VAN KAMPEN MERRITT PRIME RATE INCOME TRUST, N-2/A, 1995-04-05

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST
N-2/A, 1995-04-05

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 6, 1995

FILE NOS. 33-87032

811-5845
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- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-2

REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933 /X/

Pre-Effective Amendment No. 1 /X/

Post-Effective Amendment No. / /
-----
and
REGISTRATION STATEMENT UNDER
THE INVESTMENT COMPANY ACT OF 1940 /X/

Amendment No. 18 /X/

VAN KAMPEN MERRITT
PRIME RATE INCOME TRUST
(Exact Name of Registrant as Specified in Declaration of Trust)

One Parkview Plaza, Oakbrook Terrace, Illinois 60181
(Address of Principal Executive Offices) (Zip Code)

(708) 684-6000
(Registrant's Telephone Number, including Area Code)

Dennis J. McDonnell
President, Van Kampen Merritt Prime Rate Income Trust
One Parkview Plaza
Oakbrook Terrace, Illinois 60181
(Name and Address of Agent for Service)

Copies to:

<TABLE>
<S> <C>
Wayne W. Whalen, Esq. Ronald A. Nyberg, Esq.
Thomas A. Hale, Esq. Executive Vice President,
Skadden, Arps, Slate, Meagher & Flom General Counsel and Director
333 W. Wacker Drive Van Kampen American Capital
Chicago, Illinois 60606 Investment Advisory Corp.
(312) 407-0700 One Parkview Plaza
Oakbrook Terrace, Illinois 60181
</TABLE>

The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant shall
file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.

Approximate date of proposed public offering: As soon as practicable after
the effective date of this Post-Effective Amendment to the Registration
Statement.

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. /X/
------------------

CALCULATION OF REGISTRATION FEE UNDER THE
SECURITIES ACT OF 1933
<TABLE>
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<CAPTION>
PROPOSED* PROPOSED*
AMOUNT OF MAXIMUM MAXIMUM AMOUNT OF
TITLE OF SECURITIES SHARES BEING OFFERING PRICE AGGREGATE REGISTRATION
BEING REGISTERED REGISTERED PER UNIT OFFERING PRICE FEE*
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Shares of Beneficial
Interest.......................... 140,000,000 $10.04 $1,405,600,000 $484,693.05
- ---------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------
</TABLE>

* Estimated solely for the purpose of calculating the registration fee.
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<PAGE> 2

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

CROSS REFERENCE SHEET
PURSUANT TO RULE 404(C)

<TABLE>
<CAPTION>
ITEM NUMBER, FORM N-2 CAPTION IN PROSPECTUS
- ------------------------------------------------------------ ---------------------------------
<S> <C>
Part A
1. Outside Front Cover.................................... Cover Page
2. Inside Front and Outside Back Cover Page............... Cover Page; Outside Back Cover
3. Fee Table and Synopsis................................. Fund Expenses and Prospectus
Summary
4. Financial Highlights................................... Financial Highlights
5. Plan of Distribution................................... Use of Proceeds; Purchasing
Shares of the Fund; Management of
Fund; The Auction
6. Selling Shareholders................................... Not Applicable
7. Use of Proceeds........................................ Use of Proceeds; Investment
Objective and Policies and
Special Risk Factors
8. General Description of the Registrant.................. The Fund; Investment Objective
and Policies and Special Risk
Factors; Investment Practices and
Special Risks; Description of
Common Shares
9. Management............................................. Management of the Fund;
Custodian, Dividend Disbursing
and Transfer Agent
10. Capital Stock, Long-Term Debt and Other Securities..... The Fund; Taxation;
Distributions; Dividend
Reinvestment Plan; Repurchase of
Shares; Description of Common
Shares; Communications with
Shareholders
11. Defaults and Arrears on Senior Securities.............. Not Applicable
12. Legal Proceedings...................................... Not Applicable
13. Table of Contents of the Statement of Additional
Information............................................ Table of Contents of the
Statement of Additional
Information
</TABLE>
<PAGE> 3

<TABLE>
<CAPTION>
CAPTION IN SAI
---------------------------------
<S> <C>
Part B
14. Cover Page............................................. Cover Page
15. Table of Contents...................................... Cover Page
16. General Information and History........................ Not Applicable
17. Investment Objective and Policies...................... Investment Objective and
Policies; Investment
Restrictions; Portfolio
Transactions
18. Management............................................. Officers and Trustees
19. Control Persons and Principal Holders of Securities.... Officers and Trustees
20. Investment Advisory and Other Services................. Officers and Trustees; Management
of the Fund
21. Brokerage Allocation and Other Practices............... Portfolio Transactions
22. Tax Status............................................. Taxation
23. Financial Statements................................... Unaudited Financial Statements
for the Six Month Period Ended
January 31, 1995; Notes to
Unaudited Financial Statements;
Independent Auditors' Report;
Audited Financial Statements;
Notes to Audited Financial
Statements
</TABLE>

<PAGE> 4

VAN KAMPEN MERRITT

PRIME RATE INCOME TRUST

Van Kampen Merritt Prime Rate Income Trust (the "Fund") is a
non-diversified, closed-end management investment company. The Fund's investment
objective is to provide a high level of current income, consistent with
preservation of capital. The Fund seeks to achieve its objective by investing
primarily in a professionally managed portfolio of interests in floating or
variable rate senior loans ("Senior Loans") to United States corporations,
partnerships and other entities ("Borrowers") which operate in a variety of
industries and geographical regions. Although the Fund's net asset value will
vary, the Fund's policy of acquiring interests in floating or variable rate
Senior Loans is expected to minimize fluctuations in the Fund's net asset value
as a result of changes in interest rates. The Fund's net asset value may be
affected by changes in the credit quality of Borrowers with respect to Senior
Loan interests in which the Fund invests. The Fund's investment adviser is Van
Kampen American Capital Investment Advisory Corp. (the "Adviser"). An investment
in the Fund may not be appropriate for all investors and there is no assurance
that the Fund will achieve its investment objective. See "Investment Objective
and Policies and Special Risk Considerations."

The Board of Trustees of the Fund currently intends, each quarter, to
consider authorizing the Fund to make tender offers for all or a portion of its
outstanding common shares of beneficial interest ("Common Shares") at the then
current net asset value of the Common Shares. An early withdrawal charge payable
to Van Kampen American Capital Distributors, Inc. ("VKAC") will be imposed on
most Common Shares held for less than five years that are accepted for
repurchase pursuant to a tender offer by the Fund. The Fund does not intend to
list the Common Shares on any national securities exchange and none of the Fund,
the Adviser or VKAC intends to make a secondary market in the Common Shares at
any time. Accordingly, Common Shares of the Fund have no history of public
trading, and there is not expected to be any secondary trading market in the
Common Shares. An investment in the Common Shares should be considered illiquid.

(Continued on next page.)

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------

Shares of the Fund are not deposits or obligations of, guaranteed or
endorsed by, any bank or depository institution; further, such shares are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board, or any other government agency. Shares of the Fund involve
investment risks, including the possible loss of principal.

This Prospectus sets forth concisely the information that a prospective
investor should know before investing in the Common Shares of the Fund. Please
read and retain this Prospectus for future reference. A Statement of Additional
Information dated April 6, 1995 has been filed with the Securities and Exchange
Commission and can be obtained without charge by calling 1-800-225-2222, ext.
6504 or, for Telecommunications Device for the Deaf, 1-800-772-8889. A table of
contents to the Statement of Additional Information is located at page 46 of
this Prospectus. This Prospectus incorporates by reference the entire Statement
of Additional Information.

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VAN KAMPEN AMERICAN CAPITALSM

------------------

THIS PROSPECTUS IS DATED APRIL 6, 1995.

SM denotes a registered servicemark of Van Kampen American Capital Distributors,
Inc.

<PAGE> 5

(Continued from previous page.)

The Fund completed an initial public offering of its Common Shares in
October, 1989. Since November 13, 1989 the Fund has engaged in a continuous
offering of its Common Shares through VKAC, as principal underwriter, and
through selected broker-dealers and financial services firms, at a price per
Common Share equal to net asset value. There is no initial sales charge or
underwriting discount on purchases of Common Shares. VKAC will compensate from
its own assets the broker-dealers and financial services firms participating in
the continuous offering. The minimum initial investment is $1,000. The minimum
initial investment for tax sheltered retirement plans is $250. See "Purchasing
Shares of the Fund." The Fund has registered 140,000,000 Common Shares for sale
under the Registration Statement to which this Prospectus relates. The Fund
expects to incur approximately $865,000 in expenses in connection with the
offering of such Shares. A portion of such expenses will be charged as operating
expenses during the current period and the remainder will be amortized over a
period of not more than twelve months.

Senior Loans in which the Fund may invest generally will pay interest at
rates which are periodically redetermined on the basis of a base lending rate
plus a premium. These base lending rates are generally the Prime Rate offered by
a major United States bank, the London Inter-Bank Offered Rate, the Certificate
of Deposit rate or other base lending rates used by commercial lenders. The Fund
will seek to achieve over time an effective yield that approximates the average
published Prime Rate of major United States banks. Senior Loans generally will
hold the most senior position in the capital structure of the Borrower and
generally will be secured with specific collateral, which may include
guarantees. The terms of Senior Loans typically will include various restrictive
covenants which are designed to limit certain activities of the Borrower. It is
anticipated that the proceeds of the Senior Loans in which the Fund will acquire
interests will be used primarily to finance leveraged buyouts,
recapitalizations, mergers, acquisitions, stock repurchases and, to a lesser
extent, to finance internal growth and for other corporate purposes of
Borrowers. See "Investment Objective and Policies and Special Risk
Considerations."

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FOR TEXAS INVESTORS ONLY

There is no limit on the percentage of the Fund's assets which may be
invested in interests in Senior Loans which are not readily marketable or
subject to restrictions on resale. The value of interests in Senior Loans will
be determined by the Adviser following guidelines established by the Trustees.
Interests in Senior Loans will be valued by the Adviser on behalf of the Fund on
the basis of market quotations and transactions in instruments with comparable
credit quality, interest rate, interest rate redetermination period and maturity
(such as commercial paper, negotiable certificates of deposit, treasury bills
and short-term variable rate securities) and the relationship between such
instruments and the Senior Loan interests in the Fund's portfolio. In
determining such relationship the Adviser will consider, among other factors,
(i) the credit worthiness of the Borrower and (ii) the current interest rate,
the period until next interest rate redetermination and maturity of the Senior
Loans.

The investment advisory and administrative services fees will be determined
on the basis of the average weekly managed assets of the Fund. The price of
offers for tender of Common Shares made by the Fund will be based upon the then
current net asset value of the Common Shares.

The minimum initial investment in the Fund required for Texas investors is
$5,000.

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FOR ARIZONA, NEW JERSEY AND WASHINGTON INVESTORS ONLY

THESE SECURITIES ARE SPECULATIVE.

See "Investment Practices and Special Risks."

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2
<PAGE> 6

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fund Expenses....................................................... 4
Prospectus Summary.................................................. 5
Financial Highlights................................................ 14
The Fund............................................................ 15
Use of Proceeds..................................................... 15
Investment Objective and Policies and Special Risk Factors.......... 16
Certain Characteristics of Senior Loan Interests.................. 16
Special Risk Considerations....................................... 23
Investment Practices and Special Risks.............................. 26
Taxation............................................................ 30
Management of the Fund.............................................. 32
Distributions....................................................... 34
Dividend Reinvestment Plan.......................................... 34
Repurchase of Shares................................................ 35
Description of Common Shares........................................ 38
Purchasing Shares of the Fund....................................... 41
Communications with Shareholders.................................... 44
Custodian, Dividend Disbursing and Transfer Agent................... 45
Legal Opinions...................................................... 45
Experts............................................................. 46
Additional Information.............................................. 46
Table of Contents for Statement of Additional Information........... 46
</TABLE>

NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS, IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE FUND, THE FUND'S ADVISER OR PRINCIPAL UNDERWRITER. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER
TO BUY ANY SECURITY OTHER THAN THE COMMON SHARES OFFERED BY THIS PROSPECTUS, NOR
DOES IT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE
COMMON SHARES BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS
NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, IN ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.

3
<PAGE> 7

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FUND EXPENSES
- --------------------------------------------------------------------------------

The following tables are intended to assist investors in understanding the
various costs and expenses directly or indirectly associated with investing in
the Fund.

<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Sales Load (as a percentage of offering price)................ None
Dividend Reinvestment Plan Fees............................... None
Early Withdrawal Charge....................................... 0.00-3.00%
ANNUAL OPERATING EXPENSES (AS A PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON SHARES)
Investment Advisory and Administration Fees................... 1.20%
Interest Payments on Borrowed Funds........................... 0.00%
Other Expenses................................................ 0.31%
----------
Total Annual Fund Operating Expenses...................... 1.51%
</TABLE>

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See "Management of the Fund" for additional information.

EXAMPLE

An investor would pay the following expenses on a $1,000 investment in the
Fund, assuming a 5% annual return:

<TABLE>
<CAPTION>
ONE YEAR THREE YEARS FIVE YEARS TEN YEARS
-------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
Assuming no tender of Common Shares.... $15 $48 $82 $180
Assuming tender and repurchase of
Common Shares on last day of period and
imposition of maximum applicable early
withdrawal charge...................... $45 $68 $92 $180
</TABLE>

This "Example" assumes that all dividends and other distributions are
reinvested at net asset value and that the percentage amounts listed under Total
Annual Fund Operating Expenses remain the same in the years shown except, as to
the Three, Five and Ten Year periods, for the completion of organization expense
amortization. The above tables and the assumptions in the Example of a 5% annual
return and reinvestment at net asset value are required by regulation of the
Securities and Exchange Commission ("SEC"); the assumed 5% annual return is not
a prediction of, and does not represent, the projected or actual performance of
the Fund's Common Shares. THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION
OF FUTURE EXPENSES, AND THE FUND'S ACTUAL EXPENSES MAY BE MORE OR LESS THAN
THOSE SHOWN.

4
<PAGE> 8

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PROSPECTUS SUMMARY
- --------------------------------------------------------------------------------

The following summary is qualified in its entirety by reference to the more
detailed information included elsewhere in this Prospectus and the Statement of
Additional Information.

THE FUND Van Kampen Merritt Prime Rate Income Trust (the "Fund") is a non-
diversified, closed-end management investment company, organized as a
Massachusetts business trust on July 14, 1989. The Fund completed an initial
public offering of its common shares of beneficial interest ("Common Shares") in
October, 1989. Since November 13, 1989 the Fund has engaged in a continuous
offering of its Common Shares through Van Kampen American Capital Distributors,
Inc. ("VKAC") (an indirect affiliate of the Fund), as principal underwriter. As
of March 10, 1995, the Fund had 184,336,246 Common Shares outstanding and had
net assets of $1,848,560,371. See "The Fund."

CONTINUOUS OFFERING The Fund is continuously offering Common Shares through
VKAC, as principal underwriter, and through selected broker-dealers and
financial services firms, at a public offering price per Common Share equal to
net asset value. There is no initial sales charge or underwriting discount on
purchases of Common Shares. VKAC will compensate from its own assets the
broker-dealers and financial services firms participating in the continuous
offering. The minimum initial investment is $1,000 and minimum subsequent
investment is $100. The minimum initial investment for tax sheltered retirement
plans is $250. The Fund does not intend to list the Common Shares on any
national securities exchange. The Fund may from time to time make tender offers
for all or a portion of its Common Shares. An early withdrawal charge payable to
VKAC will be imposed on most Common Shares accepted for tender that have been
held for less than five years. See "Purchasing Shares of the Fund" and
"Repurchase of Shares."

INVESTMENT OBJECTIVE AND POLICIES The Fund's investment objective is to provide
a high level of current income, consistent with preservation of capital. The
Fund seeks to achieve its objective by investing primarily in a professionally
managed portfolio of interests in floating or variable rate senior loans
("Senior Loans") to United States corporations, partnerships and other entities
("Borrowers"). Although the Fund's net asset value will vary, the Fund's policy
of acquiring interests in floating or variable rate Senior Loans is expected to
minimize fluctuations in the Fund's net asset value as a result of changes in
interest rates. Senior Loans in which the Fund will purchase interests generally
pay interest at rates which are periodically redetermined by reference to a base
lending rate plus a premium. These base lending rates are generally the prime
rate offered by one or more major United States banks ("Prime Rate"), the London
Inter-Bank Offered Rate ("LIBOR"), the Certificate of Deposit ("CD") rate or
other base lending rates used by commercial lenders. The Fund seeks to achieve
over time an effective yield that approximates the average published Prime Rate
of major United States banks. The Fund's net asset value may be affected by
changes in the credit quality of Borrowers with respect to Senior Loan interests
in which the Fund invests. An investment in the Fund

5
<PAGE> 9

may not be appropriate for all investors and is not intended to be a complete
investment program. No assurance can be given that the Fund will achieve its
investment objective. As discussed below in this Prospectus Summary under
"Tender Offers," an investment in the Common Shares should be considered
illiquid.

Senior Loans generally are arranged through private negotiations between a
Borrower and several financial institutions ("Lenders") represented in each case
by one or more such Lenders acting as agent ("Agent") of the several Lenders. On
behalf of the several Lenders, the Agent will be primarily responsible for
negotiating the loan agreement ("Loan Agreement") that establishes the relative
terms and conditions of the Senior Loan and rights of the Borrower and the
several Lenders. The Fund will invest in participations ("Participations") in
Senior Loans, will purchase assignments ("Assignments") of portions of Senior
Loans from third parties and may act as one of the group of Lenders originating
a Senior Loan (an "Original Lender"). The Fund will purchase an Assignment or
act as Original Lender with respect to a syndicated Senior Loan, initially, only
where the Agent with respect to such Senior Loan at the time of investment has
outstanding debt or deposit obligations rated investment grade (BBB or A-3 or
higher by Standard & Poor's Ratings Group "S&P" or Baa or P-3 or higher by
Moody's Investors Service "Moody's") or determined by the Adviser to be of
comparable quality. In addition, the Fund will purchase a Participation only
when the Lender selling such Participation, and any other person interpositioned
between such Lender and the Fund at the time of investment have outstanding debt
obligations rated investment grade or determined by the Adviser to be of
comparable quality. Further, the Fund will not purchase interests in Senior
Loans unless such Agent, Lender or interpositioned person has entered into an
agreement which provides for the holding of assets in safekeeping for, or the
prompt disbursement of assets to, the Fund. With respect to any given Senior
Loan, the rights of the Fund when it acquires a Participation may be different
from, and more limited than, the rights of Original Lenders or of persons who
acquire an Assignment. Participations may entail certain risks relating to the
creditworthiness of the parties from which the Participations are obtained. The
Fund may pay a fee or forgo a portion of interest payments to the Lender selling
a Participation or Assignment pursuant to the terms of such Participation or
Assignment.

6
<PAGE> 10

those associated with investment in collateralized Senior Loans. Loan Agreements
may provide for various restrictive covenants designed to limit the activities
of the Borrower in an effort to protect the interests of the Lenders. Breach of
such covenants, if not waived by the Lenders, is generally an event of default
under the Loan Agreement and may give the Lenders the right to accelerate
principal and interest payments. The Adviser will consider the terms of such
restrictive covenants in deciding whether to invest in Senior Loans for the
Fund's portfolio. When the Fund holds a Participation in a Senior Loan it may
not have the right to vote to waive enforcement of any restrictive covenant
breached by a Borrower. Lenders voting in connection with a potential waiver of
a restrictive covenant may have interests different from those of the Fund and
such Lenders may not consider the interests of the Fund in connection with their
votes.

Pursuant to the relevant Loan Agreement, the Borrower may be required in
certain circumstances, and may have the option at any time, to prepay the
principal amount of a Senior Loan, often without incurring a prepayment penalty.
A Lender may have certain obligations pursuant to a Loan Agreement, which may
include the obligation to make additional loans in certain circumstances. The
Fund currently intends to reserve against such contingent obligations by
segregating sufficient investments in high quality short-term, liquid
instruments. The Fund will not purchase interests in Senior Loans that would
commit the Fund to make any such additional loans if the assets segregated
against such additional loan commitments, taken together with assets otherwise
held in high quality, short-term debt securities, would exceed 20% of the Fund's
total assets.

In normal market conditions, at least 80% of the Fund's total assets will be
invested in Senior Loans. The Fund is not subject to any restrictions with
respect to the maturity of Senior Loans held in its portfolio. It is currently
anticipated that the Fund's assets invested in Senior Loans will consist of
Senior Loans with stated maturities of between three and seven years, inclusive,
and with rates of interest which are redetermined either daily, monthly,
quarterly or semi-annually; provided, however, that the Fund may invest up to 5%
of its total assets in Senior Loans which permit the Borrower to select an
interest rate redetermination period of up to one year. Investment in Senior
Loans with longer interest rate redetermination periods may increase
fluctuations in the Fund's net asset value as a result of changes in interest
rates. The Senior Loans in the Fund's portfolio will at all times have a
dollar-weighted average time until next interest rate redetermination of 90 days
or less. Because most Senior Loans in the Fund's portfolio will be subject to
mandatory and/or optional prepayment and as there may be significant economic
incentives for a Borrower to prepay its Senior Loans, prepayment of Senior Loans
in the Fund's portfolio may occur. Accordingly, the actual remaining maturity of
the Fund's portfolio invested in Senior Loans may vary substantially from the
average stated maturity of the Senior Loans held in the Fund's portfolio.
However, because most Senior Loans in which the Fund may invest redetermine
interest rates at least semi-annually, the Fund and the Adviser believe that the
possibility of prepayment does not entail a significant yield risk to holders of
Common Shares.

During normal market conditions, the Fund may invest up to 20% of its total
assets in (i) high quality, short-term debt securities with remaining maturities
of one year or less

7
<PAGE> 11

(including assets maintained by the Fund as a reserve against any additional
loan commitments) and (ii) warrants, equity securities and, in limited
circumstances, junior debt securities acquired in connection with the Fund's
investments in Senior Loans. Such high quality, short-term debt securities may
include commercial paper rated at least in the top two rating categories of
either S&P or Moody's or unrated commercial paper considered by the Adviser to
be of comparable quality, interests in short-term loans of Borrowers having
short-term debt obligations rated or a short-term credit rating at least in such
top two rating categories or having no such rating but determined by the Adviser
to be of comparable quality, certificates of deposit and bankers' acceptances
and securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. Such high quality, short-term debt securities may pay
interest at rates that are periodically redetermined, or may pay interest at
fixed rates. If the Adviser determines that market conditions temporarily
warrant a defensive investment policy, the Fund may, subject to its ability to
liquidate its relatively illiquid portfolio of Senior Loans, invest up to 100%
of its assets in cash and such high quality, short-term securities. The Fund may
also lend its portfolio securities to other parties and may enter into
repurchase and reverse repurchase agreements for securities, subject to certain
restrictions. For further discussion of the Fund's investment objective and
policies and its investment practices and the associated considerations, see
"Investment Objective and Policies and Special Risk Considerations" and
"Investment Practices and Special Risks."

Senior Loans generally are not rated by nationally recognized statistical
rating organizations. Because of the collateralized nature of most Senior Loans
in the Fund's portfolio, the Fund and the Adviser believe that ratings of other
securities issued by a Borrower do not necessarily reflect adequately the
relative quality of a Borrower's Senior Loans. Therefore, although the Adviser
may consider such ratings in determining whether to invest in a particular
Senior Loan, the Adviser is not required to consider such ratings and such
ratings will not be the determinative factor in the Adviser's analysis. The Fund
may invest in Senior Loans, the Borrowers with respect to which have outstanding
debt securities which are rated below investment grade by a nationally
recognized statistical rating organization or are unrated but of comparable
quality to such securities. Debt securities rated below investment grade, or
unrated but of comparable quality, commonly are referred to as "junk bonds." The
Fund will invest only in those Senior Loans with respect to which the Borrower,
in the opinion of the Adviser, demonstrates certain of the following
characteristics: sufficient cash flow to service debt; adequate liquidity;
successful operating history; strong competitive position; experienced
management; and, with respect to collateralized Senior Loans, adequate
collateral coverage of the Senior Loan. In addition, the Adviser will consider,
and may rely in part, on analyses performed by Lenders other than the Fund.

When the Fund purchases a Participation, the Fund typically enters into a
contractual relationship with the Lender selling such Participation, but not
with the Borrower. As a result, the Fund may assume the credit risk of both the
Borrower and the Lender selling the Participation and the Fund may not directly
benefit from the collateral supporting the Senior Loan in which it has purchased
the Participation. The Fund will only acquire Participations if the Lender
selling the Participation, and any other person interpositioned

8
<PAGE> 12

between the Fund and such Lender (i) at the time of investment has outstanding
debt or deposit obligations rated investment grade or determined by the Adviser
to be of comparable quality and (ii) has entered into an agreement providing for
the holding of assets in safekeeping for the Fund. The Fund ordinarily will
purchase a Participation only if, at the time of such purchase, the Fund
believes that the party from whom it is purchasing such Participation is
retaining an interest in the underlying Senior Loan. The Fund believes that such
policies significantly reduce the credit risk that it assumes with respect to
such Lender or interpositioned person.

INVESTMENT ADVISER Van Kampen American Capital Investment Advisory Corp. (the
"Adviser"), a wholly-owned subsidiary of Van Kampen American Capital, Inc., is
the Fund's investment adviser. Van Kampen American Capital, Inc. is a
diversified asset management company with more than two million retail investor
accounts, extensive capabilities for managing institutional portfolios and
nearly $50 billion under management or supervision. Van Kampen American Capital,
Inc.'s over 40 open-end and 38 closed-end funds and more than 2,700 unit
investment trusts are professionally distributed by leading financial advisers
nationwide. In connection with advising the Fund, the Adviser will utilize, at
its own expense, credit analysis and research services provided by its
affiliate, McCarthy, Crisanti & Maffei, Inc. ("MCM"). See "Management of the
Fund."

ADMINISTRATOR VKAC is the Fund's administrator (the "Administrator"). The
Administrator is responsible for managing the business affairs of the Fund,
subject to the supervision of the Fund's Board of Trustees. The administrative
services to be provided by the Administrator include monitoring the provisions
of the Loan Agreements and any agreements with respect to Participations and
Assignments, recordkeeping responsibilities with respect to Senior Loans in the
Fund's portfolio and providing certain services to the holders of the Fund's
securities. See "Management of the Fund."

FEES AND EXPENSES The Fund will pay the Adviser a monthly fee at an annual rate
of 0.95% of the average weekly managed assets of the Fund (as defined). The
advisory fee, which also covers the credit analysis and research services of
MCM, is higher than the fees paid by most other management investment companies,
although it is comparable to the fees paid by several publicly offered,
closed-end management investment companies with an investment objective and
policies similar to those of the Fund. The Fund will pay the Administrator a
monthly fee at an annual rate of 0.25% of the average weekly managed assets of
the Fund (as defined). See "Management of the Fund."

DISTRIBUTIONS The Fund's policy will be to declare daily and pay monthly
distributions to holders of Common Shares of substantially all net investment
income of the Fund. Distributions to holders of Common Shares cannot be assured,
and the amount of each monthly distribution is likely to vary. Net realized
long-term capital gains, if any, are to be distributed to holders of Common
Shares at least annually. Holders of Common Shares may elect to have
distributions automatically reinvested in additional Common Shares. See
"Distributions," "Taxation" and "Dividend Reinvestments."

9
<PAGE> 13

TENDER OFFERS The Board of Trustees of the Fund currently intends, each
quarter, to consider authorizing the Fund to make tender offers for all or a
portion of its outstanding Common Shares at the then current net asset value of
the Common Shares. As of the date hereof, the Fund has commenced and consummated
tender offers in each quarter since the commencement of investment operations.
An early withdrawal charge payable to VKAC will be imposed on most Common Shares
accepted for tender that have been held for less than five years. The Fund does
not intend to list the Common Shares on any national securities exchange and
none of the Fund, the Adviser or VKAC intends to make a secondary trading market
in the Common Shares at any time. Accordingly, there is not expected to be any
secondary trading market in the Common Shares and an investment in the Common
Shares should be considered illiquid. There can be no assurance that the Fund
will in fact tender for any of its Common Shares. If the Fund tenders for Common
Shares there is no guarantee that all, or any, Common Shares tendered will be
purchased. Subject to its borrowing restrictions, the Fund may incur debt to
finance repurchases of its Common Shares pursuant to tender offers; such
borrowings entail additional risks. The ability of the Fund to tender for its
Common Shares may be limited by certain requirements of the Internal Revenue
Code of 1986, as amended, that must be satisfied in order for the Fund to
maintain its desired tax status as a regulated investment company. The Fund may
be required to suspend the continuous offering of its Common Shares during the
term of any such tender offer. See "The Fund," "Purchasing Shares of the Fund"
and "Repurchase of Shares."

SPECIAL RISK CONSIDERATIONS Illiquidity. The Fund is a closed-end investment
company designed primarily for long-term investors and not as a trading vehicle.
The Fund does not intend to list the Common Shares for trading on any national
securities exchange. There is not expected to be any secondary trading market in
the Common Shares and an investment in the Common Shares should be considered
illiquid. In the event that the Fund's Board of Trustees does not, at any time
or from time to time, authorize the Fund to engage in tender offers for its
Common Shares, it is unlikely that a holder of Common Shares will be able to
otherwise sell Common Shares to the Fund. The shares of closed-end investment
companies often trade at a discount from their net asset values and, in the
unlikely event that a secondary market for the Common Shares were to develop,
the Common Shares likewise may trade at a discount from net asset value. Because
the Fund intends to offer its Common Shares continuously at a price equal to net
asset value, it is unlikely that the Common Shares would trade at a premium to
net asset value should a secondary market for the Common Shares develop.

Borrowings. The Fund is authorized to borrow money in an amount up to 33 1/3%
of the Fund's total assets (after giving effect to the amount borrowed) for the
purpose of obtaining short-term credits in connection with tender offers by the
Fund for the Common Shares. Under the requirements of the 1940 Act, the Fund,
immediately after any such borrowings, must have an asset coverage of at least
300%. Asset coverage is the ratio which the value of the total assets of the
Fund, less all liabilities and indebtedness not represented by senior securities
(as that term is defined in the Investment Company Act of 1940, as amended (the
"1940 Act"), bears to the aggregate amount of any such borrowings by the Fund.
The rights of any lenders to the Fund to receive payments of

10
<PAGE> 14

interest on and repayments of principal of such borrowings will be senior to
those of the holders of Common Shares, and the terms of any such borrowings may
contain provisions which limit certain activities of the Fund, including the
payment of dividends to holders of Common Shares in certain circumstances.
Further, the terms of any such borrowings may, and the provisions of the 1940
Act do (in certain circumstances), grant lenders certain voting rights in the
event of default in the payment of interest or repayment of principal. In the
event that such provisions would impair the Fund's status as a regulated
investment company, the Fund, subject to its ability to liquidate its relatively
illiquid portfolio, intends to repay the borrowings. Interest payments and fees
incurred in connection with any such borrowings will reduce the amount of net
income available for payment to the holders of Common Shares. The Fund does not
intend to use borrowings for leverage purposes. Accordingly, the Fund will not
purchase additional portfolio securities at any time that borrowings, including
the Fund's commitments pursuant to reverse repurchase agreements, exceed 5% of
the Fund's total assets (after giving effect to the amount borrowed). See
"Repurchase of Shares."

