds from
a sale of certain of their shares of common stock pursuant to a tender offer
conducted by such funds in shares of the Fund and certain other MLAM-advised
mutual funds.
REDUCED INITIAL SALES CHARGES. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges
also may be reduced under a Right of Accumulation and a Letter of Intention.
Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors." See
"Shareholder Services."
Provided applicable threshold requirements are met, either Class A or
Class D shares are offered at net asset value to Employee Access(SM) Accounts
available through authorized employers. Class A shares are offered at net asset
value to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. and,
subject to certain conditions, Class A and Class D shares are offered at net
asset value to shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and
Merrill Lynch High Income Municipal Bond Fund, Inc. who wish to reinvest in
shares of the Fund the net proceeds from a sale of certain of their shares of
common stock, pursuant to tender offers conducted by those funds.
Class D shares are offered at net asset value without sales charge to an
investor who has a business relationship with a Merrill Lynch Financial
Consultant, if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Additional information concerning these reduced initial sales charges is
set forth in the Statement of Additional Information.
30
<PAGE>
DEFERRED SALES CHARGE ALTERNATIVES -- CLASS B AND CLASS C SHARES
INVESTORS CHOOSING THE DEFERRED SALES CHARGE ALTERNATIVES SHOULD CONSIDER
CLASS B SHARES IF THEY INTEND TO HOLD THEIR SHARES FOR AN EXTENDED PERIOD OF
TIME AND CLASS C SHARES IF THEY ARE UNCERTAIN AS TO THE LENGTH OF TIME THEY
INTEND TO HOLD THEIR ASSETS IN MLAM-ADVISED MUTUAL FUNDS.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net
asset value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four-year CDSC,
which declines each year, while Class C shares are subject only to a one-year
1.0% CDSC. On the other hand, approximately eight years after Class B shares
are issued, such Class B shares, together with shares issued upon dividend
reinvestment with respect to those shares, are automatically converted into
Class D shares of the Fund and thereafter will be subject to lower continuing
fees. See "Conversion of Class B Shares to Class D Shares" below. Both Class B
and Class C shares are subject to an account maintenance fee of 0.25% of net
assets and a distribution fee of 0.75% of net assets as discussed below under
"Distribution Plans." The proceeds from the account maintenance fees are used
to compensate the Distributor and Merrill Lynch (pursuant to a sub-agreement)
for providing continuing account maintenance activities.
Class B and Class C shares are sold without an initial sales charge so
that the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its Financial Consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.
Proceeds from the CDSC and the distribution fee are paid to the
Distributor and are used in whole or in part by the Distributor to defray the
expenses of dealers (including Merrill Lynch) that are paid from the dealers'
own funds. These expenses relate to providing distribution-related services to
the Fund in connection with the sale of Class B and Class C shares, such as the
payment of compensation to financial consultants for selling such shares. The
combination of the CDSC and the ongoing distribution fee facilitates the
ability of the Fund to sell the Class B and Class C shares without a sales
charge being deducted at the time of purchase. Approximately eight years after
issuance, Class B shares will convert automatically into Class D shares of the
Fund, which are subject to an account maintenance fee but no distribution fee;
Class B shares of certain other MLAM-advised mutual funds into which exchanges
may be made convert into Class D shares automatically after approximately ten
years. If Class B shares of the Fund are exchanged for Class B shares of
another MLAM-advised mutual fund, the conversion period applicable to the Class
B shares acquired in the exchange will apply, and the holding period for the
shares exchanged will be tacked onto the holding period for the shares
acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C
shares is limited by the NASD asset-based sales charge rule. See "Limitations
on the Payment of Deferred Sales Charges" below. Class B shareholders of the
Fund exercising the exchange privilege described under "Shareholder Services --
Exchange Privilege" will continue to be subject to the Fund's CDSC schedule if
such schedule is higher than the CDSC schedule relating to the Class B shares
acquired as a result of the exchange.
CONTINGENT DEFERRED SALES CHARGES -- CLASS B SHARES. Class B shares that
are redeemed within four years of purchase may be subject to a CDSC at the
rates set forth below charged as a percentage of the dollar amount subject
thereto. The charge will be assessed on an amount equal to the lesser of the
proceeds of redemption or the cost of the shares being redeemed. Accordingly,
no CDSC will be imposed on increases in net asset value above the initial
purchase price. In addition, no CDSC will be assessed on shares derived from
reinvestment of dividends or capital gains distributions.
31
<PAGE>
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B
CDSC AS A
YEAR SINCE PERCENTAGE OF
PURCHASE DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
- ---------------------------------- ------------------
<S> <C>
0-1 ...................... 4.00%
1-2 ...................... 3.00%
2-3 ...................... 2.00%
3-4 ...................... 1.00%
4 and thereafter ......... 0.00%
</TABLE>
During the fiscal year ended June 30, 1998, the Distributor received CDSCs
of $946,237 with respect to redemptions of Class B shares, all of which were
paid to Merrill Lynch. Additional CDSCs payable to the Distributor may have
been waived or converted to a contingent obligation in connection with a
shareholder's participation in certain fee-based programs.
In determining whether a CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore it will be assumed that the redemption
is first of shares held for over four years or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the four-year period. The charge will not be applied to dollar amounts
representing an increase in the net asset value since the time of purchase. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
To provide an example, assume an investor purchases 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares through dividend reinvestment. If at such time the investor
makes his or her first redemption of 50 shares (proceeds of $600), 10 shares
will not be subject to the CDSC because of dividend reinvestment. With respect
to the remaining 40 shares, the CDSC is applied only to the original cost of
$10 per share and not to the increase in net asset value of $2 per share.
Therefore, $400 of the $600 redemption proceeds will be charged at a rate of
2.0% (the applicable rate in the third year after purchase).
The Class B CDSC is waived on redemption of shares in connection with
certain post-retirement withdrawals from an Individual Retirement Account
("IRA") or other retirement plan or following the death or disability (as
defined in the Internal Revenue Code of 1986, as amended) of a shareholder. The
Class B CDSC also is waived on redemption of shares by certain eligible 401(a)
and eligible 401(k) plans. The CDSC also is waived for any Class B shares that
are purchased by eligible 401(k) or eligible 401(a) plans that are rolled over
into a Merrill Lynch or Merrill Lynch Trust Company custodied IRA and held in
such account at the time of redemption. The Class B CDSC is also waived for any
Class B shares purchased within qualifying Employee Access(SM) Accounts. The
Class B CDSC also is waived for any Class B shares which are purchased by a
Merrill Lynch rollover IRA that was funded by a rollover from a terminated
401(k) plan managed by the MLAM Private Portfolio Group and held in such
account at the time of redemption. Additional information concerning the waiver
of the Class B CDSC is set forth in the Statement of Additional Information.
The terms of the CDSC may be modified in connection with certain fee-based
programs. See "Shareholder Services."
CONTINGENT DEFERRED SALES CHARGES -- CLASS C SHARES. Class C shares that
are redeemed within one year after purchase may be subject to a 1.0% CDSC
charged as a percentage of the dollar amount subject thereto. The charge will
be assessed on an amount equal to the lesser of the proceeds of redemption or
the cost of the shares being redeemed. Accordingly, no Class C CDSC will be
imposed on increases in net asset value above
32
<PAGE>
the initial purchase price. In addition, no Class C CDSC will be assessed on
shares derived from reinvestment of dividends or capital gains distributions.
The CDSC may be waived in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs." During the fiscal year ended June
30, 1998, the Distributor received CDSCs of $37,127 with respect to redemptions
of Class C shares, all of which were paid to Merrill Lynch.
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over one year or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the one-year period. The charge will not be applied to dollar amounts
representing an increase in the net asset value since the time of purchase. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
CONVERSION OF CLASS B SHARES TO CLASS D SHARES. After approximately eight
years (the "Conversion Period"), Class B shares will be converted automatically
into Class D shares of the Fund. Class D shares are subject to an ongoing
account maintenance fee of 0.25% of net assets but are not subject to the
distribution fee that is borne by Class B shares. Automatic conversion of Class
B shares into Class D shares will occur at least once each month (on the
"Conversion Date") on the basis of the relative net asset values of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class
D shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will
convert approximately eight years after initial purchase, and Class B shares of
taxable and tax-exempt fixed income MLAM-advised mutual funds will convert
approximately ten years after initial purchase. If, during the Conversion
Period, a shareholder exchanges Class B shares with an eight-year Conversion
Period for Class B shares with a ten-year Conversion Period, or vice versa, the
Conversion Period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked onto
the holding period for the shares acquired.
The Conversion Period is modified for shareholders who purchased Class B
shares through certain retirement plans which qualified for a waiver of the
CDSC normally imposed on purchases of Class B shares ("Class B Retirement
Plans"). When the first share of any MLAM-advised mutual fund purchased by a
Class B Retirement Plan has been held for ten years (I.E., ten years from the
date the relationship between MLAM-advised mutual funds and the Class B
Retirement Plan was established), all Class B shares of all MLAM-advised mutual
funds held in that Class B Retirement Plan will be converted into Class D
shares of the appropriate funds. Subsequent to such conversion, that Class B
Retirement Plan will be sold Class D shares of the appropriate funds at net
asset value per share.
33
<PAGE>
The Conversion Period also may be modified for retirement plan investors
who participate in certain fee-based programs. See "Shareholder Services --
Fee-Based Programs."
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the Investment Company Act (each a
"Distribution Plan") with respect to the account maintenance and/or
distribution fees paid by the Fund to the Distributor with respect to such
classes. The Class B and Class C Distribution Plans provide for the payment of
account maintenance fees and distribution fees, and the Class D Distribution
Plan provides for the payment of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each
provide that the Fund pays the Distributor an account maintenance fee relating
to the shares of the relevant class, accrued daily and paid monthly, at the
annual rate of 0.25% of the average daily net assets of the Fund attributable
to shares of the relevant Class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) in connection with account
maintenance activities.
The Distribution Plans for Class B and Class C shares each provide that
the Fund also pays the Distributor a distribution fee relating to the shares of
the relevant class, accrued daily and paid monthly, at the annual rate of 0.75%
of the average daily net assets of the Fund attributable to the shares of the
relevant class in order to compensate the Distributor and Merrill Lynch
(pursuant to a sub-agreement) for providing shareholder and distribution
services, and bearing certain distribution-related expenses of the Fund,
including payments to financial consultants for selling Class B and Class C
shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C
shares through dealers without the assessment of an initial sales charge and at
the same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
For the fiscal year ended June 30, 1998, the Fund paid the Distributor
$2,972,044 pursuant to the Class B Distribution Plan (based on average daily
net assets subject to such Class B Distribution Plan of approximately $297.2
million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class B shares. For the fiscal year ended June 30, 1998, the Fund paid the
Distributor $562,935 pursuant to the Class C Distribution Plan (based on
average daily net assets subject to such Class C Distribution Plan of
approximately $56.3 million), all of which was paid to Merrill Lynch for
providing account maintenance and distribution-related activities and services
in connection with Class C shares. For the fiscal year ended June 30, 1998, the
Fund paid the Distributor $138,726 pursuant to the Class D Distribution Plan
(based on average daily net assets subject to such Class D Distribution Plan of
approximately $55.5 million), all of which was paid to Merrill Lynch for
providing account maintenance activities in connection with Class D shares.
The payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred, and accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Directors for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense
34
<PAGE>
and revenue/cash" basis. On the fully allocated accrual basis, revenues consist
of the account maintenance fees, distribution fees, CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses, corporate
overhead and interest expense. On the direct expense and revenue/cash basis,
revenues consist of the account maintenance fees, distribution fees and CDSCs,
and expenses consist of financial consultant compensation.
As of December 31, 1997, the fully allocated accrual expenses incurred by
the Distributor and Merrill Lynch for the period since the commencement of
operations of Class B shares exceeded fully allocated accrual revenues by
approximately $3,327,000 (1.22% of Class B net assets at that date). As of June
30, 1998, direct cash revenues for the period since the commencement of
operations of Class B shares exceeded direct cash expenses by $7,176,844 (4.35%
of Class B net assets at that date). As of December 31, 1997, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch for
the period since the commencement of operations of Class C shares exceeded
fully allocated accrual revenues by approximately $402,000 (.76% of Class C net
assets at that date). As of June 30, 1998, direct cash revenues for the period
since the commencement of operations of Class C shares exceeded direct cash
expenses by $1,033,543 (3.20% of Class C net assets at that date).
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Directors of the Fund will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Directors will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each Class of
shares separately. The initial sales charges, the account maintenance fee, the
distribution fee and/or the CDSCs received with respect to one class will not
be used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those
Class B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives -- Class B and Class C Shares -- Conversion of Class B Shares to
Class D Shares."
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee
and the CDSC borne by the Class B and Class C shares but not the account
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fees and the CDSCs). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payment
in excess of the amount payable under the NASD formula will not be made.
35
<PAGE>
REDEMPTION OF SHARES
The Fund is required to redeem for cash all shares of the Fund upon
receipt of a written request in proper form. The redemption price is the net
asset value per share next determined after the initial receipt of proper
notice of redemption. Except for any CDSC that may be applicable, there will be
no charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption. The value
of shares at the time of redemption may be more or less than the shareholder's
cost, depending on the market value of the securities held by the Fund at such
time.
REDEMPTION
A shareholder wishing to redeem shares may do so, without charge, by
tendering the shares directly to the Transfer Agent, Financial Data Services,
Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289. Redemption requests
delivered other than by mail should be delivered to Financial Data Services,
Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484. Proper
notice of redemption in the case of shares deposited with the Transfer Agent
may be accomplished by a written letter requesting redemption. Proper notice of
redemption in the case of shares for which certificates have been issued may be
accomplished by a written letter as noted above accompanied by certificates for
the shares to be redeemed. Redemption requests should not be sent to the Fund.
The redemption request in either event requires the signatures of all persons
in whose names the shares are registered, signed exactly as their names appear
on the Transfer Agent's register or on the certificates, as the case may be.
The signatures on the notice must be guaranteed by an "eligible guarantor
institution" (including, for example, Merrill Lynch branch offices and certain
other financial institutions) as such term is defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, as amended, the existence and validity of
which may be verified by the Transfer Agent through the use of industry
publications. Notarized signatures are not sufficient. In certain instances,
the Transfer Agent may require additional documents, such as, but not limited
to, trust instruments, death certificates, appointments as executor or
administrator or certificates of corporate authority. For shareholders
redeeming directly with the Transfer Agent, payment will be mailed within seven
days of receipt of a proper notice of redemption.
At various times the Fund may be requested to redeem shares for which it
has not yet received good payment. The Fund may delay or cause to be delayed
the mailing of a redemption check until such time as it has assured itself that
good payment (E.G., cash or certified check drawn on a U.S. bank) has been
collected for the purchase of such shares. Normally, this delay will not exceed
10 days.
REPURCHASE
The Fund also will repurchase shares through a shareholder's listed
securities dealer. The Fund normally will accept orders to repurchase shares by
wire or telephone from dealers for their customers at the net asset value next
computed after receipt of the order by the dealer, provided that the request
for repurchase is received by the dealer prior to the close of business on the
NYSE (generally, the NYSE closes at 4:00 p.m., Eastern time) on the day
received and that such request is received by the Fund from such dealer not
later than 30 minutes after the close of business on the NYSE on the same day.
Dealers have the responsibility of submitting such repurchase requests to the
Fund not later than 30 minutes after the close of business on the NYSE in order
to obtain that day's closing price.
The foregoing repurchase arrangements are for the convenience of
shareholders and do not involve a charge by the Fund (other than any applicable
CDSC). Securities firms that do not have selected dealer agreements with
36
<PAGE>
the Distributor, however, may impose a transaction charge on the shareholder
for transmitting the notice of repurchase to the Fund. Merrill Lynch may charge
its customers a processing fee (presently $5.35) to confirm a repurchase of
shares to such customers. Repurchases made directly through the Transfer Agent
are not subject to the processing fee. The Fund reserves the right to reject
any order for repurchase, which right of rejection might adversely affect
shareholders seeking redemption through the repurchase procedure. However, a
shareholder whose order for repurchase is rejected by the Fund may redeem
shares as set forth above.
Redemption payments will be made within seven days of the proper tender of
the certificates, if any, and stock power or letter requesting redemption, in
each instance with signatures guaranteed as noted above.
REINSTATEMENT PRIVILEGE -- CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
privilege to reinstate their accounts by purchasing Class A or Class D shares,
as the case may be, of the Fund at net asset value without a sales charge up to
the dollar amount redeemed. The reinstatement privilege may be exercised by
sending a notice of exercise along with a check for the amount to be reinstated
to the Transfer Agent within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
Financial Consultant within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. The reinstatement will
be made at the net asset value per share next determined after the notice of
reinstatement is received and cannot exceed the amount of the redemption
proceeds.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services and investment plans
described below that are designed to facilitate investment in shares of the
Fund. Full details as to each of such services, copies of the various plans
described below and instructions as to how to participate in the various
services or plans, or how to change options with respect thereto, can be
obtained from the Fund by calling the telephone number on the cover page hereof
or from the Distributor or Merrill Lynch. Certain of these services are
available only to U.S. investors.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and long-term capital gain distributions. These statements will also
show any other activity in the account since the preceding statement.
Shareholders will receive separate transaction confirmations for each purchase
or sale transaction other than automatic investment purchases and the
reinvestment of ordinary income dividends and long-term capital gain
distributions. A shareholder may make additions to his or her Investment
Account at any time by mailing a check directly to the Transfer Agent.
Shareholders also may maintain their accounts through Merrill Lynch. Upon the
transfer of shares out of a Merrill Lynch brokerage account, an Investment
Account in the transferring shareholder's name will be opened automatically,
without charge, at the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the Class A or Class D shares are to be
transferred will not take delivery of shares of the Fund, a shareholder either
must redeem the Class A or Class D shares (paying any applicable CDSC) so that
the cash proceeds can be transferred to the account at the new firm, or such
shareholder must continue to maintain an Investment Account at the Transfer
Agent for those Class
37
<PAGE>
A or Class D shares. Shareholders interested in transferring their Class B or
Class C shares from Merrill Lynch and who do not wish to have an Investment
Account maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the Transfer Agent. If
the new brokerage firm is willing to accommodate the shareholder in this
manner, the shareholder must request that he or she be issued certificates for
such shares and then must turn the certificates over to the new firm for
re-registration as described in the preceding sentence. Shareholders
considering transferring a tax-deferred retirement account such as an IRA from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the retirement account is to be transferred
will not take delivery of shares of the Fund, a shareholder must either redeem
the shares (paying any applicable CDSC) so that the cash proceeds can be
transferred to the account at the new firm, or such shareholder must continue
to maintain a retirement account at Merrill Lynch for those shares.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other MLAM-advised mutual funds and Summit Cash Reserves
Fund ("Summit"), a Merrill Lynch-sponsored money market fund specifically
designated as available for exchange by holders of Class A, Class B, Class C
and Class D shares of MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated in accordance
with the rules of the Commission.