Senior Loans. Senior Loans in which the Fund will invest generally will not be
rated by a nationally recognized statistical rating organization, will not be
registered with the SEC or any state securities commission and generally will
not be listed on any national securities exchange. Although the Fund will
generally have access to financial and other information made available to the
Lenders in connection with Senior Loans, the amount of public information
available with respect to Senior Loans will generally be less extensive than
that available for rated, registered and exchange-listed securities. As a
result, the performance of the Fund and its ability to meet its investment
objective is more dependent on the analytical abilities of the Adviser than
would be the case for an investment company that invests primarily in rated,
registered or exchange listed securities. See "Investment Objective and Policies
and Special Risk Considerations."

Interests in Senior Loans generally are not listed on any national securities
exchange or automated quotation system and no regular market has developed in
which interests in Senior Loans are traded. Any secondary market purchases and
sales of Senior Loans generally are conducted in private transactions between
buyers and sellers. Senior Loans are thus relatively illiquid, which illiquidity
may impair the Fund's ability to realize the full value of its assets in the
event of a voluntary or involuntary liquidation of such assets. Liquidity
relates to the ability of the Fund to sell an investment in a timely manner. The
market for relatively illiquid securities tends to be more volatile than the
market for liquid securities. The substantial portion of the Fund's assets
invested in relatively illiquid Senior Loan interests may restrict the ability
of the Fund to dispose of its investments in Senior Loans in a timely fashion
and at a fair price, and could result in capital losses to the Fund and holders
of Common Shares. However, many of the Senior Loans in which the Fund expects to
purchase interests are of a relatively large principal amount and are held by a
relatively large number of owners which should, in the Adviser's opinion,
enhance the relative liquidity of such interests. The risks associated with
illiquidity are particularly acute in situations where the Fund's operations
require cash, such as when the Fund tenders for its Common Shares or when the
Adviser considers it advantageous to increase the percentage of the Fund's
portfolio invested in high quality, short-term securities, and

11
<PAGE> 15

may in certain circumstances result in the Fund engaging in borrowings to meet
short-term cash requirements. See "Investment Objective and Policies and Special
Risk Considerations."

Credit Risks Associated with Investments in Participations. The Fund will
purchase Participations in Senior Loans. With respect to any given Senior Loan,
the terms of Participations are arrived at through private negotiations between
the Fund and the seller of such an interest in a Senior Loan, and may result in
the Fund having rights which differ from, and are more limited than, the rights
of Lenders or of persons who acquire such interests by Assignment.
Participations typically result in the Fund having a contractual relationship
with the Lender selling the Participation, but not with the Borrower. In the
event of the insolvency of the Lender selling the Participation, the Fund may be
treated as a general creditor of such Lender, and may not have any exclusive or
senior claim with respect to such Lender's interest in, or the collateral with
respect to, the Senior Loan. As such, the Fund may incur the credit risk of the
Lender selling the Participation in addition to the credit risk of the Borrower
with respect to the Senior Loan when purchasing Participations and may not
benefit directly from the security provided by the collateral supporting the
Senior Loan with respect to which such Participation was sold. The Fund has
implemented measures designed to reduce such risk. The Fund may pay a fee or
forgo a portion of interest payments when acquiring Participations or
Assignments. See "Investment Objective and Policies and Special Risk
Considerations."

Credit Risks Associated with Senior Loans. Senior Loans, like other corporate
debt obligations, are subject to the risk of non-payment of scheduled interest
or principal. Such non-payment would result in a reduction of income to the
Fund, a reduction in the value of the Senior Loan experiencing non-payment and a
potential decrease in the net asset value of the Fund. Although Senior Loans in
which the Fund will invest generally will be secured by specific collateral,
there can be no assurance that liquidation of such collateral would satisfy the
Borrower's obligation in the event of nonpayment of scheduled interest or
principal or that such collateral could be readily liquidated. In the event of
bankruptcy of a Borrower, the Fund could experience delays or limitations with
respect to its ability to realize the benefits of the collateral securing a
Senior Loan. In the event that the Fund invests a portion of its assets in
Senior Loans that are not secured by specific collateral, the Fund will not
enjoy the benefits of collateralization with respect to such Senior Loans. See
"Investment Objective and Policies and Special Risk Considerations."

Certain Investment Practices. The Fund may use various investment practices
that involve special considerations including lending its portfolio securities,
entering into when-issued and delayed delivery transactions and entering into
repurchase and reverse repurchase agreements. In addition, the Fund has the
authority to engage in interest rate and other hedging and risk management
transactions. For further discussion of these practices and associated special
considerations, see "Investment Practices and Special Risks."

Diversification. The Fund has registered as a "non-diversified" investment
company so that it will be able to invest more than 5% of the value of its
assets in the obligations of any single issuer, including Senior Loans of a
single Borrower or Participations purchased from

12
<PAGE> 16

a single Lender. The Fund does not intend to invest, however, more than 5% of
the value of its assets in interests in Senior Loans of a single Borrower. To
the extent the Fund invests a relatively high percentage of its assets in
obligations of a limited number of issuers, the Fund will be more susceptible
than a more widely diversified investment company to any single corporate,
economic, political or regulatory occurrence. See "The Fund."

Percentage of Assets in Participations. The Fund may invest up to 100% of its
assets in Participations. The Lenders selling such Participations and other
persons interpositioned between such Lenders and the Fund with respect to such
Participations will likely conduct their principal business activities in the
bank, finance and financial services industries. Because the Fund may invest a
relatively high percentage of its assets in such Participations, the Fund may be
more susceptible than an investment company without such a policy to any single
economic, political or regulatory occurrence affecting such industries. The Fund
has taken measures which it believes significantly reduce its exposure to such
risk. See "Investment Objective and Policies and Special Risk Considerations"
and "Investment Restrictions."

Anti-Takeover Provisions. The Fund's Declaration of Trust includes provisions
that could have the effect of limiting the ability of other persons or entities
to acquire control of the Fund or to change the composition of its Board of
Trustees. See "Description of Common Shares--Anti-Takeover Provisions of the
Declaration of Trust."

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<PAGE> 17

- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
FOR ONE COMMON SHARE OF THE FUND OUTSTANDING THROUGHOUT THE PERIODS INDICATED.

The following schedule presents financial highlights for one Common Share of
the Fund outstanding throughout the periods indicated. The information for the
six month period ending January 31, 1995 is unaudited. The financial highlights
have been audited by KPMG Peat Marwick LLP, independent certified public
accountants for the periods indicated except as previously noted, and their
report thereon appears in the Fund's related Statement of Additional
Information. This information should be read in conjunction with the financial
statements and related notes included in the Statement of Additional
Information.

OCTOBER 4,
1989
(COMMENCEMENT
SIX MONTHS OF INVESTMENT
ENDED YEAR ENDED JULY 31 OPERATIONS)
JANUARY 31, ------------------------------------- TO
1995 1994 1993 1992 1991 JULY 31, 1990
----------- -------- ------- ------ ------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period....................... $ 10.052 $ 10.004 $ 9.998 $9.985 $10.008 $10.000
--------- -------- ------- ------ ------- -------
Net Investment Income........ .360 .618 .600 .698 .907 .815
Net Realized and Unrealized
Gain/Loss on Investments... (.012) .015 .008 .004 (.008) .005
--------- -------- ------- ------ ------- -------
Total from Investment
Operations................... .348 .633 .608 .702 .899 .820
--------- -------- ------- ------ ------- -------
Less:
Distributions from Net
Investment Income.......... .356 .585 .600 .689 .910 .812
Distributions in Excess of
Net Investment Income...... -0- -0- .002 -0- .012 -0-
--------- -------- ------- ------ ------- -------
Total Distributions............ .356 .585 .602 .689 .922 .812
--------- -------- ------- ------ ------- -------
Net Asset Value, End of
Period....................... $ 10.044 $ 10.052 $10.004 $9.998 $ 9.985 $10.008
========= ======== ======= ====== ======= =======
Total Return(1)
(non-annualized)............. 3.49% 6.52% 6.17% 7.25% 9.41% 8.51%
Net Assets at End of Period (in
millions).................... $ 1,712.5 $1,229.0 $ 966.7 $928.3 $ 997.5 $ 659.1
Ratio of Expenses to Average
Net Assets(1) (annualized)... 1.51% 1.53% 1.53% 1.55% 1.56% 1.59%
Ratio of Net Investment Income
to Average Net Assets(1)
(annualized)................. 7.37% 6.16% 5.96% 6.98% 8.91% 9.91%
Portfolio Turnover(2).......... 33.04% 73.50% 66.54% 58.79% 40.73% 53.44%
</TABLE>

- ----------------
(1) If certain expenses had not been assumed by the investment advisor, total
return would have been lower and the ratios would have been as follows:

<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Ratio of Expenses to Average
Net Assets (annualized)..... N/A N/A N/A N/A 1.58% N/A
Ratio of Net Investment
Income to Average Net Assets
(annualized)................ N/A N/A N/A N/A 8.89% N/A
</TABLE>

(2) Calculation includes the proceeds from principal repayments and sales of
variable rate senior loan interests.

See Financial Statements and Notes to Financial Statements.

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<PAGE> 18

- --------------------------------------------------------------------------------
THE FUND
- --------------------------------------------------------------------------------

Van Kampen Merritt Prime Rate Income Trust (the "Fund") is a non-diversified,
closed-end management investment company which was organized as a Massachusetts
business trust on July 14, 1989 and which commenced investment operations on
October 4, 1989. The Fund completed an initial public offering of its common
shares of beneficial interest ("Common Shares") in October, 1989. Since November
13, 1989, the Fund has also engaged in a continuous offering of the Common
Shares through Van Kampen American Capital Distributors, Inc. ("VKAC") (an
indirect affiliate of the Fund), as principal underwriter. As of March 10, 1995,
the Fund had 184,336,246 Common Shares outstanding and had net assets of
$1,848,560,371. The net asset value per Common Share of the Fund on March 10,
1995 was $10.03. The Fund's principal office is located at One Parkview Plaza,
Oakbrook Terrace, Illinois 60181 and its telephone number is 1-800-225-2222.

The Fund is a closed-end investment company designed primarily for long-term
investors and not as a trading vehicle. The Fund does not intend to list the
Common Shares for trading on any national securities exchange and none of the
Fund, Van Kampen American Capital Investment Advisory Corp. (the "Adviser") or
VKAC intends to make a secondary trading market in the Common Shares at any
time. Accordingly, there is not expected to be any secondary trading market in
the Common Shares and an investment in the Common Shares should be considered
illiquid. The Board of Trustees of the Fund currently intends each quarter to
consider authorizing the Fund to make tender offers for all or a portion of its
then outstanding Common Shares at the then current net asset value for the
Common Shares. As of the date hereof the Fund has commenced and consummated
tender offers in each quarter since the commencement of investment operations.
An early withdrawal charge payable to VKAC will be imposed on most Shares held
for less than five years which are accepted for repurchase pursuant to a tender
offer by the Fund. There can be no assurance that the Fund will in fact tender
for any of its Common Shares and, in the event that the Fund does not so tender
it is unlikely that a holder of Common Shares will be able to otherwise sell
Common Shares to the Fund. If the Fund tenders for Common Shares, there is no
guarantee that all, or any, Common Shares tendered will be purchased. Subject to
its borrowing restrictions, the Fund may incur debt to finance repurchases of
its Common Shares pursuant to tender offers, which entails additional risks. The
ability of the Fund to enter into tender offers may be limited by certain
requirements of the Internal Revenue Code of 1986, as amended, that must be
satisfied in order for the Fund to maintain its desired tax status as a
regulated investment company. See "Repurchase of Shares."

- --------------------------------------------------------------------------------
USE OF PROCEEDS
- --------------------------------------------------------------------------------

The net proceeds from the sale of the Common Shares offered hereby will be
invested in accordance with the Fund's investment objective and policies.
Pending such investment, the proceeds may be invested in high quality,
short-term securities.

15
<PAGE> 19

- --------------------------------------------------------------------------------
INVESTMENT OBJECTIVE AND POLICIES AND SPECIAL RISK FACTORS
- --------------------------------------------------------------------------------

An investment in the Fund may not be appropriate for all investors and is not
intended to be a complete investment program. No assurance can be given that the
Fund will achieve its investment objective.

The Fund's investment objective is to provide a high level of current income,
consistent with preservation of capital. The Fund seeks to achieve its objective
through investment primarily in a professionally managed portfolio of interests
in floating or variable rate senior loans ("Senior Loans") to United States
corporations, partnerships and other entities ("Borrowers"). Although the Fund's
net asset value will vary, the Fund's policy of acquiring interests in floating
or variable rate Senior Loans is expected to minimize the fluctuations in the
Fund's net asset value as a result of changes in interest rates. The Fund's net
asset value may be affected by changes in the credit quality of Borrowers with
respect to Senior Loan interests in which the Fund invests. The Fund seeks to
achieve over time an effective yield that approximates the average published
Prime Rate of major United States banks. An investment in the Fund may not be
appropriate for all investors and is not intended to be a complete investment
program. No assurance can be given that the Fund will achieve its investment
objective.

CERTAIN CHARACTERISTICS OF SENIOR LOAN INTERESTS

The Fund will invest in participations ("Participations") in Senior Loans,
will purchase assignments ("Assignments") of portions of Senior Loans from third
parties and may act as one of the group of Lenders originating a Senior Loan (an
"Original Lender").

16
<PAGE> 20

bonds"), preferred stock and common stock issued by the Borrower, typically in
descending order of seniority with respect to claims on the Borrower's assets.
Senior Loans generally are secured by specific collateral, which may include
guarantees. In connection with the acquisition of collateralized Senior Loans,
the Fund may invest up to 5% of its total assets in Senior Loans which are not
secured by any collateral. Such unsecured Senior Loans would constitute an
interim financing intended to be refinanced through, in whole or in part, a
collateralized Senior Loan. In the event that the Fund invests a portion of its
assets in Senior Loans that are not secured by specific collateral, the Fund
will not enjoy the benefits associated with collateralization with respect to
such Senior Loans and such Senior Loans may pose a greater risk of nonpayment of
interest or loss of principal than do collateralized Senior Loans. As discussed
below, the Fund may also acquire warrants and equity securities issued by the
Borrower or its affiliates as part of a package of investments in the Borrower
or its affiliates. Warrants and equity securities will not be treated as Senior
Loans and thus assets invested in such securities will not count toward the 80%
of the Fund's total assets that normally will be invested in Senior Loans. The
Fund will acquire such interests in unsecured Senior Loans, warrants and equity
securities only as an incident to the intended purchase of interests in
collateralized Senior Loans. Loan Agreements may also include various
restrictive covenants designed to limit the activities of the Borrower in an
effort to protect the right of the Lenders to receive timely payments of
interest on and repayment of principal of the Senior Loans. In order to borrow
money pursuant to collateralized Senior Loans, a Borrower will frequently, for
the term of the Senior Loan, pledge as collateral assets, including but not
limited to, trademarks, accounts receivable, inventory, buildings, real estate,
franchises and common and preferred stock in its subsidiaries. In addition, in
the case of some Senior Loans, there may be additional collateral pledged in the
form of guarantees by and/or securities of affiliates of the Borrowers. In
certain instances, a Senior Loan may be secured only by stock in the Borrower or
its subsidiaries. Such collateral may consist of assets that may not be readily
liquidated, and there is no assurance that the liquidation of such assets would
satisfy fully a Borrower's obligations under a Senior Loan.

Restrictive covenants may include mandatory prepayment provisions arising from
excess cash flows and typically include restrictions on dividend payments,
specific mandatory minimum financial ratios, limits on total debt and other
financial tests. Breach of such covenants, if not waived by the Lenders, is
generally an event of default under the applicable Loan Agreement and may give
the Lenders the right to accelerate principal and interest payments. The Adviser
will consider the terms of such restrictive covenants in deciding whether to
invest in Senior Loans for the Fund's portfolio. When the Fund holds a
Participation in a Senior Loan it may not have the right to vote to waive
enforcement of any restrictive covenant breached by a Borrower. Lenders voting
in connection with a potential waiver of a restrictive covenant may have
interests different from those of the Fund and such Lenders may not consider the
interests of the Fund in connection with their votes.

17
<PAGE> 21

banks (the "Prime Rate"), the London Inter-Bank Offered Rate ("LIBOR"), the
certificate of deposit ("CD") rate or other base lending rates used by
commercial lenders. The Prime Rate quoted by a major U.S. bank is the interest
rate at which such bank is willing to lend U.S. dollars to its most creditworthy
borrowers. LIBOR, as provided for in Loan Agreements, is an average of the
interest rates quoted by several designated banks as the rates at which such
banks would offer to pay interest to major financial institutional depositors in
the London interbank market on U.S. dollar denominated deposits for a specified
period of time. The CD rate, as generally provided for in Loan Agreements, is
the average rate paid on large certificates of deposit traded in the secondary
market. At least 80% of the Fund's total assets normally will be invested in
Senior Loans. In normal market conditions, at least 65% of the Fund's assets
will be invested in Senior Loans which, at the time of the Fund's initial
investment in such Senior Loans, provided the Fund with a rate of return which
was at least equal to the Prime Rate existing on the date of such initial
investment. The Fund is not subject to any restrictions with respect to the
maturity of Senior Loans held in its portfolio. It is currently anticipated that
the Fund's assets invested in Senior Loans will consist of Senior Loans with
stated maturities of between three and seven years, inclusive, and with rates of
interest which are redetermined either daily, monthly, quarterly or
semi-annually; provided, however, that the Fund may invest up to 5% of its total
assets in Senior Loans which permit the Borrower to select an interest rate
redetermination period of up to one year. Investment in Senior Loans with longer
interest rate redetermination periods may increase fluctuations in the Fund's
net asset value as a result of changes in interest rates. The Senior Loans in
the Fund's portfolio will at all times have a dollar-weighted average time until
the next interest rate redetermination of 90 days or less. As a result, as
short-term interest rates increase, interest payable to the Fund from its
investments in Senior Loans should increase, and as short-term interest rates
decrease, interest payable to the Fund from its investments in Senior Loans
should decrease. The amount of time required to pass before the Fund will
realize the effects of changing short-term market interest rates on its
portfolio will vary with the dollar-weighted average time until the next
interest rate redetermination on the Senior Loans in the Fund's portfolio. The
Fund may utilize certain investment practices to, among other things, shorten
the effective interest rate redetermination period of Senior Loans in its
portfolio. In such event, the Fund will consider such shortened period to be the
interest rate redetermination period of the Senior Loan; provided, however, that
the Fund will not invest in Senior Loans which permit the Borrower to select an
interest rate redetermination period in excess of one year. Because most Senior
Loans in the Fund's portfolio will be subject to mandatory and/or optional
prepayment and there may be significant economic incentives for a Borrower to
prepay its loans, prepayments of Senior Loans in the Fund's portfolio may occur.
Accordingly, the actual remaining maturity of the Fund's portfolio invested in
Senior Loans may vary substantially from the average stated maturity of the
Senior Loans held in the Fund's portfolio. As a result of expected prepayments
from time to time of Senior Loans in the Fund's portfolio, the Fund estimates
that the actual average maturity of the Senior Loans held in its portfolio will
be approximately 18-24 months.

18
<PAGE> 22

asset value will vary, the Fund's management expects the Fund's policy of
acquiring interests in floating or variable rate Senior Loans to minimize
fluctuations in net asset value as a result of changes in interest rates.
Accordingly, the Fund's management expects the value of the Fund's portfolio to
fluctuate significantly less than a portfolio of fixed-rate, longer term
obligations as a result of interest rate changes. However, changes in prevailing
interest rates can be expected to cause some fluctuation in the Fund's net asset
value. In addition to changes in interest rates, changes in the credit quality
of Borrowers will also effect the Fund's net asset value. Further, a serious
deterioration in the credit quality of a Borrower could cause a prolonged or
permanent decrease in the Fund's net asset value.

The Fund may purchase and retain in its portfolio a Senior Loan interest, the
Borrower with respect to which has filed for protection under the federal
bankruptcy laws or has had an involuntary bankruptcy petition filed against it
by its creditors. As of July 31, 1994, the date of the Fund's most recent
audited financial statements, the Fund held in its portfolio and had reduced the
value of one Senior Loan interest (the value of which represented approximately
0.17% of the value of the Fund's total assets on such date), the Borrower with
respect to which, Healthco International, was then subject to the protection of
a federal bankruptcy court. The reduction in value below the stated principal
amount of such Senior Loan interest as of such date represented a $0.027
reduction in the net asset value per Common Share of the Fund. The values of
such Senior Loan interests reflect, among other things, the Adviser's assessment
of the likelihood that the Fund ultimately will receive full repayment of the
principal amount of such Senior Loan interests, the likely duration, if any, of
a lapse in the scheduled repayment of principal and prevailing interest rates.
On behalf of the several Lenders with respect to the foregoing Senior Loan and
in an effort to preserve the interests of such Lenders, the Agent has engaged in
discussions and negotiations with the Borrower with respect thereto and its
other creditors. In some instances, the Fund has participated in such
discussions and negotiations. At times, in connection with the restructuring of
a Senior Loan either outside of bankruptcy court or in the context of bankruptcy
court proceedings, the Fund may determine or be required to accept equity
securities and/or junior debt securities in exchange for all or a portion of a
Senior Loan interest. Depending upon, among other things, the Adviser's
evaluation of the potential value of such securities in relation to the price
that could be obtained by the Fund at any given time upon sale thereof, the Fund
may determine to hold such securities in its portfolio. Any equity securities
and junior debt securities held by the Fund will not be treated as Senior Loans
and thus will not count toward the 80% of the Fund's total assets that normally
will be invested in Senior Loans.

19
<PAGE> 23

organization or are unrated but of comparable quality to such securities. Debt
securities rated below investment grade or unrated but of comparable quality
commonly are referred to as "junk bonds." The Fund will invest only in those
Senior Loans with respect to which the Borrower, in the opinion of the Adviser,
demonstrates certain of the following characteristics: sufficient cash flow to
service debt; adequate liquidity; successful operating history; strong
competitive position; experienced management; and, with respect to
collateralized Senior Loans, collateral coverage that equals or exceeds the
outstanding principal amount of the Senior Loan. In addition, the Adviser will
consider, and may rely in part, on the analyses performed by the Agent and other
Lenders, including such persons' determinations with respect to collateral
securing a Senior Loan.

The Fund may invest up to 100% of its assets in Participations. The selling
Lenders and other persons interpositioned between such Lenders and the Fund with
respect to such Participations will likely conduct their principal business
activities in the banking, finance and financial services industries. Although,
as discussed below, the Fund has taken measures which it believes significantly
reduce its exposure to any risks incident to such policy, the Fund may be more
susceptible than an investment company without such a policy to any single
economic, political or regulatory occurrence affecting such industries. Persons
engaged in such industries may be more susceptible than are persons engaged in
some other industry to, among other things, fluctuations in interest rates,
changes in the Federal Open Market Committee's monetary policy, governmental
regulations concerning such industries and concerning capital raising activities
generally and fluctuations in the financial markets generally.

Participations by the Fund in a Lender's portion of a Senior Loan typically
result in the Fund having a contractual relationship only with such Lender, not
with the Borrower. The Fund has the right to receive payments of principal,
interest and any fees to which it is entitled only from the Lender selling the
Participation and only upon receipt by such Lender of such payments from the
Borrower. In connection with purchasing Participations, the Fund generally will
have no right to enforce compliance by the Borrower with the terms of the Loan
Agreement, nor any rights with respect to any funds acquired by other Lenders
through set-off against the Borrower and the Fund may not directly benefit from
the collateral supporting the Senior Loan in which it has purchased the
Participation. As a result, the Fund may assume the credit risk of both the
Borrower and the Lender selling the Participation. In the event of the
insolvency of the Lender selling a Participation, the Fund may be treated as a
general creditor of such Lender, and may not benefit from any set-off between
such Lender and the Borrower. The Fund has taken the following measures in an
effort to minimize such risks. The Fund will only acquire Participations if the
Lender selling the Participation, and any other persons interpositioned between
the Fund and the Lender, (i) at the time of investment has outstanding debt or
deposit obligations rated investment grade (BBB or A-3 or higher by Standard &
Poor's Ratings Group ("S&P") or Baa or P-3 or higher by Moody's Investors
Service ("Moody's")) or determined by the Adviser to be of comparable quality
and (ii) has entered into an agreement which provides for the holding of assets
in safekeeping for, or the prompt disbursement of assets to, the Fund. Long-term
debt rated BBB by S&P is regarded by S&P as having adequate capacity to pay
interest and repay principal and debt

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<PAGE> 24

rated Baa by Moody's is regarded by Moody's as a medium grade obligation, i.e.,
it is neither highly protected nor poorly secured. Commercial paper rated A-1 by
S&P indicates that the degree of safety regarding timely payment is considered
by S&P to be either overwhelming or very strong and issues of commercial paper
rated Prime-1 by Moody's are considered by Moody's to have a superior ability
for repayment of senior short-term debt obligations. The Fund ordinarily will
purchase a Participation only if, at the time of such purchase, the Fund
believes that the party from whom it is purchasing such Participation is
retaining an interest in the underlying Senior Loan.

The Fund may also purchase Assignments from Lenders. The purchaser of an
Assignment typically succeeds to all the rights and obligations under the Loan
Agreement of the assigning Lender and becomes a Lender under the Loan Agreement
with the same rights and obligations as the assigning Lender. Assignments are,
however, arranged through private negotiations between potential assignees and
potential assignors, and the rights and obligations acquired by the purchaser of
an Assignment may differ from, and be more limited than, those held by the
assigning Lender.

When the Fund is an Original Lender originating a Senior Loan it may share in
a fee paid to the Original Lenders. The Fund will never act as the Agent or
principal negotiator or administrator of a Senior Loan. When the Fund is a
Lender, it will have a direct contractual relationship with the Borrower, may
enforce compliance by the Borrower with the terms of the Loan Agreement and may
have rights with respect to any funds acquired by other Lenders through set-off.
Lenders also have full voting and consent rights under the applicable Loan
Agreement. Action subject to Lender vote or consent generally requires the vote
or consent of the holders of some specified percentage of the outstanding
principal amount of the Senior Loan. Certain decisions, such as reducing the
amount or increasing the time for payment of interest on or repayment of
principal of a Senior Loan, or releasing collateral therefor, frequently require
the unanimous vote or consent of all Lenders affected.

The Fund will purchase an Assignment or act as a Lender with respect to a
syndicated Senior Loan only where the Agent with respect to such Senior Loan at
the time of investment has outstanding debt or deposit obligations rated
investment grade (BBB or A-3 or higher by S&P or Baa or P-3 or higher by
Moody's) or determined by the Adviser to be of comparable quality. In addition,
the Fund will purchase a Participation only where the Lender selling such
Participation, and any other person interpositioned between such Lender and the
Fund at the time of investment, have outstanding debt obligations rated
investment grade or determined by the Adviser to be of comparable quality.
Further, the Fund will not purchase interests in Senior Loans unless such Agent,
Lender or interpositioned person has entered into an agreement which provides
for the holding of assets in safekeeping for, or the prompt disbursement of
assets to, the Fund.

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<PAGE> 25

bankruptcy, any interest in the Senior Loan of such person and any loan payment
held by such person for the benefit of the Fund should not be included in such
person's estate. If, however, any such amount were included in such person's
estate, the Fund would incur certain costs and delays in realizing payment or
could suffer a loss of principal and/or interest. In such event, the Fund could
experience a decrease in net asset value.

The Fund may be required to pay and may receive various fees and commissions
in connection with purchasing, selling and holding interests in Senior Loans.
The fees normally paid by Borrowers may include three types: facility fees,
commitment fees and prepayment penalties. Facility fees are paid to Lenders upon
origination of a Senior Loan. Commitment fees are paid to Lenders on an ongoing
basis based upon the undrawn portion committed by the Lenders of the underlying
Senior Loan. Lenders may receive prepayment penalties when a Borrower prepays
all or part of a Senior Loan. The Fund will receive these fees directly from the
Borrower if the Fund is an Original Lender, or, in the case of commitment fees
and prepayment penalties, if the Fund acquires an interest in a Senior Loan by
way of Assignment. Whether or not the Fund receives a facility fee from the
Lender in the case of an Assignment, or any fees in the case of a Participation,
depends upon negotiations between the Fund and the Lender selling such
interests. When the Fund is an assignee, it may be required to pay a fee, or
forgo a portion of interest and any fees payable to it, to the Lender selling
the Assignment. Occasionally, the assignor will pay a fee to the assignee based
on the portion of the principal amount of the Senior Loan which is being
assigned. A Lender selling a Participation to the Fund may deduct a portion of
the interest and any fees payable to the Fund as an administrative fee prior to
payment thereof to the Fund. The Fund may be required to pay over or pass along
to a purchaser of an interest in a Senior Loan from the Fund a portion of any
fees that the Fund would otherwise be entitled to.

Pursuant to the relevant Loan Agreement, a Borrower may be required in certain
circumstances, and may have the option at any time, to prepay the principal
amount of a Senior Loan, often without incurring a prepayment penalty. Because
the interest rates on Senior Loans are periodically redetermined at relatively
short intervals, the Fund and the Adviser believe that the prepayment of, and
subsequent reinvestment by the Fund in, Senior Loans will not have a materially
adverse impact on the yield on the Fund's portfolio and may have a beneficial
impact on income due to receipt of prepayment penalties, if any, and any
facility fees earned in connection with reinvestment.

A Lender may have certain obligations pursuant to a Loan Agreement, which may
include the obligation to make additional loans in certain circumstances. The
Fund currently intends to reserve against such contingent obligations by
segregating sufficient investments in high quality short-term, liquid
investments. The Fund will not purchase interests in Senior Loans that would
require the Fund to make any such additional loans if such additional loan
commitments would exceed 20% of the Fund's total assets or would cause the Fund
to fail to meet the diversification requirements set forth under the heading
"Investment Restrictions."

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<PAGE> 26

commitments) and (ii) warrants, equity securities and, in certain limited
circumstances discussed above, junior debt securities acquired in connection
with the Fund's investments in Senior Loans. Such high quality, short-term
securities may include commercial paper rated at least in the top two rating
categories of either S&P or Moody's, or unrated commercial paper considered by
the Adviser to be of similar quality, interests in short-term loans of Borrowers
having short-term debt obligations rated or a short-term credit rating at least
in such top two rating categories or having no such rating but determined by the
Adviser to be of comparable quality, certificates of deposit and bankers'
acceptances and securities issued or guaranteed by the U.S. government, its
agencies or instrumentalities. Such high quality, short-term securities may pay
interest at rates which are periodically redetermined or may pay interest at
fixed rates. If the Adviser determines that market conditions temporarily
warrant a defensive investment policy, the Fund may invest, subject to its
ability to liquidate its relatively illiquid portfolio of Senior Loans, up to
100% of its assets in cash and such high quality, short-term debt securities.
The Fund will acquire such warrants and equity securities only as an incident to
the purchase or intended purchase of interests in collateralized Senior Loans.
Warrants and equity securities will not qualify as assets required to be
maintained as a reserve against additional loan commitments. Although the Fund
generally will acquire interests in warrants and equity securities only when the
Adviser believes that the relative value being given by the Fund in exchange for
such interests is substantially outweighed by the potential value of such
instruments, investment in warrants and equity securities entail certain risks
in addition to those associated with investments in Senior Loans. Warrants and
equity securities have a subordinate claim on a Borrower's assets as compared
with debt securities and junior debt securities have a subordinate claim on such
assets as compared with Senior Loans. As such, the values of warrants and equity
securities generally are more dependent on the financial condition of the
Borrower and less dependent on fluctuations in interest rates than are the
values of many debt securities. The values of warrants, equity securities and
junior debt securities may be more volatile than those of Senior Loans and thus
may have an adverse impact on the ability of the Fund to minimize fluctuations
in its net asset value.

SPECIAL RISK CONSIDERATIONS

On behalf of the several Lenders, the Agent generally will be required to
administer and manage the Senior Loan and, with respect to collateralized Senior
Loans, to service or monitor the collateral. In this connection, the valuation
of assets pledged as collateral will reflect market value and the Agent may rely
on independent appraisals as to the value of specific collateral. The Agent,
however, may not obtain an independent appraisal as to the value of assets
pledged as collateral in all cases. The Fund normally will rely primarily on the
Agent (where the Fund is an Original Lender or owns an Assignment) or the
selling Lender (where the Fund owns a Participation) to collect principal of and
interest on a Senior Loan. Furthermore, the Fund usually will rely on the Agent
(where the Fund is an Original Lender or owns an Assignment) or the selling
Lender (where the Fund owns a Participation) to monitor compliance by the
Borrower with the restrictive covenants in the Loan Agreement and notify the
Fund of any adverse change in the Borrower's financial condition or any
declaration of insolvency. Collateralized Senior Loans will frequently be

23
<PAGE> 27

secured by all assets of the Borrower that qualify as collateral, which may
include common stock of the Borrower or its subsidiaries. Additionally, the
terms of the Loan Agreement may require the Borrower to pledge additional
collateral to secure the Senior Loan, and enable the Agent, upon proper
authorization of the Lenders, to take possession of and liquidate the collateral
and to distribute the liquidation proceeds pro rata among the Lenders. If the
terms of a Senior Loan do not require the Borrower to pledge additional
collateral in the event of a decline in the value of the original collateral,
the Fund will be exposed to the risk that the value of the collateral will not
at all times equal or exceed the amount of the Borrower's obligations under the
Senior Loan. Lenders that have sold Participation interests in such Senior Loan
will distribute liquidation proceeds received by the Lenders pro rata among the
holders of such Participations. The Adviser will also monitor these aspects of
the Fund's investments and, where the Fund is an Original Lender or owns an
Assignment, will be directly involved with the Agent and the other Lenders
regarding the exercise of credit remedies. Senior Loans, like other corporate
debt obligations, are subject to the risk of non-payment of scheduled interest
or principal. Such non-payment would result in a reduction of income to the
Fund, a reduction in the value of the Senior Loan experiencing non-payment and a
potential decrease in the net asset value of the Fund. Although, with respect to
collateralized Senior Loans, the Fund generally will invest only in Senior Loans
that the Adviser believes are secured by specific collateral, which may include
guarantees, the value of which exceeds the principal amount of the Senior Loan
at the time of initial investment, there can be no assurance that the
liquidation of any such collateral would satisfy the Borrower's obligation in
the event of non-payment of scheduled interest or principal payments, or that
such collateral could be readily liquidated. In the event of bankruptcy of a
Borrower, the Fund could experience delays or limitations with respect to its
ability to realize the benefits of the collateral securing a Senior Loan. To the
extent that a Senior Loan is collateralized by stock in the Borrower or its
subsidiaries, such stock may lose all or substantially all of its value in the
event of bankruptcy of the Borrower. The Agent generally is responsible for
determining that the Lenders have obtained a perfected security interest in the
collateral securing the Senior Loan. Some Senior Loans in which the Fund may
invest are subject to the risk that a court, pursuant to fraudulent conveyance
or other similar laws, could subordinate such Senior Loans to presently existing
or future indebtedness of the Borrower or take other action detrimental to the
holders of Senior Loans, such as the Fund, including, under certain
circumstances, invalidating such Senior Loans. Lenders commonly have certain
obligations pursuant to the Loan Agreement, which may include the obligation to
make additional loans or release collateral in certain circumstances.

Senior Loans in which the Fund will invest generally will not be rated by a
nationally recognized statistical rating organization, will not be registered
with the Securities and Exchange Commission ("SEC") or any state securities
commission and will not be listed on any national securities exchange. Although
the Fund will generally have access to financial and other information made
available to the Lenders in connection with Senior Loans, the amount of public
information available with respect to Senior Loans will generally be less
extensive than that available for rated, registered and/or exchange listed
securities. As a result, the performance of the Fund and its ability to meet its
investment objective is more dependent on the analytical ability of the Adviser
than would be the case

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<PAGE> 28

for an investment company that invests primarily in rated, registered and/or
exchange listed securities.

Senior Loans are, at present, not readily marketable and may be subject to
restrictions on resale. Interests in Senior Loans generally are not listed on
any national securities exchange or automated quotation system and no regular
market has developed for such interests. Any secondary market purchases and
sales of Senior Loans generally are conducted in private transactions between
buyers and sellers. Senior Loans are thus relatively illiquid, which illiquidity
may impair the Fund's ability to realize the full value of its assets in the
event of a voluntary or involuntary liquidation of such assets. Liquidity
relates to the ability of the Fund to sell an investment in a timely manner. The
market for relatively illiquid securities tends to be more volatile than the
market for more liquid securities. The Fund has no limitation on the amount of
its assets which may be invested in securities which are not readily marketable
or are subject to restrictions on resale. The substantial portion of the Fund's
assets invested in relatively illiquid Senior Loan interests may restrict the
ability of the Fund to dispose of its investments in Senior Loans in a timely
fashion and at a fair price, and could result in capital losses to the Fund and
holders of Common Shares. However, many of the Senior Loans in which the Fund
expects to purchase interests are of a relatively large principal amount and are
held by a relatively large number of owners which should, in the Adviser's
opinion, enhance the relative liquidity of such interests. The risks associated
with illiquidity are particularly acute in situations where the Fund's
operations require cash, such as when the Fund tenders for its Common Shares,
and may result in the Fund borrowing to meet short-term cash requirements.

To the extent that legislation or state or federal regulators that regulate
certain financial institutions impose additional requirements or restrictions
with respect to the ability of such institutions to make loans in connection
with highly leveraged transactions, the availability of Senior Loan interests
for investment by the Fund may be adversely affected. In addition, such
requirements or restrictions may reduce or eliminate sources of financing for
certain Borrowers. Further, to the extent that legislation or federal or state
regulators that regulate certain financial institutions require such
institutions to dispose of Senior Loan interests relating to highly leveraged
transactions or subject such Senior Loan interests to increased regulatory
scrutiny, such financial institutions may determine to sell such Senior Loan
interests in a manner that results in a price which, in the opinion of the
Adviser, is not indicative of fair value. Were the Fund to attempt to sell a
Senior Loan interest at a time when a financial institution was engaging in such
a sale with respect to such Senior Loan interest, the price at which the Fund
could consummate such a sale might be adversely affected.

The Fund has registered as a "non-diversified" investment company so that,
subject to its investment restrictions, it will be able to invest more than 5%
of the value of its assets in the obligations of any single issuer, including
Senior Loans of a single Borrower or Participations purchased from a single
Lender. See "Investment Restrictions" in the Statement of Additional
Information. The Fund does not intend, however, to invest more than 5% of the
value of its assets in interests in Senior Loans of a single Borrower. To the
extent the Fund invests a relatively high percentage of its assets in
obligations of a limited

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<PAGE> 29

number of issuers, the Fund will be more susceptible than a more widely
diversified investment company to any single corporate, economic, political or
regulatory occurrence.

The Fund may use various investment practices that involve special
considerations including engaging in interest rate and other hedging
transactions, lending its portfolio securities, entering into when-issued and
delayed delivery transactions and entering into repurchase and reverse
repurchase agreements. For further discussion of these practices and associated
special considerations, see "Investment Practices and Special Risks."

- --------------------------------------------------------------------------------
INVESTMENT PRACTICES AND SPECIAL RISKS
- --------------------------------------------------------------------------------

In connection with the investment objective and policies described above, the
Fund may: engage in interest rate and other hedging transactions, lend portfolio
holdings, purchase and sell interests in Senior Loans and other portfolio debt
securities on a "when issued" or "delayed delivery" basis, and enter into
repurchase and reverse repurchase agreements. These investment practices involve
certain special risk considerations. The Adviser may use some or all of the
following investment practices when, in the opinion of the Adviser, their use is
appropriate. Although the Adviser believes that these investment practices may
further the Fund's investment objective, no assurance can be given that these
investment practices will achieve this result.

INTEREST RATE AND OTHER HEDGING TRANSACTIONS

The Fund may enter into various interest rate hedging and risk management
transactions. The Fund expects to enter into these transactions primarily to
seek to preserve a return on a particular investment or portion of its
portfolio, and may also enter into such transactions to seek to protect against
decreases in the anticipated rate of return on floating or variable rate
financial instruments the Fund owns or anticipates purchasing at a later date,
or for other risk management strategies such as managing the effective dollar-
weighted average duration of the Fund's portfolio. In addition, with respect to
fixed-income securities in the Fund's portfolio or to the extent an active
secondary market develops in interests in Senior Loans in which the Fund may
invest, the Fund may also engage in hedging transactions to seek to protect the
value of its portfolio against declines in net asset value resulting from
changes in interest rates or other market changes. The Fund does not intend to
engage in such transactions to enhance the yield on its portfolio to increase
income available for distributions. Market conditions will determine whether and
in what circumstances the Fund would employ any of the hedging and risk
management techniques described below. The Fund will not engage in any of the
transactions for speculative purposes and will use them only as a means to hedge
or manage the risks associated with assets held in, or anticipated to be
purchased for, the Fund's portfolio or obligations incurred by the Fund. The
successful utilization of hedging and risk management transactions requires
skills different from those needed in the selection of the Fund's portfolio
securities. The Fund believes that the Adviser possesses the skills necessary
for the successful utilization of hedging and risk management transactions. The
Fund will incur brokerage and other costs in connection with its hedging
transactions.

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<PAGE> 30

To the extent permitted by applicable regulatory authority, the Fund may enter
into interest rate swaps or purchase or sell interest rate caps or floors. The
Fund will not sell interest rate caps or floors that it does not own. Interest
rate swaps involve the exchange by the Fund with another party of their
respective obligations to pay or receive interest, e.g., an exchange of an
obligation to make floating rate payments for an obligation to make fixed rate
payments. For example, the Fund may seek to shorten the effective interest rate
redetermination period of a Senior Loan in its portfolio the Borrower to which
has selected an interest rate redetermination period of one year. The Fund could
exchange the Borrower's obligation to make fixed rate payments for one year for
an obligation to make payments that readjust monthly. In such event, the Fund
would consider the interest rate redetermination period of such Senior Loan to
be the shorter period.

The purchase of an interest rate cap entitles the purchaser, to the extent
that a specified index exceeds a predetermined interest rate, to receive
payments of interest at the difference of the index and the predetermined rate
on a notional principal amount (the reference amount with respect to which
interest obligations are determined although no actual exchange of principal
occurs) from the party selling such interest rate cap. The purchase of an
interest rate floor entitles the purchaser, to the extent that a specified index
falls below a predetermined interest rate, to receive payments of interest at
the difference of the index and the predetermined rate on a notional principal
amount from the party selling such interest rate floor. The Fund will not enter
into swaps, caps or floors if, on a net basis, the aggregate notional principal
amount with respect to such agreements exceeds the net assets of the Fund.

In circumstances in which the Adviser anticipates that interest rates will
decline, the Fund might, for example, enter into an interest rate swap as the
floating rate payor or, alternatively, purchase an interest rate floor. In the
case of purchasing an interest rate floor, if interest rates declined below the
floor rate, the Fund would receive payments from its counterparty which would
wholly or partially offset the decrease in the payments it would receive in
respect of the portfolio assets being hedged. In the case where the Fund
purchases such an interest rate swap, if the floating rate payments fell below
the level of the fixed rate payment set in the swap agreement, the Fund's
counterparty would pay the Fund amounts equal to interest computed at the
difference between the fixed and floating rates over the notional principal
amount. Such payments would offset or partially offset the decrease in the
payments the Fund would receive in respect of floating rate portfolio assets
being hedged.

The successful use of swaps, caps and floors to preserve the rate of return on
a portfolio of financial instruments depends on the Adviser's ability to predict
correctly the direction and extent of movements in interest rates. Although the
Fund believes that use of the hedging and risk management techniques described
above will benefit the Fund, if the Adviser's judgment about the direction or
extent of the movement in interest rates in incorrect, the Fund's overall
performance would be worse than if it had not entered into any such
transactions. For example, if the Fund had purchased an interest rate swap or an
interest rate floor to hedge against its expectation that interest rates would
decline but instead interest rates rose, the Fund would lose part or all of the
benefit of the increased

27
<PAGE> 31

payments it would receive as a result of the rising interest rates because it
would have to pay amounts to its counterparty under the swap agreement or would
have paid the purchase price of the interest rate floor.

Inasmuch as these hedging transactions are entered into for good-faith risk
management purposes, the Adviser and the Fund believe such obligations do not
constitute senior securities. The Fund will usually enter into interest rate
swaps on a net basis, i.e., where the two parties make net payments with the
Fund receiving or paying, as the case may be, only the net amount of the two
payments. The net amount of the excess, if any, of the Fund's obligations over
its entitlements with respect to each interest rate swap will be accrued and an
amount of cash or liquid securities having an aggregate net asset value at least
equal to the accrued excess will be maintained in a segregated account by the
Fund's custodian. If the Fund enters into a swap on other than a net basis, the
Fund will maintain in the segregated account the full amount of the Fund's
obligations under each such swap. Accordingly, the Fund does not treat swaps as
senior securities. The Fund may enter into swaps, caps and floors with member
banks of the Federal Reserve System, members of the New York Stock Exchange or
other entities determined by the Adviser, pursuant to procedures adopted and
reviewed on an ongoing basis by the Board of Trustees, to be creditworthy. If a
default occurs by the other party to such transaction, the Fund will have
contractual remedies pursuant to the agreements related to the transaction but
such remedies may be subject to bankruptcy and insolvency laws which could
affect the Fund's rights as a creditor. The swap market has grown substantially
in recent years with a large number of banks and financial services firms acting
both as principals and as agents utilizing standardized swap documentation. As a
result, the swap market has become relatively liquid. Caps and floors are more
recent innovations and they are less liquid than swaps. There can be no
assurance, however, that the Fund will be able to enter into interest rate swaps
or to purchase interest rate caps or floors at prices or on terms the Adviser
believes are advantageous to the Fund. In addition, although the terms of
interest rate swaps, caps and floors may provide for termination, there can be
no assurance that the Fund will be able to terminate an interest rate swap or to
sell or offset interest rate caps or floors that it has purchased.

New financial products continue to be developed and the Fund may invest in any
such products as may be developed to the extent consistent with its investment
objective and the regulatory and federal tax requirements applicable to
investment companies.

LENDING OF PORTFOLIO HOLDINGS

The Fund may seek to increase its income by lending financial instruments in
its portfolio in accordance with present regulatory policies, including those of
the Board of Governors of the Federal Reserve System and the SEC. Such loans may
be made, without limit, to brokers, dealers, banks or other recognized
institutional borrowers of financial instruments and would be required to be
secured continuously by collateral, including cash, cash equivalents or U.S.
Treasury bills maintained on a current basis at an amount at least equal to the
market value of the financial instruments loaned. The Fund would have the right
to call a loan and obtain the financial instruments loaned at any time on five
days'

28
<PAGE> 32

notice. For the duration of a loan, the Fund would continue to receive the
equivalent of the interest paid by the issuer on the financial instruments
loaned and also would receive compensation from the investment of the
collateral. The Fund would not have the right to vote any financial instruments
having voting rights during the existence of the loan, but the Fund could call
the loan in anticipation of an important vote to be taken among holders of the
financial instruments or in anticipation of the giving or withholding of their
consent on a material matter affecting the financial instruments. As with other
extensions of credit, risks of delay in recovery or even loss of rights in the
collateral exist should the borrower of the financial instruments fail
financially. However, the loans would be made only to firms deemed by the
Adviser to be of good standing and when, in the judgment of the Adviser, the
consideration which can be earned currently from loans of this type justifies
the attendant risk. The creditworthiness of firms to which the Fund lends its
portfolio holdings will be monitored on an ongoing basis by the Adviser pursuant
to procedures adopted and reviewed, on an ongoing basis, by the Board of
Trustees of the Fund. No specific limitation exists as to the percentage of the
Fund's assets which the Fund may lend.

"WHEN ISSUED" AND "DELAYED DELIVERY" TRANSACTIONS

The Fund may also purchase and sell interests in Senior Loans and other
portfolio securities on a "when issued" and "delayed delivery" basis. No income
accrues to the Fund on such interests or securities in connection with such
purchase transactions prior to the date the Fund actually takes delivery of such
interests or securities. These transactions are subject to market fluctuation;
the value of the interests in Senior Loans and other portfolio debt securities
at delivery may be more or less than their purchase price, and yields generally
available on such interests or securities when delivery occurs may be higher or
lower than yields on the interests or securities obtained pursuant to such
transactions. Because the Fund relies on the buyer or seller, as the case may
be, to consummate the transaction, failure by the other party to complete the
transaction may result in the Fund missing the opportunity of obtaining a price
or yield considered to be advantageous. When the Fund is the buyer in such a
transaction, however, it will maintain, in a segregated account with its
custodian, cash or high-grade portfolio securities having an aggregate value
equal to the amount of such purchase commitments until payment is made. The Fund
will make commitments to purchase such interests or securities on such basis
only with the intention of actually acquiring these interests or securities, but
the Fund may sell such interests or securities prior to the settlement date if
such sale is considered to be advisable. To the extent the Fund engages in "when
issued" and "delayed delivery" transactions, it will do so for the purpose of
acquiring interests or securities for the Fund's portfolio consistent with the
Fund's investment objective and policies and not for the purpose of investment
leverage. No specific limitation exists as to the percentage of the Fund's
assets which may be used to acquire securities on a "when issued" or "delayed
delivery" basis.

REPURCHASE AGREEMENTS

The Fund may enter into repurchase agreements (a purchase of, and a
simultaneous commitment to resell, a financial instrument at an agreed upon
price on an agreed upon date) only with member banks of the Federal Reserve
System and member firms of the

29
<PAGE> 33

New York Stock Exchange. When participating in repurchase agreements, the Fund
buys securities from a vendor, e.g., a bank or brokerage firm, with the
agreement that the vendor will repurchase the securities at a higher price at a
later date. Such transactions afford an opportunity for the Fund to earn a
return on available cash at minimal market risk, although the Fund may be
subject to various delays and risks of loss if the vendor is unable to meet its
obligation to repurchase. Under the 1940 Act, repurchase agreements are deemed
to be collateralized loans of money by the Fund to the seller. In evaluating
whether to enter into a repurchase agreement, the Adviser will consider
carefully the creditworthiness of the vendor. If the member bank or member firm
that is the party to the repurchase agreement petitions for bankruptcy or
otherwise becomes subject to the U.S. Bankruptcy Code, the law regarding the
rights of the Fund is unsettled. The securities underlying a repurchase
agreement will be marked to market every business day so that the value of the
collateral is at least equal to the value of the loan, including the accrued
interest thereon, and the Adviser will monitor the value of the collateral. No
specific limitation exists as to the percentage of the Fund's assets which may
be used to participate in repurchase agreements.

REVERSE REPURCHASE AGREEMENTS

The Fund may enter into reverse repurchase agreements with respect to debt
obligations which could otherwise be sold by the Fund. A reverse repurchase
agreement is an instrument under which the Fund may sell an underlying debt
instrument and simultaneously obtain the commitment of the purchaser (a
commercial bank or a broker or dealer) to sell the security back to the Fund at
an agreed upon price on an agreed upon date. The Fund will maintain in a
segregated account with its custodian cash or liquid high grade portfolio
securities in an amount sufficient to cover its obligations with respect to
reverse repurchase agreements. The Fund receives payment for such securities
only upon physical delivery or evidence of book entry transfer by its custodian.
Regulations of the SEC require either that securities sold by the Fund under a
reverse repurchase agreement be segregated pending repurchase or that the
proceeds be segregated on the Fund's books and records pending repurchase.
Reverse repurchase agreements could involve certain risks in the event of
default or insolvency of the other party, including possible delays or
restrictions upon the Fund's ability to dispose of the underlying securities. An
additional risk is that the market value of securities sold by the Fund under a
reverse repurchase agreement could decline below the price at which the Fund is
obligated to repurchase them. Reverse repurchase agreements will be considered
borrowings by the Fund and as such would be subject to the restrictions on
borrowing described in the Statement of Additional Information under "Investment
Restrictions." The Fund will not hold more than 5% of the value of its total
assets in reverse repurchase agreements.

- --------------------------------------------------------------------------------
TAXATION
- --------------------------------------------------------------------------------

The following federal tax discussion is based on the advice of Skadden, Arps,
Slate, Meagher & Flom, reflects applicable tax laws as of the date of this
Prospectus and is qualified by reference to the additional federal income tax
discussion included in the Statement of Additional Information.

30
<PAGE> 34

The Fund intends to qualify each year and to elect to be treated as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). If the Fund so qualifies and distributes each
year to its shareholders at least 90% of its net investment income (including,
among other things, interest and net short-term capital gains, but not net
capital gains, which are the excess of net long-term capital gains over net
short-term capital losses) in each year, the Fund will not be required to pay
federal income taxes on any income distributed to shareholders. The Fund will
not be subject to federal income tax on any net capital gains distributed to
shareholders. As a Massachusetts business trust, the Fund will not be subject to
any excise or income taxes in Massachusetts as long as it qualifies as a
regulated investment company for federal income tax purposes.

Distributions. Distributions of the Fund's net investment income are taxable
to holders of Common Shares as ordinary income, whether paid in cash or
reinvested in additional Common Shares. Distributions of the Fund's net capital
gains ("capital gains dividends"), if any, are taxable to holders of Common
Shares at the rates applicable to long-term capital gains regardless of the
length of time shares of the Fund have been held by such shareholders. The Fund
will inform shareholders of the source and tax status of all distributions
promptly after the close of each calendar year.

Sale of Shares. Except as discussed below, selling shareholders will
generally recognize gain or loss in an amount equal to the difference between
their adjusted tax basis in the Common Shares and the amount received. If such
Common Shares are held as a capital asset, the gain or loss will be a capital
gain or loss and will be long-term if such Common Shares have been held for more
than one year. It is possible, although the Fund believes it is unlikely, that
tendering holders of Common Shares may not qualify for gain or loss treatment as
described above, which in turn may result in deemed distributions to
non-tendering holders of Common Shares. The federal income tax consequences of
the repurchase of Common Shares pursuant to tender offers will be disclosed in
the related offering documents. Any loss realized upon a taxable disposition of
Common Shares held for six months or less will be treated as a long-term capital
loss to the extent of any capital gains dividends received with respect to such
Common Shares. For purposes of determining whether Common Shares have been held
for six months or less, the holding period is suspended for any periods during
which the Common Shareholder's risk of loss is diminished as a result of holding
one or more other positions in substantially similar or related property or
through certain options or short sales.

General. The federal income tax discussion set forth above is for general
information only. Prospective investors should consult their advisors regarding
the specific federal and state tax consequences of holding and disposing of
Common Shares, as well as the effects of other state, local and foreign tax laws
and any proposed tax law changes.

31
<PAGE> 35

- --------------------------------------------------------------------------------
MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------

BOARD OF TRUSTEES

The management of the Fund, including general supervision of the duties
performed by the Adviser under the Advisory Agreement, is the responsibility of
the Fund's Board of Trustees.

THE ADVISER

Van Kampen American Capital Investment Advisory Corp. (the "Adviser") is the
Fund's investment adviser. The Adviser is a wholly-owned subsidiary of Van
Kampen American Capital, Inc., which in turn is a wholly-owned subsidiary of
VK/AC Holding, Inc. VK/AC Holding, Inc. is indirectly controlled by Clayton &
Dubilier Associates IV Limited Partnership, the general partners of which are
Joseph L. Rice, III, B. Charles Ames, William A. Barbe, Alberto Cribiore, Donald
J. Gogel, Leon J. Hendrix, Jr., Hubbard C. Howe and Andrall E. Pearson, each of
whom is a principal of Clayton, Dubilier & Rice, Inc., a New York based private
investment partnership. The Adviser's principal office is located at One
Parkview Plaza, Oakbrook Terrace, Illinois 60181.

Van Kampen American Capital, Inc. is a diversified asset management company
with more than two million retail investor accounts, extensive capabilities for
managing institutional portfolios, and nearly $50 billion under management or
supervision. Van Kampen American Capital, Inc.'s over 40 open-end and 38
closed-end funds and more than 2,700 unit investment trusts are professionally
distributed by leading financial advisers nationwide. In connection with
advising the Fund, the Adviser will utilize at its own expense credit analysis
and research services provided by its affiliate, McCarthy, Crisanti & Maffei
("MCM").

INVESTMENT ADVISORY AGREEMENT. The business and affairs of the Fund will be
managed under the direction of the Fund's Board of Trustees. Subject to their
authority, the Adviser and the Fund's officers will supervise and implement the
Fund's investment activities and will be responsible for overall management of
the Fund's business affairs. The investment advisory agreement (the "Advisory
Agreement") between the Adviser and the Fund provides that the Adviser will
supply investment research and portfolio management, including the selection of
securities for the Fund to purchase, hold, or sell and the selection of brokers
through whom the Fund's portfolio transactions are executed. The Adviser also
furnishes offices, necessary facilities and equipment and permits its officers
and employees to serve without compensation as Trustees and officers of the Fund
if duly elected to such positions. The Fund has reimbursed VKAC for costs
incurred in connection with the Fund's organization and its initial registration
of the common shares in the amount of $1,037,578. The Fund expects to incur
approximately $865,000 in expenses in connection with the offering of
140,000,000 Common Shares. A portion of such expenses will be charged as
operating expenses during the current period and the remainder will be amortized
over a period of not more than twelve months.

32
<PAGE> 36

For the services provided by the Adviser under the Advisory Agreement, the
Fund will pay the Adviser an annualized fee (accrued daily and paid monthly)
equal to 0.95% of the average weekly managed assets of the Fund (which, for
purposes of determining such fee, shall mean the average weekly value of the
total assets of the Fund, minus the sum of the accrued liabilities of the Fund
other than the aggregate amount of any borrowings undertaken by the Fund). The
advisory fee, which also covers the credit analysis and research services of
MCM, is higher than the fees paid by most management investment companies,
although it is comparable to the fees paid by several publicly offered, closed-
end management investment companies with investment objectives and policies
similar to those of the Fund.

PORTFOLIO MANAGEMENT. Jeffrey W. Maillet is a Vice President of the Adviser
and has been primarily responsible for the day to day management of the Fund's
portfolio since the Fund's commencement of investment operations. Mr. Maillet
has been employed by the Adviser since 1989.

THE ADMINISTRATOR. The administrator for the Fund is VKAC (in such capacity,
the "Administrator"). Its principal business address is One Parkview Plaza,
Oakbrook Terrace, Illinois 60181. The Administrator is a wholly-owned subsidiary
of Van Kampen American Capital, Inc., which in turn is a wholly-owned subsidiary
of VK/AC Holding, Inc. The Administrator maintains offices and regional
representatives in major cities across the nation. VKAC is the principal
underwriter of the Common Shares in connection with the offering thereof by the
Fund. See "Purchase of Shares."

Pursuant to the administration agreement between the Fund and the
Administrator (the "Administration Agreement") and in consideration of its
administrative fee, the Administrator will (i) monitor the provisions of the
Loan Agreements and any agreements with respect to Participations and
Assignments and be responsible for recordkeeping with respect to Senior Loans in
the Fund's portfolio; (ii) arrange for the printing and dissemination of reports
to holders of Common Shares; (iii) arrange for the dissemination of the Fund's
proxy and any tender offer materials to holders of Common Shares, and oversee
the tabulation of proxies by the Fund's transfer agent; (iv) negotiate the terms
and conditions under which custodian services will be provided to the Fund and
the fees to be paid by the Fund in connection therewith; (v) negotiate the terms
and conditions under which dividend disbursing services will be provided to the
Fund, and the fees to be paid by the Fund in connection therewith and review the
provision of dividend disbursing services to the Fund; (vi) provide the Fund's
dividend disbursing agent and custodian with such information as is required for
such parties to effect payment of dividends and distributions and to implement
the Fund's dividend reinvestment plan; (vii) make such reports and
recommendations to the Board of Trustees as the Trustees reasonably request or
deem appropriate; and (viii) provide shareholder services to holders or
potential holders of the Fund's securities.

For the services rendered to the Fund and related expenses borne by the
Administrator, the Fund pays the Administrator a fee, accrued daily and paid
monthly, at the annualized rate of 0.25% of the Fund's average weekly managed
assets (determined in the same manner as described above with respect to the
Advisory Agreement).

33
<PAGE> 37

- --------------------------------------------------------------------------------
DISTRIBUTIONS
- --------------------------------------------------------------------------------

The Fund's present policy is to declare daily and pay monthly distributions to
holders of Common Shares of substantially all net investment income of the Fund.
Net investment income of the Fund consists of all interest income, fee income,
other ordinary income earned by the Fund on its portfolio assets and net
short-term capital gains, less all expenses of the Fund. Expenses of the Fund
are accrued each day. Distributions to holders of Common Shares cannot be
assured, and the amount of each monthly distribution is likely to vary. Net
realized long-term capital gains, if any, are expected to be distributed to
holders of Common Shares at least annually. Holders of Common Shares may elect
to have distributions automatically reinvested in additional Common Shares. See
"Dividend Reinvestments."

- --------------------------------------------------------------------------------
DIVIDEND REINVESTMENT PLAN
- --------------------------------------------------------------------------------

The Fund offers a Dividend Reinvestment Plan (the "Plan") pursuant to which
Common Shareholders may elect to have all distributions of dividends and all
capital gains automatically reinvested in Common Shares pursuant to the Plan.
Unless Common Shareholders elect to participate in the Plan, all Common
Shareholders will receive distributions of dividends and capital gains in cash.

State Street Bank and Trust Company, as plan agent (the "Plan Agent"), serves
as agent for the Common Shareholders in administering the Plan. Participants in
the Plan will receive the equivalent in Common Shares valued on the valuation
date, at net asset value. The valuation date will be the dividend or
distribution payment date or, if that date is not a business day, the next
preceding business day.

The Plan Agent maintains each Common Shareholder's account in the Plan and
furnishes monthly written confirmations of all transactions in the accounts,
including information needed by Common Shareholders for personal and tax
records. Common Shares in the account of each Plan participant will be held by
the Plan Agent in non-certificated form in the name of the participant, and each
Common Shareholder's proxy will include those Common Shares purchased pursuant
to the Plan. The Plan Agent's fees for the handling of the reinvestment of
dividends and distributions will be paid by the Fund.