Under the Merrill Lynch Select Pricing(SM) System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
his or her account in which the exchange is made at the time of the exchange or
is otherwise eligible to purchase Class A shares of the second fund. If the
Class A shareholder wants to exchange Class A shares for shares of a second
MLAM-advised mutual fund, and the shareholder does not hold Class A shares of
the second fund in his or her account at the time of the exchange and is not
otherwise eligible to acquire Class A shares of the second fund, the
shareholder will receive Class D shares of the second fund as a result of the
exchange. Class D shares also may be exchanged for Class A shares of a second
MLAM-advised mutual fund at any time as long as, at the time of the exchange,
the shareholder holds Class A shares of the second fund in the account in which
the exchange is made or is otherwise eligible to purchase Class A shares of the
second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously
paid on the Class A or Class D shares being exchanged and the sales charge
payable at the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the
same class of other MLAM-advised mutual funds.
Shares of the Fund that are subject to a CDSC are exchangeable on the
basis of relative net asset value per share without the payment of any CDSC
that might otherwise be due upon redemption of the shares of the Fund. For
purposes of computing the CDSC that may be payable upon a disposition of the
shares acquired in the exchange, the holding period for the previously owned
shares of the Fund is "tacked" to the holding period for the newly acquired
shares of the other fund.
Class A and Class D shares are exchangeable for Class A shares of, and
Class B and Class C shares are exchangeable for Class B shares of, Summit.
Class A shares of Summit have an exchange privilege back into Class A or Class
D shares of MLAM-advised mutual funds; Class B shares of Summit have an
exchange privilege
38
<PAGE>
back into Class B or Class C shares of MLAM-advised mutual funds and, in the
event of such an exchange, the period of time that Class B shares of Summit are
held will count toward satisfaction of the holding period requirement for
purposes of reducing any CDSC and, with respect to Class B shares, toward
satisfaction of any Conversion Period. Class B shares of Summit will be subject
to a distribution fee at an annual rate of 0.75% of average daily net assets of
such Class B shares. This exchange privilege does not apply with respect to
certain Merrill Lynch fee-based programs, for which alternative exchange
arrangements may exist. Please see your Merrill Lynch Financial Consultant for
further information.
Prior to October 12, 1998 exchanges from the Fund and other MLAM-advised
mutual funds into a money market fund were directed to certain Merrill
Lynch-sponsored money market funds other than Summit. Shareholders who exchanged
shares of a MLAM-advised mutual fund for shares of such other money market funds
and subsequently wish to exchange those money market fund shares for shares of
the Fund will be subject to the CDSC schedule applicable to such Fund shares, if
any. The holding period for those money market fund shares will not count toward
satisfaction of the holding period requirement for reduction of the CDSC imposed
on such shares, if any, and, with respect to Class B shares, toward satisfaction
of the Conversion Period. However, the holding period for Class B or Class C
shares received in exchange for such money market fund shares will be aggregated
with the holding period for the original shares for purposes of reducing the
CDSC or satisfying the Conversion Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.
Exercise of the exchange privilege is treated as a sale of the exchanged
shares and a purchase of the acquired shares for Federal income tax purposes.
For further information, see "Shareholder Services -- Exchange Privilege" in
the Statement of Additional Information.
The exchange privilege is modified with respect to certain retirement plans
which participate in the MFA program. Such retirement plans may exchange Class
B, Class C or Class D shares that have been held for at least one year for Class
A shares of the same fund on the basis of relative net asset values in
connection with the commencement of participation in the MFA program, I.E., no
CDSC will apply. The one year holding period does not apply to shares acquired
through reinvestment of dividends. Upon termination of participation in the MFA
program, Class A shares will be re-exchanged for the class of shares originally
held. For purposes of computing any CDSC that may be payable upon redemption of
Class B or Class C shares so reacquired, or the Conversion Period for Class B
shares so reacquired, the holding period for the Class A shares will be "tacked"
to the holding period for the Class B or Class C shares originally held. The
Fund's exchange privilege is also modified with respect to purchases of Class A
and Class D shares by non-retirement plan investors under the MFA program.
First, the initial allocation of assets is made under the MFA program. Then, any
subsequent exchange under the MFA program of Class A or Class D shares of a
MLAM-advised mutual fund for Class A and Class D shares of the Fund will be made
solely on the basis of the relative net asset values of the shares being
exchanged. Therefore, there will not be a charge for any difference between the
sales charge previously paid on the shares of the other MLAM-advised mutual fund
and the sales charge payable on the shares of the Fund being acquired in the
exchange under the MFA program.
39
<PAGE>
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
All dividends and capital gains distributions are automatically reinvested
in full and fractional shares of the Fund, without sales charge, at the net
asset value per share next determined after the close of business on the NYSE
on the ex-dividend date of such dividend or distribution. A shareholder may at
any time, by written notification to Merrill Lynch if the shareholder's account
is maintained with Merrill Lynch or by written notification or by telephone
(1-800-MER-FUND) to the Transfer Agent if the shareholder's account is
maintained with the Transfer Agent, elect to have subsequent dividends, or both
dividends and capital gains distributions, paid in cash, rather than
reinvested, in which event payment will be mailed on or about the payment date
(provided that, in the event that a payment on an account maintained at the
Transfer Agent would amount to $10.00 or less, a shareholder will not receive
such payment in cash and such payment will automatically be reinvested in
additional shares). The Fund is not responsible for any failure of delivery to
the shareholder's address of record and no interest will accrue on amounts
represented by uncashed distribution or redemption checks. Cash payments can
also be directly deposited to the shareholder's bank account. No CDSC will be
imposed on redemption of shares issued as a result of the automatic
reinvestment of dividends or capital gains distributions.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to receive systematic withdrawal payments from his
or her Investment Account in the form of payments by check or through automatic
payment by direct deposit to his or her bank account on either a monthly or
quarterly basis. A shareholder whose shares are held within a CMA(R), CBA(R) or
Retirement Account may elect to have shares redeemed on a monthly, bimonthly,
quarterly, semiannual or annual basis through the CMA(R) or CBA(R) Systematic
Redemption Program, subject to certain conditions. With respect to redemptions
of Class B and Class C shares pursuant to a systematic withdrawal plan, the
maximum number of Class B or Class C shares that can be redeemed from an account
annually shall not exceed 10% of the value of shares of such class in that
account at the time the election to join the systematic withdrawal plan was
made. Any CDSC that otherwise might be due on such redemption of Class B or
Class C shares will be waived. Shares redeemed pursuant to a systematic
withdrawal plan will be redeemed in the same order as Class B or Class C shares
are otherwise redeemed. See "Purchase of Shares -- Deferred Sales Charge
Alternatives -- Class B and Class C Shares -- Contingent Deferred Sales Charges
- -- Class B Shares" and " -- Contingent Deferred Sales Charges -- Class C
Shares." Where the systematic withdrawal plan is applied to Class B shares, upon
conversion of the last Class B shares in an account to Class D shares, the
systematic withdrawal plan will be applied thereafter to Class D shares if the
shareholder so elects. See "Purchase of Shares -- Deferred Sales Charge
Alternatives -- Class B and Class C Shares -- Conversion of Class B Shares to
Class D Shares."
AUTOMATIC INVESTMENT PLANS
Regular additions of Class A, Class B, Class C or Class D shares may be
made to an investor's Investment Account by prearranged charges of $50 or more
to his or her regular bank account. An investor whose shares of the Fund are
held within a CMA(R) or CBA(R) account may arrange to have periodic investments
made in the Fund in amounts of $100 ($1 for retirement accounts) or more through
the CMA(R) or CBA(R) Automated Investment Program.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives
for securities transactions (each referred to in this paragraph as a
"Program"), may permit the purchase of Class A shares at net asset value. Under
specified circumstances, participants in certain Programs may deposit other
classes of shares which will
40
<PAGE>
be exchanged for Class A shares. Initial or deferred sales charges otherwise due
in connection with such exchanges may be waived or modified, as may the
Conversion Period applicable to the deposited shares. Termination of
participation in a Program may result in the redemption of shares held therein
or the automatic exchange thereof to another class at net asset value, which may
be shares of a money market fund. In addition, upon termination of participation
in a Program, shares that have been held for less than specified periods within
such Program may be subject to a fee based upon the current value of such
shares. These Programs also generally prohibit such shares from being
transferred to another account at Merrill Lynch, to another broker-dealer or to
the Transfer Agent. Except in limited circumstances (which may also involve an
exchange as described above), such shares must be redeemed and another class of
shares purchased (which may involve the imposition of initial or deferred sales
charges and distribution and account maintenance fees) in order for the
investment not to be subject to Program fees. Additional information regarding a
specific Program (including charges and limitations on transferability
applicable to shares that may be held in such Program) is available in such
Program's client agreement and from the Transfer Agent at (800) MER-FUND or
(800) 637-3863.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return for
various specified time periods in advertisements or information furnished to
present or prospective shareholders. Average annual total return is computed
separately for Class A, Class B, Class C and Class D shares in accordance with
a formula specified by the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any capital gains or losses on portfolio investments over
such periods) that would equate the initial amount invested to the redeemable
value of such investment at the end of each period. Average annual total return
will be computed assuming all dividends and distributions are reinvested and
taking into account all applicable recurring and nonrecurring expenses,
including any CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period such as in the case of Class B
and Class C shares and the maximum sales charge in the case of Class A and
Class D shares. Dividends paid by the Fund with respect to all shares, to the
extent any dividends are paid, will be calculated in the same manner at the
same time on the same day and will be in the same amount, except that account
maintenance and distribution fees and any incremental transfer agency costs
relating to each class of shares will be borne exclusively by that class. The
Fund will include performance data for all classes of shares of the Fund in any
advertisement or information including performance data of the Fund.
The Fund also may quote total return and aggregate total return
performance data for various specified time periods. Such data will be
calculated substantially as described above, except that (1) the rates of
return calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return, and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the impact on the performance data calculations
of including or excluding the maximum applicable sales charges, actual annual
or annualized total return data generally will be lower than average annual
total return data since the average annual rates of return reflect compounding;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over longer
periods of time. In advertisements directed to investors whose purchases are
subject to reduced sales charges in the case of Class A and Class D shares or
waiver of the CDSC in the case of Class B or Class C shares (such as investors
in certain retirement plans), performance data may take into account the
reduced, and not the maximum, sales charge or may not take into account the
CDSC and therefore may reflect greater total return since, due to the reduced
sales charges or waiver of the CDSC, a lower amount of expenses may be
41
<PAGE>
deducted. See "Purchase of Shares." The Fund's total return may be expressed
either as a percentage or as a dollar amount in order to illustrate the effect
of such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Total return figures are based on the Fund's historical performance and
are not intended to indicate future performance. The Fund's total return will
vary depending on market conditions, the securities comprising the Fund's
portfolio, the Fund's operating expenses and the amount of realized and
unrealized net capital gains or losses during the period. The value of an
investment in the Fund will fluctuate, and an investor's shares, when redeemed,
may be worth more or less than their original cost.
On occasion, the Fund may compare its performance to the Standard & Poor's
500 Index, the Dow Jones Industrial Average, other market indices or
performance data published by Lipper Analytical Services, Inc., Morningstar
Publications, Inc., MONEY MAGAZINE, U.S. NEWS & WORLD REPORT, BUSINESS WEEK,
CDA Investment Technology, Inc., FORBES MAGAZINE, FORTUNE MAGAZINE or other
industry publications. When comparing its performance to a market index, the
Fund may refer to various statistical measures derived from the historic
performance of the Fund and the index, such as standard deviation and beta. In
addition, from time to time the Fund may include the Fund's risk-adjusted
performance ratings assigned by Morningstar Publications, Inc. in advertising
or supplemental sales literature. As with other performance data, performance
comparisons should not be considered indicative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DIVIDENDS AND DISTRIBUTIONS
It is the Fund's intention to distribute all of its net investment income,
if any. Dividends from such net investment income are paid at least annually.
All net realized capital gains, if any, are distributed to the Fund's
shareholders at least annually. The per share dividends and distributions on
each class of shares will be reduced as a result of any account maintenance,
distribution and transfer agency fees applicable to that class. See
"Determination of Net Asset Value." Dividends and distributions will be
reinvested automatically in shares of the Fund at net asset value without a
sales charge. However, a shareholder whose account is maintained at the
Transfer Agent or whose account is maintained through Merrill Lynch may elect
in writing to receive any such dividends or distributions, or both, in cash
(provided that, in the event that a payment on an account maintained at the
Transfer Agent would amount to $10.00 or less, a shareholder will not receive
such payment in cash and such payment will automatically be reinvested in
additional shares). Dividends and distributions are taxable to shareholders as
described below whether they are reinvested in shares of the Fund or received
in cash. From time to time, the Fund may declare a special distribution at or
about the end of the calendar year in order to comply with Federal tax
requirements that certain percentages of its ordinary income and capital gains
be distributed during the year.
Gains or losses attributable to foreign currency gains or losses from
certain of the Fund's investments may increase or decrease the amount of the
Fund's income available for distribution to shareholders. If such losses exceed
other income during a taxable year, (a) the Fund would not be able to make any
ordinary income dividend distributions, and (b) all or a portion of
distributions made before the losses were realized would be recharacterized as
a return of capital to shareholders, rather than as an ordinary income
dividend, thereby reducing each shareholder's tax basis in Fund shares for
Federal income tax purposes. For a detailed discussion of the Federal tax
considerations relevant to foreign currency transactions, see "Additional
Information -- Taxes." If in any fiscal year, the Fund has net income from
certain foreign currency transactions, such income will be distributed
annually.
42
<PAGE>
See "Shareholder Services -- Automatic Reinvestment of Dividends and
Distributions" for information as to how to elect either dividend reinvestment
or cash payments.
DETERMINATION OF NET ASSET VALUE
Net asset value per share for all classes of the Fund is determined by the
Manager once daily as of 15 minutes after the close of business on the NYSE
(generally, the NYSE closes at 4:00 p.m., Eastern time) on each day during
which the NYSE is open for trading.
The net asset value is computed by dividing the sum of the market values of
the securities held by the Fund plus any cash or other assets (including
interest and dividends accrued but not yet received) minus all liabilities
(including accrued expenses) by the total number of shares outstanding at such
time, rounded to the nearest cent. Expenses, including the management fee
payable to the Manager and any account maintenance and/or distribution fees
payable to the Distributor, are accrued daily. The Fund employs Merrill Lynch
Securities Pricing(SM) Service ("MLSPS"), an affiliate of the Manager, to
provide certain securities prices for the Fund. During the fiscal year ended
June 30, 1998, the Fund did not pay MLSPS a fee for such service. The per share
net asset value of Class A shares generally will be higher than the per share
net asset value of shares of the other classes, reflecting the daily expense
accruals of the account maintenance, distribution and higher transfer agency
fees applicable with respect to Class B and Class C shares and the daily expense
accruals of the account maintenance fees applicable with respect to Class D
shares; in addition, the per share net asset value of Class D shares generally
will be higher than the per share net asset value of Class B and Class C shares,
reflecting the daily expense accruals of the distribution and higher transfer
agency fees applicable with respect to Class B and Class C shares. It is
expected, however, that the per share net asset value of the classes will tend
to converge (although not necessarily meet) immediately after the payment of
dividends or distributions, which will differ by approximately the amount of
the expense accrual differentials between the classes.
Portfolio securities that are traded on stock exchanges are valued at the
last sale price (regular way) on the exchange on which such securities are
traded, as of the close of business on the day the securities are being valued
or, lacking any sales, at the last available bid price for long positions and
at the last available ask price for short positions. In cases where securities
are traded on more than one exchange, the securities are valued on the exchange
designated by or under the authority of the Board of Directors as the primary
market. Long positions in securities traded in the OTC market are valued at the
last available bid price in the OTC market prior to the time of valuation.
Short positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation.
Securities which are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. When the Fund
writes an option, the amount of the premium received is recorded on the books
of the Fund as an asset and an equivalent liability. The amount of the
liability is subsequently valued to reflect the current market value of the
option written, based upon the last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last asked
price. Options purchased by the Fund are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Any assets or liabilities expressed in terms of
foreign currencies are translated into U.S. dollars at the prevailing market
rates as obtained from one or more dealers. Other investments, including
futures contracts and related options, are stated at market value. Securities
and assets for which market quotations are not readily available are valued at
fair value as determined in good faith by or under the direction of the Board
of Directors of the Fund.
43
<PAGE>
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Code. As long as it
so qualifies, the Fund (but not its shareholders) will not be subject to
Federal income tax on the part of its net ordinary income and net realized
capital gains which it distributes to Class A, Class B, Class C and Class D
shareholders (together, the "shareholders"). The Fund intends to distribute
substantially all of such income.
Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in futures and options) ("capital gain
dividends") are taxable to shareholders as long-term capital gains, regardless
of the length of time the shareholder has owned Fund shares. Any loss upon the
sale or exchange of Fund shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain dividends received by
the shareholder. Distributions in excess of the Fund's earnings and profits
will first reduce the adjusted tax basis of a holder's shares, and after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Recent legislation
created additional categories of capital gains taxable at different rates.
Additional legislation eliminates the highest 28% category for most sales of
capital assets occurring after December 31, 1997. Generally not later than 60
days after the close of its taxable year, the Fund will provide its
shareholders with a written notice designating the amounts of any ordinary
income dividends or capital gain dividends, as well as the amount of capital
gain dividends in the different categories of capital gain referred to above.
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Distributions by the Fund, whether from ordinary
income or capital gains, generally will not be eligible for the dividends
received deduction allowed to corporations under the Code. If the Fund pays a
dividend in January which was declared in the previous October, November or
December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% U.S. withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the U.S. withholding
tax.
Dividends and interest received by the Fund may give rise to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the U.S. may reduce or eliminate such taxes. Shareholders may be
able to claim U.S. foreign tax credits with respect to such taxes, subject to
certain conditions and limitations contained in the Code. For example, certain
retirement accounts cannot claim foreign tax credits on investments in foreign
securities held in the Fund. In addition, recent legislation permits a foreign
tax credit to be claimed with respect to withholding tax on a dividend from the
Fund only if the shareholder meets certain holding period requirements. The
Fund also must meet these holding period requirements, and if the Fund fails to
do so, it will not be able to "pass through" to shareholders the ability to
claim a credit or a deduction for the related foreign taxes paid by the Fund.
If the Fund satisfies the holding period requirements and more than 50% in
value of the Fund's total assets at the close of its taxable year consists of
securities of foreign corporations, the Fund will be eligible, and intends, to
file an election with the Internal Revenue Service pursuant to which
shareholders of the Fund will be required to include their proportionate shares
of such withholding taxes in their U.S. income tax
44
<PAGE>
returns as gross income, treat such proportionate shares as taxes paid by them,
and deduct such proportionate shares in computing their taxable incomes or,
alternatively, use them as foreign tax credits against their U.S. income taxes.
No deductions for foreign taxes, moreover, may be claimed by noncorporate
shareholders who do not itemize deductions. A shareholder that is a nonresident
alien individual or a foreign corporation may be subject to U.S. withholding tax
on the income resulting from the Fund's election described in this paragraph but
may not be able to claim a credit or deduction against such U.S. tax for the
foreign taxes treated as having been paid by such shareholder. The Fund will
report annually to its shareholders the amount per share of such withholding
taxes and other information needed to claim the foreign tax credit.