In the case of Common Shareholders, such as banks, brokers or nominees, which
hold Common Shares for others who are the beneficial owners, the Plan Agent will
administer the Plan on the basis of the number of Common Shares certified from
time to time by the record Common Shareholders as representing the total amount
registered in the record Common Shareholder's name and held for the account of
beneficial owners who are participating in the Plan.

The automatic reinvestment of dividends and distributions will not relieve
participants of any federal income tax that may be payable or required to be
withheld on such dividends or distributions.

34
<PAGE> 38

Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan as
applied to any dividend or distribution paid subsequent to written notice of the
change sent to all Common Shareholders of the Fund at least 90 days before the
record date for the dividend distribution. The Plan also may be amended or
terminated by the Plan Agent by at least 90 days written notice to all Common
Shareholders of the Fund.

All registered Common Shareholders (other than brokers or nominees) will be
mailed information regarding the Plan, including a form with which they may
elect to participate in the Plan. Shareholders who intend to hold their Common
Shares through a broker or nominee should contact such person to confirm that
they may participate in the Plan and to determine the effect, if any, that a
transfer of the account by the shareholder to another broker or nominee will
have on continued participation in the Plan. A Common Shareholder may withdraw
from the Plan at any time by contacting the Plan Agent at the address or
telephone number set forth below. There is no penalty for non-participation in
or withdrawal from the Plan, and Common Shareholders who have previously
withdrawn from the Plan may rejoin it at any time. Changes in elections should
be directed to the Plan Agent and should include the name of the Fund and the
Common Shareholder's name and address as registered. An election to withdraw
from the Plan will, until such election is changed, be deemed to be an election
by a Common Shareholder to take all subsequent dividends and distributions in
cash. Elections will only be effective for dividends and distributions declared
after, and with a record date of at least ten days after, such elections are
received by the Plan Agent. When a participant withdraws from the Plan or upon
termination of the Plan as provided above, certificates for whole Common Shares
credited to his or her account under the Plan will be issued and a cash payment
will be made for any fraction of a Common Share credited to such account. All
correspondence concerning the Plan should be directed to the Plan Agent at P.O.
Box 8200, Boston, MA 02101. Telephone calls concerning the Plan may be directed
to the Plan Agent between the hours of 7:30 a.m. and 5:00 p.m. Central Standard
Time at (800) 341-2929.

- --------------------------------------------------------------------------------
REPURCHASE OF SHARES
- --------------------------------------------------------------------------------

The Board of Trustees of the Fund currently intends, each quarter, to consider
authorizing the Fund to make tender offers for all or a portion of its then
outstanding Common Shares at the net asset value of the Common Shares on the
expiration date of the tender offer. Although such tender offers, if undertaken
and completed, will provide some liquidity for holders of the Common Shares,
there can be no assurance that such tender offers will in fact be undertaken or
completed or, if completed, that they will provide sufficient liquidity for all
holders of Common Shares who may desire to sell such Common Shares. As such,
investment in the Common Shares should be considered illiquid. As of the date of
this Prospectus, the Fund has commenced and consummated tender offers in each
quarter since the commencement of investment operations. An early withdrawal
charge payable to VKAC will be imposed on most Common Shares accepted for tender
by the Fund which have been held for less than five years, as described below.

35
<PAGE> 39

Although the Board of Trustees believes that tender offers for the Common
Shares generally would increase the liquidity of the Common Shares, the
acquisition of Common Shares by the Fund will decrease the total assets of the
Fund and, therefore, have the effect of increasing the Fund's expense ratio.
Because of the nature of the Fund's investment objective and policies and the
Fund's portfolio, the Adviser anticipates potential difficulty in disposing of
portfolio securities in order to consummate tender offers for the Common Shares.
As a result, the Fund may be required to borrow money in order to finance
repurchases and tenders.

The Fund's Declaration of Trust authorizes the Fund, without prior approval of
the holders of Common Shares, to borrow money in an amount up to 33 1/3% of the
Fund's total assets, for the purpose of, among other things, obtaining
short-term credits in connection with tender offers by the Fund for Common
Shares. In this connection, the Fund may issue notes or other evidence of
indebtedness or secure any such borrowings by mortgaging, pledging or otherwise
subjecting as security the Fund's assets. Under the requirements of the 1940
Act, the Fund, immediately after any such borrowing, must have an "asset
coverage" of at least 300%. With respect to any such borrowing, asset coverage
means the ratio which the value of the total assets of the Fund, less all
liabilities and indebtedness not represented by senior securities (as defined in
the 1940 Act), bears to the aggregate amount of such borrowing by the Fund. The
rights of lenders to the Fund to receive interest on and repayment of principal
of any such borrowings will be senior to those of the holders of Common Shares,
and the terms of any such borrowings may contain provisions which limit certain
activities of the Fund, including the payment of dividends to holders of Common
Shares in certain circumstances. Further, the terms of any such borrowing may
and the 1940 Act does (in certain circumstances) grant to the lenders to the
Fund certain voting rights in the event of default in the payment of interest on
or repayment of principal. In the event that such provisions would impair the
Fund's status as a regulated investment company, the Fund, subject to its
ability to liquidate its relatively illiquid portfolio, intends to repay the
borrowings. Any borrowing will likely rank senior to or pari passu with all
other existing and future borrowings of the Fund. Interest payments and fees
incurred in connection with borrowings will reduce the amount of net income
available for payment to the holders of Common Shares. The Fund does not intend
to use borrowings for leverage purposes. Accordingly, the Fund will not purchase
additional portfolio securities at any time that borrowings, including the
Fund's commitments, pursuant to reverse repurchase agreements, exceed 5% of the
Fund's total assets (after giving effect to the amount borrowed).

The Fund has entered into a Credit Agreement with Morgan Guaranty Trust
Company of New York ("Morgan") pursuant to which Morgan has agreed to provide a
credit facility in the maximum amount of $50,000,000 to the Fund. The credit
facility provided by Morgan will terminate on January 26, 1996, unless extended
pursuant to the terms thereof. The Fund has entered into a revolving credit
agreement with Bank of America Illinois, formerly known as Continental Bank N.A.
("Bank of America") pursuant to which Bank of America has agreed to provide a
credit facility in the maximum amount of $25,000,000 to the Fund. The credit
facility provided by Bank of America will terminate on December 13, 1995, unless
extended by its terms. The Fund is also a party to a letter

36
<PAGE> 40

agreement with State Street Bank and Trust Company ("State Street") pursuant to
which State Street has agreed to provide a credit facility in the maximum amount
of $25,000,000 to the Fund. The credit facility provided by State Street will
terminate on February 28, 1996, unless extended by its terms. As of the date of
this Prospectus, the Fund had not borrowed any amounts pursuant to the credit
agreements with Morgan, State Street and Bank of America. See "Repurchase of
Shares" in the Statement of Additional Information.

Should the Fund determine to make a tender offer for its Common Shares, a
notice describing the tender offer, containing information shareholders should
consider in deciding whether to tender their Common Shares and including
instructions on how to tender Common Shares will be sent to shareholders of
record. Information concerning the purchase price to be paid by the Fund and the
manner in which shareholders may ascertain net asset value during the pendency
of a tender offer will also be set forth in the notice. The Fund will purchase
all Common Shares tendered in accordance with the terms of the offer unless it
determines to terminate the offer. Costs associated with the tender will be
charged against capital. See the Statement of Additional Information for
additional information concerning repurchase of Common Stock.

Upon the death of a holder of Common Shares, VKAC will waive any early
withdrawal charge (discussed below) applicable to the first $100,000 worth of
such holder's Common Shares repurchased pursuant to a tender offer commenced
within one year of such holder's death; provided that the Transfer Agent has
received, on VKAC's behalf, proper notice of the death of such holder. For this
purpose, the Transfer Agent will be deemed to have received proper notice of
such holder's death upon its receipt of (i) a duly executed Letter of
Transmittal duly submitted in connection with a tender offer, (ii) a written
request for waiver of the early withdrawal charge, in form satisfactory to the
Transfer Agent, signed by the holder's duly authorized representative or
surviving tenant, (iii) appropriate evidence of death and (iv) appropriate
evidence of the authority of the representative of the deceased holder or
surviving tenant. Common Shares held in joint tenancy or tenancy in common will
be deemed to be held by a single holder (which may be either tenant in the case
of joint tenancy) and the death of any such tenant will be deemed to be the
death of such holder of Common Shares. Information concerning the waiver of the
early withdrawal charge may be obtained by contacting the Fund.

If the Fund must liquidate portfolio holdings in order to purchase Common
Shares tendered, the Fund may realize gains and losses. Such gains may be
realized on securities held for less than three months. Due to the requirement
for qualification as a regulated investment company under the Code that less
than 30% of the Fund's annual gross income be derived from the disposition of
securities held for less than three months, the Fund may not be able to sell
portfolio holdings held for less than three months that the Fund may wish to
sell in the ordinary course of its portfolio management, which may affect
adversely the Fund's yield.

EARLY WITHDRAWAL CHARGE. An early withdrawal charge to recover offering
expenses will be charged in connection with most Common Shares held for less
than five years which are accepted by the Fund for repurchase pursuant to tender
offers. The early

37
<PAGE> 41

withdrawal charge will be imposed on a number of Common Shares accepted for
tender from a record holder of Common Shares the value of which exceeds the
aggregate value at the time the tender is accepted of (a) all Common Shares
owned by such holder that were purchased more than five years prior to such
acceptance, (b) all Common Shares owned by such holder that were acquired
through reinvestment of distributions, and (c) the increase, if any, of value of
all other Common Shares owned by such holder (namely those purchased within the
five years preceding the acceptance) over the purchase price of such Common
Shares. The early withdrawal charge will be paid to VKAC. For the fiscal years
ended July 31, 1992, 1993, 1994 and the six months ended January 31, 1995, VKAC
received payments totalling $4,400,000, $1,354,000, $2,100,000 and $885,800
respectively pursuant to the early withdrawal charge. In determining whether an
early withdrawal charge is payable, it is assumed that the acceptance of a
repurchase offer would be made from the earliest purchase of Common Shares. Any
early withdrawal charge which is required to be imposed will be made in
accordance with the following schedule.

<TABLE>
<CAPTION>
YEAR OF REPURCHASE
AFTER PURCHASE EARLY WITHDRAWAL CHARGE
- -------------------------------------------------------- -----------------------
<S> <C>
First............................................. 3.0%
Second............................................ 2.5%
Third............................................. 2.0%
Fourth............................................ 1.5%
Fifth............................................. 1.0%
Sixth and following............................... 0.0%
</TABLE>

The following example will illustrate the operation of the early withdrawal
charge. Assume that an investor purchases $10,000 worth of the Fund's Common
Shares for cash through VKAC and that 21 months later the value of the account
has grown through the reinvestment of dividends and capital appreciation to
$12,000. The investor then may submit for repurchase pursuant to a tender offer
up to $2,000 worth of Common Shares without incurring an early withdrawal
charge. If the investor should submit for repurchase pursuant to a tender offer
$5,000 worth of Common Shares, an early withdrawal charge would be imposed on
$3,000 worth of the Common Shares submitted. The charge would be imposed at the
rate of 2.5% because it is in the second year after the purchase was made and
the charge would be $75.

- --------------------------------------------------------------------------------
DESCRIPTION OF COMMON SHARES
- --------------------------------------------------------------------------------

The Fund is an unincorporated business trust established under the laws of the
Commonwealth of Massachusetts by a Declaration of Trust dated July 14, 1989, as
amended and restated on September 19, 1989 (the "Declaration of Trust"). The
Declaration of Trust provides that the Trustees of the Fund may authorize
separate classes of shares of beneficial interest. The Trustees have authorized
an unlimited number of Common Shares. The Declaration of Trust also authorizes
the Fund to borrow money or otherwise obtain credit and in this connection issue
notes or other evidence of indebtedness. The Fund does not intend to hold annual
meetings of the holders of Common Shares.

38
<PAGE> 42

COMMON SHARES. The Declaration of Trust permits the Fund to issue an
unlimited number of full and fractional Common Shares of beneficial interest,
$.01 par value per Common Share. Each Common Share represents an equal
proportionate interest in the assets of the Fund with each other Common Share in
the Fund. Holders of Common Shares will be entitled to the payment of dividends
when, as and if declared by the Board of Trustees. The terms of any borrowings
may limit the payment of dividends to the holders of Common Shares. Each whole
Common Share shall be entitled to one vote as to matters on which it is entitled
to vote pursuant to the terms of the Fund's Declaration of Trust on file with
the SEC. Upon liquidation of the Fund, after paying or adequately providing for
the payment of all liabilities of the Fund, and upon receipt of such releases,
indemnities and refunding agreements as they deem necessary for their
protection, the Trustees may distribute the remaining assets of the Fund among
the holders of the Common Shares. The Declaration of Trust provides that
shareholders are not liable for any liabilities of the Fund, requires inclusion
of a clause to that effect in every agreement entered into by the Fund and
indemnifies shareholders against any such liability. Although shareholders of an
unincorporated business trust established under Massachusetts law, in certain
limited circumstances, may be held personally liable for the obligations of the
Trust as though they were general partners, the provisions of the Declaration of
Trust described in the foregoing sentence make the likelihood of such personal
liability remote.

As a rule, the Fund will not issue share certificates. However, upon written
request to the Transfer Agent, a Share certificate will be issued for any or all
of the full Common Shares credited to an investor's account. Share certificates
which have been issued to an investor may be returned at any time.

The Common Shares are not, and are not expected to be, listed for trading on
any national securities exchange nor, to the Fund's knowledge, is there, or is
there expected to be, any secondary trading market in the Common Shares. The
following table sets forth, since the commencement of the Fund's investment
operations, for the quarterly periods

39
<PAGE> 43

ending on the dates set forth below the high and low net asset value per Common
Share during such period.

<TABLE>
<CAPTION>
QUARTERLY PERIOD ENDING HIGH LOW
- ---------------------------------------------------- ------ ------
<S> <C> <C>
December 31, 1994................................... $10.06 $10.04
September 30, 1994.................................. 10.05 10.03
June 30, 1994....................................... 10.05 10.03
March 31, 1994...................................... 10.07 10.05

December 31, 1993................................... $10.07 $10.00
September 30, 1993.................................. 10.01 9.99
June 30, 1993....................................... 10.06 9.99
March 31, 1993...................................... 10.06 10.04

December 31, 1992................................... $10.04 $ 9.97
September 30, 1992.................................. 10.02 9.99
June 30, 1992....................................... 10.01 9.98
March 31, 1992...................................... 10.02 10.00

December 31, 1991................................... $10.01 $ 9.99
September 30, 1991.................................. 9.99 9.98
</TABLE>

As of March 10, 1995, the net asset value per Common Share was $10.03. The
following table sets forth certain information with respect to the Common Shares
as of March 10, 1995:

<TABLE>
<CAPTION>
(3)
AMOUNT (4)
HELD AMOUNT
BY OUTSTANDING
FUND EXCLUSIVE
FOR OF
(2) ITS AMOUNT
(1) AMOUNT OWN SHOWN
TITLE OF CLASS AUTHORIZED ACCOUNT UNDER (3)
- -------------------------------------- --------- --- -----------
<S> <C> <C> <C>
Common Shares of beneficial
interest, $.01 par value unlimited 0 184,336,246
</TABLE>

To the knowledge of the Fund, as of March 10, 1995, no person held 5% or more
of the Fund's Common Shares either beneficially or of record. Further, as of
such date, officers and trustees of the Fund as a group owned less than 1% of
the Common Shares.

ANTI-TAKEOVER PROVISIONS IN THE DECLARATION OF TRUST. The Fund's Declaration
of Trust includes provisions that could have the effect of limiting the ability
of other entities or persons to acquire control of the Fund or to change the
composition of its Board of Trustees by discouraging a third party from seeking
to obtain control of the Fund. In addition, in the event a secondary market were
to develop in the Common Shares, such provisions could have the effect of
depriving holders of Common Shares of an opportunity to sell their Common Shares
at a premium over prevailing market prices. A Trustee may be removed from office
only for cause by a written instrument signed by at least two-thirds of the
remaining Trustees or by a vote of the holders of at least two-thirds of the
Common Shares.

In addition, the Declaration of Trust requires the favorable vote of the
holders of at least two-thirds of the outstanding Common Shares then entitled to
vote to approve, adopt or

40
<PAGE> 44

authorize certain transactions with 5%-or-greater holders of Common Shares and
their associates, unless the Board of Trustees shall by resolution have approved
a memorandum of understanding with such holders, in which case normal voting
requirements would be in effect. See "Repurchase of Shares--Anti-takeover
Provisions" in the Statement of Additional Information.

- --------------------------------------------------------------------------------
PURCHASING SHARES OF THE FUND
- --------------------------------------------------------------------------------

The Fund offers continuously its Common Shares through VKAC, the principal
underwriter of the continuous offering of the Common Shares, whose offices are
located at One Parkview Plaza, Oakbrook Terrace, Illinois 60181. The Common
Shares will also be offered through members of the National Association of
Securities Dealers, Inc. ("NASD") or eligible non-NASD members who are acting as
brokers or agents for investors ("broker-dealers"). The Fund reserves the right
to terminate or suspend the continuous offering of its Shares at any time
without prior notice.

The Fund does not intend to list the Common Shares on any national securities
exchange and none of the Fund, the Adviser or VKAC, intends to make a secondary
market in the Common Shares. Accordingly, there is not expected to be any
secondary trading market in the Common Shares and an investment in the Common
Shares should be considered illiquid.

Except as discussed below under "Investments by Tax Sheltered Retirement
Plans," the minimum initial investment in the Fund is $1,000 and minimum
subsequent investment is $100.

During the continuous offering, the Common Shares will be offered by the Fund
at the public offering price next computed after an investor places an order to
purchase directly with VKAC, or with the investor's broker-dealer. The price of
Common Shares ordered through an investor's broker-dealer will be the public
offering price next determined after the Fund receives the order. Because the
Fund determines the public offering price once daily on each business day as of
5:00 p.m. Eastern time, orders placed through an investor's broker-dealer must
be transmitted to the Fund by the broker-dealer prior to such time for the
investor's order to be executed at the public offering price to be determined
that day. Any change in price due to the failure of the Fund to receive an order
prior to such time must be settled between the investor and the broker-dealer
placing the order. The public offering price is equal to the net asset value per
Common Share. There will be no initial sales charge or underwriting discount on
purchases of Common Shares.

VKAC will compensate broker-dealers participating in the continuous offering
at a rate of 3.0% of the dollar value of Common Shares purchased from the Fund
by such broker-dealers. If the Common Shares remain outstanding after one year
from the date of their original purchase, VKAC will compensate such
broker-dealers at an annual rate, paid

41
<PAGE> 45

quarterly, in an amount based on a percentage of the value of such Common
Shares, in accordance with the following schedule:

<TABLE>
<CAPTION>
ANNUAL
COMPENSATION AS A
YEAR AFTER DATE PERCENTAGE OF VALUE
OF ORIGINAL PURCHASE OF SHARES OUTSTANDING
- --------------------------------------------------------- -----------------------
<S> <C>
First.................................................... 0.00%
Second................................................... 0.10%
Third.................................................... 0.15%
Fourth................................................... 0.20%
Fifth.................................................... 0.25%
Sixth and following...................................... 0.35%
</TABLE>

At various times VKAC may implement programs under which a broker-dealer's sales
force may be eligible to win nominal awards for certain sales efforts. The value
of any such non-cash awards will not exceed $50 per person annually. These
incentives will not change the price investors pay for Common Shares or the
amount that the Fund will receive from the sale of Common Shares. The
compensation paid to broker-dealers at the time of purchase, the quarterly
payments mentioned above will be paid by VKAC out of its own assets, and not out
of the assets of the Fund. An early withdrawal charge payable to VKAC will be
imposed on most Common Shares held for less than five years that are accepted
for repurchase pursuant to a tender offer by the Fund. See "Repurchase of
Shares." The compensation paid to broker-dealers and VKAC, including the
compensation paid at the time of purchase, the quarterly payments mentioned
above and the early withdrawal charge, if any, will not in the aggregate exceed
applicable limitations, which the Fund currently understands to be 8.0%. VKAC
will monitor the aggregate value of all such compensation on an ongoing basis.

Automatic Investment. Once an investor has opened an account in the Fund with
the minimum $1,000 investment, the automatic investment option may be utilized
to make regular monthly investments of $100 or more into such investor's account
with the Fund. In order to utilize this option, an investor must fill out and
sign the Automatic Investment application bound in this Prospectus or available
from the Transfer Agent, the Fund, such investor's broker or dealer, or VKAC.
Once the Transfer Agent has received this application, such investor's checking
account at his designated local bank will be debited each month in the amount
authorized by such investor to purchase shares of the Fund. Once enrolled in the
Automatic Investment Program, an investor may change the monthly amount or
terminate participation at any time by writing the Transfer Agent. Investors in
the automatic investment program will receive a confirmation of these
transactions from the Fund quarterly and their regular bank account statements
will show the debit transaction each month.

Investments by Tax-Sheltered Retirement Plans. Common Shares are available for
purchase in connection with certain types of tax-sheltered retirement plans,
including: Individual Retirement Accounts ("IRA's") for individuals; Simplified
Employee Pension

42
<PAGE> 46

Plans ("SEP's") for employees; qualified plans for self-employed individuals;
and qualified corporate pension and profit sharing plans for employees.

The purchase of shares of the Fund may be limited by the plans' provisions and
does not itself establish such plans. The minimum initial investment in
connection with a tax-sheltered retirement plan is $250.

IRAs are available for individuals under age 70-1/2 whether or not they are
active participants in any other tax-qualified employer plan. Generally,
individuals who are not active participants in a tax-qualified employer plan may
deduct from gross income their IRA contributions which do not exceed 100% of
compensation received during a year or $2,000 ($2,250 for a spousal account),
whichever is less. If an employee or the employee's spouse is an active
participant in a tax-qualified employer plan, the IRA deduction is phased out
above certain income levels. Individuals may, however, make non-deductible
contributions to their IRAs up to the lesser of 100% of annual compensation or
$2,000 ($2,250 for a spousal account) without being subject to an excise tax on
excessive contributions. Generally, earnings on investments held in an IRA are
not taxable until withdrawn. Subject to certain exceptions, substantial tax
penalties apply to withdrawals before age 59-1/2.

A SEP is a retirement program established by an employer (including
individuals) for the benefit of its eligible employees. Generally, any employee
who has attained age 21, worked for the employer during three of the past five
years and earned a specified amount from the employer in the current year will
be eligible to participate. Under a SEP, each participant establishes an IRA to
which the sponsoring employer makes annual calendar year contributions.
Generally, those contributions cannot exceed the lesser of $30,000 or 15% of the
participant's compensation for the year. A participating employee may also make
his or her IRA contribution to the same account. Generally, earnings on accounts
held in an IRA established pursuant to a SEP are not taxable until withdrawn.
Subject to certain exceptions, substantial tax penalties apply to withdrawals
before attainment of age 59-1/2.

Common Shares may also be purchased by employer sponsored tax qualified
retirement plans which allow for investments in investment companies. A
standardized plan is available through securities dealers or brokers, the Fund,
or VKAC for employers (including individuals) who desire to start or amend a
retirement plan. The form of this standardized plan has been determined to be
"qualified" under the Internal Revenue Code. An employer may use this prototype
to establish a profit sharing plan, a money purchase pension plan or both for
its eligible employees. The cost for the use of the prototype is an initial fee
of $50 and there are no annual fees. The adopting employer determines within the
prescribed limits the eligibility standards, rate of contributions and other
significant provisions of the prototype plan. VKAC, as sponsor of this prototype
plan, reserves the right to amend such plan from time to time to assure its
continued qualification under the Internal Revenue Code or for other reasons.
Employers adopting this prototype plan will be bound by such amendments.

43
<PAGE> 47

Shareholders considering establishing a retirement plan or purchasing any Fund
shares in connection with a retirement plan, should consult with their attorney
or tax advisor with respect to plan requirements and tax aspects pertaining to
the shareholder.

The illiquid nature of the Fund's Common Shares may affect the nature of
distributions from tax sheltered retirement plans and may affect the ability of
participants in such plans to rollover assets to other tax sheltered retirement
plans.

- --------------------------------------------------------------------------------
COMMUNICATIONS WITH SHAREHOLDERS
- --------------------------------------------------------------------------------

The Fund will send semi-annual and annual reports to shareholders, including a
list of the portfolio investments held by the Fund.

From time to time advertisements and other sales materials for the Fund may
include information concerning the historical performance of the Fund. Any such
information may include a distribution rate and an average compounded
distribution rate of the Fund for specified periods of time. Such information
may also include performance rankings and similar information from independent
organizations such as Lipper Analytical Services, Inc., Business Week, Forbes or
other industry publications.

The Fund's distribution rate generally is determined on a monthly basis with
respect to the immediately preceding monthly distribution period. The
distribution rate is computed by first annualizing the Fund's distributions per
Share during such a monthly distribution period and dividing the annualized
distribution by the Fund's maximum offering price per Share on the last day of
such period. The Fund calculates the compounded distribution rate by adding one
to the monthly distribution rate, raising the sum to the power of 12 and
subtracting one from the product. In circumstances in which the Fund believes
that, as a result of decreases in market rates of interest, its expected monthly
distributions may be less than the distributions with respect to the immediately
preceding monthly distribution period, the Fund reserves the right to calculate
the distribution rate on the basis of a period of less than one month.

Distribution rate and compounded distribution rate figures utilized by the
Fund are based on historical performance and are not intended to indicate future
performance. Distribution rate, compounded distribution rate and net asset value
per share can be expected to fluctuate over time.

44
<PAGE> 48

The following table is intended to provide investors with a comparison of
short-term money market rates. This comparison should not be considered a
representation of future money market rates, nor what an investment in the Fund
may earn or what an investor's yield or total return may be in the future. These
comparisons may be used in advertisements and in information furnished to
present or prospective shareholders.

<TABLE>
<CAPTION>
COMPARISON OF PRIME RATE,
CERTIFICATE OF DEPOSIT RATE, MONEY MARKET RATE AND
LONDON INTER-BANK OFFERED RATE
(AVERAGE OF CALENDAR YEAR)
---------------------------------------------------------------------------------------------------------
1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Prime Rate(1)... 15.06% 10.78% 12.06% 9.99% 8.38% 8.15% 9.24% 10.88% 10.01% 8.46% 6.25% 6.00% 8.50%
C.D. Rate(2).... 12.57 9.27 10.68 8.25 6.51 7.01 7.91 9.08 8.17 5.91 3.76 3.28 6.90
Money Market
Rate(3)........ 11.70 8.20 9.58 7.50 6.17 5.89 6.77 8.53 7.82 5.44 3.36 2.70 3.75
LIBOR(4)........ 9.18 9.81 8.75 8.00 6.37 7.43 9.62 8.37 7.56 4.25 3.43 3.37 6.50
</TABLE>

- ---------------
(1) The Prime Rate quoted by a major U.S. bank is the base rate on corporate
loans at large U.S. money center commercial banks. Source: Federal Reserve
Bulletin.

(2) The Certificate of Deposit Rate represents the average annual rate paid on
large six-month CDs traded in the secondary market. Source: Bloomberg.

(3) The Money Market Rate represents Donoghue's Money Fund Averages for taxable
money market funds.

(4) The London Inter-Bank Offered Rate represents the rate at which most
creditworthy international banks dealing in Eurodollars charge each other
for large loans. Source: Bloomberg.

- --------------------------------------------------------------------------------
CUSTODIAN, DIVIDEND DISBURSING AND TRANSFER AGENT
- --------------------------------------------------------------------------------

State Street Bank and Trust Company, 225 Franklin Street, P.O. Box 1713,
Boston, Massachusetts 02105-1713, is the custodian, dividend disbursing and
transfer agent of the Fund and has custody of the securities and cash of the
Fund. The custodian, among other things, attends to the collection of principal
and income and payment for and collection of proceeds of securities bought and
sold by the Fund. State Street Bank and Trust Company also will perform certain
accounting services for the Fund pursuant to the Fund Accounting Agreement
between it and the Fund.

- --------------------------------------------------------------------------------
LEGAL OPINIONS
- --------------------------------------------------------------------------------

Certain legal matters in connection with the Common Shares offered hereby have
been passed upon for the Fund by Skadden, Arps, Slate, Meagher & Flom.

45
<PAGE> 49

- --------------------------------------------------------------------------------
EXPERTS
- --------------------------------------------------------------------------------

The audited financial statements for the period ended July 31, 1994, included
in the Statement of Additional Information, have been so included in reliance on
the report of KPMG Peat Marwick LLP, independent certified public accountants,
given on the authority of said firm as experts in auditing and accounting.

- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------

The Prospectus and the Statement of Additional Information do not contain all
of the information set forth in the Registration Statement that the Fund has
filed with the SEC. The complete Registration Statement may be obtained from the
SEC upon payment of the fee prescribed by its Rules and Regulations.

Statements contained in this Prospectus as to the contents of any contract or
other documents referred to are not necessarily complete, and, in each instance,
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement of which this Prospectus forms a part,
each such statement being qualified in all respects by such reference.

The Table of Contents for the Statement of Additional Information is as
follows:

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies and Special Risk Considerations.... B-2
Investment Restrictions.............................................. B-8
Officers and Trustees................................................ B-10
Portfolio Transactions............................................... B-13
Management of the Fund............................................... B-14
Net Asset Value...................................................... B-16
Taxation............................................................. B-17
Repurchase of Shares................................................. B-19
Unaudited Financial Statements for the Six Month Period Ended January
31, 1995........................................................... B-23
Notes to Unaudited Financial Statements.............................. B-34
Independent Auditors' Report......................................... B-37
Audited Financial Statements......................................... B-38
Notes to Audited Financial Statements................................ B-47
</TABLE>

46
<PAGE> 50

VAN KAMPEN MERRITT
PRIME RATE INCOME TRUST
One Parkview Plaza
Oakbrook Terrace, IL 60181

Investment Adviser

VAN KAMPEN AMERICAN CAPITAL

INVESTMENT ADVISORY CORP.
One Parkview Plaza
Oakbrook Terrace, IL 60181

Principal Underwriter

VAN KAMPEN AMERICAN CAPITAL
DISTRIBUTORS, INC.

One Parkview Plaza
Oakbrook Terrace, IL 60181

Transfer Agent and
EXISTING SHAREHOLDERS-- Dividend Disbursing Agent
FOR INFORMATION ON YOUR STATE STREET BANK AND
EXISTING ACCOUNT PLEASE TRUST COMPANY
CALL THE FUND'S TOLL-FREE c/o National Financial Data Services
NUMBER 1-800-341-2911. P.O. Box 419001
Kansas City, MO 64141-6001
PROSPECTIVE INVESTORS--CALL Attn: Van Kampen Merritt Funds
YOUR BROKER OR 1-800-341-2911.
Custodian
DEALERS--FOR DEALER STATE STREET BANK AND
INFORMATION, CALL TRUST COMPANY
1-800-225-2222. FOR SELLING 225 Franklin Street, P.O. Box 1713
AGREEMENTS OR WIRE ORDERS Boston, MA 02105-1713
CALL THE PRINCIPAL
UNDERWRITER'S TOLL FREE Legal Counsel
NUMBER--1-800-225-2222 SKADDEN, ARPS, SLATE,
MEAGHER & FLOM
333 West Wacker Drive
FOR SHAREHOLDER AND Chicago, IL 60606
DEALER INQUIRIES THROUGH
TELECOMMUNICATIONS Independent Auditors
DEVICE FOR THE DEAF (TDD) KPMG PEAT MARWICK LLP
DIAL 1-800-772-8889 Peat Marwick Plaza
303 East Wacker Drive
FOR AUTOMATED TELEPHONE Chicago, IL 60601
SERVICES DIAL 1-800-542-4344
<PAGE> 51

VAN KAMPEN MERRITT
PRIME RATE INCOME TRUST

STATEMENT OF ADDITIONAL INFORMATION

Van Kampen Merritt Prime Rate Income Trust (the "Fund") is a non-diversified,
closed-end management investment company whose investment objective is to
provide Common Shareholders with a high level of current income, consistent with
preservation of capital. This Statement of Additional Information is not a
prospectus, but should be read in conjunction with the Prospectus for the Fund
dated April 6, 1995 (the "Prospectus"). This Statement of Additional Information
does not include all information that a prospective investor should consider
before purchasing shares of the Fund, and investors should obtain and read the
Prospectus prior to purchasing shares. A copy of the Prospectus may be obtained
without charge, by calling 1-800-225-2222, ext. 6504, or for Telecommunications
Device for the Deaf, 1-800-772-8889. This Statement of Additional Information
incorporates by reference the entire Prospectus.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies and Special Risk Considerations..................... B-2
Investment Restrictions............................................................... B-8
Officers and Trustees................................................................. B-10
Portfolio Transactions................................................................ B-13
Management of the Fund................................................................ B-14
Net Asset Value....................................................................... B-16
Taxation.............................................................................. B-17
Repurchase of Shares.................................................................. B-19
Unaudited Financial Statements for the Six Month Period Ended January 31, 1995........ B-23
Notes to Unaudited Financial Statements............................................... B-34
Independent Auditors' Report.......................................................... B-37
Audited Financial Statements.......................................................... B-38
Notes to Audited Financial Statements................................................. B-47
</TABLE>

The Prospectus and this Statement of Additional Information omit certain of
the information contained in the registration statement filed with the
Securities and Exchange Commission, Washington, D.C. (the "SEC"). These items
may be obtained from the SEC upon payment of the fee prescribed, or inspected at
the SEC's office at no charge.

THIS STATEMENT OF ADDITIONAL INFORMATION IS DATED APRIL 6, 1995

B-1
<PAGE> 52

INVESTMENT OBJECTIVE AND POLICIES
AND SPECIAL RISK CONSIDERATIONS

The Fund's investment objective is to provide a high level of current income,
consistent with preservation of capital. The Fund seeks to achieve its objective
through investment primarily in a professionally managed portfolio of interests
in floating or variable rate Senior Loans to Borrowers. Although the Fund's net
asset value will vary, the Fund's policy of acquiring interests in floating or
variable rate Senior Loans is expected to minimize the fluctuations in the
Fund's net asset value as a result of changes in interest rates. The Fund's net
asset value may be affected by changes in the credit quality of Borrowers with
respect to Senior Loan interests in which the Fund invests. The Fund seeks to
achieve over time an effective yield that approximates the average published
Prime Rate of major United States banks. An investment in the Fund may not be
appropriate for all investors and is not intended to be a complete investment
program. No assurance can be given that the Fund will achieve its investment
objective.

CERTAIN CHARACTERISTICS OF SENIOR LOAN INTERESTS

It is anticipated that the proceeds of the Senior Loans in which the Fund will
acquire interests primarily will be used to finance leveraged buyouts,
recapitalizations, mergers, acquisitions, stock repurchases, and, to a lesser
extent, to finance internal growth and for other corporate purposes of
Borrowers. The Fund currently does not intend to acquire interests in Senior
Loans the proceeds of which would be used primarily to finance construction or
real estate development projects. Senior Loans have the most senior position in
a Borrower's capital structure, although some Senior Loans may hold an equal
ranking with other senior securities of the Borrower. The capital structure of
Borrowers may include Senior Loans, senior and junior subordinated debt (which
may include "junk bonds"), preferred stock and common stock issued by the
Borrower, typically in descending order of seniority with respect to claims on
the Borrower's assets. Senior Loans generally are secured by specific
collateral, which may include guarantees. In connection with the acquisition of
collateralized Senior Loans, the Fund may invest up to 5% of its total assets in
Senior Loans which are not secured by any collateral. Such unsecured Senior
Loans would constitute an interim financing intended to be refinanced through,
in whole or in part, a collateralized Senior Loan. In the event that the Fund
invests a portion of its assets in Senior Loans that are not secured by specific
collateral, the Fund will not enjoy the benefits associated with
collateralization with respect to such Senior Loans and such Senior Loans may
pose a greater risk of nonpayment of interest or loss of principal than do
collateralized Senior Loans. As discussed below, the Fund may also acquire
warrants and equity securities issued by the Borrower or its affiliates as part
of a package of investments in the Borrower or its affiliates. Warrants and
equity securities will not be treated as Senior Loans and thus assets invested
in such securities will not count toward the 80% of the Fund's total assets that
normally will be invested in Senior Loans. The Fund will acquire such interests
in unsecured Senior Loans, warrants and equity securities only as an incident to
the intended purchase of interests in collateralized Senior Loans. Loan
Agreements may also include various restrictive covenants designed to limit the
activities of the Borrower in an effort to protect the right of the Lenders to
receive timely payments of interest on and repayment of principal of the Senior
Loans. In order to borrow money pursuant to collateralized Senior Loans, a
Borrower will frequently, for the term of the Senior Loan, pledge as collateral
assets, including but not limited to, trademarks, accounts receivable,
inventory, buildings, real estate, franchises and common and

B-2
<PAGE> 53

preferred stock in its subsidiaries. In addition, in the case of some Senior
Loans, there may be additional collateral pledged in the form of guarantees by
and/or securities of affiliates of the Borrowers. In certain instances, a Senior
Loan may be secured only by stock in the Borrower or its subsidiaries. Such
collateral may consist of assets that may not be readily liquidated, and there
is no assurance that the liquidation of such assets would satisfy fully a
Borrower's obligations under a Senior Loan.

Senior Loans in which the Fund will invest generally pay interest at rates
which are periodically redetermined by reference to a base lending rate plus a
premium. These base lending rates are generally the Prime Rate, LIBOR, the CD
rate or other base lending rates used by commercial lenders. The Prime Rate
quoted by a major U.S. bank is the interest rate at which such bank is willing
to lend U.S. dollars to its most creditworthy borrowers. LIBOR, as provided for
in Loan Agreements, is an average of the interest rates quoted by several
designated banks as the rates at which such banks would offer to pay interest to
major financial institutional depositors in the London interbank market on U.S.
dollar denominated deposits for a specified period of time. The CD rate, as
generally provided for in Loan Agreements, is the average rate paid on large
certificates of deposit traded in the secondary market. At least 80% of the
Fund's total assets normally will be invested in Senior Loans. In normal market
conditions, at least 65% of the Fund's assets will be invested in Senior Loans
which, at the time of the Fund's initial investment in such Senior Loans,
provided the Fund with a rate of return which was at least equal to the Prime
Rate existing on the date of such initial investment. The Fund is not subject to
any restrictions with respect to the maturity of Senior Loans held in its
portfolio. It is currently anticipated that the Fund's assets invested in Senior
Loans will consist of Senior Loans with stated maturities of between three and
seven years, inclusive, and with rates of interest which are redetermined either
daily, monthly, quarterly or semi-annually; provided, however, that the Fund may
invest up to 5% of its total assets in Senior Loans which permit the Borrower to
select an interest rate redetermination period of up to one year. Investment in
Senior Loans with longer interest rate redetermination periods may increase
fluctuations in the Fund's net asset value as a result of changes in interest
rates. The Senior Loans in the Fund's portfolio will at all times have a
dollar-weighted average time until the next interest rate redetermination of 90
days or less. As a result, as short-term interest rates increase, interest
payable to the Fund from its investments in Senior Loans should increase, and as
short-term interest rates decrease, interest payable to the Fund from its
investments in Senior Loans should decrease. The amount of time required to pass
before the Fund will realize the effects of changing short-term market interest
rates on its portfolio will vary with the dollar-weighted average time until the
next interest rate redetermination on the Senior Loans in the Fund's portfolio.
The Fund may utilize certain investment practices to, among other things,
shorten the effective interest rate redetermination period of Senior Loans in
its portfolio. In such event, the Fund will consider such shortened period to be
the interest rate redetermination period of the Senior Loan; provided, however,
that the Fund will not invest in Senior Loans which permit the Borrower to
select an interest rate redetermination period in excess of one year. Because
most Senior Loans in the Fund's portfolio will be subject to mandatory and/or
optional prepayment and there may be significant economic incentives for a
Borrower to prepay its loans, prepayments of Senior Loans in the Fund's
portfolio may occur. Accordingly, the actual remaining maturity of the Fund's
portfolio invested in Senior Loans may vary substantially from the average
stated maturity of the Senior Loans held in the Fund's portfolio. As a result of
expected prepayments from time to time of Senior Loans in the Fund's portfolio,
the Fund estimates that the actual average maturity of the Senior Loans held in
its portfolio will be approximately 18-24 months.

B-3
<PAGE> 54

When interest rates decline, the value of a portfolio invested in fixed-rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of a portfolio invested in fixed-rate obligations can be expected to
decline. Although the Fund's net asset value will vary, the Fund's management
expects the Fund's policy of acquiring interests in floating or variable rate
Senior Loans to minimize fluctuations in net asset value as a result of changes
in interest rates. Accordingly, the Fund's management expects the value of the
Fund's portfolio to fluctuate significantly less than a portfolio of fixed-rate,
longer term obligations as a result of interest rate changes. However, changes
in prevailing interest rates can be expected to cause some fluctuation in the
Fund's net asset value. In addition to changes in interest rates, changes in the
credit quality of Borrowers will also effect the Fund's net asset value.
Further, a serious deterioration in the credit quality of a Borrower could cause
a prolonged or permanent decrease in the Fund's net asset value.

Senior Loans generally are not rated by nationally recognized statistical
rating organizations. Because of the collateralized and/or guaranteed nature of
most Senior Loans, the Fund and the Adviser believe that ratings of other
securities issued by a Borrower do not necessarily reflect adequately the
relative quality of a Borrower's Senior Loans. Therefore, although the Adviser
may consider such ratings in determining whether to invest in a particular
Senior Loan, the Adviser is not required to consider such ratings and such
ratings will not be the determinative factor in the Adviser's analysis. The Fund
may invest in Senior Loans, the Borrowers with respect to which have outstanding
debt securities which are rated below investment grade by a nationally
recognized statistical rating organization or are unrated but of comparable
quality to such securities. Debt securities rated below investment grade or
unrated but of comparable quality commonly are referred to as "junk bonds." The
Fund will invest only in those Senior Loans with respect to which the Borrower,
in the opinion of the Adviser, demonstrates certain of the following
characteristics: sufficient cash flow to service debt; adequate liquidity;
successful operating history; strong competitive position; experienced
management; and, with respect to collateralized Senior Loans, collateral
coverage that equals or exceeds the outstanding principal amount of the Senior
Loan. In addition, the Adviser will consider, and may rely in part, on the
analyses performed by the Agent and other Lenders, including such persons'
determinations with respect to collateral securing a Senior Loan.

B-4
<PAGE> 55

assets in safekeeping for, or the prompt disbursement of assets to, the Fund.
Long-term debt rated BBB by S&P is regarded by S&P as having adequate capacity
to pay interest and repay principal and debt rated Baa by Moody's is regarded by
Moody's as a medium grade obligation, i.e., it is neither highly protected nor
poorly secured. Commercial paper rated A-1 by S&P indicates that the degree of
safety regarding timely payment is considered by S&P to be either overwhelming
or very strong and issues of commercial paper rated Prime-1 by Moody's are
considered by Moody's to have a superior ability for repayment of senior
short-term debt obligations. The Fund ordinarily will purchase a Participation
only if, at the time of such purchase, the Fund believes that the party from
whom it is purchasing such Participation is retaining an interest in the
underlying Senior Loan. In the event that the Fund does not so believe, it will
only purchase such a Participation if, in addition to the requirements set forth
above, the party from whom the Fund is purchasing such Participation (i) is a
bank, a member of a national securities exchange or other entity designated in
the Investment Company Act of 1940, as amended, as qualified to serve as a
custodian for a registered investment company and (ii) has been approved as a
custodian by the Board of Trustees of the Fund (a "Designated Custodian").

The Fund will purchase an Assignment or act as a Lender with respect to a
syndicated Senior Loan only where the Agent with respect to such Senior Loan at
the time of investment has outstanding debt or deposit obligations rated
investment grade (BBB or A-3 or higher by S&P or Baa or P-3 or higher by
Moody's) or determined by the Adviser to be of comparable quality. In addition,
the Fund will purchase a Participation only where the Lender selling such
Participation, and any other person interpositioned between such Lender and the
Fund at the time of investment have outstanding debt obligations rated
investment grade or determined by the Adviser to be of comparable quality.
Further, the Fund will not purchase interests in Senior Loans unless such Agent,
Lender or interpositioned person has entered into an agreement which provides
for the prompt disbursement of assets to the Fund.

Loan Agreements typically provide for the termination of the Agent's agency
status in the event that it fails to act as required under the relevant Loan
Agreement, becomes insolvent, enters FDIC receivership, or if not FDIC insured,
enters into bankruptcy. Should such an Agent, Lender or assignor with respect to
an Assignment interpositioned between the Fund and the Borrower become insolvent
or enter FDIC receivership or bankruptcy, any interest in the Senior Loan of
such person and any loan payment held by such person for the benefit of the Fund
should not be included in such person's estate. If, however, any such amount
were included in such person's estate, the Fund would incur certain costs and
delays in realizing payment or could suffer a loss of principal and/or interest.
In such event, the Fund could experience a decrease in net asset value.

B-5
<PAGE> 56

undrawn portion committed by the Lenders of the underlying Senior Loan. Lenders
may receive prepayment penalties when a Borrower prepays all or part of a Senior
Loan. The Fund will receive these fees directly from the Borrower if the Fund is
an Original Lender, or, in the case of commitment fees and prepayment penalties,
if the Fund acquires an interest in a Senior Loan by way of Assignment. Whether
or not the Fund receives a facility fee from the Lender in the case of an
Assignment, or any fees in the case of a Participation, depends upon
negotiations between the Fund and the Lender selling such interests. When the
Fund is an assignee, it may be required to pay a fee, or forgo a portion of
interest and any fees payable to it, to the Lender selling the Assignment.
Occasionally, the assignor will pay a fee to the assignee based on the portion
of the principal amount of the Senior Loan which is being assigned. A Lender
selling a Participation to the Fund may deduct a portion of the interest and any
fees payable to the Fund as an administrative fee prior to payment thereof to
the Fund. The Fund may be required to pay over or pass along to a purchaser of
an interest in a Senior Loan from the Fund a portion of any fees that the Fund
would otherwise be entitled to.

During normal market conditions, the Fund may invest up to 20% of its total
assets in (i) high quality, short-term debt securities with remaining maturities
of one year or less (including assets maintained by the Fund as a reserve
against any additional loan commitments) and (ii) warrants, equity securities
and, in certain limited circumstances discussed above, junior debt securities
acquired in connection with the Fund's investments in Senior Loans. If the
Adviser determines that market conditions temporarily warrant a defensive
investment policy, the Fund may invest, subject to its ability to liquidate its
relatively illiquid portfolio of Senior Loans, up to 100% of its assets in cash
and such high quality, short-term debt securities. The Fund will acquire such
warrants and equity securities only as an incident to the purchase or intended
purchase of interests in collateralized Senior Loans. Warrants and equity
securities will not qualify as assets required to be maintained as a reserve
against additional loan commitments. Although the Fund generally will acquire
interests in warrants and equity securities only when the Adviser believes that
the relative value being given by the Fund in exchange for such interests is
substantially outweighed by the potential value of such instruments, investment
in warrants and equity securities entail certain risks in addition to those
associated with investments in Senior Loans. Warrants and equity securities have
a subordinate claim on a Borrower's assets as compared with debt securities and
junior debt securities have a subordinate claim on such assets as compared with
Senior Loans. As such, the values of warrants and equity securities generally
are more dependent on the financial condition of the Borrower and less dependent
on fluctuations in interest rates than are the values of many debt securities.
The values of warrants, equity securities and junior debt securities may be more
volatile than those of Senior Loans and thus may have an adverse impact on the
ability of the Fund to minimize fluctuations in its net asset value.

SPECIAL RISK CONSIDERATIONS

B-6
<PAGE> 57

(where the Fund is an Original Lender or owns an Assignment) or the selling
Lender (where the Fund owns a Participation) to collect principal of and
interest on a Senior Loan. Furthermore, the Fund usually will rely on the Agent
(where the Fund is an Original Lender or owns an Assignment) or the selling
Lender (where the Fund owns a Participation) to monitor compliance by the
Borrower with the restrictive covenants in the Loan Agreement and notify the
Fund of any adverse change in the Borrower's financial condition or any
declaration of insolvency. Collateralized Senior Loans will frequently be
secured by all assets of the Borrower that qualify as collateral, which may
include common stock of the Borrower or its subsidiaries. Additionally, the
terms of the Loan Agreement may require the Borrower to pledge additional
collateral to secure the Senior Loan, and enable the Agent, upon proper
authorization of the Lenders, to take possession of and liquidate the collateral
and to distribute the liquidation proceeds pro rata among the Lenders. If the
terms of a Senior Loan do not require the Borrower to pledge additional
collateral in the event of a decline in the value of the original collateral,
the Fund will be exposed to the risk that the value of the collateral will not
at all times equal or exceed the amount of the Borrower's obligations under the
Senior Loan. Lenders that have sold Participation interests in such Senior Loan
will distribute liquidation proceeds received by the Lenders pro rata among the
holders of such Participations. The Adviser will also monitor these aspects of
the Fund's investments and, where the Fund is an Original Lender or owns an
Assignment, will be directly involved with the Agent and the other Lenders
regarding the exercise of credit remedies. Senior Loans, like other corporate
debt obligations, are subject to the risk of non-payment of scheduled interest
or principal. Such non-payment would result in a reduction of income to the
Fund, a reduction in the value of the Senior Loan experiencing non-payment and a
potential decrease in the net asset value of the Fund. Although, with respect to
collateralized Senior Loans, the Fund generally will invest only in Senior Loans
that the Adviser believes are secured by specific collateral, which may include
guarantees, the value of which exceeds the principal amount of the Senior Loan
at the time of initial investment, there can be no assurance that the
liquidation of any such collateral would satisfy the Borrower's obligation in
the event of non-payment of scheduled interest or principal payments, or that
such collateral could be readily liquidated. In the event of bankruptcy of a
Borrower, the Fund could experience delays or limitations with respect to its
ability to realize the benefits of the collateral securing a Senior Loan. To the
extent that a Senior Loan is collateralized by stock in the Borrower or its
subsidiaries, such stock may lose all or substantially all of its value in the
event of bankruptcy of the Borrower. The Agent generally is responsible for
determining that the Lenders have obtained a perfected security interest in the
collateral securing the Senior Loan. In the event that the Fund does not believe
that a perfected security interest has been obtained with respect to a
collateralized Senior Loan, the Fund will only obtain an interest in such Senior
Loan if the Agent is a Designated Custodian. Some Senior Loans in which the Fund
may invest are subject to the risk that a court, pursuant to fraudulent
conveyance or other similar laws, could subordinate such Senior Loans to
presently existing or future indebtedness of the Borrower or take other action
detrimental to the holders of Senior Loans, such as the Fund, including, under
certain circumstances, invalidating such Senior Loans. Lenders commonly have
certain obligations pursuant to the Loan Agreement, which may include the
obligation to make additional loans or release collateral in certain
circumstances.

Senior Loans in which the Fund will invest generally will not be rated by a
nationally recognized statistical rating organization, will not be registered
with the SEC or any state securities commission and will not be listed on any
national securities exchange. Although the Fund will generally have access to
financial and other information made available to the Lenders in connection with
Senior Loans, the amount of public information available with respect to Senior
Loans will generally be less extensive than that available for rated, registered
and/or exchange listed securities. As a result, the performance of the Fund and
its ability to meet its investment objective is more dependent on the analytical
ability of the Adviser than would be the case for an investment company that
invests primarily in rated, registered and/or exchange listed securities.

B-7
<PAGE> 58

invested in securities which are not readily marketable or are subject to
restrictions on resale. The substantial portion of the Fund's assets invested in
relatively illiquid Senior Loan interests may restrict the ability of the Fund
to dispose of its investments in Senior Loans in a timely fashion and at a fair
price, and could result in capital losses to the Fund and holders of Common
Shares. However, many of the Senior Loans in which the Fund expects to purchase
interests are of a relatively large principal amount and are held by a
relatively large number of owners which should, in the Adviser's opinion,
enhance the relative liquidity of such interests. The risks associated with
illiquidity are particularly acute in situations where the Fund's operations
require cash, such as when the Fund tenders for its Common Shares, and may
result in the Fund borrowing to meet short-term cash requirements.

INVESTMENT RESTRICTIONS

The Fund's investment objective and the following investment restrictions are
fundamental and cannot be changed without the approval of the holders of a
majority (defined as the lesser of (i) 67 percent or more of the voting
securities present at a meeting of shareholders, if the holders of more than 50
percent of the outstanding voting securities are present or represented by proxy
at such meeting, or (ii) more than 50 percent of the outstanding voting
securities) of the Fund's outstanding Common Shares. All other investment
policies or practices are considered by the Fund not to be fundamental and
accordingly may be changed without shareholder approval. If a percentage
restriction on investment or use of assets set forth below is adhered to at the
time a transaction is effected, later changes in percentage resulting from
changing market values will not be considered a deviation from policy. In
accordance with the foregoing, the Fund may not:

1. Purchase any securities (other than obligations issued or guaranteed by
the United States Government or by its agencies or instrumentalities), if
as a result more than 5% of the Fund's total assets would then be invested
in securities of a single issuer or if as a result the Fund would hold
more than 10% of the outstanding voting securities of any single issuer;
provided that, with respect to 50% of the Fund's assets, the Fund may
invest up to 25% of its assets in the securities of any one issuer. For
purposes of this restriction, the term issuer includes both the Borrower
under a Loan Agreement and the Lender selling a Participation to the Fund
together with any other persons interpositioned between such Lender and
the Fund with respect to a Participation.

2. Purchase any security if, as a result of such purchase, more than 25% of
the Fund's total assets (taken at current value) would be invested in the
securities of Borrowers and other issuers having their principal business
activities in the same industry (the electric, gas, water and telephone
utility industries, commercial banks, thrift institutions and finance
companies being treated as separate industries for purposes of this
restriction); provided, that this limitation shall not apply with respect
to obligations issued or guaranteed by the U.S. Government or by its
agencies or instrumentalities.

B-8
<PAGE> 59

3. Issue senior securities (including borrowing money or entering into
reverse repurchase agreements) in excess of 33 1/3% of its total assets
(including the amount of senior securities issued but excluding any
liabilities and indebtedness not constituting senior securities) except
that the Fund may borrow up to an additional 5% of its total assets for
temporary purposes, or pledge its assets other than to secure such
issuance or in connection with hedging transactions, when-issued and
delayed delivery transactions and similar investment strategies. The Fund
will not purchase additional portfolio securities at any time that
borrowings, including the Fund's commitments pursuant to reverse
repurchase agreements, exceed 5% of the Fund's total assets (after giving
effect to the amount borrowed).

4. Make loans of money or property to any person, except for obtaining
interests in Senior Loans in accordance with its investment objective,
through loans of portfolio securities or the acquisition of securities
subject to repurchase agreements.

5. Buy any security "on margin." Neither the deposit of initial or variation
margin in connection with hedging transactions nor short-term credits as
may be necessary for the clearance of such transactions is considered the
purchase of a security on margin.

6. Sell any security "short," write, purchase or sell puts, calls or
combinations thereof, or purchase or sell financial futures or options,
except to the extent that the hedging transactions in which the Fund may
engage would be deemed to be any of the foregoing transactions.

7. Act as an underwriter of securities, except to the extent the Fund may be
deemed to be an underwriter in connection with the sale of or granting of
interests in Senior Loans or other securities acquired by the Fund.

8. Make investments for the purpose of exercising control or participation in
management, except to the extent that exercise by the Fund of its rights
under Loan Agreements would be deemed to constitute such control or
participation.

9. Invest in securities of other investment companies, except as part of a
merger, consolidation or other acquisitions. The Fund will rely on
representations of Borrowers in Loan Agreements in determining whether
such Borrowers are investment companies.

10. Buy or sell oil, gas or other mineral leases, rights or royalty contracts
except pursuant to the exercise by the Fund of its rights under Loan
Agreements. In addition, the Fund may purchase securities of issuers which
deal in, represent interests in or are secured by interests in such
leases, rights or contracts.

11. Purchase or sell real estate, commodities or commodities contracts except
pursuant to the exercise by the Fund of its rights under Loan Agreements,
except to the extent the interests in Senior Loans the Fund may invest in
are considered to be interests in real estate, commodities or commodities
contracts and except to the extent that hedging instruments the Fund may
invest in are considered to be commodities or commodities contracts.

For purposes of investment restriction number 2, the Fund will consider all
relevant factors in determining whether to treat the Lender selling a
Participation and any persons interpositioned between such Lender and the Fund
as an issuer, including: the terms of the Loan Agreement and other relevant
agreements (including inter-creditor agreements and any agreements between such
person and the Fund's custodian); the credit quality of such Lender or
interpositioned person; general economic conditions applicable to such Lender or
interpositioned person; and other factors relating to the degree of credit risk,
if any, of such Lender or interpositioned person incurred by the Fund.

Pursuant to requirements of Minnesota law, the Fund will not invest more than
30% of its total assets in restricted debt securities; invest more than 15% of
its total assets in illiquid securities (excluding restricted debt securities);
invest in securities carrying more than 10% of the voting rights of an issuer;
invest in more than 10% of the equity securities of any one issuer; or invest
more than 10% of its total assets in securities of real estate investment trusts
or other investment companies, in each case except as permitted by the Minnesota
Commissioner of Securities. For purposes of the foregoing, instruments and
securities not subject to the registration provisions of the Securities Act of
1933 are not considered restricted securities and an illiquid security is any
security that in the Adviser's view cannot be sold at a fair price within a
commercially reasonable period of time.

B-9
<PAGE> 60

The Fund generally will not engage in the trading of securities for the
purpose of realizing short-term profits, but it will adjust its portfolio as it
deems advisable in view of prevailing or anticipated market conditions to
accomplish the Fund's investment objective. For example, the Fund may sell
portfolio securities in anticipation of a movement in interest rates. Frequency
of portfolio turnover will not be a limiting factor if the Fund considers it
advantageous to purchase or sell securities. The Fund anticipates that the
annual portfolio turnover rate of the Fund will not be in excess of 100%. A high
rate of portfolio turnover involves correspondingly greater expenses than a
lower rate, which expenses must be borne by the Fund and its shareholders. High
portfolio turnover also may result in the realization of substantial net
short-term capital gains. Due to the requirement for qualification as a
regulated investment company under the Internal Revenue Code of 1986, as
amended, that less than 30% of the Fund's annual gross income be derived from
the disposition of securities held for less than three months, the Fund may not
be able to sell portfolio holdings held for less than three months that the Fund
may wish to sell in the ordinary course of management, which may affect
adversely the Fund's yield.

OFFICERS AND TRUSTEES

The officers and trustees of the Fund, their principal occupations for the
last five years and their affiliations, if any, with the Adviser, Van Kampen
American Capital Management, Inc., McCarthy, Crisanti & Maffei, Inc. (a
financial credit research firm), MCM Asia Pacific Company, Limited, Van Kampen
American Capital Distributors, Inc., Van Kampen American Capital, Inc. or VK/AC
Holding, Inc. (affiliates of the Adviser), are as follows:

DON G. POWELL*, CHAIRMAN AND TRUSTEE. Mr. Powell is President, Chief Executive
Officer and a Director of VK/AC Holding, Inc. and Van Kampen American Capital,
Inc., and is Chairman, Chief Executive Officer and a Director of Van Kampen
American Capital Distributors, Inc., the Adviser and Van Kampen American Capital
Management, Inc. His address is 2800 Post Oak Blvd., Houston, TX 77056. He is
also Chairman and a Trustee of other investment companies advised by the
Adviser.

DENNIS J. MCDONNELL,* PRESIDENT, CHIEF EXECUTIVE OFFICER AND TRUSTEE. Mr.
McDonnell is President, Chief Operating Officer and a Director of the Adviser
and Van Kampen American Capital Management, Inc. He is also a Director of VK/AC
Holding, Inc., Van Kampen American Capital, Inc., McCarthy, Crisanti & Maffei,
Inc. and Chairman and Director of MCM Asia Pacific Company, Limited. His address
is One Parkview Plaza, Oakbrook Terrace, Illinois 60181. Mr. McDonnell is the
President, Chief Executive Officer and a Trustee of other investment companies
advised by the Adviser. Prior to December, 1991, Mr. Donnell was Senior Vice
President of Van Kampen Merritt Inc.

THEODORE A. MYERS, TRUSTEE. Mr. Myers is an Executive Vice President and Chief
Financial Officer of Qualitech Steel Corporation, a producer of high quality
engineered steels for automotive, transportation and capital goods industries.
He is also a Director of McClouth Steel Co. Prior to August, 1993, Mr. Myers was
Senior Vice President, Chief Financial Officer and a Director of Doskocil
Companies, Inc., a food processing and distribution company. Prior to January,
1990, Mr. Myers was Vice President and Chief Financial Officer of Inland Steel
Industries. His address is 1940 East 6th Street, Cleveland, Ohio 44114. Mr.
Myers is also a Trustee of other investment companies advised by the Adviser.
Prior to October, 1989 he was a Director of First National Bank of East Chicago.

ROD DAMMEYER, TRUSTEE. Mr. Dammeyer is President, Chief Executive Officer and
Director of Itel Corporation, a Chicago-based transportation, distribution and
financial services company, the subsidiaries of which are engaged in supplying
wiring systems for data, voice and energy, and Great American Management &
Investment, Inc., a diversified manufacturing company. He is also a Director of
Santa Fe Energy Resources, Inc., Lomas Financial Corporation, Revco D.S., Inc.,
Falcon Building Products, Inc., Jacor Communications, Inc., Kent State
University Foundation, National Advisory Board of Chemical Bank, Capsure
Holdings Corp., The Vigoro Corporation, and ANTEC Corporation. Prior to October,
1991, Mr. Dammeyer was a Director of Santa Fe Pacific Corporation, Q-TEL, S.A.
de C.V. and Servicios Financieros Quadrum, S.A. His address is Two North
Riverside Plaza, Chicago, Illinois 60606. Mr. Dammeyer is also a Trustee of
other investment companies advised by the Adviser.