Under certain provisions of the Code, some shareholders may be subject to
a 31% withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that such investor is
not otherwise subject to backup withholding.
The Fund may invest up to 10% of its total assets in securities of
closed-end investment companies. If the Fund purchases shares of an investment
company (or similar investment entity) organized under foreign law, the Fund
will be treated as owning shares in a passive foreign investment company
("PFIC") for U.S. Federal income tax purposes. The Fund may be subject to U.S.
Federal income tax, and an additional tax in the nature of interest (the
"interest charge"), on a portion of the distributions from such a company and on
gain from the disposition of the shares of such a company (collectively referred
to as "excess distributions"), even if such excess distributions are paid by the
Fund as a dividend to its shareholders. The Fund may be eligible to make an
election with respect to certain PFICs in which it owns shares that will allow
it to avoid the taxes on excess distributions. However, such election may cause
the Fund to recognize income in a particular year in excess of the distributions
received from such PFICs. Alternatively, under recent legislation the Fund could
elect to "mark to market" at the end of each taxable year all shares that it
holds in PFICs. If it made this election, the Fund would recognize as ordinary
income any increase in the value of such shares over their adjusted basis and as
ordinary loss any decrease in such value to the extent it did not exceed prior
increases. By making the mark-to-market election, the Fund could avoid
imposition of the interest charge with respect to its distributions from PFICs,
but in any particular year might be required to recognize income in excess of
the distributions it received from PFICs and its proceeds from dispositions of
PFIC stock.
Under Code Section 988, foreign currency gains or losses from certain debt
instruments, from certain forward contracts, from futures contracts that are
not "regulated futures contracts" and from unlisted options will generally be
treated as ordinary income or loss. Such Code Section 988 gains or losses will
generally increase or decrease the amount of the Fund's investment company
taxable income available to be distributed to shareholders as ordinary income.
Additionally, if Code Section 988 losses exceed other investment company
taxable income during a taxable year, the Fund would not be able to make any
ordinary income dividend distributions, and all or a portion of distributions
made before the losses were realized but in the same taxable year would be
recharacterized as a return of capital to shareholders, thereby reducing the
basis of each shareholder's Fund shares and resulting in a capital gain for any
shareholder who received a distribution greater than such shareholder's basis
in Fund shares (assuming the shares were held as a capital asset).
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis
in the Class D shares acquired will be the same as such shareholder's basis in
the Class B shares converted, and the holding period of the acquired Class D
shares will include the holding period for the converted Class B shares.
45
<PAGE>
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund on the exchanged shares reduces any sales charge the
shareholder would have owed upon purchase of the new shares in the absence of
the exchange privilege. Instead, such sales charge will be treated as an amount
paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state
and local taxes.
Certain states exempt from state income taxation dividends paid by RICs
which are derived from interest on U.S. Government obligations. State law
varies as to whether dividend income attributable to U.S. Government
obligations is exempt from state income tax.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors
should consider applicable foreign taxes in their evaluation of an investment
in the Fund.
ORGANIZATION OF THE FUND
The Fund was incorporated under Maryland law on April 14, 1989. As of the
date of this Prospectus, the Fund has an authorized capital of 400,000,000
shares of Common Stock, par value $0.10 per share, divided into four classes
designated Class A, Class B, Class C and Class D Common Stock, each of which
consists of 100,000,000 shares. Shares of Class A, Class B, Class C and Class D
Common Stock represent an interest in the same assets of the Fund and are
identical in all respects except that Class B, Class C and Class D shares bear
certain expenses relating to the account maintenance associated with such
shares, and Class B and Class C shares bear certain expenses relating to the
distribution of such shares. Each class has exclusive voting rights with
respect to matters relating to account maintenance and distribution
expenditures, as applicable. See "Purchase of Shares." The Directors of the
Fund may classify and reclassify the shares of the Fund into additional classes
of Common Stock at a future date.
Shareholders are entitled to one vote for each share held and fractional
votes for fractional shares held and will vote on the election of Directors and
any other matter submitted to a shareholder vote. The Fund does not intend to
hold meetings of shareholders in any year in which the Investment Company Act
does not require shareholders to act upon any of the following matters: (i)
election of Directors; (ii) approval of an investment advisory agreement; (iii)
approval of a distribution agreement; and (iv) ratification of selection of
independent accountants. Also, the by-laws of the Fund require that a special
meeting of stockholders be held upon the written request of at least 10% of the
outstanding shares of the Fund entitled to vote at such meeting if such request
is in compliance with applicable Maryland law. Voting rights for Directors are
not cumulative. Shares issued are fully paid and non-assessable and have no
preemptive rights. Shares have the conversion rights described in this
Prospectus. Each share of Common Stock is entitled to participate equally in
dividends and distributions declared
46
<PAGE>
by the Fund and in the net assets of the Fund on liquidation or dissolution
after satisfaction of outstanding liabilities, except that, as noted above, the
Class B, Class C and Class D shares bear certain additional expenses.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts, the shareholder should notify in writing:
Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, FL 32232-5289
The written notification should include the shareholder's name, address,
tax identification number and Merrill Lynch and/or mutual fund account numbers.
If you have any questions regarding this, please call your Merrill Lynch
Financial Consultant or Financial Data Services, Inc. at 1-800-637-3863.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Prospectus.
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the Year
1900 (commonly known as the "Year 2000 Problem"). Like other investment
companies and financial and business organizations, the Fund could be adversely
affected if the computer systems used by the Manager or other Fund service
providers do not properly address this problem prior to January 1, 2000. The
Manager has established a dedicated group to analyze these issues and to
implement any systems modifications necessary to prepare for the Year 2000.
Currently, the Manager does not anticipate that the transition to the Year 2000
will have any material impact on its ability to continue to service the Fund at
current levels. In addition, the Manager has sought assurances from the Fund's
other service providers that they are taking all necessary steps to ensure that
their computer systems will accurately reflect the Year 2000, and the Manager
will continue to monitor the situation. At this time, however, no assurance can
be given that the Fund's other service providers have anticipated every step
necessary to avoid any adverse effect on the Fund attributable to the Year 2000
Problem.
47
<PAGE>
[This page intentionally left blank.]
<PAGE>
[This page intentionally left blank.]
<PAGE>
[This page intentionally left blank.]
<PAGE>
MANAGER
Merrill Lynch Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor,
a division of Princeton Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540
COUNSEL
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN
OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE FUND, THE MANAGER OR THE DISTRIBUTOR. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING
MAY NOT LAWFULLY BE MADE.
----------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Fee Table .......................................... 2
Merrill Lynch Select Pricing(SM) System .............. 3
Consolidated Financial Highlights .................. 8
Risk Factors and Special Considerations ............ 11
Investment Objective and Policies .................. 15
Portfolio Strategies Involving Options and
Futures ....................................... 16
Other Investment Policies and Practices .......... 21
Investment Restrictions .......................... 24
Management of the Fund ............................. 25
Board of Directors ............................... 25
Management and Advisory Arrangements ............. 25
Code of Ethics ................................... 26
Transfer Agency Services ......................... 26
Purchase of Shares ................................. 27
Initial Sales Charge Alternatives -- Class A
and Class D Shares ............................ 29
Deferred Sales Charge Alternatives -- Class B
and Class C Shares ............................ 31
Distribution Plans ............................... 34
Limitations on the Payment of Deferred Sales
Charges ....................................... 35
Redemption of Shares ............................... 36
Redemption ....................................... 36
Repurchase ....................................... 36
Reinstatement Privilege -- Class A and
Class D Shares ................................ 37
Shareholder Services ............................... 37
Investment Account ............................... 37
Exchange Privilege ............................... 38
Automatic Reinvestment of Dividends and Capital
Gains Distributions ........................... 40
Systematic Withdrawal Plans ...................... 40
Automatic Investment Plans ....................... 40
Fee-Based Programs ............................... 40
Performance Data ................................... 41
Additional Information ............................. 42
Dividends and Distributions ...................... 42
Determination of Net Asset Value ................. 43
Taxes ............................................ 44
Organization of the Fund ......................... 46
Shareholder Reports .............................. 47
Shareholder Inquiries ............................ 47
Year 2000 Issues ................................. 47
</TABLE>
Code # 10893-1098
(MERRILL LYNCH logo appears here)
MERRILL LYNCH
DEVELOPING CAPITAL
MARKETS FUND, INC.
(compass appears here)
PROSPECTUS
October 28, 1998
Distributor:
Merrill Lynch
Funds Distribution
This Prospectus should be
retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
Merrill Lynch Developing Capital Markets Fund, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 - Phone No. (609) 282-2800
----------------
Merrill Lynch Developing Capital Markets Fund, Inc. (the "Fund") is a
non-diversified, open-end management investment company that seeks long-term
capital appreciation by investing in securities, principally equities, of
issuers in countries having smaller capital markets. This objective of the Fund
reflects the belief that investment opportunities may result from an evolving
long-term international trend favoring more market-oriented economies, a trend
that may especially benefit certain countries having smaller capital markets.
The Fund may employ a variety of instruments and techniques to hedge against
market and currency risk.
----------------
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of
time the investor expects to hold the shares and other relevant circumstances.
----------------
This Statement of Additional Information of the Fund is not a prospectus
and should be read in conjunction with the prospectus of the Fund, dated
October 28, 1998 (the "Prospectus"), which has been filed with the Securities
and Exchange Commission (the "Commission") and can be obtained, without charge,
by calling or by writing the Fund at the above telephone number or address.
This Statement of Additional Information has been incorporated by reference
into the Prospectus.
----------------
Merrill Lynch Asset Management -- Manager
Merrill Lynch Funds Distributor -- Distributor
----------------
The date of this Statement of Additional Information is October 28, 1998.
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek long-term capital
appreciation by investing in securities, principally equities, of issuers in
countries having smaller capital markets. Reference is made to "Investment
Objective and Policies" in the Prospectus for a discussion of the investment
objective and policies of the Fund.
While it is the policy of the Fund generally not to engage in trading for
short-term gains, Merrill Lynch Asset Management, L.P. (the "Manager"), will
effect portfolio transactions without regard to holding period, if, in its
judgment, such transactions are advisable in light of a change in circumstances
of a particular company or within a particular industry or due to general
market, economic or financial conditions. The portfolio turnover rate is
calculated by dividing the lesser of the Fund's annual sales or purchases of
portfolio securities (exclusive of purchases or sales of U.S. Government
securities and of all other securities whose maturities at the time of
acquisition were one year or less) by the monthly average value of securities
in the portfolio during the year. For the fiscal years ended June 30, 1997 and
1998, the Fund's portfolio turnover rates were 86.68% and 98.16%, respectively.
The U.S. Government has from time to time in the past imposed
restrictions, through taxation and otherwise, on foreign investments by U.S.
investors such as the Fund. If such restrictions should be reinstituted, it
might become necessary for the Fund to invest all or substantially all of its
assets in U.S. securities. In such event, the Fund would review its investment
objective and investment policies to determine whether changes are appropriate.
Any changes in the investment objective or fundamental policies set forth under
"Investment Restrictions" below would require the approval of the holders of a
majority of the Fund's outstanding voting securities.
The Fund's ability and decisions to purchase or sell portfolio securities
may be affected by laws or regulations relating to the convertibility and
repatriation of assets. Because the shares of the Fund are redeemable on a
daily basis on each day the Fund determines its net asset value in U.S.
dollars, the Fund intends to manage its portfolio so as to give reasonable
assurance that it will be able to obtain U.S. dollars to the extent necessary
to meet anticipated redemptions. See "Redemption of Shares." Under present
conditions, the Manager does not believe that these considerations will have
any significant effect on its portfolio strategy, although there can be no
assurance in this regard.
PORTFOLIO STRATEGIES INVOLVING OPTIONS AND FUTURES
Reference is made to the discussion under the caption "Investment
Objective and Policies -- Portfolio Strategies Involving Options and Futures"
in the Prospectus for information with respect to various portfolio strategies
involving options and futures. The Fund may seek to hedge its portfolio against
movements in the equity, debt and currency markets. The Fund has authority to
write (I.E., sell) covered put and call options on its portfolio securities,
purchase put and call options on securities and engage in transactions in stock
index options, stock index futures and stock futures and financial futures, and
related options on such futures. The Fund may also deal in forward foreign
exchange transactions, foreign currency options and futures and related options
on such futures. Each of such portfolio strategies is described in the
Prospectus. Although certain risks are involved in options and futures
transactions (as discussed in the Prospectus and below), the Manager believes
that, because the Fund will engage in options and futures transactions only for
hedging purposes, the options and futures portfolio strategies of the Fund will
not subject the Fund to the risks frequently associated with the speculative
use of options and futures transactions. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of its
shares, the net asset value of the Fund's shares will fluctuate. There can be
no assurance that the Fund's hedging transactions will be effective. The
following is further information relating to portfolio strategies involving
options and futures the Fund may utilize.
2
<PAGE>
WRITING COVERED OPTIONS. The Fund is authorized to write (I.E., sell)
covered call options on the securities in which it may invest and to enter into
closing purchase transactions with respect to certain of such options. A
covered call option is an option where the Fund, in return for a premium, gives
another party a right to buy specified securities owned by the Fund on or
before a specified future date and at a specified price set at the time of the
contract. The principal reason for writing call options is to attempt to
realize, through the receipt of premiums, a greater return than would be
realized on the securities alone. By writing covered call options, the Fund
gives up the opportunity, while the option is in effect, to profit from any
price increase in the underlying security above the option exercise price. In
addition, the Fund's ability to sell the underlying security will be limited
while the option is in effect unless the Fund effects a closing purchase
transaction. A closing purchase transaction cancels out the Fund's position as
the writer of an option by means of an offsetting purchase of an identical
option prior to the expiration of the option it has written. Covered call
options serve as a particular hedge against the price of the underlying
security declining.
The writer of a covered call option has no control over when he or she may
be required to sell his or her securities since he or she may be assigned an
exercise notice at any time prior to the termination of his or her obligation
as a writer. If an option expires unexercised, the writer realizes a gain in
the amount of the premium. Such a gain, of course, may be offset by a decline
in the market value of the underlying security during the option period. If a
call option is exercised, the writer realizes a gain or loss from the sale of
the underlying security.
The Fund also may write put options which give the holder of the option
the right to sell the underlying security to the Fund at the stated exercise
price. The Fund will receive a premium for writing a put option which increases
the Fund's return. The Fund writes only covered put options which means that so
long as the Fund is obligated as the writer of the option, it will, through its
custodian, have deposited and maintained cash, cash equivalents, U.S.
Government securities or other liquid securities denominated in U.S. dollars or
non-U.S. currencies with a securities depository with a value equal to or
greater than the exercise price of the underlying securities. By writing a put,
the Fund will be obligated to purchase the underlying security at a price that
may be higher than the market value of that security at the time of exercise
for as long as the option is outstanding. The Fund may engage in closing
transactions in order to terminate put options that it has written. The Fund
will not write put options if the aggregate value of the obligations underlying
the put options shall exceed 50% of the Fund's net assets.
Options referred to herein and in the Fund's Prospectus may be options
traded on foreign securities exchanges such as the Amsterdam Stock Exchange,
the Stock Exchange of Singapore or the Sydney Stock Exchange. An option
position may be closed out only on an exchange which provides a secondary
market for an option of the same series. If a secondary market does not exist,
it might not be possible to effect closing transactions in particular options,
with the result, in the case of a covered call option, that the Fund will not
be able to sell the underlying security until the option expires or it delivers
the underlying security upon exercise. Reasons for the absence of a liquid
secondary market on an exchange include the following: (i) there may be
insufficient trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing transactions or both;
(iii) trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options or underlying securities;
(iv) unusual or unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or the clearing corporation may not
at all times be adequate to handle current trading volume; or (vi) one or more
exchanges could, for economic or other reasons, decide or be compelled at some
future date to discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that exchange (or in
that class or series of options) would cease to exist,
3
<PAGE>
although outstanding options on that exchange that had been issued by the
clearing corporation as a result of trades on that exchange would continue to
be exercisable in accordance with their terms.
The Fund may also enter into over-the-counter options transactions ("OTC
options"), which are two party contracts with price and terms negotiated
between the buyer and seller. The Fund will only enter into OTC options
transactions with respect to portfolio securities for which management believes
the Fund can receive on each business day at least two independent bids or
offers (one of which will be from an entity other than a party to the option).
The staff of the Commission has taken the position that OTC options and the
assets used as cover for written OTC options are illiquid securities.
PURCHASING OPTIONS. The Fund is authorized to purchase put options to
hedge against a decline in the market value of its securities. By buying a put,
the Fund has a right to sell the underlying security at the exercise price,
thus limiting the Fund's risk of loss through a decline in the market value of
the security until the put option expires. The amount of any appreciation in
the value of the underlying security will be partially offset by the amount of
the premium paid for the put option and any related transaction costs. Prior to
its expiration, a put option may be sold in a closing sale transaction and
profit or loss from the sale will depend on whether the amount received is more
or less than the premium paid for the put option plus the related transaction
costs. A closing sale transaction cancels out the Fund's position as the
purchaser of an option by means of an offsetting sale of an identical option
prior to the expiration of the option it has purchased. In certain
circumstances, the Fund may purchase call options on securities held in its
portfolio on which it has written call options or on securities which it
intends to purchase. The Fund may purchase either exchange-traded options or
OTC options. The Fund will not purchase options on securities (including stock
index options discussed below) if as a result of such purchase, the aggregate
cost of all outstanding options on securities held by the Fund would exceed 5%
of the market value of the Fund's total assets.
STOCK INDEX OPTIONS AND FUTURES AND FINANCIAL FUTURES. As described in the
Prospectus, the Fund is authorized to engage in transactions in stock index
options and futures and financial futures and related options on such futures.
Set forth below is further information concerning futures transactions.
A futures contract is an agreement between two parties to buy and sell a
security or, in the case of an index-based futures contract, to make and accept
a cash settlement for a set price on a future date. A majority of transactions
in futures contracts, however, do not result in the actual delivery of the
underlying instrument or cash settlement, but are settled through liquidation,
I.E., by entering into an offsetting transaction.
The purchase or sale of a futures contract differs from the purchase or
sale of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is typically between 2% and 15% of the value of the
futures contract, must be deposited with the broker. This amount is known as
"initial margin" and represents a "good faith" deposit assuring the performance
of both the purchaser and seller under the futures contract. Subsequent
payments to and from the broker, called "variation margin," are required to be
made on a daily basis as the price of the futures contract fluctuates, making
the long and short positions in the futures contract more or less valuable, a
process known as "marking to the market." At any time prior to the settlement
date of the futures contract, the position may be closed out by taking an
opposite position which will operate to terminate the position in the futures
contract. A final determination of variation margin is then made, additional
cash is required to be paid to or released by the broker, and the purchaser
realizes a loss or gain. In addition, a nominal commission is paid on each
completed sale transaction.
4
<PAGE>
An order has been obtained from the Commission exempting the Fund from the
provisions of Section 17(f) and Section 18(f) of the Investment Company Act of
1940, as amended (the "Investment Company Act"), in connection with its
strategy of investing in futures contracts. Section 17(f) relates to the
custody of securities and other assets of an investment company and may be
deemed to prohibit certain arrangements between the Fund and commodities
brokers with respect to initial and variation margin. Section 18(f) of the
Investment Company Act prohibits an open-end investment company such as the
Fund from issuing a "senior security" other than a borrowing from a bank. The
staff of the Commission has in the past indicated that a futures contract may
be a "senior security" under the Investment Company Act.