DAVID C. ARCH, TRUSTEE. Mr. Arch is Chairman and Chief Executive Officer of
Blistex Inc., a consumer health care products manufacturer. His address is 1800
Swift Drive, Oak Brook, Illinois 60521. Mr. Arch is also a Trustee of other
investment companies advised by the Adviser.

B-10
<PAGE> 61

HOWARD J KERR, TRUSTEE. Mr. Kerr is President and Chief Executive Officer of
Pocklington Corporation, Inc., an investment holding company. His address is 736
North Western Ave., P.O. Box 317, Lake Forest, Illinois 60045. Prior to 1991,
Mr. Kerr was President, Chief Executive Officer and Chairman of the Board of
Directors of Grabill Aerospace Industries, Ltd. Mr. Kerr is also a Director of
Canbra Foods, Ltd., a Canadian oilseed crushing, refining, processing and
packaging operation. Mr. Kerr is a Trustee of other investment companies advised
by the Adviser.

HUGO F. SONNENSCHEIN, TRUSTEE. Mr. Sonnenschein is President of the University
of Chicago. Mr. Sonnenschein is a member of the Board of Trustees of the
University of Rochester and a member of its investment committee. Prior to July,
1993, Mr. Sonnenschein was Provost of Princeton University, and, from 1988 to
1991, Mr. Sonnenschein was Dean of the School of Arts and Sciences at the
University of Pennsylvania. Mr. Sonnenschein is a member of the National Academy
of Sciences and a fellow of the American Academy of Arts and Sciences. His
address is 5801 South Ellis Avenue, suite 502, Chicago, Illinois 60637. Mr.
Sonnenschein is also a trustee of other investment companies advised by the
Adviser.

WAYNE W. WHALEN,* TRUSTEE. Mr. Whalen is a partner in the law firm of Skadden,
Arps, Slate, Meagher & Flom. His address is 333 West Wacker Drive, Chicago,
Illinois 60606. Mr. Whalen is also a Trustee of other investment companies
advised by the Adviser.

PETER W. HEGEL,* VICE PRESIDENT. Mr. Hegel is Senior Vice President and
Portfolio Manager of the Adviser. His address is One Parkview Plaza, Oakbrook
Terrace, Illinois 60181. Mr. Hegel is a Vice President of other investment
companies advised by the Adviser.

JEFFREY W. MAILLET,* VICE PRESIDENT. Mr. Maillet is Vice President and
Portfolio Manager of the Adviser. His address is One Parkview Plaza, Oakbrook
Terrace, Illinois 60181.

RONALD A. NYBERG,* VICE PRESIDENT AND SECRETARY. Mr. Nyberg is Executive Vice
President, General Counsel and Secretary of Van Kampen American Capital, Inc.
and VK/AC Holding, Inc., and Executive Vice President, General Counsel and
Director of the Adviser, Van Kampen American Capital Management, Inc. and Van
Kampen American Capital Distributors, Inc. He is also General Counsel and
Assistant Secretary of McCarthy, Crisanti & Maffei, Inc., a financial credit
research firm. His address is One Parkview Plaza, Oakbrook Terrace, Illinois
60181. Mr. Nyberg is a Vice President and Secretary of other investment
companies advised by the Adviser and is a Director of ICI Mutual Insurance Co.,
a provider of insurance to members of the Investment Company Institute. Prior to
March, 1991, Mr. Nyberg was also Secretary of Van Kampen Merritt Inc., the
Adviser and McCarthy, Crisanti & Maffei, Inc.

EDWARD C. WOOD III,* VICE PRESIDENT, TREASURER AND CHIEF FINANCIAL OFFICER. Mr.
Wood is First Vice President of the Adviser. His address is One Parkview Plaza,
Oakbrook Terrace, Illinois 60181. Mr. Wood is Vice President, Treasurer and
Chief Financial Officer of other investment companies advised by the Adviser.

SCOTT E. MARTIN,* ASSISTANT SECRETARY. Mr. Martin is First Vice President,
Deputy General Counsel and Assistant Secretary of Van Kampen American Capital,
Inc., VK/AC Holding, Inc., Van Kampen American Capital Distributors, Inc., the
Adviser and Van Kampen American Capital Management, Inc. and Deputy General
Counsel and Secretary of McCarthy, Crisanti & Maffei, Inc., a financial credit
research firm. His address is One Parkview Plaza, Oakbrook Terrace, Illinois
60181. Mr. Martin is an Assistant Secretary of other investment companies
advised by the Adviser.

WESTON B. WETHERELL,* ASSISTANT SECRETARY. Mr. Wetherell is Vice President,
Associate General Counsel and Assistant Secretary of Van Kampen American
Capital, Inc., Van Kampen American Capital Distributors, Inc. and the Adviser
and an Assistant Secretary of McCarthy, Crisanti & Maffei, Inc., a financial
credit research firm. His address is One Parkview Plaza, Oakbrook Terrace,
Illinois 60181. Mr. Wetherell is an Assistant Secretary of other investment
companies advised by the Adviser.

JOHN L. SULLIVAN,* CONTROLLER. Mr. Sullivan is Vice President of the Adviser.
His address is One Parkview Plaza, Oakbrook Terrace, Illinois 60181. Mr.
Sullivan is the Controller of other investment companies advised by the Adviser.

B-11
<PAGE> 62

STEVEN M. HILL,* ASSISTANT TREASURER. Mr. Hill is Assistant Vice President of
Van Kampen American Capital Investment Advisory Corp. His address is One
Parkview Plaza, Oakbrook Terrace, Illinois 60181.

- ---------------

* Interested persons of the Fund as defined in the 1940 Act.

The officers and Trustees as a group own less than 1% of the Fund's outstanding
Common Shares. The compensation of the officers and trustees who are affiliated
persons (as defined in the 1940 Act) of the Adviser, Van Kampen American Capital
Distributors, Inc. or Van Kampen American Capital, Inc. is paid by the
respective entity. The Fund pays the compensation of all other officers and
trustees of the Fund. During the next year, the Fund expects to pay the Trustees
who are not affiliated persons of the Adviser, Van Kampen American Capital
Distributors, Inc. or Van Kampen American Capital, Inc. an annual fee of $2,500
and $250 per meeting of the Board of Trustees and each committee meeting, as
well as reimbursement of expenses incurred in connection with such meetings.
Under the Fund's retirement plan, trustees who are not affiliated with the
Adviser, Van Kampen American Capital Distributors, Inc. or Van Kampen American
Capital, Inc., have at least ten years of service and retire at or after
attaining the age of 60, are eligible to receive a retirement benefit equal to
the annual retainer for each of the ten years following such trustee's
retirement. Under certain conditions, reduced benefits are available for early
retirement. Under the Fund's deferred compensation plan, a trustee who is not
affiliated with the Adviser, Van Kampen American Capital Distributors, Inc. or
Van Kampen American Capital, Inc. can elect to defer receipt of all or a portion
of the trustee's fees earned by such trustee until such trustee's retirement.
The deferred compensation earns a rate of return determined by reference to the
Fund or other Van Kampen Merritt mutual funds advised by the Adviser as selected
by the trustee. To the extent permitted by the 1940 Act, the Fund may invest in
securities of other Van Kampen Merritt mutual funds advised by the Adviser in
order to match the deferred compensation obligation. The deferred compensation
plan is not funded and obligations thereunder represent general unsecured claims
against the general assets of the Fund. Subject to certain exceptions and
limitations, as fully described in Section 5.3 of the Fund's Declaration of
Trust on file with the SEC, the Fund indemnifies every Trustee and officer of
the Fund against liabilities and expenses reasonably incurred or paid in
connection with any claim, action, suit or proceeding in which he becomes
involved by virtue of his being or having been a Trustee or officer. Such
indemnification is unavailable for any Trustee or officer who is deemed to have
engaged in willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties or to not have acted in good faith in the reasonable
belief that his action was in the best interest of the Fund. As more fully
described in the Fund's Declaration of Trust, a Trustee may be removed by a vote
of not less than two-thirds of the outstanding Common Shares and, in certain
circumstances, holders of Common Shares may call a meeting to remove a Trustee.
The Fund is required to assist in communications with holders of Common Shares
regarding such a meeting.

COMPENSATION TABLE

<TABLE>
<CAPTION>
PENSION OR
RETIREMENT TOTAL COMPENSATION
AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL FROM REGISTRANT AND
COMPENSATION AS PART OF FUND BENEFITS UPON FUND COMPLEX PAID
NAME FROM REGISTRANT(1) EXPENSES RETIREMENT TO TRUSTEE(2)
- -------------------------------- ------------------ ---------------- ---------------- -------------------
<S> <C> <C> <C> <C>
John C. Merritt (prior to
January 28, 1995)............. N/A N/A N/A N/A
Don G. Powell (since January 28,
1995)......................... N/A N/A N/A N/A
Dennis J. McDonnell............. N/A N/A N/A N/A
David C. Arch................... 3,513 0 0 147,175
Rod Dammeyer.................... 3,513 0 0 146,675
Theodore A. Myers............... 2,638 0 0 147,175
Hugo F. Sonnenschein (since
February 25, 1994)............ 1,756 0 0 155,175
Howard J Kerr................... 3,513 0 0 146,675
Wayne W. Whalen................. 881 0 0 111,975
Clyde H. Keith (prior to
February 25, 1994)............ 2,631 0 0 33,600
</TABLE>

- ---------------

N/A Not Applicable. An affiliated person of Adviser, Van Kampen American Capital
Distributors, Inc. or Van Kampen American Capital, Inc., who does not
receive compensation directly from the Fund.

B-12
<PAGE> 63

(1) The Registrant is Van Kampen Merritt Prime Rate Income Trust (the "Fund").
The amounts shown in this column are the Aggregate Compensation of the Fund
during its last completed fiscal year ended July 31, 1994.

(2) The Fund Complex consists of 34 closed-end investment companies advised by
the Adviser that have the same members on each investment company; Board of
Trustees. The amounts shown in this column are accumulated from the
Aggregate Compensation of each of these 34 closed-end investment companies
in the Fund Complex for the year ended December 31, 1994. The Adviser also
serves as investment adviser for other investment companies; however, with
the exception of Messrs. Merritt, McDonnell, Powell and Whalen, the
Trustees are not trustees of other investment companies. Combining the Fund
Complex with other the investment companies advised by the Adviser, Mr.
Whalen received Total Compensation of $161,850.

PORTFOLIO TRANSACTIONS

With respect to interests in Senior Loans, the Fund generally will engage in
privately negotiated transactions for purchase or sale in which the Adviser will
negotiate on behalf of the Fund. The Fund may be required to pay fees, or forgo
a portion of interest and any fees payable to the Fund, to the Lender selling
Participations or Assignments to the Fund. The Adviser will determine the
Lenders from whom the Fund will purchase Assignments and Participations by
considering their professional ability, level of service, relationship with the
Borrower, financial condition, credit standards and quality of management.
Although the Fund intends generally to hold interests in Senior Loans until
maturity or prepayment of the Senior Loan, the illiquidity of Senior Loans may
restrict the ability of the Adviser to locate in a timely manner persons willing
to purchase the Fund's interests in Senior Loans at a fair price should the Fund
desire to sell such interests. See "Investment Objective and Policies."

With respect to investments other than in Senior Loans, the Adviser will place
orders for portfolio transactions for the Fund with broker-dealer firms giving
consideration to the quality, quantity and nature of each firm's professional
services. These services include execution, clearance procedures, wire service
quotations and statistical and other research information provided to the Fund
and the Adviser, including quotations necessary to determine the value of the
Fund's net assets. Any research benefits so obtained are available for all
clients of the Adviser. Because statistical and other research information only
supplements the research efforts of the Adviser and still must be analyzed and
reviewed by its staff, the receipt of research information is not expected to
reduce materially its expenses. In selecting among the firms believed to meet
the criteria for handling a particular transaction, the Adviser may take into
consideration the fact that certain firms have sold Common Shares of the Fund
and that certain firms provide market, statistical or other research information
to the Fund and the Adviser and may select firms that are affiliated with the
Fund, the Adviser, Van Kampen American Capital Distributors, Inc. ("VKAC") or
Van Kampen American Capital, Inc. As of the date of this Prospectus, the Fund
has paid no brokerage commissions.

If it is believed to be in the best interest of the Fund, the Adviser may
place portfolio transactions with brokers who provide the types of services
described above, even if the Fund will have to pay a higher commission (or, if
the broker's profit is part of the cost of the security, will have to pay a
higher price for the security) than would be the case if the Adviser did not
consider the broker's furnishing of such services. This will be done, however,
only if, in the opinion of the Adviser, the amount of additional commission or
increased cost is reasonable in relation to the value of the services.

If purchases or sales of financial instruments for the Fund and for one or
more other investment companies or clients advised by the Adviser are considered
at or about the same time, transactions in such financial instruments will be
allocated among the several investment companies and clients, in a manner deemed
equitable by the Adviser, to each such investment company or client, taking into
account their respective sizes and the aggregate amount of financial instruments
to be purchased or sold. Although in some cases this procedure could have a
detrimental effect on the price paid by the Fund for the financial instrument or
the volume of the financial instrument purchased by the Fund, the ability to
participate in volume transactions and to negotiate lower commissions, fees and
expenses possibly could benefit the Fund.

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Although the Adviser will be responsible for the management of the Fund's
portfolio, the policies and practices in this regard must be consistent with the
foregoing and will be subject at all times to review by the Trustees of the
Fund. The Fund anticipates that the annual portfolio turnover rate will not
exceed 100%.

The Trustees have adopted certain policies incorporating the standards of Rule
17e-1 issued by the SEC under the 1940 Act, which requires that the commissions
paid to affiliates of the Fund, or to affiliates of such persons, be reasonable
and fair compared to the commissions, fees or other remuneration received or to
be received by other brokers in connection with comparable transactions
involving similar financial instruments during a comparable period of time. The
rule and procedures also contain review requirements and require the Adviser to
furnish reports to the Trustees and to maintain records in connection with such
reviews. After review of all factors deemed relevant, the Trustees will consider
from time to time whether the advisory fee will be reduced by all or a portion
of the brokerage commissions given to brokers that are affiliated with the Fund.

MANAGEMENT OF THE FUND

THE ADVISER

The Adviser was incorporated as a Delaware corporation in 1982. The Adviser is
a wholly-owned subsidiary of Van Kampen American Capital, Inc., which in turn is
a wholly-owned subsidiary of VK/AC Holding, Inc. VK/AC Holding, Inc. is
controlled, through the ownership of a substantial majority of its common stock,
by The Clayton & Dubilier Private Equity Fund IV Limited Partnership ("C&D
L.P."), a Connecticut limited partnership. C&D L.P. is managed by Clayton,
Dubilier & Rice, Inc. a New York based private investment firm. The General
Partners of C&D L.P. is Clayton & Dubilier Associates IV Limited Partnership
("C&D Associates L.P."). The general partners of C&D Associates L.P. are Joseph
L. Rice, III, B. Charles Ames, William A. Barbe, Alberto Cribiore, Donald J.
Gogel, Leon J. Hendrix, Jr., Hubbard C. Howe and Andrall E. Pearson, each of
whom is a principal of Clayton, Dubilier & Rice, Inc. In addition, certain
officers, directors and employees of Van Kampen American Capital, Inc. own, in
the aggregate, not more than 6% of the common stock of VK/AC Holding, Inc. and
have the right to acquire, upon the exercise of options, approximately an
additional 10% of the common stock of VK/AC Holding, Inc.

INVESTMENT ADVISORY AGREEMENT

The investment advisory agreement (the "Advisory Agreement") between the
Adviser and the Fund was approved by the shareholders of the Fund at a
shareholders meeting held on January 14, 1993 and will continue in effect from
year to year, unless earlier terminated as described below, if approved annually
(a) by the Trustees of the Fund or by a majority of the Fund's Common Shares and
(b) by a majority of the Trustees who are not parties to the agreement or
interested persons of any such party, in compliance with the requirements of the
1940 Act. The Advisory Agreement may be terminated without penalty upon 60 days
written notice by either party (in the case of the Fund, such termination may be
effected by the Board of Trustees or by a majority of the Common Shares) and
will automatically terminate in the event of assignment. The Adviser may in its
sole discretion from time to time waive all or a portion of the advisory fee or
reimburse the Fund for all or a portion of its other expenses.

The investment advisory agreement (the "Advisory Agreement") between the
Adviser and the Fund provides that the Adviser will supply investment research
and portfolio management, including the selection of securities for the Fund to
purchase, hold or sell and the selection of financial institutions through whom
the Fund's portfolio transactions are executed. The Adviser also furnishes
necessary facilities and equipment, and permits its officers and employees to
serve without compensation as trustees and officers of the Fund if duly elected
to such positions. For the fiscal years ended July 31, 1992, 1993, 1994 and the
six months ended January 31, 1995, the Fund recognized investment advisory fees
pursuant to the Advisory Agreement of $9,351,693, $8,981,700, $9,867,144 and
$7,002,005, respectively.

The Advisory Agreement specifies that the Adviser will reimburse the Fund for
annual expenses of the Fund which exceed the most stringent limits prescribed by
any State in which the Common Shares are offered for sale. The most stringent
limit as of the date of this Prospectus, as affecting the Fund, requires the
Adviser

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to reimburse the Fund to the extent that aggregate expenses of the Fund
(excluding interest, taxes and other expenses which may be excludable under
applicable state law) exceed in any fiscal year 2 1/2% of the average annual net
assets of the Fund up to $30 million, 2% of the average annual net assets of the
Fund of the next $70 million, and 1 1/2% of the remaining average annual net
assets of the Fund. In addition to making any required reimbursements, the
Adviser may in its discretion, but is not obligated to, waive all or any portion
of its fee or assume all or any portion of the expenses of the Fund.

The Advisory Agreement provides that the Adviser shall not be liable for any
error of judgment or of law, or for any loss suffered by the Fund in connection
with the matters to which the Advisory Agreement relates, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
the Adviser in the performance of its obligations and duties, or by reason of
its reckless disregard of its obligations and duties under the Advisory
Agreement.

The Trustees are responsible for the overall management and supervision of the
Fund's affairs. The Adviser's activities are subject to the review and
supervision of the Trustees to whom the Adviser renders periodic reports of the
Fund's investment activities. The Advisory Agreement continues in effect from
year to year only if specifically approved by the Trustees, and by the
disinterested Trustees, or the Fund's holders of Common Shares in compliance
with the requirements of the 1940 Act. The Advisory Agreement may be terminated
without penalty upon 60 days' written notice by either party and will terminate
automatically in the event of assignment.

THE ADMINISTRATOR

The administrator for the Fund is Van Kampen American Capital Distributors,
Inc. (in such capacity, the "Administrator"), who is an affiliate of the
Adviser. For the fiscal years ended July 31, 1992, 1993, 1994 and the six months
ended January 31, 1995, the Fund recognized administrative fees pursuant to the
Administration Agreement of $2,460,972, $2,363,763, $2,596,617 and $1,842,633,
respectively.

The Fund pays all other expenses incurred in the operation of the Fund
including, but not limited to, direct charges relating to the purchase and sale
of financial instruments in its portfolio, interest charges, fees and expenses
of legal counsel and independent auditors, taxes and governmental fees, cost of
share certificates, expenses (including clerical expenses) of issuance, sale or
repurchase of any of the Fund's portfolio holdings, expenses in connection with
the Fund's dividend reinvestments, membership fees in trade associations,
expenses of registering and qualifying the Common Shares of the Fund for sale
under federal and state securities laws, expenses of printing and distributing
reports, notices and proxy materials to existing holders of Common Shares,
expenses of filing reports and other documents filed with governmental agencies,
expenses of annual and special meetings of holders of Common Shares, fees and
disbursements of the transfer agents, custodians and sub-custodians, expenses of
disbursing dividends and distributions, fees, expenses and out-of-pocket costs
of Trustees of the Fund who are not affiliated with the Adviser, insurance
premiums, indemnification and other expenses not expressly provided for in the
Advisory Agreement or the Administration Agreement and any extraordinary
expenses of a nonrecurring nature.

OTHER AGREEMENTS

SUPPORT SERVICES AGREEMENT. Under a support services agreement with VKAC the
Fund receives support services for shareholders, including the handling of all
written and telephonic communications, except initial order entry and other
distribution related communications. Upon entering into such agreement, the Fund
realized a reduction in the fee which would have been paid to the Transfer Agent
if the Transfer Agent had provided such services. Payment by the Fund for such
services is made on cost basis for the employment of the personnel and the
equipment necessary to render the support services. The Fund, and the other Van
Kampen Merritt funds distributed by VKAC, share such costs proportionately among
themselves based upon their respective net asset values.

LEGAL SERVICES AGREEMENT. The Fund has entered into a Legal Services Agreement
pursuant to which Van Kampen American Capital, Inc. provides legal services,
including without limitation: maintenance of the Fund's minute books and
records, preparation and oversight of the Fund's regulatory reports, and other
information provided to shareholders, as well as responding to day-to-day legal
issues on behalf of the Fund.

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Payment by the Fund for such services is made on a cost basis for the salary and
salary related benefits, including but not limited to bonuses, group insurances
and other regular wages for the employment of personnel, as well as overhead and
the expenses related to the office space and the equipment necessary to render
the legal services. The Fund and the other Van Kampen Merritt mutual funds
distributed by VKAC, share one half (50%) of such costs equally. The remaining
one half (50%) of such costs are allocated to specific funds based on specific
time allocations, or in the event services are attributable only to types of
funds (i.e. closed-end or open-end), the relative amount of time spent on each
type of fund and then further allocated between funds of that type based upon
their respective net asset values.

NET ASSET VALUE

The net asset value per share of the Fund's Common Shares is determined by
calculating the total value of the Fund's assets, deducting its total
liabilities, and dividing the result by the number of Common Shares outstanding.
The net asset value will be computed on each business day as of 5:00 p.m.
Eastern time. The Fund reserves the right to calculate the net asset value more
frequently if deemed desirable.

The value of the Fund's portfolio will be determined by the Adviser, following
guidelines established and periodically reviewed by the Trustees. Interests in
Senior Loans will be valued by the Adviser on behalf of the Fund on the basis of
market quotations and transactions in instruments which the Adviser believes may
be comparable to Senior Loan interests with respect to the following
characteristics: credit quality, interest rate, interest rate redetermination
period and maturity. Such instruments may include commercial paper, negotiable
certificates of deposit and short-term variable rate securities which have
adjustment periods comparable to the Senior Loan interests in the Fund's
portfolio. In determining the relationship between such instruments and the
Senior Loan interests in the Fund's portfolio, the Adviser will consider on an
ongoing basis, among other factors, (i) the credit worthiness of the Borrower
and (ii) the current interest rate, the period until next interest rate
redetermination and maturity of such Senior Loan interests. It is expected that
the Fund's net asset value will fluctuate as a function of interest rate and
credit factors. Because of the short-term nature of such instruments, however,
the Fund's net asset value is expected to fluctuate less in response to changes
in interest rates than the net asset values of investment companies with
portfolios consisting primarily of fixed-income or longer term securities. The
Adviser believes that Lenders selling Senior Loan interests or otherwise
involved in a Senior Loan transaction may tend, in valuing Senior Loan interests
for their own account, to be less sensitive to interest rate and credit quality
changes and, accordingly, the Adviser does not intend to rely solely on such
valuations in valuing the Senior Loan interests for the Fund's account. In
addition, because a secondary trading market in Senior Loans has not yet fully
developed, in valuing Senior Loans, the Adviser may not rely solely on but may
consider, to the extent the Adviser believes such information to be reliable,
prices or quotations provided by banks, dealers or pricing services with respect
to secondary market transactions in Senior Loans. To the extent that an active
secondary market in Senior Loan interests develops to a reliable degree, the
Adviser may rely to an increasing extent on such market prices and quotations in
valuing the Senior Loan interests in the Fund's portfolio. In light of the
senior nature of Senior Loan interests included in the Fund's portfolio and
taking into account the Fund's access to non-public information with respect to
Borrowers relating to such Senior Loan interests, the Adviser does not currently
believe that consideration on a systematic basis of ratings provided by any
nationally recognized statistical rating organization or price fluctuations with
respect to long- or short-term debt of such Borrowers subordinate to the Senior
Loans of such Borrowers is necessary for the determination of the value of such
Senior Loan interests. Accordingly, the Adviser generally does not
systematically consider (but may consider in certain instances) and, in any
event, does not rely upon such ratings or price fluctuations in determining the
value of Senior Loan interests in the Fund's portfolio.

Other portfolio securities (other than short-term obligations, but including
listed issues) may be valued on the basis of prices furnished by one or more
pricing services which determine prices for normal, institutional-size trading
units of such securities using market information, transactions for comparable
securities and various relationships between securities which are generally
recognized by institutional traders. In certain circumstances, portfolio
securities will be valued at the last sale price on the exchange that is the
primary market for such securities, or the last quoted bid price for those
securities for which the over-the-counter

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market is the primary market or for listed securities in which there were no
sales during the day. The value of interest rate swaps will be determined in
accordance with a discounted present value formula and then confirmed by
obtaining a bank quotation.

Short-term obligations which mature in 60 days or less are valued at amortized
cost, if their original term to maturity when acquired by the Fund was 60 days
or less, or are valued at amortized cost using their value on the 61st day prior
to maturity, if their original term to maturity when acquired by the Fund was
more than 60 days, unless in each case this is determined not to represent fair
value. Repurchase agreements will be valued at cost plus accrued interest.
Securities for which there exist no price quotations or valuations and all other
assets are valued at fair value as determined in good faith by or on behalf of
the Trustees.

The Fund's net asset value has ranged from a high of $10.07 to a low of $9.97
since its commencement of investment operations on October 4, 1989. During such
time the world has experienced a number of significant political and economic
events. In 1989, East and West Germany moved toward unification and high yield
bonds experienced significant defaults. In 1990, Germany reunified, Iraq invaded
Kuwait and the Dow reached 3,000. During 1991, the U.S. experienced and recorded
negative growth in Gross Domestic Product, the Gulf War began, the Soviet Union
collapsed and U.S. unemployment reached an eight year high. In 1992, the ERM
crashed, beginning a currency crisis and Bill Clinton was elected. In 1993,
Israel and the PLO signed a peace accord, long-term treasury rates fell to
5.79%, NAFTA was approved and the Dow Jones Industrial Average reached a new
high. During 1994, the Fed began its first interest rate tightening in 5 years.

TAXATION

The following federal income tax discussion is based on the advice of Skadden,
Arps, Slate, Meagher & Flom, and reflects applicable tax laws as of the date of
this Statement of Additional Information.

FEDERAL TAXATION

The Fund intends to qualify each year and to elect to be treated as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). To qualify as a regulated investment company, the
Fund must, among other things: (a) derive at least 90% of its gross income from
dividends, interest, payments with respect to loans of securities and gains from
the sale or other disposition of securities or certain other related income; (b)
derive less than 30% of its gross income from gains from the sale or other
disposition of securities and certain other investments held for less than three
months (the "short-short rule"); and (c) diversify its holdings so that at the
end of each quarter of the Fund's taxable year (i) at least 50% of the value of
the Fund's assets is represented by cash, U.S. government securities, securities
of other regulated investment companies, and other securities which, with
respect to any one issuer, do not represent more than 5% of the value of the
Fund's assets or more than 10% of the voting securities of such issuer, and (ii)
not more than 25% of the value of the Fund's assets is invested in the
securities of any one issuer (other than U.S. government securities or the
securities of other regulated investment companies).

If the Fund so qualifies and distributes each year to its Shareholders at
least 90% of its net investment income (including among other things, interest
and net short-term capital gain, but not net capital gains, which are the excess
of net long-term capital gains over net short-term capital losses), in each
year, it will not be required to pay federal income taxes on any income
distributed to Shareholders. The Fund intends to distribute at least the minimum
amount of net investment income necessary to satisfy the 90% distribution
requirement. The Fund will not be subject to federal income tax on any net
capital gains distributed to Shareholders. As a Massachusetts business trust,
the Fund will not be subject to any excise or income taxes in Massachusetts as
long as it qualifies as a regulated investment company for federal income tax
purposes.

In order to avoid a 4% excise tax, the Fund will be required to distribute, by
December 31 of each year, at least 98% of its ordinary income for such year and
at least 98% of its capital gain net income (the latter of which generally is
computed on the basis of the one-year period ending on October 31 of such year),
plus any amounts that were not distributed in previous taxable years. For
purposes of the excise tax, any ordinary income or capital gain net income
retained by, and subject to federal income tax in the hands of, the Fund will be
treated as having been distributed.

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If the Fund failed to qualify as a regulated investment company or failed to
satisfy the 90% distribution requirement in any taxable year, the Fund would be
taxed as an ordinary corporation on its taxable income (even if such income was
distributed to its Shareholders) and all distributions out of earnings and
profits would be taxed to Shareholders as ordinary income. To qualify again as a
regulated investment company in a subsequent year, the Fund may be required to
pay an interest charge on 50% of its earnings and profits attributable to
non-regulated investment company years and would be required to distribute such
earnings and profits to shareholders (less any interest charge). In addition, if
the Fund failed to qualify as a regulated investment company for its first
taxable year or, if immediately after qualifying as a regulated investment
company for any taxable year, it failed to qualify for a period greater than one
taxable year, the Fund would be required to recognize any net built-in gains
(the excess of aggregate gains, including items of income, over aggregate losses
that would have been realized if it had been liquidated) in order to qualify as
a regulated investment company in a subsequent year.

Some of the Fund's investment practices are subject to special provisions of
the Code that, among other things, may defer the use of certain losses of the
Fund and affect the holding period of the securities held by the Fund and the
character of the gains or losses realized by the Fund. These provisions may also
require the Fund to mark-to-market some of the positions in its portfolio (i.e.,
treat them as if they were closed out), which may cause the Fund to recognize
income without receiving cash with which to make distributions in amounts
necessary to satisfy the 90% distribution requirement and the distribution
requirements for avoiding income and excise taxes. The Fund will monitor its
transactions and may make certain tax elections in order to mitigate the effect
of these rules and prevent disqualification of the Fund as a regulated
investment company.

Investments of the Fund in securities issued at a discount or providing for
deferred interest or payment of interest in kind are subject to special tax
rules that will affect the amount, timing and character of distributions to
Shareholders. For example, with respect to certain securities issued at a
discount, the Fund will be required to accrue as income each year a portion of
the discount and to distribute such income each year in order to maintain its
qualification as a regulated investment company and to avoid income and excise
taxes. In order to generate sufficient cash to make distributions necessary to
satisfy the 90% distribution requirement and to avoid income and excise taxes,
the Fund may have to dispose of securities that it would otherwise have
continued to hold.

The Fund's ability to dispose of portfolio securities may be limited by the
requirement for qualification as a regulated investment company that less than
30% of the Fund's gross income be derived from the disposition of securities
held for less than three months.

Income from investments in foreign securities received by the Fund may be
subject to withholding or other taxes imposed by foreign countries and U.S.
possessions. Such taxes will not be deductible or creditable by shareholders.

DISTRIBUTIONS

Distributions of the Fund's net investment income are taxable to Common
Shareholders as ordinary income, whether paid in cash or reinvested in
additional Common Shares. Distributions of the Fund's net capital gains
("capital gains dividends"), if any, are taxable to Common Shareholders at the
rates applicable to long-term capital gains regardless of the length of time
Shares of the Fund have been held by such Common Shareholders. Distributions in
excess of the Fund's earnings and profits will first reduce the adjusted tax
basis of a holder's Common Shares and, after such adjusted tax basis is reduced
to zero, will constitute capital gains to such holder (assuming such Common
Shares are held as a capital asset). It is not expected that any portion of the
distributions from the Fund will be eligible for the dividends received
deduction for corporations. The Fund will inform Shareholders of the source and
tax status of all distributions promptly after the close of each calendar year.

Common Shareholders receiving distributions in the form of additional Common
Shares issued by the Fund will be treated for federal income tax purposes as
receiving a distribution in an amount equal to the fair market value of the
Common Shares received, determined as of the distribution date. The basis of
such Common Shares will equal the fair market value on the distribution date.

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<PAGE> 69

Although dividends generally will be treated as distributed when paid,
dividends declared in October, November or December, payable to Shareholders of
record on a specified date in such a month and paid during January of the
following year will be treated as having been distributed by the Fund and
received by the Shareholders on the December 31 prior to the date of payment. In
addition, certain other distributions made after the close of a taxable year of
the Fund may be "spilled back" and treated as paid by the Fund (except for
purposes of the 4% excise tax) during such taxable year. In such case,
Shareholders will be treated as having received such dividends in the taxable
year in which the distribution was actually made.

The Fund is required, in certain circumstances, to withhold 31% of taxable
dividends and certain other payments, including redemptions, paid to Common
Shareholders who do not furnish to the Fund their correct taxpayer
identification number (in the case of individuals, their social security number)
and certain required certifications or who are otherwise subject to backup
withholding.

SALE OF SHARES

Except as discussed below, selling Common Shareholders will generally
recognize gain or loss in an amount equal to the difference between their
adjusted tax basis in the Common Shares and the amount received. If such Common
Shares are held as a capital asset, the gain or loss will be a capital gain or
loss and will be long-term if such Common Shares have been held for more than
one year. It is possible, although the Fund believes it is unlikely, that
tendering holders of Common Shares may not qualify for gain or loss treatment as
described above, which in turn may result in deemed distributions to
non-tendering holders of Common Shares. The federal income tax consequences of
repurchase of Common Shares pursuant to tender offers will be disclosed in the
related offering documents. Any loss realized upon a taxable disposition of
Common Shares held for six months or less will be treated as a long-term capital
loss to the extent of any capital gains dividends received with respect to such
Common Shares. For purposes of determining whether Common Shares have been held
for six months or less, the holding period is suspended for any periods during
which the Common Shareholder's risk of loss is diminished as a result of holding
one or more other positions in substantially similar or related property or
through certain options or short sales.

GENERAL

The federal income tax discussion set forth above is for general information
only. Prospective investors should consult their advisers regarding the specific
federal tax consequences of holding and disposing of Common Shares, as well as
the effects of state, local and foreign tax laws and any proposed tax law
changes.

REPURCHASE OF SHARES

Commencement by the Fund of a tender offer during a period in which it is
simultaneously engaged in the continuous offering of its Common Shares may be a
violation of rules promulgated by the SEC under the Securities Exchange Act of
1934. The Fund has obtained an exemption from the SEC that would permit the Fund
to make tender offers for its Common Shares while simultaneously engaged in the
continuous offering of its Common Shares. No assurance can be given that the
Fund will be able to maintain such exemption indefinitely. If the Board of
Trustees of the Fund authorizes the Fund to make such a tender offer at such
time, if any, that the Fund shall be unable to rely on such exemption, the Fund
intends to suspend the continuous offering of its Common Shares during the term
of such tender offer.

The Fund has entered into a Credit Agreement dated March 14, 1991, as amended
as of January 31, 1992, January 30, 1993, January 19, 1994 and January 27, 1995,
(the "Morgan Agreement") with Morgan Guaranty Trust Company of New York
("Morgan") pursuant to which Morgan has agreed to provide a credit facility in
the maximum amount of $50,000,000 to the Fund, which is not secured by the
assets of the Fund or other collateral. As of the date of this Prospectus, the
Fund has not borrowed any of the money available pursuant to the Morgan
Agreement. The purpose of this credit facility is to provide the Fund with
additional liquidity to meet its obligations to purchase Common Shares pursuant
to any tender offer that the Fund may make. The Fund paid approximately $30,000
of fees and expenses to Morgan on the date the Morgan Agreement was executed. In
addition, during the term of the Morgan Agreement, the Fund is obligated to pay
a commitment fee computed at the rate of 1/4 of 1% per annum on the average
daily amount of the unused facility. Loans made under the Morgan Agreement, if
any, will bear interest daily at a rate equal to the higher of (1) the

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prime rate for such day and (2) the sum of one-half of one percent (1/2 of 1%)
plus the federal funds rate for such day. Such interest will be due on the
outstanding principal amount of each loan on each interest payment date
thereunder, thirty (30) days from the date of the loan and each day which is
thirty days thereafter. Overdue payments of principal and interest will bear
interest, payable upon demand, at a penalty rate. The credit facility provided
pursuant to the Morgan Agreement will terminate on January 26, 1996, unless
extended pursuant to the terms thereof, and all accrued interest and principal
will be due thereon.

The Fund has entered into a Revolving Credit Agreement dated July 11, 1991 and
amended as of July 11, 1992, December 16, 1992, December 15, 1993 and December
14, 1994 (the "Bank of America Agreement") with Bank of America Illinois,
formerly known as Continental Bank N.A. ("Bank of America") pursuant to which
Bank of America has agreed to provide a credit facility in the maximum amount of
$25,000,000 to the Fund, which is not secured by the assets of the Fund or other
collateral. As of the date of this Prospectus, the Fund has not borrowed any of
the money available under the Bank of America Agreement. The purpose of the Bank
of America Agreement is to provide the Fund with additional liquidity to meet
its obligations to purchase Common Shares pursuant to any tender offer that it
may make. The Fund paid a closing fee in an amount equal to $12,500 to Bank of
America upon the execution of the Bank of America Agreement. In addition, during
the term of the Bank of America Agreement, the Fund is obligated to pay a
commitment fee computed at the rate of 0.25% per annum on the daily average of
Bank of America's commitment to make loans under the terms of such agreement.
Loans made under the Bank of America Agreement, if any, will bear interest, at
the option of the Fund, either, (1) at a rate equal to the fluctuating rate per
annum equal to the greater of (a) the rate of interest announced from time to
time by Bank of America at Chicago, Illinois as its reference rate (an
"Alternate Rate Loan") or (b) the Federal Funds Effective Rate for any such day
plus 1/4 of 1% per annum, or (2) at a rate per annum equal to the rate at which
dollar deposits are offered to Bank of America's eurodollar office by major
banks in the interbank eurodollar market (adjusted for any applicable reserve
requirements) plus 2% (an "Eurodollar Loan"). Accrued interest shall be payable
on (1) with respect to any Alternate Reference Rate Loan, the last day of each
June, September, December and March, and (2) with respect to any Eurodollar
Loan, the last day of each Interest Period (defined as a period commencing on
the borrowing date and ending not less than one day nor more than two months
thereafter, as selected by the Fund upon the initiation of the loan). All
accrued interest on both Alternate Reference Rate Loans and Eurodollar Loans
shall be payable on the termination date of the Bank of America Agreement.
Overdue payments of principal will bear interest, payable upon demand, at a
penalty rate. As extended, the credit facility provided pursuant to the Bank of
America Agreement will terminate on December 13, 1995.

The Fund is a party to a letter agreement dated March 3, 1994, as amended as
of March 8, 1995 (the "State Street Agreement") with State Street Bank and Trust
Company ("State Street") pursuant to which State Street has agreed to provide up
to $25,000,000 of unsecured bank financing to the Fund. The Fund has not drawn
down any of the money available under the State Street Agreement. The purpose of
the State Street Agreement is to provide the Trust with additional liquidity to
meet its obligation to purchase Common Shares of the Fund pursuant to any tender
offer the Fund may make or for temporary or emergency purposes. The State Street
Agreement has the following terms and conditions:

a. The Fund is entitled to borrow from State Street in such amounts as
the Fund may from time to time request of up to $25,000,000 of
unsecured bank financing.

b. The drawdown of the initial loan, if any, under the State Street
Agreement is subject to certain conditions, including, among other
things, executing and providing to State Street: (i) an advance
request form, in the form set forth as an exhibit to the State Street
Agreement (the "Advance Request"), (ii) an executed promissory note,
in the form set forth as an exhibit to the State Street Agreement,
(iii) a certified copy of the resolutions of the Board of Trustees of
the Fund approving the loan, and (iv) an opinion of counsel to the
Fund in a form satisfactory to State Street. The drawdown advance is
further conditioned upon the Fund warranting (i) its compliance with
the Investment Company Act of 1940 and the prospectus and statement of
additional information of the Fund, (ii) usage in accordance with the
terms of the State Street Agreement, and (iii) compliance with the
requirement that all borrowings utilized to fund previous tender
requests be repaid in full.

c. Subsequent advances under the State Street Agreement require a
completed Advance Request.

B-20
<PAGE> 71

d. The principal amount of any advances made pursuant to the State Street
Agreement are payable on demand by State Street. The principal amount
bears interest (computed on the basis of actual days elapsed and a 360
day-year) at a fluctuating rate per annum, as it exists from time to
time, announced by State Street as its prime rate (the "State Street
Rate") and payable in arrears on the same day as the principal amount
is paid or demand is made, whichever is earlier. Overdue payments of
principal bear interest at a fluctuating rate equal to 4% above the
State Street Rate.

e. While any advance is outstanding under the State Street Agreement, the
Fund shall not create, incur or assume or suffer to exist any lien
(statutory or otherwise), security interest, priority, conditional
sale, pledge, charge or other encumbrance or similar rights of others
or any agreement to give any of the foregoing, upon or with respect to
any of its properties, owned or acquired during such period and the
Fund shall maintain a net asset value of at least $500,000,000.

f. During the term of the State Street Agreement, the Fund is required to
pay a commitment fee computed at a rate of 1/4% per annum on the
unused portion of the commitment. Such fee is payable quarterly in
arrears.

g. The State Street Agreement contains the following events of default
causing any amounts outstanding to become immediately due and payable
without notice or demand: (i) failure of the Fund to make any payment
of principal or interest or pay any fee on any loan made to the Fund
when due, (ii) failure of the Fund to pay or perform any liability,
obligation or agreement under the State Street Agreement or other
borrowing agreements, (iii) failure of any representation or warranty
in any statement or document or financial statements delivered to
State Street pursuant to the State Street Agreement, (iv) failure to
promptly furnish financial information to State Street, (v) loss,
theft, substantial damage, sale or encumbrance to or of any Fund
property deemed collateral under the State Street Agreement or the
making of any levy, seizure or attachment thereof or thereon or the
failure to pay when due any tax thereon or, with respect to any
insurance policy, any premium therefor, (vi) default under any
instrument constituting, or under any agreement relating to, any
collateral, (vii) change in the condition (financial or otherwise) of
the Fund which in the opinion of State Street will impair its security
or increase its risk and (viii) the occurrence of any of the
following: admission of the Fund in writing of its inability, or to be
generally unable, to pay debts as they become due, dissolution,
termination of existence, business failure, insolvency, appointment of
a receiver for the benefit of creditors or commencement of any
proceedings under bankruptcy or insolvency laws.

h. The State Street Agreement terminates on February 28, 1996.

Even if a tender offer has been made, the Trustees' announced policy, which
may be changed by the Trustees, is that the Fund cannot accept tenders if (1) in
the sole and exclusive judgment of the Trustees, there is not sufficient
liquidity of the assets of the Fund; (2) such transactions, if consummated,
would (a) impair the Fund's status as a regulated investment company under the
Code (which would make the Fund a taxable entity, causing the Fund's taxable
income to be taxed at the Fund level, as more fully described in "Taxation") or
(b) result in a failure to comply with applicable asset coverage requirements;
or (3) there is, in the Board of Trustees' judgment, any (a) material legal
action or proceeding instituted or threatened challenging such transactions or
otherwise materially adversely affecting the Fund, (b) suspension of or
limitation on prices for trading securities generally on any United States
national securities exchange or in the over-the-counter market, (c) declaration
of a banking moratorium by federal or state authorities or any suspension of
payment by banks in the United States or New York State, (d) limitation
affecting the Fund or the issuers of its portfolio securities imposed by federal
or state authorities on the extension of credit by lending institutions, (e)
commencement of war, armed hostilities or other international or national
calamity directly or indirectly involving the United States or (f) other event
or condition which would have a material adverse effect on the Fund or the
holders of its Common Shares if Common Shares were repurchased. The Trustees may
modify these conditions in light of experience.

Under the requirements of the 1940 Act, the Fund cannot accept tenders or
effect repurchases of the Common Shares if, after deducting the amount of the
purchase or tender price, the Fund's total assets, less all liabilities or
indebtedness of the Fund, would fall below 200% of the aggregate liquidation
value of the

B-21
<PAGE> 72

Preferred Shares. In addition, the Fund may be precluded from accepting tenders
or effecting repurchases at any time dividends on the Preferred Shares are in
arrears. Any tender offer made by the Fund for its Common Shares will be at a
price equal to the net asset value of the Common Shares determined at the close
of business on the day the offer ends. During the pendency of any tender offer
by the Fund, the Fund will calculate daily the net asset value of the Common
Shares and will establish procedures which will be specified in the tender offer
documents, to enable Common Shareholders to ascertain readily such net asset
value. The relative illiquidity of some of the Fund's portfolio securities could
adversely impact the Fund's ability to calculate net asset value in connection
with determinations of pricing for tender offers, if any. Each offer will be
made and Common Shareholders notified in accordance with the requirements of the
Securities Exchange Act of 1934, as amended, and the 1940 Act, either by
publication or mailing or both. Each offering document will contain such
information as is prescribed by such laws and the rules and regulations
promulgated thereunder.

Tendered Common Shares that have been accepted and repurchased by the Fund
will be held in treasury and may be retired by the Board of Trustees. Treasury
Common Shares will be recorded and reported as an offset to Shareholders' equity
and accordingly will reduce the Fund's total assets. If Treasury Common Shares
are retired, Common Shares issued and outstanding and capital in excess of par
value will be reduced accordingly.

If the Fund must liquidate portfolio securities in order to repurchase Common
Shares tendered, the Fund may realize gains and losses. Such gains may be
realized on securities held for less than three months. Because of the
limitation of 30% on the portion of the Fund's gross income that may be derived
from the sale or disposition of stocks and securities held less than three
months (in order to retain the Fund's tax status as a regulated investment
company under the Code), such gains would reduce the ability of the Fund to sell
other securities held for less than three months that the Fund may wish to sell
in the ordinary course of its portfolio management which may adversely affect
the Fund's yield.

ANTI-TAKEOVER PROVISIONS

For purposes of these provisions, a 5%-or-greater holder of Common Shares (a
"Principal Shareholder") refers to any person who, whether directly or
indirectly and whether alone or together with its affiliates and associates,
beneficially owns 5% or more of the outstanding Common Shares of the Fund. The
transactions subject to these special approval requirements are: (i) the merger
or consolidation of the Fund or any subsidiary of the Fund with or into any
Principal Shareholder; (ii) the issuance of any securities of the Fund to any
Principal Shareholder for cash; (iii) the sale, lease or exchange of all or any
substantial part of the assets of the Fund to any Principal Shareholder (except
assets having an aggregate fair market value of less than $1,000,000,
aggregating for the purpose of such computation all assets sold, leased or
exchanged in any series of similar transactions within a twelve-month period);
or (iv) the sale, lease or exchange to the Fund or any subsidiary thereof, in
exchange for securities of the Fund, of any assets of any Principal Shareholder
(except assets having an aggregate fair market value of less than $1,000,000,
aggregating for the purposes of such computation all assets sold, leased or
exchanged in any series of similar transactions within a twelve-month period).

The Board of Trustees has determined that the voting requirements described
above, which are greater than the minimum requirements under Massachusetts law
or the 1940 Act, are in the best interests of shareholders generally. Reference
should be made to the Declaration of Trust on file with the SEC for the full
text of these provisions.

B-22
<PAGE> 73

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- -------------------------------------------------------------------------------

PORTFOLIO OF INVESTMENTS
January 31, 1995 (Unaudited)

- -------------------------------------------------------------------------------

<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT LOAN STATED
(000) BORROWER TYPE MATURITY* VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
VARIABLE RATE** SENIOR LOAN INTERESTS
CHEMICAL 2.2%
$ 10,000 Exide Corporation - Automotive and industrial battery manufacturer .............. Term 09/30/01 $ 9,987,991
3,417 Findley Adhesives, Incorporated - Industrial glue manufacturer .................. Term 12/31/97 3,364,027
9,000 Freedom Chemical Company - Manufacturer of specialty chemicals .................. Term 06/30/02 8,984,035
5,870 Rheox, Incorporated - Chemical additives manufacturer ........................... Term 12/31/97 5,783,405
9,104 Thoro System Products, Incorporated - Manufacturer of chemicals for
construction industry ........................................................... Term 12/31/01 9,069,248
------------
37,188,706
------------
COMMUNICATIONS 7.0%
4,151 Alexcom Limited Partnership - Cellular telephone systems operator ............... Term 06/30/00 4,078,651
10,000 Cable Services Group, Incorporated - Cable systems billing service .............. Term 11/30/01 10,061,760
17,000 Coaxial Communications of Central Ohio - Cable television systems operator ...... Term 12/31/99 16,992,698
8,500 Northland Cable Television, Incorporated - Cable television systems operator .... Revolving Credit 09/30/03 8,582,817
10,000 Pyramid Finance Corporation - Radio station owner/operator ...................... Term 09/30/01 10,087,666
13,930 SKTV, Incorporated - Television station owner/operator ......................... Term 07/31/02 13,908,138
39,257 Smart SMR of California, Incorporated - Cellular telephone systems operator ..... Term 03/15/01 39,257,000
2,950 U.S. Radio Holdings, Incorporated - Radio station owner/operator ............... Term 12/31/01 2,989,775
4,050 U.S. Radio Holdings, Incorporated ............................................... Term 09/20/03 4,104,843
10,000 Young Broadcasting, Incorporated - Television station owner/operator ........... Term 12/31/01 9,974,693
------------
120,038,041
------------
ELECTRIC/ELECTRONICS 3.3%
9,347 Bell & Howell Company - Electronic storage and information systems ............. Term 12/31/99 9,336,109
4,456 Berg Electronics, Incorporated - Manufacturer of electronic connectors .......... Term 03/31/00 4,433,907
21,908 Berg Electronics, Incorporated .................................................. Term 03/31/01 21,976,937
5,668 Grimes Aerospace Company - Airplane electronics manufacturer ................... Term 12/31/99 5,623,259
2,022 Grimes Aerospace Company ....................................................... Revolving Credit 12/31/99 2,042,070
8,358 Rowe International, Incorporated - Manufacturer of jukeboxes and
electronic equipment ............................................................ Term 06/30/00 8,398,045
5,000 Thermoscan Incorporated - Electronic thermometer manufacturer ................... Term 07/31/00 5,063,082
------------
56,873,409
------------
FOOD AND TOBACCO 4.2%
9,500 American Italian Pasta Company - Pasta products producer ........................ Term 12/29/00 9,570,752
5,750 Amerifoods, Incorporated - Manufacturer of snack foods and bakery products ...... Term 06/30/01 5,730,744
5,750 Amerifoods, Incorporated ........................................................ Term 06/30/02 5,730,744
8,199 Core-Mark International, Incorporated - Confectionary and tobacco distributor ... Term 03/31/95 8,199,337
13,500 G. Heileman Brewing Company - Beverage brewing company .......................... Term 12/31/00 13,553,493
9,938 President Baking Company, Incorporated - Bread/bread products manufacturer ...... Term 09/29/00 9,906,854
3,510 Tom's Foods Incorporated - Snack foods producer/distributor ..................... Term 12/31/98 3,506,106
</TABLE>

See Notes to Financial Statements

B-23
<PAGE> 74

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

PORTFOLIO OF INVESTMENTS (CONTINUED)
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT LOAN STATED
(000) BORROWER TYPE MATURITY* VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
VARIABLE RATE** SENIOR LOAN INTERESTS (CONTINUED)
FOOD AND TOBACCO (CONTINUED)
$ 12,333 U.S. Food Service Incorporated - Wholesale food distributor .................... Term 06/30/00 $ 12,272,991
4,266 U.S. Food Service Incorporated ................................................. Term 12/31/98 4,264,255
-----------
72,735,276
-----------
FOOD STORES 6.3%
9,600 Big V Supermarkets, Incorporated - Northeastern retail food chain operator ..... Term 03/15/00 9,624,576
27,158 Food 4 Less Supermarkets, Incorporated - Midwest and California retail food
chain operator .................................................................. Term 01/01/99 27,153,253
1,834 Mayfair Supermarkets, Incorporated - New Jersey based retail food chain operator. Term 02/28/98 1,797,179
1,147 Mayfair Supermarkets, Incorporated .............................................. Term 08/31/99 1,124,110
7,889 Pathmark Stores, Incorporated - New Jersey based retail food chain operator .... Term 07/31/98 8,061,534
2,403 Pathmark Stores, Incorporated ................................................... Revolving Credit 07/31/98 2,523,163
27,225 Pathmark Stores, Incorporated .................................................. Term 10/31/99 27,463,766
15,427 Ralph's Grocery Company - Los Angeles, California based
retail food chain operator ...................................................... Term 06/30/98 15,426,504
582 Ralph's Grocery Company ........................................................ Revolving Credit 06/30/98 581,634
8,421 Star Markets Company, Incorporated - New England based retail food chain
operator......................................................................... Term 01/31/02 8,412,672
6,316 Star Markets Company, Incorporated ............................................. Term 12/31/02 6,330,998
-----------
108,499,389
-----------
MANUFACTURING 23.7%
35,000 American Standard Incorporated - Manufacturer of HVAC systems, braking systems
and plumbing fixtures .......................................................... Term 02/28/01 34,974,476
12,103 American Standard Incorporated .................................................. Term 02/28/00 12,149,295
7,000 Bankers Systems, Incorporated - Compliance services supplier ................... Term 11/01/02 7,041,832
20,000 Collins & Aikman Products Company - Manufacturer of auto interiors,
home interiors and wallpapers ................................................... Term 01/12/02 19,988,422
5,926 Dade International Incorporated - Medical equipment manufacturer/marketer ...... Term 12/31/01 5,923,795
6,667 Dade International Incorporated ................................................ Term 12/31/02 6,664,269
7,407 Dade International Incorporated ................................................ Term 06/30/03 7,404,744
9,697 Dal-Tile Group Incorporated - Ceramic tile and floor covering
manufacturer/retailer .......................................................... Revolving Credit 01/09/98 9,565,945
10,021 Ebel USA Incorporated - Manufacturer of luxury time pieces ...................... Term 09/30/01 10,171,362
17,925 Elsag Bailey, Incorporated - Manufacturer of electronic measurement and
control systems ................................................................. Term 08/30/02 17,906,566
33,000 Formica Corporation - Manufacturer, designer and distributor of laminates ....... Term 10/17/01 33,474,550
7,368 Golden Cat Corporation - Household pet products producer ........................ Term 05/01/99 7,368,184
19,800 Gulfstream Delaware Corporation - Aircraft manufacturer ......................... Term 03/31/98 19,895,477
12,292 Health O Meter, Incorporated - Manufacturer of small appliances ................ Term 08/15/01 12,277,677
4,341 Intermetro Industries Corporation - Manufacturer of metal/polymer storage
products......................................................................... Term 06/30/01 4,340,532
</TABLE>

See Notes to Financial Statements

B-24
<PAGE> 75

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

PORTFOLIO OF INVESTMENTS (CONTINUED)
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT LOAN STATED
(000) BORROWER TYPE MATURITY* VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
VARIABLE RATE** SENIOR LOAN INTERESTS (CONTINUED)
MANUFACTURING (CONTINUED)
$ 6,272 Intermetro Industries Corporation ............................................... Term 12/31/02 $ 6,271,521
4,236 KDI Corporation - Manufacturer of defense and leisure products (c) ............. Term 03/31/98 2,753,529
11,057 Overhead Door Corporation - Manufacturer of garage doors and
garage door openers ............................................................ Term 08/18/99 11,052,069
2,332 Overhead Door Corporation ....................................................... Revolving Credit 08/18/99 2,326,303
24,474 Playtex Products, Incorporated - Manufacturer of beauty aid and hygiene products. Term 06/01/02 24,853,858
27,000 PSF Finance L.P. - Integrated pork producer ..................................... Term 12/23/99 28,179,879
4,000 RSI Home Products, Incorporated - Bath and kitchen cabinet manufacturer ......... Term 11/30/99 4,135,679
7,465 Spalding & Evenflo Companies, Incorporated - Manufacturer of sporting goods ..... Term 10/14/02 7,497,155
4,213 Sperry Marine Incorporated - Manufacturer of navigational instruments .......... Term 11/12/00 4,189,350
3,494 Sun Pharmaceuticals Corporation - Skincare product producer ..................... Term 12/31/97 3,494,020
9,520 The Pullman Company - Diversified manufacturer, primarily in the
transportation sector .......................................................... Term 12/31/99 9,218,022
4,485 The Pullman Company ............................................................. Term 12/31/99 4,354,046
9,700 The U.S. Playing Card Company - Manufacturer/distributor of playing cards ....... Term 09/30/02 9,696,014
20,000 Thompson Minwax Company - Manufacturer of wood stains and finishing products .... Term 12/31/02 20,215,066
4,493 Tyler Refrigeration Corporation - Manufacturer of refrigeration systems ......... Term 09/30/98 4,446,304
14,656 UCAR International, Incorporated - Manufacturer of graphite/carbide electrodes .. Term 01/31/03 14,803,399
7,672 UCAR International, Incorporated ................................................ Term 07/31/03 7,748,902
7,672 UCAR International, Incorporated ................................................ Term 01/30/04 7,748,902
10,456 USG Corporation - Manufacturer of building materials/gypsum wallboard ........... Term 12/31/00 10,518,285
5,644 Waters Corporation - Manufacturer/distributor of high
performance liquid chromatography instruments ................................... Term 11/30/01 5,677,534
3,950 Waters Corporation ............................................................. Term 11/30/02 3,973,442
3,175 Waters Corporation ............................................................. Term 05/31/03 3,193,705
-----------
405,494,110
-----------
PAPER 9.0%
19,125 Fort Howard Corporation - Paper manufacturer ................................... Term 05/01/97 19,153,345
3,897 Fort Howard Corporation ......................................................... Term 12/31/96 3,896,997
39,000 Jefferson Smurfit Corporation - Corrugated paper products manufacturer .......... Term 04/30/02 39,411,433
40,000 S.D. Warren Company - Coated-free paper manufacturer ........................... Term 12/20/02 40,563,092
50,000 Stone Container Corporation - Paper products manufacturer ...................... Term 04/01/00 50,570,234
-----------
153,595,101
-----------
PRINTING 4.8%
36,400 American Media Operations, Incorporated - Magazine/newspaper publisher .......... Term 09/30/02 36,390,663
4,800 TransWestern Publishing Company, L.P. - Publisher of telephone yellow pages ..... Term 04/30/00 4,797,941
</TABLE>

See Notes to Financial Statements

B-25
<PAGE> 76

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

PORTFOLIO OF INVESTMENTS (CONTINUED)
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT LOAN STATED
(000) BORROWER TYPE MATURITY* VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
VARIABLE RATE** SENIOR LOAN INTERESTS (CONTINUED)
PRINTING (CONTINUED)
$ 20,588 Ziff-Davis Publishing Company - Publisher of computer magazine .................. Term 12/31/01 $ 21,188,942
19,412 Ziff-Davis Publishing Company .................................................. Term 12/31/02 19,978,145
-----------
82,355,691
-----------
RESTAURANTS 1.4%
13,617 America's Favorite Chicken Company - Church's and
Popeye's Fried Chicken restaurants .............................................. Term 11/05/98 13,617,370
1,960 Carvel Corporation - Soft ice cream products franchisor ......................... Term 12/31/98 1,958,763
8,034 Long John Silver's Restaurants, Incorporated - Retail seafood restaurant
owner/operator ................................................................. Term 09/30/97 8,033,350
-----------
23,609,483
-----------
RETAIL 9.6%
32,500 Camelot Music, Incorporated - Retail distributor of music and video cassettes ... Term 02/28/02 32,952,668
17,600 Color Tile, Incorporated - Ceramic tile and floor covering retailer ............. Term 12/31/98 17,593,237
10,000 Duane Reade - Retail drug store ................................................ Term 09/30/99 9,997,580
19,112 Eckerd Corporation - Retail drug store .......................................... Term 07/29/00 19,107,503
9,750 General Nutrition Incorporated - Vitamin, mineral and food supplement
manufacturer and retailer ....................................................... Term 06/30/01 9,784,329
4,000 Petro PSC Properties, L.P. - Multi-service truck-stop operator ................. Term 05/18/01 4,057,328
19,825 Saks & Company - Retail fashions and accessories ................................ Term 06/30/00 19,868,152
19,867 The Circle K Corporation, Incorporated - Convenience store operator ............. Term 07/31/01 19,937,553
27,897 Thrifty Payless, Incorporated - Retail drug store ............................... Term 09/30/01 28,308,821
3,493 Truckstops of America, Incorporated - Interstate fueling stations operator ..... Term 12/10/00 3,470,261
-----------
165,077,432
-----------
TEXTILES 4.1%
8,631 Bidermann Industries Corporation - Apparel manufacturer ......................... Term 03/31/97 8,542,771
73 Bidermann Industries Corporation ............................................... Revolving Credit 03/31/97 65,152
9,500 Hosiery Corporation of America - Manufacturer/direct mail marketer
of women's hosiery ............................................................. Term 07/31/01 9,479,308
8,909 Ithaca Industries, Incorporated - Undergarment and hosiery manufacturer ......... Term 10/31/98 8,939,199
5,752 Lincoln Group Holdings Corporation - Book binding material manufacturer ........ Term 09/30/97 5,722,900
12,000 London Fog Industries, Incorporated - Manufacturer of rainwear and outerwear ... Term 06/30/01 10,532,114
30,000 London Fog Industries, Incorporated ............................................ Term 06/30/02 26,285,826
-----------
69,567,270
-----------
</TABLE>

See Notes to Financial Statements

B-26
<PAGE> 77

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

PORTFOLIO OF INVESTMENTS (CONTINUED)
JANUARY 31, 1995 (UNAUDITED)