FOREIGN CURRENCY HEDGING. Generally, the foreign exchange transactions of
the Fund will be conducted on a spot, I.E., cash basis at the spot rate for
purchasing or selling currency prevailing in the foreign exchange market. This
rate under normal market conditions differs from the prevailing exchange rate
in an amount generally less than one tenth of one percent due to the costs of
converting from one currency to another. The Fund has authority, however, to
deal in forward foreign exchange among currencies of the different countries in
which it will invest as a hedge against possible variations in the foreign
exchange rates among these currencies. This is accomplished through contractual
agreements to purchase or sell a specified currency at a specified future date
and price set at the time of the contract. The Fund's dealings in forward
foreign exchange will be limited to hedging involving either specific
transactions or portfolio positions. Transaction hedging is the purchase or
sale of forward foreign currency with respect to specific receivables or
payables of the Fund accruing in connection with the purchase and sale of its
portfolio securities, the sale and redemption of shares of the Fund or the
payment of dividends and distributions by the Fund. Position hedging is the
sale of forward foreign currency with respect to portfolio security positions
denominated or quoted in such foreign currency. The Fund will not speculate in
forward foreign exchange. The Fund may not position hedge with respect to the
currency of a particular country to an extent greater than the aggregate market
value (at the time of making such sale) of the securities held in its portfolio
denominated or quoted in that particular foreign currency. If the Fund enters
into a position hedging transaction, its custodian bank will place cash or
liquid securities in a separate account of the Fund in an amount equal to the
value of the Fund's total assets committed to the consummation of such forward
contract. If the value of the securities placed in the separate account
declines, additional cash or securities will be placed in the account so that
the value of the account will equal the amount of the Fund's commitment with
respect to such contracts. The Fund will not enter into a forward contract with
a term of more than one year.
The Fund is also authorized to purchase or sell listed or over-the-counter
("OTC") foreign currency options, foreign currency futures and related options
on foreign currency futures as a short or long hedge against possible
variations in foreign exchange rates. Such transactions may be effected with
respect to hedges on non-U.S. dollar denominated securities owned by the Fund,
sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund. As an illustration, the Fund may use such techniques to
hedge the stated value in U.S. dollars of an investment in a franc denominated
security. In such circumstances, for example, the Fund may purchase a foreign
currency put option enabling it to sell a specified amount of francs for
dollars at a specified price by a future date. To the extent the hedge is
successful, a loss in the value of the francs relative to the dollar will tend
to be offset by an increase in the value of the put option. To offset, in whole
or part, the cost of acquiring such a put option, the Fund may also sell a call
option which, if exercised, requires it to sell a specified amount of francs
for dollars at a specified price by a future date (a technique called a
"straddle"). By selling such call option in this illustration, the Fund gives
up the opportunity to profit without limit from increases in the relative value
of the franc to the dollar. The Manager believes that "straddles" of the type
which may be utilized by the Fund constitute hedging transactions and are
consistent with the policies described above.
5
<PAGE>
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the
currency at a price above the devaluation level it anticipates. The cost to the
Fund of engaging in foreign currency transactions varies with such factors as
the currencies involved, the length of the contract period and the market
conditions then prevailing. Since transactions in foreign currency exchange
usually are conducted on a principal basis, no fees or commissions are
involved.
RISK FACTORS IN OPTIONS AND FUTURES TRANSACTIONS. Utilization of options
and futures transactions involves the risk of imperfect correlation in
movements in the prices of options and futures contracts and movements in the
prices of the securities or currencies which are the subject of the hedge. If
the prices of the options and futures contract move more or less than the
prices of the hedged securities or currencies, the Fund will experience a gain
or loss which will not be completely offset by movements in the prices of the
securities or currencies which are the subject of the hedge. The successful use
of options and futures also depends on the Manager's ability to correctly
predict price movements in the market involved in a particular options or
futures transaction.
Prior to exercise or expiration, an exchange-traded option or futures
position can only be terminated by entering into a closing purchase or sale
transaction. This requires a secondary market on an exchange for call or put
options of the same series. The Fund will enter into an option or futures
transaction on an exchange only if there appears to be a liquid secondary
market for such options or futures. As a result, it is expected that the Fund
will enter into exchange traded options and futures transactions only in the
relatively mature smaller capital markets such as Australia, Hong Kong or
Sweden, which have liquid secondary markets for such instruments. However,
there can be no assurance that a liquid secondary market will exist for any
particular call or put option or futures contract at any specific time. Thus,
it may not be possible to close an option or futures position. The Fund will
acquire only OTC options for which management believes the Fund can receive on
each business day at least two independent bids or offers (one of which will be
from an entity other than a party to the option) or which can be sold at a
formula price provided for in the OTC option agreement. In the case of a
futures position or an option on a futures position written by the Fund in the
event of adverse price movements, the Fund would continue to be required to
make daily cash payments of variation margin. In such situations, if the Fund
has insufficient cash, it may have 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 take or make delivery of the
securities and currencies underlying futures contracts it holds. The inability
to close options and futures positions also could have an adverse impact on the
Fund's ability to hedge its portfolio effectively. There is also the risk of
loss by the Fund of margin deposits in the event of bankruptcy of a broker with
whom the Fund has an open position in a futures contract or related option. The
risk of loss from investing in futures transactions is theoretically unlimited.
The exchanges on which the Fund intends to conduct options transactions
generally have established limitations governing the maximum number of call or
put options on the same underlying security or currency (whether or not
covered) which may be written by a single investor, whether acting alone or in
concert with others (regardless of whether such options are written on the same
or different exchanges or are held or written on one or more accounts or
through one or more brokers). "Trading limits" are imposed on the maximum
number of contracts which any person may trade on a particular trading day. An
exchange may order the liquidation of positions found to be in violation of
these limits, and it may impose other sanctions or restrictions. The Manager
does not believe that these trading and position limits will have any adverse
impact on the portfolio strategies for hedging the Fund's portfolio.
6
<PAGE>
OTHER INVESTMENT POLICIES AND PRACTICES
NON-DIVERSIFIED STATUS. The Fund is classified as non-diversified within
the meaning of the Investment Company Act, which means that the Fund is not
limited by such Act in the proportion of its assets that it may invest in
securities of a single issuer. The Fund's investments will be limited, however,
in order to qualify for the special tax treatment afforded regulated investment
companies ("RICs") under the Internal Revenue Code of 1986, as amended (the
"Code"). See "Dividends, Distributions and Taxes -- Taxes." To qualify, the
Fund will comply with certain requirements, including limiting its investments
so that at the close of each quarter of the taxable year (i) not more than 25%
of the market value of the Fund's total assets will be invested in the
securities of a single issuer, and (ii) with respect to 50% of the market value
of its total assets, not more than 5% of the market value of its total assets
will be invested in the securities of a single issuer, and the Fund will not
own more than 10% of the outstanding voting securities of a single issuer. A
fund which elects to be classified as "diversified" under the Investment
Company Act must satisfy the foregoing 5% and 10% requirements with respect to
75% of its total assets. To the extent that the Fund assumes large positions in
the securities of a small number of issuers, the Fund's net asset value may
fluctuate to a greater extent than that of a diversified investment company as
a result of changes in the financial condition or in the market's assessment of
the issuers, and the Fund may be more susceptible to any single economic,
political or regulatory occurrence than a diversified company.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS. The Fund may
purchase securities on a when-issued basis, and it may purchase or sell
securities for delayed delivery. These transactions occur when securities are
purchased or sold by the Fund with payment and delivery taking place in the
future to secure what is considered an advantageous yield and price to the Fund
at the time of entering into the transaction. Although the Fund has not
established any limit on the percentage of its assets that may be committed in
connection with such transactions, the Fund will maintain a segregated account
with its custodian of cash, cash equivalents, U.S. Government securities or
other liquid securities denominated in U.S. dollars or non-U.S. currencies in
an aggregate amount equal to the amount of its commitment in connection with
such purchase transactions.
STANDBY COMMITMENT AGREEMENTS. The Fund may from time to time enter into
standby commitment agreements. Such agreements commit the Fund, for a stated
period of time, to purchase a stated amount of a fixed income security or a
stated number of shares of equity securities which may be issued and sold to
the Fund at the option of the issuer. The price and coupon of the security is
fixed at the time of the commitment. At the time of entering into the agreement
the Fund is paid a commitment fee, regardless of whether or not the security is
ultimately issued, which is typically approximately 0.5% of the aggregate
purchase price of the security that the Fund has committed to purchase. The
Fund will enter into such agreements only for the purpose of investing in the
security underlying the commitment at a yield and price that is considered
advantageous to the Fund. The Fund will not enter into a standby commitment
with a remaining term in excess of 45 days and will limit its investment in
such commitments so that the aggregate purchase price of the securities subject
to such commitments, together with the value of portfolio securities subject to
legal restrictions on resale, will not exceed 15% of its total assets taken at
the time of acquisition of such commitment or security. The Fund will at all
times maintain a segregated account with its custodian of cash, cash
equivalents, U.S. Government securities or other liquid securities denominated
in U.S. dollars or non-U.S. currencies in an aggregate amount equal to the
purchase price of the securities underlying the commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued, and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Because the issuance
of the security underlying the commitment is at the option of the issuer, the
Fund may bear the risk of a decline in the value of such security and may not
benefit from an appreciation in the value of the security during the commitment
period.
7
<PAGE>
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued, and the value of the security will
thereafter be reflected in the calculation of the Fund's net asset value. The
cost basis of the security will be adjusted by the amount of the commitment
fee. In the event the security is not issued, the commitment fee will be
recorded as income on the expiration date of the standby commitment.
REPURCHASE AGREEMENTS AND PURCHASE AND SALE CONTRACTS. The Fund may invest
in securities pursuant to repurchase agreements and purchase and sale
contracts. Repurchase agreements may be entered into only with financial
institutions which (i) have, in the opinion of the Manager, substantial capital
relative to the Fund's exposure, or (ii) have provided the Fund with a
third-party guaranty or other credit enhancement. Under a repurchase agreement
or a purchase and sale contract, the counterparty agrees, upon entering into
the contract, to repurchase the security at a mutually agreed upon time and
price in a specified currency, thereby determining the yield during the term of
the agreement. This results in a fixed rate of return insulated from market
fluctuations during such period although it may be affected by currency
fluctuations. Such agreements usually cover short periods, such as under one
week. Repurchase agreements may be construed to be collateralized loans by the
purchaser to the seller secured by the securities transferred to the purchaser.
In the case of a repurchase agreement, as a purchaser, the Fund will require
the seller to provide additional collateral if the market value of the
securities falls below the repurchase price at any time during the term of the
repurchase agreement; the Fund does not have the right to seek additional
collateral in the case of purchase and sale contracts. In the event of default
by the seller under a repurchase agreement construed to be a collateralized
loan, the underlying securities are not owned by the Fund but constitute only
collateral for the seller's obligation to pay the repurchase price. Therefore,
the Fund may suffer time delays and incur costs or possible losses in
connection with the disposition of the collateral. In the event of a default
under such a repurchase agreement or under a purchase and sale contract,
instead of the contractual fixed rate of return, the rate of return to the Fund
shall be dependent upon intervening fluctuations of the market value of such
securities and the accrued interest on the securities. In such event, the Fund
would have rights against the seller for breach of contract with respect to any
losses arising from market fluctuations following the failure of the seller to
perform.
LENDING OF PORTFOLIO SECURITIES. Subject to the investment restrictions
stated below, the Fund may lend securities from its portfolio to approved
borrowers and receive collateral therefor in cash or securities issued or
guaranteed by the U.S. Government which are maintained at all times in an
amount equal to at least 100% of the current market value of the loaned
securities. The purpose of such loans is to permit the borrower to use such
securities for delivery to purchasers when such borrower has sold short. If
cash collateral is received by the Fund, it is invested in short-term money
market securities, and a portion of the yield received in respect of such
investment is retained by the Fund. Alternatively, if securities are delivered
to the Fund as collateral, the Fund and the borrower negotiate a rate for the
loan premium to be received by the Fund for lending its portfolio securities.
In either event, the total yield on the Fund's portfolio is increased by loans
of its portfolio securities. The Fund will have the right to regain record
ownership of loaned securities to exercise beneficial rights such as voting
rights, subscription rights and rights to dividends, interest or other
distributions. Such loans are terminable at any time, and the borrower, after
notice, will be required to return borrowed securities within five business
days. The Fund may pay reasonable finder's, administrative and custodial fees
in connection with such loans. With respect to the lending of portfolio
securities, there is the risk of failure by the borrower to return the
securities involved in such transactions.
NO RATING CRITERIA FOR DEBT SECURITIES. The Fund has established no rating
criteria for the debt securities in which it may invest. Therefore, the Fund
may invest in debt securities either (a) which are rated in one of the top four
rating categories by a nationally recognized rating organization or which, in
the Manager's judgment,
8
<PAGE>
possess similar credit characteristics ("investment grade securities") or (b)
which are rated below the top four rating categories or which, in the Manager's
judgment, possess similar credit characteristics ("high yield securities"). The
Manager considers ratings as one of several factors in its independent credit
analysis of issuers.
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if
such issuers are highly leveraged. During such periods, such issuers may not
have sufficient revenues to meet their interest payment obligations. The
issuer's ability to service its debt obligations also may be adversely affected
by specific issuer developments or the issuer's inability to meet specific
projected business forecasts or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield securities because such securities may be unsecured and
may be subordinated to other creditors of the issuer.
High yield securities frequently have call or redemption features which
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends
to shareholders.
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. The secondary
trading market for high yield securities is generally not as liquid as the
secondary market for higher rated securities. Reduced secondary market
liquidity may have an adverse impact on market price and the Fund's ability to
dispose of particular issues when necessary to meet the Fund's liquidity needs
or in response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent it is required to seek recovery upon a default on a portfolio
holding or participate in the restructuring of the obligation.
INVESTMENT RESTRICTIONS
In addition to the investment restrictions set forth in the Prospectus,
the Fund has adopted a number of fundamental and non-fundamental restrictions
and policies relating to the investment of its assets and its activities. The
fundamental policies set forth below may not be changed without the approval of
the holders of a majority of the Fund's outstanding voting securities (which
for this purpose and under the Investment Company Act means the lesser of (i)
67% of the shares represented at a meeting at which more than 50% of the
outstanding shares are represented or (ii) more than 50% of the outstanding
shares).
Under the fundamental investment restrictions, the Fund may not:
1. Invest more than 25% of its assets, taken at market value at the time
of each investment, in the securities of issuers in any particular industry
(excluding the U.S. Government and its agencies and instrumentalities).
9
<PAGE>
2. Make investments for the purpose of exercising control or management.
Investments by the Fund in wholly-owned investment entities created under
the laws of certain countries will not be deemed the making of investments
for the purpose of exercising control or management.
3. Purchase or sell real estate, except that, to the extent permitted by
applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may borrow up
to an additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (iv) the Fund
may purchase securities on margin to the extent permitted by applicable
law. The Fund may not pledge its assets other than to secure such
borrowings or, to the extent permitted by the Fund's investment policies as
set forth in its Prospectus and Statement of Additional Information, as
they may be amended from time to time, in connection with hedging
transactions, short sales, when-issued and forward commitment transactions
and similar investment strategies.
7. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act"), in selling portfolio securities.
8. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
In addition, the Fund has adopted non-fundamental restrictions which may be
changed by the Board of Directors. Under the non-fundamental investment
restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law. As a matter of
policy, however, the Fund will not purchase shares of any registered
open-end investment company or registered unit investment trust, in
reliance on Section 12(d)(1)(F) or (G) (the "fund of funds" provisions) of
the Investment Company Act, at any time its shares are owned by another
investment company that is part of the same group of investment companies
as the Fund.
b. Make short sales of securities or maintain a short position, except
to the extent permitted by applicable law. The Fund currently does not
intend to engage in short sales, except short sales "against the box."
10
<PAGE>
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Directors of the Fund has otherwise
determined to be liquid pursuant to applicable law. Securities purchased in
accordance with Rule 144A under the Securities Act and determined to be
liquid by the Fund's Board of Directors are not subject to the limitations
set forth in this investment restriction.
d. Notwithstanding fundamental investment restriction (6) above, borrow
amounts in excess of 20% of its total assets, taken at market value, and
then only from banks as a temporary measure for extraordinary or emergency
purposes, including to meet redemptions or to settle securities
transactions. In addition, the Fund will not purchase securities while
borrowings exceed 5% of its total assets, except (a) to honor prior
commitments or (b) to exercise subscription rights where outstanding
borrowings have been obtained exclusively for settlement of other
securities transactions.
The staff of the Commission has taken the position that purchased OTC
options and the assets used as cover for written OTC options are illiquid
securities. Therefore, the Fund has adopted an investment policy pursuant to
which it will not purchase or sell OTC options if, as a result of such
transaction, the sum of the market value of OTC options currently outstanding
which are held by the Fund, the market value of the underlying securities
covered by OTC call options currently outstanding which were sold by the Fund
and margin deposits on the Fund's existing OTC options on futures contracts
exceeds 15% of the total assets of the Fund, taken at market value, together
with all other assets of the Fund which are illiquid or are not otherwise
readily marketable. However, if the OTC option is sold by the Fund to a primary
U.S. Government securities dealer recognized by the Federal Reserve Bank of New
York and the Fund has the unconditional contractual right to repurchase such
OTC option from the dealer at a predetermined price, then the Fund will treat
as illiquid such amount of the underlying securities as is equal to the
repurchase price less the amount by which the option is "in-the-money" (I.E.,
current market value of the underlying securities minus the option's strike
price). The repurchase price with the primary dealers is typically a formula
price which is generally based on a multiple of the premium received for the
option, plus the amount by which the option is "in-the-money." This policy as
to OTC options is not a fundamental policy of the Fund and may be amended by
the Board of Directors of the Fund without the approval of the Fund's
shareholders. However, the Fund will not change or modify this policy prior to
the change or modification by the Commission staff of its position.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Manager, the Fund is prohibited from
engaging in certain transactions involving Merrill Lynch or its affiliates
except for brokerage transactions permitted under the Investment Company Act
involving only usual and customary commissions or transactions pursuant to an
exemptive order under the Investment Company Act. See "Portfolio Transactions
and Brokerage." Without such an exemptive order, the Fund is prohibited from
engaging in portfolio transactions with Merrill Lynch or any of its affiliates
acting as principal.
11
<PAGE>
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
Information about the Directors and executive officers of the Fund,
including their ages and their principal occupations for at least the last five
years, is set forth below. Unless otherwise noted, the address of each
executive officer and Director is P.O. Box 9011, Princeton, New Jersey
08543-9011.
ARTHUR ZEIKEL (66) -- PRESIDENT AND DIRECTOR(1)(2) -- Chairman of the
Manager and of Fund Asset Management, L.P. ("FAM") (which terms as used herein
include their corporate predecessors) since 1997; President of the Manager and
FAM from 1977 to 1997; Chairman of Princeton Services, Inc. ("Princeton
Services") since 1997 and Director thereof since 1993; President of Princeton
Services from 1993 to 1997; Executive Vice President of Merrill Lynch & Co.,
Inc. ("ML & Co.") since 1990.
DONALD CECIL (71) -- DIRECTOR(2) -- 1114 Avenue of the Americas, New York,
New York 10036. Special Limited Partner of Cumberland Associates (an investment
partnership) since 1982; Member of Institute of Chartered Financial Analysts;
Member and Chairman of Westchester County (N.Y.) Board of Transportation.
ROLAND M. MACHOLD (62) -- DIRECTOR(2) -- 1091 Princeton-Kingston Road,
Princeton, New Jersey 08540. Director of the State of New Jersey Division of
Investment from 1977 to 1998; Trustee of Bryn Mawr College since 1990 and of
Teacher's College, Columbia University since 1985; Co-Chair Emeritus and
Founding Director of the Council of Insitutional Investors; Member of the
Capital Formation and Regulatory Processes Advisory Committee of the Securities
and Exchange Commission from 1995 to 1996; Member of the Institutional Investor
Advisory Committee of the New York Stock Exchange from 1992 to 1995.
EDWARD H. MEYER (71) -- DIRECTOR(2) -- 777 Third Avenue, New York, New
York 10017. President of Grey Advertising Inc. since 1968, Chief Executive
Officer since 1970 and Chairman of the Board of Directors since 1972; Director
of The May Department Stores Company, Bowne & Co., Inc. (financial printers),
Ethan Allen Interiors Inc. and Harman International Industries, Inc.
CHARLES C. REILLY (67) -- DIRECTOR(2) -- 9 Hampton Harbor Road, Hampton
Bays, New York 11946. Self-employed financial consultant since 1990; President
and Chief Investment Officer of Verus Capital, Inc. from 1979 to 1990; Senior
Vice President of Arnhold and S. Bleichroeder, Inc. from 1973 to 1990; Adjunct
Professor, Columbia University Graduate School of Business from 1990 to 1991;
Adjunct Professor, Wharton School, University of Pennsylvania from 1989 to
1990; Partner, Small Cities Cable Television from 1986 to 1997.
RICHARD R. WEST (60) -- DIRECTOR(2) -- Box 604, Genoa, Nevada 89411.
Professor of Finance since 1984, Dean from 1984 to 1993, and currently Dean
Emeritus of New York University Leonard N. Stern School of Business
Administration; Director of Bowne & Co., Inc. (financial printers), Vornado
Realty Trust, Inc. (real estate holding company) and Alexander's, Inc. (real
estate company).
EDWARD D. ZINBARG (63) -- DIRECTOR(2) -- 5 Hardwell Road, Short Hills, New
Jersey 07078-2117. Executive Vice President of The Prudential Insurance Company
of America from 1988 to 1994; former Director of Prudential Reinsurance Company
and former Trustee of The Prudential Foundation.
TERRY K. GLENN (58) -- EXECUTIVE VICE PRESIDENT(1)(2) -- Executive Vice
President of the Manager and FAM since 1983; Executive Vice President and
Director of Princeton Services since 1993; President of Princeton Funds
Distributor, Inc. ("PFD") since 1986 and Director thereof since 1991; President
of Princeton Administrators, L.P. since 1988.
NORMAN R. HARVEY (65) -- SENIOR VICE PRESIDENT(1)(2) -- Senior Vice
President of the Manager and FAM since 1982; Senior Vice President of Princeton
Services since 1993.
12
<PAGE>
DONALD C. BURKE (38) -- VICE PRESIDENT(1)(2) -- First Vice President of
the Manager since 1997 and Director of Taxation thereof since 1990; Vice
President of the Manager from 1990 to 1997.
A. GRACE PINEDA (41) -- SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER(1)(2)
- -- First Vice President of the Manager since 1997; Vice President of the Manager
from 1989 to 1997 and Senior Portfolio Manager thereof since 1989.
GERALD M. RICHARD (49) -- TREASURER(1)(2) -- Senior Vice President and
Treasurer of the Manager and FAM since 1984; Senior Vice President and
Treasurer of Princeton Services since 1993; Vice President of PFD since 1981
and Treasurer thereof since 1984.
BARBARA G. FRASER (54) -- SECRETARY(1)(2) -- First Vice President of the
Manager since 1996; Vice President of the Manager from 1994 to 1996; attorney
in private practice from 1991 to 1994.
- --------
(1) Interested person, as defined in the Investment Company Act, of the Fund.
(2) Such Director or officer is a director, trustee or officer of one or more
additional investment companies for which the Manager or its affiliate,
FAM, acts as investment adviser or manager.
On September 30, 1998, the officers and Directors of the Fund as a group
(12 persons) owned an aggregate of less than 1% of the outstanding shares of the
Fund. At such date, Mr. Zeikel, a Director and officer of the Fund, and the
other officers of the Fund owned less than 1% of the outstanding shares of
common stock of ML & Co.
COMPENSATION OF DIRECTORS
The Fund pays each Director not affiliated with the Manager (each a
"non-affiliated Director") a fee of $3,500 per year plus $500 per Board meeting
attended, together with such Director's actual out-of-pocket expenses relating
to attendance at meetings. The Fund also compensates members of its Audit and
Nominating Committee (the "Committee"), which consists of all of the
non-affiliated Directors, at a rate of $500 per Committee meeting attended. The
Chairman of the Committee receives an additional fee of $250 per Committee
meeting attended. For the fiscal year ended June 30, 1998, fees and expenses
paid to non-affiliated Directors aggregated $36,543.
The following table sets forth the compensation earned by the
non-affiliated Directors from the Fund for the fiscal year ended June 30, 1998
and the aggregate compensation paid to the non-affiliated Directors from all
registered investment companies advised by the Manager and its affiliate, FAM
("MLAM/FAM Advised Funds") for the calendar year ended December 31, 1997.
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
FROM FUND AND
PENSION OR RETIREMENT OTHER MLAM/FAM
COMPENSATION BENEFITS ACCRUED AS ADVISED FUNDS PAID
NAME OF DIRECTOR FROM FUND PART OF FUND'S EXPENSES TO DIRECTORS(1)
- --------------------------- -------------- ------------------------- -------------------
<S> <C> <C> <C>
Donald Cecil .............. $8,500 None $275,850
Roland M. Machold (2)...... $ -- None $ --
Edward H. Meyer ........... $5,000 None $222,100
Charles C. Reilly ......... $7,500 None $313,000
Richard R. West ........... $7,500 None $299,000
Edward D. Zinbarg ......... $7,500 None $133,500
</TABLE>
- --------
(1) The Directors serve on the boards of MLAM/FAM Advised Funds as follows:
Mr. Cecil (34 registered investment companies consisting of 34 portfolios);
Mr. Machold (19 registered investment companies consisting of 19
portfolios); Mr. Meyer (34 registered investment companies consisting of 34
portfolios); Mr. Reilly (54 registered investment companies consisting of 67
portfolios); Mr. West (56 registered investment companies consisting of 81
portfolios); and Mr. Zinbarg (19 registered investment companies consisting
of 19 portfolios).
(2) Mr. Machold was elected a Director of the Fund and certain other MLAM/FAM
Advised Funds on October 21, 1998.
13
<PAGE>
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Fund -- Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or other investment advisory clients for which the
Manager or its affiliates act as an adviser. Because of different objectives
or other factors, a particular security may be bought for one or more clients
when one or more clients are selling the same security. If purchases or sales
of securities by the Manager for the Fund or other funds for which it acts as
investment adviser or for its other advisory clients arise for consideration at
or about the same time, transactions in such securities will be made, insofar
as feasible, for the respective funds and clients in a manner deemed equitable
to all. To the extent that transactions on behalf of more than one client of
the Manager or its affiliates during the same period may increase the demand
for securities being purchased or the supply of securities being sold, there
may be an adverse effect on price.
The Fund has entered into a management agreement with the Manager (the
"Management Agreement"). As discussed in the Prospectus, the Manager receives
for its services to the Fund monthly compensation at the annual rate of 1.00%
of the Fund's average daily net assets. For the fiscal years ended June 30,
1996, 1997 and 1998, the management fees paid by the Fund to the Manager
aggregated $6,265,747, $8,154,217 and $7,818,489, respectively.
As described in the Prospectus, the Manager has also entered into a
sub-advisory agreement with Merrill Lynch Asset Management U.K. Limited ("MLAM
U.K.") pursuant to which MLAM U.K. provides investment advisory services to the
Manager with respect to the Fund. For the fiscal years ended June 30, 1996,
1997 and 1998, no sub-advisory fees were paid by the Manager to MLAM U.K.
pursuant to such agreement.
The Management Agreement obligates the Manager to provide investment
advisory services and to pay all compensation of and furnish office space for
officers and employees of the Fund connected with investment and economic
research, trading and investment management of the Fund, as well as the fees of
all Directors of the Fund who are affiliated persons of the Manager. The Fund
pays all other expenses incurred in its operations, including, among other
things, taxes; expenses for legal and auditing services; costs of printing
proxies, stock certificates, shareholder reports and prospectuses and
statements of additional information (except to the extent paid by Merrill
Lynch Funds Distributor, a division of PFD (the "Distributor")); charges of the
custodian, any sub-custodian and transfer agent; expenses of redemption of
shares; Commission fees; expenses of registering the shares under Federal,
state or foreign laws; fees and expenses of unaffiliated Directors; accounting
and pricing costs (including the daily calculation of net asset value);
insurance; interest; brokerage costs; litigation and other extraordinary or
non-recurring expenses; and other expenses properly payable by the Fund.
Accounting services are provided to the Fund by the Manager, and the Fund
reimburses the Manager for its costs in connection with such services. For the
fiscal years ended June 30, 1996, 1997 and 1998, the amount of such
reimbursement was $168,938, $198,942 and $168,374, respectively. Certain
expenses in connection with the distribution of Class B, Class C and Class D
shares will be financed by the Fund pursuant to distribution plans in
compliance with Rule 12b-1 under the Investment Company Act. See "Purchase of
Shares -- Distribution Plans."
The Manager is a limited partnership, the partners of which are ML & Co.
and Princeton Services. ML & Co. and Princeton Services are "controlling
persons" of the Manager as defined under the Investment Company Act because of
their ownership of its voting securities or their power to exercise a
controlling influence over its management or policies. Similarly, the following
entities may be considered "controlling persons" of MLAM U.K.: Merrill Lynch
Europe PLC (MLAM U.K.'s parent), a subsidiary of Merrill Lynch International
Holdings, Inc., a subsidiary of Merrill Lynch International, Inc., a subsidiary
of ML & Co.
14
<PAGE>
DURATION AND TERMINATION. Unless earlier terminated as described herein,
the Management Agreement will remain in effect from year to year if approved
annually (a) by the Board of Directors or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Directors who are not parties
to such contract or interested persons (as defined in the Investment Company
Act) of any such party. Such contract is not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party
thereto or by the vote of the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System: shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives, and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class
A, Class B, Class C and Class D share of the Fund represents identical
interests in the investment portfolio of the Fund and has the same rights,
except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
Class B, Class C and Class D shares each have exclusive voting rights with
respect to the Rule 12b-1 distribution plan adopted with respect to such class
pursuant to which account maintenance and/or distribution fees are paid (except
that Class B shareholders may vote upon any material changes to expenses
charged under the Class D Distribution Plan). Each class has different exchange
privileges. See "Shareholder Services -- Exchange Privilege."
The Merrill Lynch Select Pricing(SM) System is used by more than 50
registered investment companies advised by the Manager or its affiliate, FAM.
Funds advised by the Manager or FAM which utilize the Merrill Lynch Select
Pricing(SM) System are referred to herein as "Select Pricing Funds."
The Fund has entered into separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the
offering of each class of shares of the Fund. After the prospectuses,
statements of additional information and periodic reports have been prepared,
set in type and mailed to shareholders, the Distributor pays for the printing
and distribution of copies thereof used in connection with the offering to
dealers and investors. The Distributor also pays for other supplementary sales
literature and advertising costs. The Distribution Agreements are subject to
the same renewal requirements and termination provisions as the Management
Agreement described above.
INITIAL SALES CHARGE ALTERNATIVES -- CLASS A AND CLASS D SHARES
The Fund sells its Class A and Class D shares through the Distributor and
Merrill Lynch, as dealers. The gross sales charges for the sale of Class A
shares for the fiscal year ended June 30, 1996 were $285,264, of which $266,754
was received by Merrill Lynch and $18,510 was received by the Distributor. The
gross sales charges for the sale of Class A shares for the fiscal year ended
June 30, 1997 were $139,059, of which $130,119 was received by Merrill Lynch and
$8,940 was received by the Distributor. The gross sales charges for the sale of
Class A shares for the fiscal year ended June 30, 1998 were $72,619, of which
$67,350 was received by Merrill Lynch and $5,269 was received by the
Distributor. The gross sales charges for the sale of Class D shares for the
fiscal year ended June 30, 1996 were $487,134, of which $454,439 was received by
Merrill Lynch and $32,695 was received by the Distributor. The gross sales
charges for the sale of Class D shares for the fiscal
15
<PAGE>
year ended June 30, 1997 were $302,358, of which $279,492 was received by
Merrill Lynch and $22,866 was received by the Distributor. The gross sales
charges for the sale of Class D shares for the fiscal year ended June 30, 1998
were $122,480, of which $113,684 was received by Merrill Lynch and $8,796 was
received by the Distributor. For the fiscal years ended June 30, 1996, 1997 and
1998, the Distributor received no contingent deferred sales charges ("CDSCs")
with respect to redemptions within one year after purchase of Class A or Class D
shares purchased subject to a front-end sales charge waiver.
The term "purchase" as used in the Prospectus and this Statement of
Additional Information refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children
under the age of 21 years purchasing shares for his, her or their own account
and to single purchases by a trustee or other fiduciary purchasing shares 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 Code) although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company," as that
term is defined in the Investment Company Act, but does not include purchases
by any such company that has not been in existence for at least six months or
that has no purpose other than the purchase of shares of the Fund or shares of
other registered investment companies at a discount. The term "purchase" shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser. The term "purchase" also
includes purchases by employee benefit plans not qualified under Section 401 of
the Code, including purchases of shares of the Fund by employees or by
employers on behalf of employees, by means of a payroll deduction plan or
otherwise. Purchases by such a company or non-qualified employee benefit plan
will qualify for the above quantity discounts only if the Fund and the
Distributor are able to realize economies of scale in sales effort and sales
related expense by means of the company, employer or plan making the Fund's
Prospectus available to individual investors or employees and forwarding
investments by such persons to the Fund and by any such employer or plan
bearing the expense of any payroll deduction plan.
CLOSED-END FUND INVESTMENT OPTION. Class A shares of the Fund and other
Select Pricing Funds ("Eligible Class A Shares") are offered at net asset value
to shareholders of certain closed-end funds advised by the Manager or its
affiliate, FAM, who purchased such closed-end fund shares prior to October 21,
1994 (the date the Merrill Lynch Select Pricing(SM) System commenced
operations), and wish to reinvest the net proceeds from a sale of their
closed-end fund shares of common stock in Eligible Class A Shares, if the
conditions set forth below are satisfied. Alternatively, closed-end fund
shareholders who purchased such shares on or after October 21, 1994, and wish to
reinvest the net proceeds from a sale of their closed-end fund shares are
offered Class A shares (if eligible to buy Class A shares) or Class D shares of
the Fund and other Select Pricing Funds ("Eligible Class D Shares"), if the
following conditions are met. First, the sale of the closed-end fund shares must
be made through Merrill Lynch, and the net proceeds therefrom must be
immediately reinvested in Eligible Class A or Class D Shares. Second, the
closed-end fund shares must either have been acquired in the initial public
offering or be shares representing dividends from shares of common stock
acquired in such offering. Third, the closed-end fund shares must have been
continuously maintained in a Merrill Lynch securities account. Fourth, there
must be a minimum purchase of $250 to be eligible for the investment option.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund,
Inc. will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond
Fund, Inc. will receive Class D shares of the Fund, except that shareholders
already
16
<PAGE>
owning Class A shares of the Fund will be eligible to purchase additional Class
A shares pursuant to this option, if such additional Class A shares will be held
in the same account as the existing Class A shares and the other requirements
pertaining to the reinvestment privilege are met. In order to exercise this
investment option, a shareholder of one of the above-referenced continuously
offered closed-end funds (an "eligible fund") must sell his or her shares of
common stock of the eligible fund (the "eligible shares") back to the eligible
fund in connection with a tender offer conducted by the eligible fund and
reinvest the proceeds immediately in the designated class of shares of the Fund.
This investment option is available only with respect to eligible shares as to
which no Early Withdrawal Charge or CDSC (each as defined in the eligible fund's
prospectus) is applicable. Purchase orders from eligible fund shareholders
wishing to exercise this investment option will be accepted only on the day that
the related tender offer terminates and will be effected at the net asset value
of the designated class of the Fund on such day.
REDUCED INITIAL SALES CHARGES
RIGHT OF ACCUMULATION. The reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value or
cost, whichever is higher, of the purchaser's combined holdings of all classes
of shares of the Fund and of other Select Pricing Funds. For any such right of
accumulation to be made available, the Distributor must be provided at the time
of purchase, by the purchaser or the purchaser's securities dealer, with
sufficient information to permit confirmation of qualification for such right
of accumulation. Acceptance of the purchase order is subject to such
confirmation. The right of accumulation may be amended or terminated at any
time. Shares held in the name of a nominee or custodian under pension,
profit-sharing, or other employee benefit plans may not be combined with other
shares to qualify for the right of accumulation.
LETTER OF INTENTION. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of Class A or Class D shares of the Fund or any
other Select Pricing Funds made within a 13-month period starting with the
first purchase pursuant to a Letter of Intention in the form provided in the
Prospectus. The Letter of Intention is available only to investors whose
accounts are maintained at the Fund's transfer agent. The Letter of Intention
is not available to employee benefit plans for which Merrill Lynch provides
plan participant recordkeeping services. The Letter of Intention is not a
binding obligation to purchase any amount of Class A or Class D shares, but its
execution will result in the purchaser paying a lower sales charge at the
appropriate quantity purchase level. A purchase not originally made pursuant to
a Letter of Intention may be included under a subsequent Letter of Intention
executed within 90 days of such purchase if the Distributor is informed in
writing of this intent within such 90-day period. The value of Class A and
Class D shares of the Fund and of other Select Pricing Funds presently held, at
cost or maximum offering price (whichever is higher), on the date of the first
purchase under the Letter of Intention, may be included as a credit toward
completion of such Letter but the reduced sales charge applicable to the amount
covered by such Letter will be applied only to new purchases. If the total
amount of shares does not equal the amount stated in the Letter of Intention
(minimum of $25,000), the investor will be notified and must pay, within 20
days of the expiration of such Letter, the difference between the sales charge
on the Class A or Class D shares purchased at the reduced rate and the sales
charge applicable to the shares actually purchased through the Letter. Class A
or Class D shares equal to at least five percent of the intended amount will be
held in escrow during the 13-month period (while remaining registered in the
name of the purchaser) for this purpose. The first purchase under the Letter of
Intention must be at least five percent of the dollar amount of such Letter. If
a purchase during the term of such Letter would otherwise be subject to a
further reduced sales charge based on the right of accumulation, the purchaser
will be entitled on that purchase and subsequent purchases to the further
reduced percentage sales charge that would be applicable to a single purchase
equal to the total
17
<PAGE>
dollar value of the shares then being purchased under such Letter, but there
will be no retroactive reduction of the sales charges on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intention will be deducted
from the total purchases made under such Letter. An exchange from
the Summit Cash Reserves Fund into the Fund that creates a sales charge will
count toward completing a new or existing Letter of Intention from the Fund.
TMA(SM) MANAGED TRUSTS. Class A shares are offered to TMA(SM) Managed
Trusts to which Merrill Lynch Trust Company provides discretionary trustee
services at net asset value.
EMPLOYEE ACCESS(SM) ACCOUNTS. Provided applicable threshold requirements
are met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. The initial
minimum investment for such accounts is $500, except that the initial minimum
investment for shares purchased for such accounts pursuant to the Automatic
Investment Program is $50.
PURCHASE PRIVILEGE OF CERTAIN PERSONS. Directors of the Fund, members of
the Boards of other MLAM-advised investment companies, ML & Co. and its
subsidiaries (the term "subsidiaries," when used herein with respect to ML &
Co., includes MLAM, FAM and certain other entities directly or indirectly
wholly-owned and controlled by ML & Co.) and their directors and employees, and
any trust, pension, profit-sharing or other benefit plan for such persons may
purchase Class A shares of the Fund at net asset value.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Financial
Consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor if the following
conditions are satisfied. First, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the Financial Consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, the investor must establish that such redemption had been
made within 60 days prior to the investment in the Fund, and the proceeds from
the redemption had been maintained in the interim in cash or a money market
fund.
Class D shares of the Fund are also offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied. First, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and such fund
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, such purchase of Class D shares must be made within 90 days
after such notice.
Class D shares of the Fund will be offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund for which
Merrill Lynch has not served as a selected dealer if the following conditions
are satisfied. First, the investor must advise Merrill Lynch that it will
purchase Class D shares of the Fund with proceeds from the redemption of such
shares of the other mutual funds and that such shares have been outstanding for
a period of no less than six months; and second, such purchase of Class D
shares must be made within 60 days after the redemption and the proceeds from
the redemption must be maintained in the interim in cash or a money market
fund.
18
<PAGE>
ACQUISITION OF ASSETS OF CERTAIN INVESTMENT COMPANIES. The public offering
price of Class D shares may be reduced to the net asset value per Class D share
in connection with the acquisition of the assets of or merger or consolidation
with a public or private investment company. The value of the assets or company
acquired in a tax-free transaction may in appropriate cases be adjusted to
reduce possible adverse tax consequences to the Fund that might result from an
acquisition of assets having net unrealized appreciation that is
disproportionately higher at the time of acquisition than the realized or
unrealized appreciation of the Fund. The issuance of Class D shares for
consideration other than cash is limited to bona fide reorganizations, statutory
mergers or other acquisitions of portfolio securities that (i) meet the
investment objectives and policies of the Fund; (ii) are acquired for investment
and not for resale (subject to the understanding that the disposition of the
Fund's portfolio securities shall at all times remain within its control); and
(iii) are liquid securities, the value of which is readily ascertainable, that
are not restricted as to transfer either by law or liquidity of market (except
that the Fund may acquire through such transactions restricted or illiquid
securities to the extent the Fund does not exceed the applicable limits on
acquisition of such securities set forth under "Investment Objective and
Policies" herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be
needed in obtaining such investments.
EMPLOYER-SPONSORED RETIREMENT OR SAVINGS PLANS AND CERTAIN OTHER ARRANGEMENTS
Certain employer-sponsored retirement or savings plans and certain other
arrangements may purchase Class A or Class D shares at net asset value, based
on the number of employees or number of employees eligible to participate in
the plan, the aggregate amount invested by the plan in specified investments
and/or the services provided by Merrill Lynch to the plan. Certain other plans
may purchase Class B shares with a waiver of the CDSC upon redemption, based on
similar criteria. Such Class B shares will convert into Class D shares
approximately ten years after the plan purchases the first share of any
MLAM-advised mutual fund. Minimum purchase requirements may be waived or varied
for such plans. Additional information regarding purchases by
employer-sponsored retirement or savings plans and certain other arrangements
is available toll-free from Merrill Lynch Business Financial Services at (800)
237-7777.
DISTRIBUTION PLANS
Reference is made to "Purchase of Shares -- Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
Investment Company Act (each a "Distribution Plan") with respect to the account
maintenance and/or distribution fees paid by the Fund to the Distributor with
respect to such classes.
Payments of the account maintenance fees and/or distribution fees are
subject to the provisions of Rule 12b-1 under the Investment Company Act. Among
other things, each Distribution Plan provides that the Distributor shall
provide and the Directors shall review quarterly reports of the disbursement of
the account maintenance fees and/or distribution fees paid to the Distributor.
In their consideration of each Distribution Plan, the Directors must consider
all factors they deem relevant, including information as to the benefits of the
Distribution Plan to the Fund and its related class of shareholders. Each
Distribution Plan further provides that, so long as the Distribution Plan
remains in effect, the selection and nomination of Directors who are not
"interested persons" of the Fund, as defined in the Investment Company Act (the
"Independent Directors"), shall be committed to the discretion of the
Independent Directors then in office. In approving each Distribution Plan in
accordance with Rule 12b-1, the Independent Directors concluded that there is a
reasonable likelihood that such Distribution Plan will benefit the Fund and its
related class of shareholders. Each Distribution Plan can be terminated at any
time, without penalty, by the vote of a majority of the Independent Directors
or by the vote of the holders of a majority of the outstanding related class of
voting securities of the Fund. A Distribution Plan cannot be amended to
increase
19
<PAGE>
materially the amount to be spent by the Fund without the approval of the
related class of shareholders, and all material amendments are required to be
approved by the vote of the Directors, including a majority of the Independent
Directors who have no direct or indirect financial interest in such Distribution
Plan, cast in person at a meeting called for that purpose. Rule 12b-1 further
requires that the Fund preserve copies of each Distribution Plan and any report
made pursuant to such plan for a period of not less than six years from the date
of such Distribution Plan or such report, the first two years in an easily
accessible place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the National
Association of Securities Dealers, Inc. ("NASD") imposes a limitation on
certain asset-based sales charges such as the distribution fee and the CDSC
borne by the Class B and Class C shares but not the account maintenance fee.
The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of
eligible gross sales of Class B shares and Class C shares, computed separately
(defined to exclude shares issued pursuant to dividend reinvestments and
exchanges), plus (2) interest on the unpaid balance for the respective class,
computed separately, at the prime rate plus 1% (the unpaid balance being the
maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payment
in excess of the amount payable under the NASD formula will not be made.
The following table sets forth comparative information as of June 30,
1998, with respect to the Class B and Class C shares of the Fund indicating the
maximum allowable payments that can be made under the NASD maximum sales charge
rule and with respect to Class B shares the Distributor's voluntary maximum:
20
<PAGE>
<TABLE>
<CAPTION>
DATA CALCULATED AS OF JUNE 30, 1998
----------------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT
GROSS SALES OF UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
---------- ----------- ------------ --------- ---------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B SHARES, FOR THE PERIOD
JULY 1, 1994
(COMMENCEMENT OF OPERATIONS)
TO JUNE 30, 1998:
Under NASD Rule as Adopted .. $325,916 $20,370 $3,912 $24,282 $10,094 $14,188 $1,237
Under Distributor's Voluntary
Waiver .................... $325,916 $20,370 $1,629 $21,999 $10,094 $11,905 $1,237
CLASS C SHARES, FOR THE PERIOD
OCTOBER 21, 1994
(COMMENCEMENT OF OPERATIONS)
TO JUNE 30, 1998:
Under NASD Rule as Adopted .. $ 82,448 $ 5,153 $1,011 $ 6,164 $ 1,210 $ 4,954 $ 243
</TABLE>
- --------
(1) Purchase price of all eligible Class B or Class C shares sold during
periods indicated, other than shares acquired through dividend
reinvestment and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in THE WALL STREET JOURNAL, plus 1%, as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals. See
"Purchase of Shares -- Distribution Plans" in the Prospectus. This figure
may include CDSCs that were deferred when a shareholder redeemed shares
prior to the expiration of the applicable CDSC period and invested the
proceeds, without the imposition of a sales charge, in Class A shares in
conjunction with the shareholder's participation in the Merrill Lynch
Mutual Fund Advisor (Merrill Lynch MFA(SM)) program (the "MFA program").
The CDSC is booked as a contingent obligation that may be payable if the
shareholder terminates participation in the MFA program.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the NASD maximum (with respect to Class
B and Class C shares) or the voluntary maximum (with respect to Class B
shares).
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for periods during
which trading on the New York Stock Exchange (the "NYSE") is restricted, as
determined by the Commission, or the NYSE is closed (other than customary
weekend and holiday closings), for any period during which an emergency exists,
as defined by the Commission, as a result of which disposal of portfolio
securities or determination of the net asset value of the Fund is not
reasonably practicable, and for such other periods as the Commission may by
order permit for the protection of shareholders of the Fund.
The value of shares at the time of redemption may be more or less than the
shareholder's cost, depending on the market value of the securities held by the
Fund at such time.
DEFERRED SALES CHARGES -- CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares," while Class B shares
redeemed within four years of purchase are subject to a
21
<PAGE>
CDSC under most circumstances, the charge is waived on redemptions of Class B
shares in certain instances, including in connection with certain
post-retirement withdrawals from an Individual Retirement Account ("IRA") or
other retirement plan or following the death or disability of a Class B
shareholder. Redemptions for which the waiver applies in the case of such
withdrawals are: (a) any partial or complete redemption in connection with a
tax-free distribution following retirement under a tax-deferred retirement plan
or attaining age 59 1/2 in the case of an IRA or other retirement plan, or part
of a series of equal periodic payments (not less frequently than annually) made
for the life (or life expectancy) or any redemption resulting from the tax-free
return of an excess contribution to an IRA; or (b) any partial or complete
redemption following the death or disability (as defined in the Code) of a Class
B shareholder (including one who owns the Class B shares as joint tenant with
his or her spouse), provided the redemption is requested within one year of the
death or initial determination of disability. For the fiscal years ended June
30, 1996, 1997 and 1998, with respect to redemptions of Class B shares, the
Distributor received CDSCs of $440,116, $714,967 and $946,237, respectively, all
of which were paid to Merrill Lynch. Additional CDSCs payable to the Distributor
during the fiscal years ended June 30, 1997 and 1998 may have been waived or
converted to a contingent obligation in connection with a shareholder's
participation in certain fee-based programs. For the fiscal years ended June 30,
1996, 1997 and 1998, with respect to redemptions of Class C shares, the
Distributor received CDSCs of $21,166, $20,007 and $37,127, respectively, all of
which were paid to Merrill Lynch.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Reference is made to "Investment Objective and Policies -- Other
Investment Policies and Practices" in the Prospectus.
Subject to policies established by the Board of Directors of the Fund, the
Manager is primarily responsible for the execution of the Fund's portfolio
transactions. In executing such transactions, the Manager seeks to obtain the
best net results for the Fund, taking into account such factors as price
(including the applicable brokerage commission or dealer spread), size of
order, difficulty of execution and operational facilities of the firm involved
and the firm's risk in positioning a block of securities. While the Manager
generally seeks reasonably competitive commission rates, the Fund does not
necessarily pay the lowest commission or spread available. The Fund has no
obligation to deal with any broker or group of brokers in the execution of
transactions in portfolio securities. Subject to obtaining the best price and
execution, brokers who provide supplemental investment research to the Manager
may receive orders for transactions by the Fund. Information so received will
be in addition to and not in lieu of the services required to be performed by
the Manager under the Management Agreement, and the expenses of the Manager
will not necessarily be reduced as a result of the receipt of such supplemental
information. It is possible that certain of the supplementary investment
research so received will primarily benefit one or more other investment
companies or other accounts for which investment discretion is exercised.
Conversely, the Fund may be the primary beneficiary of the research or services
received as a result of portfolio transactions effected for such other accounts
or investment companies. In addition, consistent with the Conduct Rules of the
NASD and policies established by the Directors of the Fund, the Manager may
consider sales of shares of the Fund as a factor in the selection of brokers or
dealers to execute portfolio transactions for the Fund.
The Fund anticipates that its brokerage transactions involving securities
of companies domiciled in countries other than the United States generally will
be conducted primarily on the principal stock exchanges of such countries.
Brokerage commissions and other transaction costs on foreign stock exchange
transactions are generally higher than in the United States, although the Fund
will endeavor to achieve the best net results in effecting its portfolio
transactions. There is generally less governmental supervision and regulation
of foreign stock exchanges and brokers than in the United States.
22
<PAGE>
The Fund may invest in securities traded in the OTC markets and intends,
where possible, to deal directly with the dealers who make markets in the
securities involved, except in those circumstances where better prices and
execution are available elsewhere. Under the Investment Company Act, persons
affiliated with the Fund and persons affiliated with such persons are
prohibited from dealing with the Fund as principal in the purchase and sale of
securities unless a permissive order allowing such transactions is obtained
from the Commission. Since transactions in the OTC market usually involve
transactions with dealers acting as principal for their own accounts,
affiliated persons of the Fund, including Merrill Lynch and any of its
affiliates, will not serve as the Fund's dealer in such transactions. However,
affiliated persons of the Fund may serve as its broker in listed or OTC
transactions conducted on an agency basis provided that, among other things,
the fee or commission received by such affiliated broker is reasonable and fair
compared to the fee or commission received by non-affiliated brokers in
connection with comparable transactions. In addition, the Fund may not purchase
securities during the existence of any underwriting syndicate for such
securities of which Merrill Lynch is a member and in a private transaction in
which Merrill Lynch serves as placement agent except pursuant to procedures
adopted by the Board of Directors of the Fund that either comply with rules
adopted by the Commission or with interpretations of the Commission staff. See
"Investment Objective and Policies -- Investment Restrictions."
For the fiscal year ended June 30, 1996, the Fund paid total brokerage
commissions of $4,562,760, of which $214,282, or 4.7%, was paid to Merrill
Lynch for effecting 6.5% of the aggregate dollar amount of transactions
on which the Fund paid brokerage commissions. For the fiscal year ended June
30, 1997, the Fund paid total brokerage commissions of $5,196,036, of which
$413,827, or 8.0%, was paid to Merrill Lynch for effecting 8.9% of the
aggregate dollar amount of transactions on which the Fund paid brokerage
commissions. For the fiscal year ended June 30, 1998, the Fund paid total
brokerage commissions of $5,604,055, of which $341,717, or 6.10%, was paid to
Merrill Lynch for effecting 5.79% of the aggregate dollar amount of
transactions on which the Fund paid brokerage commissions.
The Fund's ability and decisions to purchase or sell portfolio securities
may be affected by laws or regulations relating to the convertibility and
repatriation of assets. Because the shares of the Fund are redeemable on a
daily basis in U.S. dollars, the Fund intends to manage its portfolio so as to
give reasonable assurance that it will be able to obtain U.S. dollars to the
extent necessary to meet anticipated redemptions. Under present conditions, it
is not believed that these considerations will have any significant effect on
its portfolio strategy.
Section 11(a) of the Securities Exchange Act of 1934, as amended,
generally prohibits members of the U.S. national securities exchanges from
executing exchange transactions for their affiliates and institutional accounts
that they manage unless the member (i) has obtained prior express authorization
from the account to effect such transactions, (ii) at least annually furnishes
the account with a statement disclosing the aggregate compensation received by
the member in effecting such transactions and (iii) complies with any rules the
Commission has prescribed with respect to the requirements of clauses (i) and
(ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund, and annual statements as to aggregate compensation will
be provided to the Fund.
The Board of Directors has considered the possibility of seeking to
recapture for the benefit of the Fund brokerage commissions and other expenses
of possible portfolio transactions by conducting portfolio transactions through
affiliated entities. For example, brokerage commissions received by affiliated
brokers could be offset against the advisory fee paid by the Fund. After
considering all factors deemed relevant, the Board of Directors made a
determination not to seek such recapture. The Board will reconsider this matter
from time to time.
23
<PAGE>
DETERMINATION OF NET ASSET VALUE
Reference is made to "Additional Information -- Determination of Net Asset
Value" in the Prospectus concerning the determination of net asset value. The
net asset value of the shares of the Fund is determined once daily Monday
through Friday as of 15 minutes after the close of business on the NYSE
(generally, the NYSE closes at 4:00 p.m., Eastern time), on each day the NYSE
is open for trading. The NYSE is not open on New Year's Day, Martin Luther
King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day. Any assets or liabilities
initially expressed in terms of non-U.S. dollar currencies are translated into
U.S. dollars at the prevailing market rates as quoted by one or more banks or
dealers on the day of valuation.
Net asset value is computed by dividing the value of the securities held by
the Fund plus any cash or other assets (including interest and dividends accrued
but not yet received) minus all liabilities (including accrued expenses) by the
total number of shares outstanding at such time. Expenses, including the fees
payable to the Manager and the account maintenance and/or distribution fees, are
accrued daily. The per share net asset value of Class B, Class C and Class D
shares generally will be lower than the per share net asset value of Class A
shares, reflecting the daily expense accruals of the account maintenance,
distribution and higher transfer agency fees applicable with respect to Class B
and Class C shares, and the daily expense accruals of the account maintenance
fees applicable with respect to Class D shares; moreover, the per share net
asset value of Class B and Class C shares generally will be lower than the per
share net asset value of Class D shares, reflecting the daily expense accruals
of the distribution fees and higher transfer agency fees applicable with respect
to Class B and Class C shares of the Fund. It is expected, however, that the per
share net asset value of the four classes will tend to converge (although not
necessarily meet) immediately after the payment of dividends or distributions,
which will differ by approximately the amount of the expense accrual
differentials between the classes.
Portfolio securities that are traded on stock exchanges are valued at the
last sale price (regular way) on the exchange on which such securities are
traded, as of the close of business on the day the securities are being valued
or, lacking any sales, at the last available bid price for long positions and
at the last available ask price for short positions. In cases where securities
are traded on more than one exchange, the securities are valued on the exchange
designated by or under the authority of the Board of Directors as the primary
market. Long positions in securities traded in the OTC market are valued at the
last available bid price in the OTC market prior to the time of valuation.
Short positions in securities traded in the OTC market are valued at the last
available ask price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. When the Fund
writes an option, the amount of the premium received is recorded on the books
of the Fund as an asset and an equivalent liability. The amount of the
liability is subsequently valued to reflect the current market value of the
option written, based upon the last sale price in the case of exchange-traded
options or, in the case of options traded in the OTC market, the last asked
price. Options purchased by the Fund are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Other investments, including futures contracts and
related options, are stated at market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Directors of
the Fund. Such valuations and procedures will be reviewed periodically by the
Board of Directors.
24
<PAGE>
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below which are
designed to facilitate investment in its shares. Full details as to each of
such services, copies of the various plans described below and instructions as
to how to participate in the various services or plans, or how to change
options with respect thereto, can be obtained from the Fund, the Distributor or
Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the transfer agent has an
Investment Account and will receive statements, at least quarterly, from the
transfer agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and long-term capital gain distributions. The statements will also
show any other activity in the account since the preceding statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gain distributions. A
shareholder may make additions to his or her Investment Account at any time by
mailing a check directly to the Fund's transfer agent.
Share certificates are issued only for full shares and only upon the
specific request of the shareholder. Issuance of certificates representing all
or only part of the full shares in an Investment Account may be requested by a
shareholder directly from the Fund's transfer agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the Class A or Class D shares are to be
transferred will not take delivery of shares of the Fund, a shareholder either
must redeem the Class A or Class D shares (paying any applicable CDSC) so that
the cash proceeds can be transferred to the account at the new firm or continue
to maintain an Investment Account at the transfer agent for those Class A or
Class D shares. Shareholders interested in transferring their Class B or Class
C shares from Merrill Lynch and who do not wish to have an Investment Account
maintained for such shares at the transfer agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the transfer agent. If
the new brokerage firm is willing to accommodate the shareholder in this
manner, the shareholder must request that he or she be issued certificates for
his or her shares, and then must turn the certificates over to the new firm for
re-registration as described in the preceding sentence. Shareholders
considering transferring a tax-deferred retirement account such as an IRA from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the retirement account is to be transferred
will not take delivery of shares of the Fund, a shareholder must either redeem
the shares (paying any applicable CDSC) so that the cash proceeds can be
transferred to the account at the new firm or continue to maintain a retirement
account at Merrill Lynch for those shares.
AUTOMATIC INVESTMENT PLANS
A U.S. shareholder may make additions to an Investment Account at any time
by purchasing Class A shares (if he or she is an eligible Class A investor as
described in the Prospectus) or Class B, Class C or Class D shares at the
applicable public offering price either through the shareholder's securities
dealer or by mail directly to the Transfer Agent, acting as agent for such
securities dealer. Voluntary accumulation also can be made through a service
known as the Automatic Investment Plan whereby the Fund is authorized through
pre-authorized checks or automated clearing house debits of $50 or more to
charge the regular bank account of the shareholder on a regular basis to
provide systematic additions to the Investment Account of such shareholder. An
investor whose
25
<PAGE>
shares of the Fund are held within a CMA(R) or CBA(R) account
may arrange to have periodic investments made in the Fund in amounts of $100
($1 for retirement accounts) or more through the CMA(R) or CBA(R) Automated
Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions to the contrary are given as to the method of
payment of dividends and capital gains distributions, dividends and
distributions will automatically be reinvested in additional shares of the
Fund. Such reinvestment will be at the net asset value of the shares of the
Fund as of the close of business on the NYSE on the ex-dividend date of the
dividend or distribution. Shareholders may elect to receive either their
dividends or capital gains distributions, or both, in cash, in which event
payment will be mailed or direct deposited on or about the payment date
(provided that, in the event that a payment on an account maintained at the
Transfer Agent would amount to $10.00 or less, a shareholder will not receive
such payment in cash and such payment will automatically be reinvested in
additional shares). The Fund is not responsible for any failure of delivery to
the shareholder's address of record and no interest will accrue on amounts
represented by uncashed distributions or redemption checks.
Shareholders may, at any time, notify Merrill Lynch in writing if the
shareholder's account is maintained with Merrill Lynch, or notify the Transfer
Agent in writing or by telephone (1-800-MER-FUND) if the shareholder's account
is maintained with the Transfer Agent, that they no longer wish to have their
dividends and/or distributions reinvested in shares of the Fund or vice versa,
and commencing ten days after receipt of such notice, those instructions will be
effected.
SYSTEMATIC WITHDRAWAL PLANS
A shareholder may elect to make systematic withdrawals from an Investment
Account of Class A, Class B, Class C or Class D shares on either a monthly or
quarterly basis as provided below. Quarterly withdrawals are available for
shareholders who have acquired shares of the Fund having a value, based upon
cost or the current offering price, of $5,000 or more, and monthly withdrawals
are available for shareholders with shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient shares are redeemed
from those on deposit in the shareholder's account to provide the withdrawal
payment specified by the shareholder. The shareholder may specify the dollar
amount and the class of shares to be redeemed. Redemptions will be made at net
asset value as determined as of 15 minutes after the close of business on the
NYSE (generally, the NYSE closes at 4:00 p.m., Eastern time) on the 24th day of
each month or the 24th day of the last month of each quarter, whichever is
applicable. If the NYSE is not open for business on such date, the shares will
be redeemed at the close of business on the following business day. The check
for the withdrawal payment will be mailed, or the direct deposit of the
withdrawal payment will be made, on the next business day following redemption.
When a shareholder is making systematic withdrawals, dividends and
distributions on all shares in the Investment Account are automatically
reinvested in shares of the Fund. A shareholder's Systematic Withdrawal Plan
may be terminated at any time, without charge or penalty, by the shareholder,
the Fund, the Transfer Agent or the Distributor.
Withdrawal payments should not be considered as dividends, yield or
income. Each withdrawal is a taxable event. If periodic withdrawals
continuously exceed reinvested dividends and capital gains distributions, the
shareholder's original investment may be correspondingly reduced. Purchase of
additional shares concurrent with withdrawals are ordinarily disadvantageous to
the shareholder because of sales charges and tax liabilities. The Fund will not
knowingly accept purchase orders for shares of the Fund from investors who
maintain a Systematic Withdrawal
26
<PAGE>
Plan unless such purchase is equal to at least one year's scheduled withdrawals
or $1,200, whichever is greater. Periodic investments may not be made into an
Investment Account in which the shareholder has elected to make systematic
withdrawals.
Alternatively, a shareholder whose shares are held within a CMA(R), CBA(R)
or Retirement Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA(R) or CBA(R)
Systematic Redemption Program. The minimum fixed dollar amount redeemable is
$50. The proceeds of systematic redemptions will be posted to the shareholder's
account three business days after the date the shares are redeemed. All
redemptions are made at net asset value. A shareholder may elect to have his or
her shares redeemed on the first, second, third or fourth Monday of each month,
in the case of monthly redemptions, or of every other month, in the case of
bimonthly redemptions. For quarterly, semiannual or annual redemptions, the
shareholder may select the month in which the shares are to be redeemed and may
designate whether the redemption is to be made on the first, second, third or
fourth Monday of the month. If the Monday selected is not a business day, the
redemption will be processed at net asset value on the next business day. The
CMA(R) or CBA(R) Systematic Redemption Program is not available if Fund shares
are being purchased within the account pursuant to the Automatic Investment
Program. For more information on the CMA(R) or CBA(R) Systematic Redemption
Program, eligible shareholders should contact their Merrill Lynch Financial
Consultant.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares
that can be redeemed from an account annually shall not exceed
10% of the value of shares of such class in that account at the time the
election to join the systematic withdrawal plan was made. Any CDSC that
otherwise might be due on such redemption of Class B or Class C shares will be
waived. Shares redeemed pursuant to a systematic withdrawal plan will be
redeemed in the same order as Class B or Class C shares are otherwise redeemed.
See "Purchase of Shares -- Deferred Sales Charge Alternatives -- Class B and
Class C Shares -- Contingent Deferred Sales Charges -- Class B Shares" and " --
Contingent Deferred Sales Charges -- Class C Shares" in the Prospectus. Where
the systematic withdrawal plan is applied to Class B shares, upon conversion of
the last Class B shares in an account to Class D shares, the systematic
withdrawal plan will be applied thereafter to Class D shares if the shareholder
so elects. See "Purchase of Shares -- Deferred Sales Charge Alternatives --
Class B and Class C Shares -- Conversion of Class B Shares to Class D Shares" in
the Prospectus; if an investor wishes to change the amount being withdrawn in a
systematic withdrawal plan the investor should contact his or her Merrill Lynch
Financial Consultant.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other Select Pricing Funds and Summit Cash Reserves Fund
("Summit"), a series of Financial Institutions Series Trust, which is a Merrill
Lynch-sponsored money market mutual fund specifically designated as available
for exchange by holders of Class A, Class B, Class C and Class D shares of
Select Pricing Funds. Shares with a net asset value of at least $100 are
required to qualify for the exchange privilege and any shares utilized in an
exchange must have been held by the shareholder for at least 15 days. Before
effecting an exchange, shareholders should obtain a currently effective
prospectus of the fund into which the exchange is to be made. Exercise of the
exchange privilege is treated as a sale of the exchanged shares and a purchase
of the acquired shares for Federal income tax purposes.
EXCHANGES OF CLASS A AND CLASS D SHARES. Class A shareholders may exchange
Class A shares of the Fund for Class A shares of a second Select Pricing Fund
if the shareholder holds any Class A shares of the second fund in his or her
account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class
A shareholder wants to exchange Class A shares for
27
<PAGE>
shares of a second Select Pricing Fund, but does not hold Class A shares of the
second fund in his or her account at the time of the exchange and is not
otherwise eligible to acquire Class A shares of the second fund, the shareholder
will receive Class D shares of the second fund as a result of the exchange.
Class D shares also may be exchanged for Class A shares of a second Select
Pricing Fund at any time as long as, at the time of the exchange, the
shareholder holds Class A shares of the second fund in the account in which the
exchange is made or is otherwise eligible to purchase Class A shares of the
second fund. Class D shares are exchangeable with shares of the same class of
other Select Pricing Funds.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of other Select Pricing Funds or
Class A shares of Summit ("new Class A or Class D shares") are transacted on the
basis of relative net asset value per Class A or Class D share, respectively,
plus an amount equal to the difference, if any, between the sales charge
previously paid on the outstanding Class A or Class D shares and the sales
charge payable at the time of the exchange on the new Class A or Class D shares.
With respect to outstanding Class A or Class D shares as to which previous
exchanges have taken place, the "sales charge previously paid" shall include the
aggregate of the sales charges paid with respect to such Class A or Class D
shares in the initial purchase and any subsequent exchange. Class A or Class D
shares issued pursuant to dividend reinvestment are sold on a no-load basis in
each of the funds offering Class A or Class D shares. For purposes of the
exchange privilege, Class A or Class D shares acquired through dividend
reinvestment shall be deemed to have been sold with a sales charge equal to the
sales charge previously paid on the Class A or Class D shares on which the
dividend was paid. Based on this formula, Class A and Class D shares generally
may be exchanged into the Class A or Class D shares, respectively, of the other
funds with a reduced sales charge or without a sales charge.
EXCHANGES OF CLASS B AND CLASS C SHARES. Each Select Pricing Fund with
Class B or Class C shares outstanding ("outstanding Class B or Class C shares")
offers to exchange its Class B or Class C shares for Class B or Class C shares,
respectively, of another Select Pricing Fund or for Class B shares of Summit
("new Class B or Class C shares") on the basis of relative net asset value per
Class B or Class C share, without the payment of any CDSC that might otherwise
be due on redemption of the outstanding shares. Class B shareholders of the
Fund exercising the exchange privilege will continue to be subject to the
Fund's CDSC schedule if such schedule is higher than the CDSC schedule relating
to the new Class B shares acquired through use of the exchange privilege. In
addition, Class B shares of the Fund acquired through use of the exchange
privilege will be subject to the Fund's CDSC schedule if such schedule is
higher than the CDSC schedule relating to the Class B shares of the fund from
which the exchange has been made. For purposes of computing the CDSC that may
be payable on a disposition of the new Class B or Class C shares, the holding
period for the outstanding Class B or Class C shares is "tacked" to the holding
period of the new Class B or Class C shares. For example, an investor may
exchange Class B or Class C shares of the Fund for those of Merrill Lynch
Special Value Fund, Inc. ("Special Value Fund") after having held the Fund's
Class B shares for two and a half years. The 2% CDSC that generally would apply
to a redemption would not apply to the exchange. Three years later the investor
may decide to redeem the Class B shares of Special Value Fund and receive cash.
There will be no CDSC due on this redemption, since by "tacking" the two and a
half year holding period of Fund Class B shares to the three-year holding
period for the Special Value Fund Class B shares, the investor will be deemed
to have held the Special Value Fund Class B shares for more than five years.
EXCHANGES FOR SHARES OF A MONEY MARKET FUND. Class A and Class D shares are
exchangeable for Class A shares of Summit and Class B and Class C shares are
exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class A or Class D shares of Select Pricing Funds;
Class B shares of Summit have an exchange privilege back into Class B or Class C
shares of Select Pricing Funds and,
28
<PAGE>
in the event of such an exchange, the period of time that Class B shares of
Summit are held will count toward satisfaction of the holding period requirement
for purposes of reducing any CDSC and toward satisfaction of any conversion
period with respect to Class B shares. Class B shares of Summit will be subject
to a distribution fee at an annual rate of 0.75% of average daily net assets of
such Class B shares. This exchange privilege does not apply with respect to
certain Merrill Lynch fee-based programs for which alternative exchange
arrangements may exist. Please see your Merrill Lynch Financial Consultant for
further information.
Prior to October 12,1998, exchanges from the Fund and other Select Pricing
Funds into a money market fund were directed to certain Merrill Lynch-sponsored
money market funds other than Summit. Shareholders who exchanged Select Pricing
Fund shares for shares of such other money market funds and subsequently wish to
exchange those money market fund shares for shares of the Fund will be subject
to the CDSC schedule applicable to such Fund shares, if any. The holding period
for those money market fund shares will not count toward satisfaction of the
holding period requirement for reduction of the CDSC imposed on such shares, if
any, and, with respect to Class B shares, toward satisfaction of the conversion
period. However, the holding period for Class B or Class C shares received in
exchange for such money market fund shares will be aggregated with the holding
period for the original Select Pricing Fund shares for purposes of reducing the
CDSC or satisfying the conversion period.
EXCHANGES BY PARTICIPANTS IN THE MFA PROGRAM. The exchange privilege is
modified with respect to certain retirement plans which participate in the MFA
program. Such retirement plans may exchange Class B, Class C or Class D shares
that have been held for at least one year for Class A shares of the same fund on
the basis of relative net asset values in connection with the commencement of
participation in the MFA program, I.E., no CDSC will apply. The one year holding
period does not apply to shares acquired through reinvestment of dividends. Upon
termination of participation in the MFA program, Class A shares will be
re-exchanged for the class of shares originally held. For purposes of computing
any CDSC that may be payable upon redemption of Class B or Class C shares so
reacquired, or the Conversion Period for Class B shares so reacquired, the
holding period for the Class A shares will be "tacked" to the holding period for
the Class B or Class C shares originally held. The Fund's exchange privilege is
also modified with respect to purchases of Class A and Class D shares by
non-retirement plan investors under the MFA program. First, the initial
allocation of assets is made under the MFA program. Then, any subsequent
exchange under the MFA program of Class A or Class D shares of a Select Pricing
Fund for Class A and Class D shares of the Fund will be made solely on the basis
of the relative net asset values of the shares being exchanged. Therefore, there
will not be a charge for any difference between the sales charge previously paid
on the shares of the other Select Pricing Fund and the sales charge payable on
the shares of the Fund being acquired in the exchange under the MFA program.
EXERCISE OF THE EXCHANGE PRIVILEGE. To exercise the exchange privilege, a
shareholder should contact his or her Merrill Lynch Financial Consultant, who
will advise the Fund of the exchange. Shareholders of the Fund, and shareholders
of the other Select Pricing Funds with shares for which certificates have not
been issued, may exercise the exchange privilege by wire through their
securities dealers. The Fund reserves the right to require a properly completed
Exchange Application. This exchange privilege may be modified or terminated in
accordance with the rules of the Commission. The Fund reserves the right to
limit the number of times an investor may exercise the exchange privilege.
Certain funds may suspend the continuous offering of their shares to the general
public at any time and may thereafter resume such offering from time to time.
The exchange privilege is available only to U.S. shareholders in states where
the exchange legally may be made. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
29
<PAGE>
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute all of its net investment income, if any.
Dividends from such net investment income are paid at least annually. All net
realized capital gains, if any, are distributed to the Fund's shareholders at
least annually. Premiums from expired options written by the Fund and net gains
from closing purchase transactions are treated as short-term capital gains for
Federal income tax purposes. See "Shareholder Services -- Automatic
Reinvestment of Dividends and Capital Gains Distributions" in the Prospectus
for information concerning the manner in which dividends and distributions may
be reinvested automatically in shares of the Fund. A shareholder whose account
is maintained through the transfer agent may elect in writing to receive any
such dividends or distributions, or both, in cash. A shareholder whose account
is maintained through Merrill Lynch may elect in writing to receive both
dividends and distributions in cash. Dividends and distributions are taxable to
shareholders as described below whether they are invested in shares of the Fund
or received in cash. The per share dividends and distributions on Class B and
Class C shares will be lower than the per share dividends and distributions on
Class A and Class D shares as a result of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares; similarly, the per share dividends and distributions on Class D shares
will be lower than the per share dividends and distributions on Class A shares
as a result of the account maintenance fees applicable with respect to Class D
shares. See "Determination of Net Asset Value."
TAXES
The Fund intends to continue to qualify for the special tax treatment
afforded RICs under the Code. As long as it so qualifies, the Fund (but not its
shareholders) will not be subject to Federal income tax on the part of its net
ordinary income and net realized capital gains which it distributes to Class A,
Class B, Class C and Class D shareholders (together, the "shareholders"). The
Fund intends to distribute substantially all of such income.
Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in futures and options) ("capital gain
dividends") are taxable to shareholders as long-term capital gains, regardless
of the length of time the shareholder has owned Fund shares. Any loss upon the
sale or exchange of Fund shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain dividends received by
the shareholder. Distributions in excess of the Fund's earnings and profits
will first reduce the adjusted tax basis of a holder's shares, and after such
adjusted tax basis is reduced to zero, will constitute capital gains to such
holder (assuming the shares are held as a capital asset). Recent legislation
created additional categories of capital gains taxable at different rates.
Additional legislation eliminates the highest 28% category for most sales of
capital assets occurring after December 31, 1997. Generally not later than 60
days after the close of its taxable year, the Fund will provide
its shareholders with a written notice designating the amounts of any ordinary
income dividends or capital gain dividends, as well as the amount of capital
gain dividends in the different categories of capital gain referred to above.
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Distributions by the Fund, whether from ordinary
income or capital gains, generally will not be eligible for the dividends
received deduction allowed to corporations under the Code. If the Fund pays a
dividend in January that was declared in the previous October, November or
December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
30
<PAGE>
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% U.S. withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the U.S. withholding
tax.
Under certain provisions of the Code, some shareholders may be subject to
a 31% withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that such investor is
not otherwise subject to backup withholding.
Dividends and interest received by the Fund may give rise to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes.
Shareholders may be able to claim U.S. foreign tax credits with respect to such
taxes, subject to certain conditions and limitations contained in the Code. For
example, certain retirement accounts cannot claim foreign tax credits on
investments in foreign securities held in the Fund. In addition, recent
legislation permits a foreign tax credit to be claimed with respect to
withholding tax on a dividend only if the shareholder meets certain holding
period requirements. The Fund also must meet these holding period requirements,
and if the Fund fails to do so, it will not be able to "pass through" to
shareholders the ability to claim a credit or a deduction for the related
foreign taxes paid by the Fund. If the Fund satisfies the holding period
requirements and more than 50% in value of the Fund's total assets at the close
of its taxable year consists of securities of foreign corporations, the Fund
will be eligible, and intends, to file an election with the Internal Revenue
Service pursuant to which shareholders of the Fund will be required to include
their proportionate shares of such withholding taxes on their U.S. income tax
returns as gross income, treat such proportionate shares as taxes paid by them
and deduct such proportionate shares in computing their taxable incomes or,
alternatively, use them as foreign tax credits against their U.S. income taxes.
No deductions for foreign taxes, moreover, may be claimed by noncorporate
shareholders who do not itemize deductions. A shareholder that is a nonresident
alien individual or a foreign corporation may be subject to U.S. withholding
tax on the income resulting from the Fund's election described in this
paragraph but may not be able to claim a credit or deduction against such U.S.
tax for the foreign taxes treated as having been paid by such shareholder. The
Fund will report annually to its shareholders the amount per share of such
withholding taxes and other information needed to claim the foreign tax credit.
For this purpose, the Fund will allocate foreign taxes and foreign source
income among the Class A, Class B, Class C and Class D shareholders according
to a method (which it believes is consistent with the Commission rule
permitting the issuance and sale of multiple classes of stock) that is based on
the gross income allocable to the Class A, Class B, Class C and Class D
shareholders during the taxable year or such other method as the Internal
Revenue Service may prescribe.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis
in the Class D shares acquired will be the same as such shareholder's basis in
the Class B shares converted, and the holding period of the acquired Class D
shares will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring the shares, then the loss the shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent any sales charge
paid to the Fund on the exchanged shares reduces any sales charge the
shareholder would have owed upon purchase of the new shares in the absence of
the exchange privilege. Instead, such sales charge will be treated as an amount
paid for the new shares.
31
<PAGE>
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income
and capital gains in the manner necessary to minimize imposition of the 4%
excise tax, there can be no assurance that sufficient amounts of the Fund's
taxable income and capital gains will be distributed to avoid entirely the
imposition of the tax. In such event, the Fund will be liable for the tax only
on the amount by which it does not meet the foregoing distribution
requirements.
The Fund may invest in securities rated in the medium to lower rating
categories of nationally recognized rating organizations, and in unrated
securities ("high yield/high risk securities"), as described in the Prospectus.
Some of these high yield securities may be purchased at a discount and may
therefore cause the Fund to accrue and distribute income before amounts due
under the obligations are paid. In addition, a portion of the interest payments
on such high yield securities may be treated as dividends for Federal income
tax purposes; in such case, if the issuer of such high yield/high risk
securities is a domestic corporation, dividend payments by the Fund will be
eligible for the dividends received deduction to the extent of the deemed
dividend portion of such interest payments.
The Fund may invest up to 10% of its total assets in securities of other
closed-end investment companies. If the Fund purchases shares of an investment
company (or similar investment entity) organized under foreign law, the Fund
will be treated as owning shares in a passive foreign investment company
("PFIC") for U.S. Federal income tax purposes. The Fund may be subject to U.S.
Federal income tax, and an additional tax in the nature of interest (the
"interest charge"), on a portion of the distributions from such a company and on
gain from the disposition of the shares of such a company (collectively referred
to as "excess distributions"), even if such excess distributions are paid by the
Fund as a dividend to its shareholders. The Fund may be eligible to make an
election with respect to certain PFICs in which it owns shares that will allow
it to avoid the taxes on excess distributions. However, such election may cause
the Fund to recognize income in a particular year in excess of the distributions
received from such PFICs. Alternatively, under recent legislation the Fund could
"mark to market" at the end of each taxable year all shares that it holds in
PFICs. If it made this election, the Fund would recognize as ordinary income any
increase in the value of such shares over their adjusted basis and as ordinary
loss any decrease in such value to the extent it did not exceed prior increases.
By making the mark-to-market election, the Fund could avoid imposition of the
interest charge with respect to its distributions from PFICs, but in any
particular year might be required to recognize income in excess of the
distributions it received from PFICs and its proceeds from dispositions of PFIC
stock.
TAX TREATMENT OF OPTIONS, FUTURES AND FORWARD FOREIGN EXCHANGE
TRANSACTIONS. The Fund may write, purchase or sell options, futures and forward
foreign exchange contracts. Options and futures contracts that are "Section
1256 contracts" will be "marked to market" for Federal income tax purposes at
the end of each taxable year, I.E., each such option or futures contract will
be treated as sold for its fair market value on the last day of the taxable
year. Unless such contract is a forward foreign exchange contract, or is a
non-equity option or a regulated futures contract for a non-U.S. currency for
which the Fund elects to have gain or loss treated as ordinary gain or loss
under Code Section 988 (as described below), gain or loss from Section 1256
contracts will be 60% long-term and 40% short-term capital gain or loss.
Application of these rules to Section 1256 contracts held by
32
<PAGE>
the Fund may alter the timing and character of distributions to shareholders.
The mark-to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest or currency exchange rates with respect to its investments.
A forward foreign exchange contract that is a Section 1256 contract will
be marked to market, as described above. However, the character of gain or loss
from such a contract will generally be ordinary under Code Section 988. The
Fund may, nonetheless, elect to treat the gain or loss from certain forward
foreign exchange contracts as capital. In this case, gain or loss realized in
connection with a forward foreign exchange contract that is a Section 1256
contract will be characterized as 60% long-term and 40% short-term capital gain
or loss.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and transactions in options, futures
and forward foreign exchange contracts. Under Section 1092, the Fund may be
required to postpone recognition for tax purposes of losses incurred in certain
sales of securities and certain closing transactions in options, futures and
forward foreign exchange contracts.
SPECIAL RULES FOR CERTAIN FOREIGN CURRENCY TRANSACTIONS. In general, gains
from "foreign currencies" and from foreign currency options, foreign currency
futures and forward foreign exchange contracts relating to investments in
stock, securities or foreign currencies will be qualifying income for purposes
of determining whether the Fund qualifies as a RIC. It is currently unclear,
however, who will be treated as the issuer of a foreign currency instrument or
how foreign currency options, foreign currency futures and forward foreign
exchange contracts will be valued for purposes of the RIC diversification
requirements applicable to the Fund.
Under Code Section 988, special rules are provided for certain transactions
in a currency other than the taxpayer's functional currency (I.E., unless
certain special rules apply, currencies other than the U.S. dollar). In general,
foreign currency gains or losses from certain debt instruments, from certain
forward contracts, from futures contracts that are not "regulated futures
contracts" and from unlisted options will be treated as ordinary income or loss
under Code Section 988. In certain circumstances, the Fund may elect capital
gain or loss treatment for such transactions. Regulated futures contracts, as
described above, will be taxed under Code Section 1256 unless application of
Section 988 is elected by the Fund. In general, however, Code Section 988 gains
or losses will increase or decrease the amount of the Fund's investment company
taxable income available to be distributed to shareholders as ordinary income.
Additionally, if Code Section 988 losses exceed other investment company taxable
income during a taxable year, the Fund would not be able to make any ordinary
income dividend distributions, and all or a portion of distributions made before
the losses were realized but in the same taxable year would be recharacterized
as a return of capital to shareholders, thereby reducing the basis of each
shareholder's Fund shares and resulting in a capital gain for any shareholder
who received a distribution greater than the shareholder's basis in Fund shares
(assuming the shares were held as a capital asset). These rules and the
mark-to-market rules described above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of currency
fluctuations with respect to its investments.
The Treasury Department has authority to issue regulations concerning the
recharacterization of principal and interest payments with respect to debt
obligations issued in hyperinflationary currencies, which may include the
currencies of certain developing Asia-Pacific and Latin American countries in
which the Fund intends to invest. No such regulations have been issued.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
33
<PAGE>
Ordinary income and capital gain dividends may also be subject to state
and local taxes.
Certain states exempt from state income taxation dividends paid by RICs
that are derived from interest on U.S. Government obligations. State law varies
as to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax.
Shareholders are urged to consult their own tax advisors regarding
specific questions as to Federal, foreign, state or local taxes. Foreign
investors should consider applicable foreign taxes in their evaluation of an
investment in the Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present
or prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is determined separately for Class A, Class B,
Class C and Class D shares in accordance with a formula specified by the
Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A and Class D shares and the CDSC that would be applicable to a complete
redemption of the investment at the end of the specified period in the case of
Class B and Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (i) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted,
and (ii) the maximum applicable sales charges will not be included with respect
to annual or annualized rates of return calculations. Aside from the impact on
the performance data calculations of including or excluding the maximum
applicable sales charges, actual annual or annualized total return data
generally will be lower than average annual total return data since the average
rates of return reflect compounding of return; aggregate total return data
generally will be higher than average annual total return data since the
aggregate rates of return reflect compounding over longer periods of time.
Set forth in the tables below is total return information for the Class A,
Class B, Class C and Class D shares of the Fund for the periods indicated.
34
<PAGE>
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES
--------------------------------------- --------------------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A PERCENTAGE VALUE OF A AS A PERCENTAGE VALUE OF A
BASED ON A HYPOTHETICAL BASED ON A HYPOTHETICAL
HYPOTHETICAL $1,000 INVESTMENT HYPOTHETICAL $1,000 INVESTMENT
$1,000 AT THE END OF $1,000 AT THE END OF
PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD
- ---------------------------------------- ----------------- ------------------- ----------------- ------------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
One Year Ended June 30, 1998 ........... (39.36)% $ 606.40 (39.07)% $ 609.30
Five Years Ended June 30, 1998 ......... 0.73% $ 1,036.80 -- --
Inception (September 1, 1989) to
June 30, 1998 ......................... 4.63% $ 1,491.10 -- --
Inception (July 1, 1994) to
June 30, 1998 ......................... -- -- ( 5.07)% $ 812.20
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Year Ended June 30, 1998 ............... (36.00)% $ 640.00 (36.68)% $ 633.20
Year Ended June 30, 1997 ............... 17.66% $ 1,176.60 16.39% $ 1,163.90
Year Ended June 30, 1996 ............... 14.82% $ 1,148.20 13.63% $ 1,136.30
Year Ended June 30, 1995 ............... ( 1.67)% $ 983.30 -- --
Inception (July 1, 1994) to
June 30, 1995 ......................... -- -- ( 2.22)% $ 977.80
Year Ended June 30, 1994 ............... 28.73% $ 1,287.30 -- --
Year Ended June 30, 1993 ............... 5.17% $ 1,051.70 -- --
Year Ended June 30, 1992 ............... 17.02% $ 1,170.20 -- --
Year Ended June 30, 1991 ............... ( 4.45)% $ 955.50 -- --
Inception (September 1, 1989) to
June 30, 1990 ......................... 22.29% $ 1,222.90
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Inception (September 1, 1989) to
June 30, 1998 ......................... 49.11% $ 1,491.10 -- --
Inception (July 1, 1994) to
June 30, 1998 ......................... -- -- (18.78)% $ 812.20
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
CLASS C SHARES CLASS D SHARES
--------------------------------------- --------------------------------------
EXPRESSED REDEEMABLE EXPRESSED REDEEMABLE
AS A PERCENTAGE VALUE OF A AS A PERCENTAGE VALUE OF A
BASED ON A HYPOTHETICAL BASED ON A HYPOTHETICAL
HYPOTHETICAL $1,000 INVESTMENT HYPOTHETICAL $1,000 INVESTMENT
$1,000 AT THE END OF $1,000 AT THE END OF
PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD
- ---------------------------------- ----------------- ------------------- ----------------- ------------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C> <C> <C>
Year Ended June 30, 1998 ......... ( 37.28)% $ 627.80 ( 39.49)% $ 605.10
Inception (October 21, 1994) to
June 30, 1998 ................... ( 8.79)% $ 712.20 ( 9.38)% $ 695.30
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Year Ended June 30, 1998 ......... ( 36.69)% $ 633.10 ( 36.13)% $ 638.70
Year Ended June 30, 1997 ......... 16.37% $ 1,163.70 17.30% $ 1,173.00
Year Ended June 30, 1996 ......... 13.68% $ 1,136.80 14.55% $ 1,145.50
Inception (October 21, 1994) to
June 30, 1995 ................... (14.97)% $ 850.30 (14.49)% $ 855.10
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Inception (October 21, 1994) to
June 30, 1998 ................... ( 28.78)% $ 712.20 ( 30.47)% $ 695.30
</TABLE>
In order to reflect the reduced sales charges in the case of Class A or
Class D shares, or the waiver of the CDSC in the case of Class B or Class C
shares, applicable to certain investors, as described under "Purchase of
Shares" and "Redemption of Shares," respectively, the total return data quoted
by the Fund in advertisements directed to such investors may take into account
the reduced, and not the maximum, sales charge or may not take into account the
CDSC and therefore may reflect greater total return since, due to the reduced
sales charges or the waiver of sales charges, a lower amount of expenses may be
deducted.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Fund was incorporated under Maryland law on April 14, 1989. At the
date of this Statement of Additional Information, the Fund has an authorized
capital of 400,000,000 shares of Common Stock, par value $0.10 per share,
divided into four classes, designated Class A, Class B, Class C and Class D
Common Stock, each of which consists of 100,000,000 shares. Each share of Class
A, Class B, Class C and Class D Common Stock represents an interest in the same
assets of the Fund and is identical in all respects except that the Class B,
Class C and Class D shares bear certain expenses related to the account
maintenance and/or distribution of such shares and have exclusive voting rights
with respect to matters relating to such account maintenance and/or
distribution expenditures. The Board of Directors of the Fund may classify and
reclassify the shares of the Fund into additional classes of Common Stock at a
future date.
Shareholders are entitled to one vote for each share held and fractional
votes for fractional shares held and will vote on the election of Directors and
any other matter submitted to a shareholder vote. The Fund does not intend to
hold meetings of shareholders in any year in which the Investment Company Act
does not require shareholders to act upon any of the following matters: (i)
election of Directors; (ii) approval of a management
36
<PAGE>
agreement; (iii) approval of a distribution agreement; and (iv) ratification of
selection of independent accountants. In addition, the by-laws of the Fund
require that a special meeting of shareholders be held upon the written request
of at least 10% of the outstanding shares of the Fund entitled to vote at such
meeting, if such request is in compliance with applicable Maryland law. Voting
rights for Directors are not cumulative. Shares issued are fully paid and
non-assessable and have no preemptive rights. Redemption and conversion rights
are discussed elsewhere herein and in the Prospectus. Each share is entitled to
participate equally in dividends and distributions declared by the Fund and in
the net assets of the Fund upon liquidation or dissolution after satisfaction
of outstanding liabilities. Stock certificates are issued by the transfer agent
only on specific request. Certificates for fractional shares are not issued in
any case. A Director may be removed at a special meeting of shareholders by a
vote of a majority of the votes entitled to be cast for the election of
Directors.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A,
Class B, Class C and Class D shares of the Fund based on the value of the
Fund's net assets on June 30, 1998, and its shares outstanding on June 30, 1998
is set forth below:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
----------------- ----------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net Assets .................................. $ 219,421,814 $ 164,929,560 $ 32,339,121 $ 31,685,740
============= ============= ============ ============
Number of Shares Outstanding ................ 21,026,252 16,044,527 3,157,682 3,044,847
============= ============= ============ ============
Net Asset Value Per Share (net assets divided
by number of shares outstanding) ........... $ 10.44 $ 10.28 $ 10.24 $ 10.41
Sales Charge (for Class A and Class D shares:
5.25% of offering price (5.54% of net asset
value per share))* ......................... .58 ** ** .58
------------- ------------- ------------ ------------
Offering Price .............................. $ 11.02 $ 10.28 $ 10.24 $ 10.99
============= ============= ============ ============
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C Shares are not subject to an initial sales charge but
may be subject to a CDSC upon redemption. See "Purchase of Shares --
Deferred Sales Charge Alternatives -- Class B and Class C Shares" in the
Prospectus and "Redemption of Shares -- Deferred Sales Charges -- Class B
and Class C Shares" herein.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to approval by the independent Directors of the
Fund. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02119 (the "Custodian"), acts as the custodian of the Fund's assets. Under its
contract with the Fund, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by the
Fund to be held in its offices outside the United States and with certain
foreign banks and securities depositories. The Custodian is responsible for
safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Fund's investments.
37
<PAGE>
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, acts as the Fund's transfer agent (the "Transfer Agent").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Management of the Fund -- Transfer Agency Services" in the Prospectus.
LEGAL COUNSEL
Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557,
is counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on June 30 of each year. The Fund sends
to its shareholders at least semi-annually reports showing the Fund's portfolio
and other information. An annual report, containing financial statements
audited by independent auditors, is sent to shareholders each year. After the
end of each year shareholders will receive Federal income tax information
regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act and the Investment
Company Act, to which reference is hereby made.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
To the knowledge of the Fund, no person or entity owned beneficially 5% or
more of the Fund's common stock on October 1, 1998.
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated by reference in
this Statement of Additional Information to its 1998 annual report to
shareholders. You may request a copy of the annual report at no charge by
calling 1-800-456-4587 ext. 789 between 8:00 a.m. and 8:00 p.m. on any business
day.
38
<PAGE>
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Investment Objective and Policies ................... 2
Portfolio Strategies Involving Options and
Futures ....................................... 2
Other Investment Policies and Practices .......... 7
Investment Restrictions .......................... 9
Management of the Fund .............................. 12
Directors and Officers ........................... 12
Compensation of Directors ........................ 13
Management and Advisory Arrangements ............. 14
Purchase of Shares .................................. 15
Initial Sales Charge Alternatives -- Class A and
Class D Shares ................................ 15
Reduced Initial Sales Charges .................... 17
Employer-Sponsored Retirement or Savings
Plans and Certain Other Arrangements .......... 19
Distribution Plans ............................... 19
Limitations on the Payment of Deferred Sales
Charges ....................................... 20
Redemption of Shares ................................ 21
Deferred Sales Charges -- Class B and Class C
Shares ........................................ 21
Portfolio Transactions and Brokerage ................ 22
Determination of Net Asset Value .................... 24
Shareholder Services ................................ 25
Investment Account ............................... 25
Automatic Investment Plans ....................... 25
Automatic Reinvestment of Dividends and
Capital Gains Distributions ................... 26
Systematic Withdrawal Plans ...................... 26
Exchange Privilege ............................... 27
Dividends, Distributions and Taxes .................. 30
Dividends and Distributions ...................... 30
Taxes ............................................ 30
Performance Data .................................... 34
General Information ................................. 36
Description of Shares ............................ 36
Computation of Offering Price Per Share .......... 37
Independent Auditors ............................. 37
Custodian ........................................ 37
Transfer Agent ................................... 38
Legal Counsel .................................... 38
Reports to Shareholders .......................... 38
Additional Information ........................... 38
Security Ownership of Certain Beneficial
Owners ........................................ 38
Financial Statements ................................ 38
</TABLE>
Code # 10894-1098
(MERRILL LYNCH logo appears here)
MERRILL LYNCH
DEVELOPING CAPITAL
MARKETS FUND, INC.
(compass appears here)
Statement of
Additional
Information
October 28, 1998
Distributor:
Merrill Lynch
Funds Distributor