B-27
<PAGE> 78

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

PORTFOLIO OF INVESTMENTS (CONTINUED)
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BORROWER VALUE
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C>
EQUITIES 0.6%
America's Favorite Chicken Company (604,251 common shares) (b)(c) .................................................. $ 1,148,077
America's Favorite Chicken Company (34,864 preferred shares) (b)(c)................................................. 2,370,752
Best Products Company, Incorporated (297,480 common shares) (c) ................................................... 1,710,510
Best Products Company, Incorporated (Warrants for 28,080 common shares) (c) ........................................ 0
Braelan Corporation (533 common shares) (b)(c) .................................................................... 0
Core-Mark International, Incorporated, Preferred Stock ($2,782,512 par amount, 0% coupon, maturity 12/31/95) (b) ... 2,551,040
Core-Mark International, Incorporated (Warrants for 18,365 common shares) (b)(c) .................................. 0
DM Holdings, Incorporated (Series A) (Warrants for 2,739 common shares) (b)(c) .................................... 1,225,018
DM Holdings, Incorporated (Series B) (Warrants for 1,013 common shares) (b)(c) .................................... 453,064
Flagstar Companies, Incorporated (8,755 common shares) (c) ......................................................... 56,909
MICOM Communications, Incorporated (Warrants for 114,035 common shares) (c) ....................................... 898,025
Nextel Communications, Incorporated (Warrants for 60,000 common shares) (b)(c) .................................... 0
Sun Pharmaceuticals Corporation (Warrants for 120 common shares) (b)(c) ........................................... 0
Thermoscan Incorporated (Warrants for 3,930 common shares) (b)(c) ................................................. 0
--------------
TOTAL EQUITIES ...................................................................................................... 10,413,395
--------------
CORPORATE BONDS 0.1%
Braelan Corporation ($861,291 par, 16.35% coupon, 09/03/95 maturity) ............................................... 921,741
--------------
TOTAL LONG-TERM INVESTMENTS 83.4%
(Cost $1,426,251,564) (a) .......................................................................................... 1,428,163,430
--------------
SHORT-TERM INVESTMENTS AT AMORTIZED COST
COMMERCIAL PAPER 3.4%
Cargill, Incorporated ($17,600,000 par, maturing 02/01/95 through 02/03/95, yielding 5.50% to 5.75%) ............... 17,596,150
Dow Chemical Company ($15,000,000 par, maturing 02/01/95, yielding 5.85%) .......................................... 15,000,000
Northern Illinois Gas Company ($6,000,000 par, maturing 02/17/95, yielding 5.95%) .................................. 5,984,133
Raytheon Company ($20,000,000 par, maturing 02/01/95, yielding 5.32%) .............................................. 20,000,000
--------------
TOTAL COMMERCIAL PAPER .............................................................................................. 58,580,283
--------------
</TABLE>
See Notes to Financial Statements

B-28
<PAGE> 79

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

PORTFOLIO OF INVESTMENTS (CONTINUED)
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BORROWER VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C>
SHORT-TERM INVESTMENTS AT AMORTIZED COST (CONTINUED)
SHORT-TERM LOAN PARTICIPATIONS 11.5%
Alltel Corporation ($20,000,000 par, maturing 02/01/95, yielding 5.95%) ............................................ $ 20,000,000
AON Corporation ($20,000,000 par, maturing 02/06/95, yielding 5.75%) .............................................. 20,000,000
Army & Air Force Exchange Service ($20,000,000 par, maturing 02/03/95, yielding 5.75%) ............................ 20,000,000
Avery Dennison ($8,900,000 par, maturing 02/01/95, yielding 5.91%) ................................................ 8,900,000
Bell Atlantic Network Funding Corporation ($15,000,000 par, maturing 02/01/95, yielding 5.62%) .................... 15,000,000
General Mills, Incorporated ($18,200,000 par, maturing 02/08/95, yielding 5.95%) ................................... 18,200,000
Gillette Company ($20,000,000 par, maturing 02/01/95, yielding 5.82%) ............................................. 20,000,000
ITT Hartford Group ($10,000,000 par, maturing 2/21/95, yielding 5.92%) ............................................. 10,000,000
Indiana Gas, Incorporated ($15,300,000 par, maturing 02/01/95, yielding 5.65% to 5.95%) ........................... 15,300,000
Morton International, Incorporated ($20,000,000 par, maturing 02/01/95 through 02/16/95, yielding 5.72% to 5.89%) .. 20,000,000
Sara Lee Corporation ($10,000,000 par, maturing 02/27/95, yielding 5.90%) ......................................... 10,000,000
USAA Capital Corporation ($20,000,000 par, maturing 02/21/95, yielding 5.87%) ...................................... 20,000,000
--------------
TOTAL SHORT-TERM LOAN PARTICIPATIONS ................................................................................ 197,400,000
--------------
TOTAL SHORT-TERM INVESTMENTS AT AMORTIZED COST 14.9% ................................................................ 255,980,283
OTHER ASSETS IN EXCESS OF LIABILITIES 1.7% ......................................................................... 28,329,112
--------------
NET ASSETS 100.0% .................................................................................................. $1,712,472,825
==============
</TABLE>
(a) At January 31, 1995, cost for federal income tax purposes is
$1,426,251,564; the aggregate gross unrealized appreciation is
$16,684,438, and the aggregate gross unrealized depreciation is
$14,772,572, resulting in net unrealized appreciation of $1,911,866.
(b) Restricted security.

(d) As of January 31, 1995, this Senior Loan is non-income producing. The
Borrower falls under the protection of the federal bankruptcy laws.

* Senior Loans in the Trust's portfolio generally are subject to mandatory
and/or optional prepayment. Because of these mandatory prepayment conditions
and because there may be significant economic incentives for a Borrower to
prepay, prepayments of Senior Loans in the Trust's portfolio may occur. As
a result, the actual remaining maturity of Senior Loans held in the Trust's
portfolio may be substantially less than the stated maturities shown.
Although the Trust is unable to accurately estimate the actual remaining
maturity of individual Senior Loans, the Trust estimates that the actual
average maturity of the Senior Loans held in its portfolio will be
approximately 18-24 months.

** Senior Loans in which the Trust invests generally pay interest at rates
which are periodically redetermined by reference to a base lending rate
plus a premium. These base lending rates are generally (i) the prime
rate offered by one or more major United States banks, (ii) the lending
rate offered by one or more major European banks, such as the London
Inter-Bank Offered Rate ("LIBOR") and (iii) the certificate of deposit
rate. Senior loans are generally considered to be restricted in that
the Trust ordinarily is contractually obligated to receive approval
from the Agent Bank and/or borrower prior to the disposition of a Senior
Loan.

See Notes to Financial Statements

B-29
<PAGE> 80

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

STATEMENT OF ASSETS AND LIABILITIES
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
Investments, at Market Value (Cost $1,426,251,564) (Note 1) .................................. $ 1,428,163,430
Short-Term Investments (Note 1) .............................................................. 255,980,283
Cash ........................................................................................ 304,838
Receivables:
Fund Shares Sold ........................................................................... 19,900,932
Investments Sold ............................................................................ 14,158,076
Interest and Fees .......................................................................... 12,905,528
Other ........................................................................................ 117,521
----------------
Total Assets .............................................................................. 1,731,530,608
----------------
LIABILITIES:
Deferred Facility Fees ....................................................................... 13,961,265
Payables:
Income Distributions ....................................................................... 2,264,214
Investment Advisory Fee (Note 2) ............................................................ 1,340,563
Administrative Fee (Note 2) ................................................................ 352,780
Investments Purchased ....................................................................... 208,228
Fund Shares Repurchased .................................................................... 15,053
Accrued Expenses ............................................................................ 915,680
----------------
Total Liabilities ........................................................................ 19,057,783
----------------
NET ASSETS ................................................................................... $ 1,712,472,825
================
NET ASSETS CONSIST OF:
Common Shares ($.01 par value with an unlimited number of shares authorized,
170,484,390 shares issued and outstanding) (Note 3) ......................................... $ 1,704,844
Paid in Surplus ............................................................................. 1,707,025,632
Accumulated Undistributed Net Investment Income ............................................. 5,527,818
Net Unrealized Appreciation on Investments .................................................. 1,911,866
Accumulated Net Realized Loss on Investments ................................................. (3,697,335)
----------------
NET ASSETS ................................................................................... $ 1,712,472,825
================
NET ASSET VALUE PER COMMON SHARE($1,712,472,825 divided by 170,484,390 shares outstanding) ... $ 10.04
================
</TABLE>
See Notes to Financial Statements

B-30
<PAGE> 81

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

STATEMENT OF OPERATIONS
For the Six Months Ended January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest ........................................................................... $ 58,919,903
Fees ............................................................................... 5,873,704
Other .............................................................................. 395,753
---------------
Total Income ................................................................... 65,189,360
---------------
EXPENSES:
Investment Advisory Fee (Note 2) ................................................... 7,002,005
Administrative Fee (Note 2) ........................................................ 1,842,633
Shareholder Services (Note 2) ..................................................... 748,129
Legal (Note 2) .................................................................... 301,000
Amortization of Organizational Expenses and Initial Registration Costs (Note 1) ... 37,067
Other .............................................................................. 1,123,922
---------------
Total Expenses .................................................................. 11,054,756
---------------
NET INVESTMENT INCOME .............................................................. $ 54,134,604
===============
REALIZED AND UNREALIZED GAIN/LOSS ON INVESTMENTS:
Realized Gain/Loss on Investments:
Proceeds from Sales and Principal Repayments ..................................... $ 403,294,320
Cost of Securities Sold and Repaid ................................................ (401,714,059)
---------------
Net Realized Gain on Investments ................................................... 1,580,261
---------------
Unrealized Appreciation/Depreciation on Investments:
Beginning of the Period .......................................................... 6,529,519
End of the Period ................................................................. 1,911,866
---------------
Net Unrealized Depreciation on Investments During the Period ....................... (4,617,653)
---------------
NET REALIZED AND UNREALIZED LOSS ON INVESTMENTS ................................... $ (3,037,392)
===============
NET INCREASE IN NET ASSETS FROM OPERATIONS ......................................... $ 51,097,212
===============
</TABLE>
See Notes to Financial Statements

B-31
<PAGE> 82

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

STATEMENT OF CHANGES IN NET ASSETS
For the Six Months Ended January 31, 1995
and the Year Ended July 31, 1994 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JANUARY 31, 1995 JULY 31, 1994
---------------- -------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Net Investment Income........................................................ $ 54,134,604 $ 64,333,964
Net Realized Gain/Loss on Investments........................................ 1,580,261 (1,392,765)
Net Unrealized Appreciation/Depreciation on Investments During the Period ... (4,617,653) 2,441,749
---------------- -----------------
Change in Net Assets from Operations ....................................... 51,097,212 65,382,948
Distributions from Net Investment Income..................................... (51,995,207) (60,454,184)
---------------- -----------------
NET CHANGE IN NET ASSETS FROM INVESTMENT ACTIVITIES.......................... (897,995) 4,928,764
---------------- -----------------
FROM CAPITAL TRANSACTIONS (NOTES 3 AND 5):
Proceeds from Common Shares Sold............................................. 498,527,251 355,652,204
Value of Shares Issued Through Dividend Reinvestment ........................ 28,667,926 33,006,495
Cost of Shares Repurchased................................................... (42,828,137) (131,252,262)
---------------- -----------------
NET CHANGE IN NET ASSETS FROM CAPITAL TRANSACTIONS........................... 484,367,040 257,406,437
---------------- -----------------
TOTAL INCREASE IN NET ASSETS ................................................ 483,469,045 262,335,201
NET ASSETS:
Beginning of the Period ..................................................... 1,229,003,780 966,668,579
---------------- -----------------
End of the Period (Including undistributed net investment income of
$5,527,818 and $3,388,421, respectively) ................................... $ 1,712,472,825 $ 1,229,003,780
================ ================
</TABLE>
See Notes to Financial Statements

B-32
<PAGE> 83

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

STATEMENT OF CASH FLOWS
For the Six Months Ended January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
CHANGE IN NET ASSETS FROM OPERATIONS ............................................... $ 51,097,212
---------------
Adjustments to Reconcile the Change in Net Assets from
Operations to Net Cash Provided by Operating Activities:
Increase in Investments at Value .................................................. (406,492,653)
Increase in Short-Term Investments at Amortized Cost .............................. (64,866,290)
Increase in Interest and Fee Receivables .......................................... (5,912,789)
Increase in Receivable for Investments Sold ...................................... (14,158,076)
Decrease in Unamortized Organizational Expenses and Initial Registration Costs ... 37,067
Decrease in Other Assets ......................................................... 111,723
Increase in Investment Advisory and Administrative Fees Payable .................. 470,617
Increase in Deferred Facility Fees ................................................ 5,249,718
Increase in Investments Purchased ................................................. 208,228
Increase in Accrued Expenses ...................................................... 251,244
---------------
Total Adjustments ............................................................. (485,101,211)
---------------
NET CASH USED FOR OPERATING ACTIVITIES ............................................. (434,003,999)
---------------
CASH FLOWS FROM FINANCING ACTIVITIES (NOTES 3 AND 5):
Proceeds from Shares Sold .......................................................... 497,159,338
Payments on Shares Repurchased ..................................................... (43,040,542)
Cash Dividends Paid ............................................................... (22,328,020)
---------------
Net Cash Provided by Financing Activities ....................................... 431,790,776
---------------
NET DECREASE IN CASH .............................................................. (2,213,223)
Cash at Beginning of Period ........................................................ 2,518,061
---------------
CASH AT END OF PERIOD ............................................................. $ 304,838
===============
</TABLE>
See Notes to Financial Statements

B-33
<PAGE> 84

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

NOTES TO FINANCIAL STATEMENTS
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------

1. SIGNIFICANT ACCOUNTING POLICIES
Van Kampen Merritt Prime Rate Income Trust (the "Trust") is registered as a
non-diversified closed-end management investment company under the Investment
Company Act of 1940, as amended. The Trust commenced investment operations on
October 4, 1989.

The following is a summary of significant accounting policies consistently
followed by the Trust in the preparation of its financial statements.

A. SECURITY VALUATION--The value of the Trust's portfolio is
determined by Van Kampen American Capital Investment Advisory Corp. (the
"Adviser") following guidelines and procedures established, and periodically
reviewed, by the Board of Trustees. The value of a Variable Rate Senior Loan
interest in the Trust's portfolio is determined with reference to changes in
market interest rates and to the creditworthiness of the underlying obligor. In
valuing Variable Rate Senior Loan interests, the Adviser considers market
quotations and transactions in instruments that the Adviser believes may be
comparable to such Variable Rate Senior Loan interests. In determining the
relationship between such instruments and the Variable Rate Senior Loan
interests, the Adviser considers such factors as the creditworthiness of the
underlying obligor, the current interest rate, the interest rate redetermination
period and maturity date. To the extent that reliable market transactions in
Variable Rate Senior Loan interests have occurred, the Adviser also considers
pricing information derived from such secondary market transactions in valuing
Variable Rate Senior Loan interests. Other portfolio securities are valued on
the basis of prices furnished by pricing services or as determined in good faith
by the Adviser. Short-term securities are valued at amortized cost.

B. SECURITY TRANSACTIONS--Security transactions are recorded on a
trade date basis. Realized gains and losses are determined on an identified cost
basis. The Trust may purchase and sell interests in Variable Rate Senior Loans
and other portfolio securities on a "when issued" and "delayed delivery" basis,
with settlement to occur at a later date. The value of the security so purchased
is subject to market fluctuations during this period. The Trust will maintain,
in a segregated account with its custodian, assets having an aggregate value at
least equal to the amount of the when issued or delayed delivery purchase
commitments until payment is made. At January 31, 1995, there were no when
issued or delayed delivery purchase commitments.

C. INVESTMENT INCOME--Interest income is recorded on an accrual basis.
Facility fees received are recognized as income ratably over the expected life
of the loan. Market discounts are accreted over the stated life of each
applicable security.

D. ORGANIZATIONAL EXPENSES AND INITIAL REGISTRATION COSTS--The Trust has
reimbursed Van Kampen American Capital Distributors, Inc. or its affiliates
("VKAC") for costs incurred in connection with the Trust's organization and its
initial registration of the common shares in the amount of $1,037,578. These
costs have been amortized on a straight line basis over the 60 month period
ended October 4, 1994.

The Trust intends to utilize provisions of the federal income tax laws which
allow it to carry a realized capital loss forward for eight years following the
year of the loss and offset such losses against any future realized capital
gains. At July 31, 1994, the Trust had an accumulated capital loss carryforward
of $1,837,054 which will expire on July 31, 2002. Net realized gains or losses
may differ for financial and tax reporting purposes primarily as a result of
post October 31 losses which are not recognized for tax purposes until the
first day of the following fiscal year.

F. DISTRIBUTION OF INCOME AND GAINS--The Trust declares daily and pays
monthly dividends from net investment income. Net realized gains, if any, are
distributed annually. Due to inherent differences in the recognition of interest
income under generally accepted accounting principles and federal income tax
purposes, for those securities which the Trust has placed on non-accrual status,
the amount of distributable net investment income may differ between book and
federal income tax purposes for a particular period. These differences are
temporary in nature, but may result in book basis distributions in excess of net
investment income for certain periods.

B-34
<PAGE> 85

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------

Certain legal expenses are paid to Skadden, Arps, Slate, Meagher & Flom,
counsel to the Trust, of which a trustee of the Trust is an affiliated person.

For the six months ended January 31, 1995, the Trust recognized expenses of
approximately $56,800 representing VKAC's cost of providing legal and certain
shareholder services to the Trust.

Certain officers and trustees of the Trust are also officers and directors of
VKAC. The Trust does not compensate its officers or trustees who are officers
of VKAC.

The Trust has implemented deferred compensation and retirement plans for its
Trustees. Under the deferred compensation plan, Trustees may elect to defer all
or a portion of their compensation to a later date. The retirement plan covers
those Trustees who are not officers of VKAC.

3. CAPITAL TRANSACTIONS
At January 31, 1995 and July 31, 1994, paid in surplus aggregated
$1,707,025,632 and $1,223,140,759, respectively.

Transactions in common shares were as follows:

<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JANUARY 31, 1995 JULY 31, 1994
- ---------------------------------------------------------
<S> <C> <C>
Beginning Shares ....... 122,267,677 96,624,807
------------ -----------
Shares Sold ............ 49,629,173 35,430,303
Shares Issued Through
Dividend Reinvestment.. 2,853,286 3,287,782
Shares Repurchased...... (4,265,746) (13,075,215)
------------ ------------
Net Increase in
Shares Outstanding..... 48,216,713 25,642,870
------------ ------------
Ending Shares........... 170,484,390 122,267,677
============ ============
</TABLE>

4. INVESTMENT TRANSACTIONS
Aggregate purchases and the cost of securities sold and repaid, excluding
short-term notes, for the six months ended January 31, 1995, were $813,197,131
and $401,714,059, respectively.

5. TENDER OF SHARES
The Board of Trustees currently intends, each quarter, to consider authorizing
the Trust to make tender offers for all or a portion of its then outstanding
common shares at the then net asset value of the common shares. For the six
months ended January 31, 1995, 4,265,746 shares were tendered and repurchased
by the Trust.

6. EARLY WITHDRAWAL CHARGE
An early withdrawal charge to recover offering expenses will be imposed in
connection with most common shares held for less than five years which are
accepted by the Trust for repurchase pursuant to tender offers. The early
withdrawal charge will be imposed on the number of common shares accepted for
payment from a record holder of common shares, the value of which exceeds the
aggregate value at the time the tender is accepted of (a) all common shares
owned by such holder that were purchased more than five years prior to such
acceptance, (b) all common shares owned by such holder that were acquired
through dividend reinvestment and (c) the increase, if any, of value of all
other common shares owned by such holder (namely those purchased within the
five years preceding the acceptance) over the purchase price of such common
shares. The early withdrawal charge will be payable to VKAC. Any early
withdrawal charge which is required to be imposed will be made in accordance
with the following schedule.

<TABLE>
<CAPTION>
YEAR OF REPURCHASE WITHDRAWAL CHARGE
- ------------------------------------------
<S> <C>
First ................. 3.0%
Second ................ 2.5%
Third ................. 2.0%
Fourth ............... 1.5%
Fifth ................. 1.0%
Sixth and following ... 0.0%
</TABLE>

For the six months ended January 31, 1995, VKAC received early withdrawal
charges of approximately $885,800 in connection with tendered shares of the
Trust.

B-35
<PAGE> 86

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

- --------------------------------------------------------------------------------

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
January 31, 1995 (Unaudited)

- --------------------------------------------------------------------------------

7. COMMITMENTS
Pursuant to the terms of certain of the Variable Rate Senior Loan agreements,
the Trust had unfunded loan commitments of approximately $55,140,000 as of
January 31, 1995.

The Trust has entered into revolving credit agreements with Morgan
Guaranty Trust Company of New York, Bank of America and State Street Bank and
Trust Company for up to $50,000,000, $25,000,000 and $25,000,000, respectively.
The proceeds of any borrowing by the Trust under the revolving credit agreements
may only be used, directly or indirectly, in connection with the consummation of
a tender offer by the Trust for its shares. Annual commitment fees ranging from
1/4 to 3/8 of 1% will be charged on the unused portion of the credit lines.
Borrowings under these facilities will bear interest at either the banks' prime
rate or the Federal Funds rate plus 1/4 to 1/2 of 1%. There have been no
borrowings under these agreements to date.

8. SENIOR LOAN PARTICIPATION COMMITMENTS
The Trust invests primarily in participations, assignments, or acts as a party
to the primary lending syndicate of a Variable Rate Senior Loan interest to
United States corporations, partnerships, and other entities. When the Trust
purchases a participation of a Senior Loan interest, the Trust typically enters
into a contractual agreement with the lender or other third party selling the
participation, but not with the borrower directly. As such, the Trust assumes
the credit risk of the Borrower, Selling Participant or other persons
interpositioned between the Trust and the Borrower.

At January 31, 1995, the following sets forth the selling participants with
respect to interests in Senior Loans purchased by the Trust on a participation
basis.

<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
SELLING PARTICIPANT (000) VALUE
- --------------------------------------------------
<S> <C> <C>
Bankers Trust ......... $ 52,644 $ 53,005,295
National Westminster ... 9,697 9,565,945
Chase Manhattan ........ 1,185 1,185,246
Chemical Bank ......... 12,184 10,827,228
Banque Paribas ......... 4,456 4,433,907
FNB Canada ............ 3,510 3,506,106
Union Bank ............. 432 431,765
--------- -------------
Totals ................. $ 84,108 $ 82,955,492
========= =============
</TABLE>

B-36
<PAGE> 87
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

INDEPENDENT AUDITORS' REPORT

The Board of Trustees and Shareholders of
Van Kampen Merritt Prime Rate Income Trust:

We have audited the accompanying statement of assets and liabilities of Van
Kampen Merritt Prime Rate Income Trust (the "Trust"), including the portfolio
of investments, as of July 31, 1994, and the related statements of operations
and cash flows for the year then ended and the statement of changes in net
assets for each of the two years in the period then ended, and the financial
highlights for each of the periods presented. These financial statements and
financial highlights are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.

We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation of securities
and variable rate senior loan interests owned as of July 31, 1994, by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Van Kampen Merritt Prime Rate Income Trust as of July 31, 1994, and the results
of its operations and cash flows for the year then ended, the changes in its
net assets for each of the two years in the period then ended, and the
financial highlights for each of the periods presented in conformity with
generally accepted accounting principles.

As discussed in Note 1A, the financial statements include variable rate
senior loan interests valued at $1,010,147,537 (82.2% of net assets), whose
values are determined by the Trust's management, following procedures
established by the Board of Trustees, in the absence of actual market values.
Because of uncertainty inherent in the valuation process, the estimated value
of a variable rate senior loan interest may differ significantly from the value
that would have been used had there been recent market activity for that senior
loan interest. We have reviewed the procedures established by the Board of
Trustees and used by the Trust's management in arriving at its estimate of the
value of these senior loan interests and have inspected underlying
documentation, and, in the circumstances, we believe the procedures are
reasonable and the documentation appropriate.

KPMG Peat Marwick LLP

Chicago, Illinois
September 20, 1994

B-37

<PAGE> 88

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

PORTFOLIO OF INVESTMENTS
July 31, 1994

PRINCIPAL
AMOUNT
(000) BORROWER LOAN TYPE STATED MATURITY* VALUE
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
VARIABLE RATE** SENIOR LOAN INTERESTS
CHEMICAL 2.3%
$ 3,750 Findley Adhesives Incorporated - Industrial glue
manufacturer............................................. Term 12/31/97 $ 3,707,407
9,000 Freedom Chemical Company - Manufacturer of
specialty chemicals...................................... Term 06/30/02 8,999,908
6,522 Rheox Incorporated - Chemical additives manufacturer..... Term 12/31/97 6,423,290
9,200 Thoro System Products - Manufacturer of chemicals
for construction industry................................ Term 12/31/01 9,181,235
-----------
28,311,840
-----------
COMMUNICATIONS 7.6%
4,380 Alexcom Limited Partnership - Cellular telephone
systems operator......................................... Term 06/30/00 4,302,592
920 American Cable Systems Company - Cable television
systems operator......................................... Term 06/01/00 920,346
10,000 Bell and Howell - Electronic storage and information
systems.................................................. Term 12/31/99 10,000,090
2,098 Continental Cablevision - Cable television systems
operator................................................. Term 06/01/00 2,098,335
9,500 Lin Cellular Network Incorporated - Cellular telephone
systems operator......................................... Term 06/30/00 9,498,552
5,841 Lin Television Corporation - Cable television systems
operator................................................. Term 12/31/98 5,841,424
10,000 Pyramid Finance Corporation - Radio station
owner/operator........................................... Term 09/30/01 10,118,750
1,938 River City Broadcasting - Radio/television
owner/operator........................................... Revolving Credit 12/31/97 1,936,512
39,257 Smart SMR of California - Cellular telephone systems
operator................................................. Term 03/15/01 39,257,000
9,150 Vanguard Cellular Systems - Cellular telephone systems
operator................................................. Term 09/30/01 9,214,719
-----------
93,188,320
-----------
ELECTRICAL SUPPLY 4.2%
4,638 Berg Electronics - Manufacturer of electronic connectors.. Term 03/31/00 4,618,833
22,000 Berg Electronics.......................................... Term 03/31/01 22,093,607
4,541 Maximum Protection, Incorporated - Manufacturer of
electronic security systems............................... Term 09/30/95 4,713,971
6,414 MESC Holdings - Electronics manufacturer.................. Term 09/30/00 6,513,717
8,500 Rowe International - Manufacturer of jukeboxes and
electronic equipment...................................... Term 06/30/00 8,493,464
4,917 Steerage Acquisition - Electronic manufacturer............ Term 11/15/00 4,889,477
-----------
51,323,069
-----------
FINANCIAL SERVICES 1.7%
3,147 Ark Asset Management Company - Institutional money
manager................................................... Term 05/23/96 3,146,649
12,500 Blackstone Capital Corporation - Investment banker........ Term 07/13/01 12,498,630
5,145 New Street Capital Corporation - Investment banker........ Term 02/28/96 5,186,931
-----------
20,832,210
-----------
FOOD AND TOBACCO 5.8%
9,500 American Italian Pasta Company - Pasta products producer.. Term 07/01/02 9,496,456
2,250 Carvel Corporation - Soft ice cream products
producer/retailer......................................... Term 12/31/98 2,249,560
3,964 Consolidated Food Service - Wholesale food distributor.... Term 11/30/98 3,944,103
8,756 Core-Mark International, Incorporated - Confectionary
and tobacco distributor................................... Term 12/31/94 8,755,839
16,000 Heilman Holding Company - Beverage brewing company........ Term 12/31/00 15,888,009
9,966 President Baking Company - Bread/bread products
manufacturer.............................................. Term 09/29/00 9,947,860
3,613 TF Acquisition Corporation - Snack foods producer/
distributor............................................... Term 12/31/98 3,608,121
12,417 US Food Services - Wholesale food distributor............. Term 06/30/00 12,373,742
4,755 US Food Services.......................................... Term 12/31/98 4,753,522
-----------
71,017,213
-----------

</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS

B-38
<PAGE> 89
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

PORTFOLIO OF INVESTMENTS (CONTINUED)
July 31, 1994
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT STATED
(000) BORROWER LOAN TYPE MATURITY* VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
VARIABLE RATE** SENIOR LOAN INTERESTS (CONTINUED)
FOOD STORES 8.6%
$ 9,600 Big V Corporation - Northeastern retail food chain operator................... Term 03/15/00 $ 9,643,133
27,158 Food 4 Less Supermarkets, Incorporated - Midwestern and Californian
retail food chain operator.................................................... Term 01/01/99 27,383,718
6,524 Grand Union Holdings Corporation - New York based retail food chain operator.. Term 06/30/98 6,518,612
4,000 Grand Union Holdings Corporation.............................................. Revolving Credit 06/30/97 3,917,572
2,083 Mayfair Supermarkets, Incorporated - New Jersey based retail food chain
operator...................................................................... Term 02/28/98 2,041,202
1,162 Mayfair Supermarkets, Incorporated............................................ Term 08/31/99 1,138,942
27,500 Pathmark Stores, Incorporated - New Jersey based retail food chain operator... Term 10/31/99 27,820,704
8,678 Pathmark Stores, Incorporated................................................. Term 07/31/98 8,919,266
1,068 Pathmark Stores, Incorporated................................................. Revolving Credit 07/31/98 1,225,799
17,159 Ralph's Grocery Company - Los Angeles, California based retail food chain
operator...................................................................... Term 06/30/98 17,160,768
198 Ralph's Grocery Company....................................................... Revolving Credit 06/30/98 198,333
-----------
105,968,049
-----------
MANUFACTURING 16.2%
19,755 ASI Holdings - Manufacturers of HVAC systems, braking systems and
plumbing fixtures.............................................................. Term 02/29/00 19,862,356
20,000 Collins & Aikman Products Company - Manufacturer of auto interiors,
home interiors and wallpapers.................................................. Term 01/12/02 20,006,596
7,600 Color Tile Incorporated - Ceramic tile and floor covering
manufacturer/retailer.......................................................... Term 12/31/98 7,571,159
9,697 DTM Holdings Incorporated - Ceramic tile manufacturer/distributor/retailer..... Revolving Credit 01/09/98 9,567,455
7,483 Eagle Industrial Products - Aerospace and airplane parts manufacturer.......... Term 12/31/00 7,474,913
7,368 Golden Cat Corporation - Household pet products producer....................... Term 05/01/99 7,274,219
19,800 Gulfstream Delaware - Aircraft manufacturer.................................... Term 03/31/98 19,925,786
3,230 HGP Acquisition Corporation - Architectural glass manufacturer................. Term 12/31/99 2,745,366
4,500 Intermetro Industries - Manufacturer of metal/polymer storage products......... Term 06/30/01 4,499,252
6,500 Intermetro Industries.......................................................... Term 12/31/02 6,498,919
4,236 KDI Corporation - Defense and leisure products manufacturer (c)................ Term 03/31/98 2,753,529
1,889 MRC Acquisition Corporation - Aircraft parts manufacturer...................... Revolving Credit 12/31/99 1,969,899
5,668 MRC Acquisition Corporation.................................................... Term 12/31/99 5,723,236
49,737 Playtex Holdings, Incorporated - Beauty aid and hygiene products manufacturer.. Term 06/01/02 50,328,647
3,937 Sun Pharmaceuticals - Skincare products manufacturer........................... Term 12/31/97 3,956,791
6,939 The Pullman Company - Diversified manufacturer, primarily in the
transportation sector.......................................................... Term 09/30/96 7,073,010
8,377 The Pullman Company............................................................ Revolving Credit 09/30/96 8,626,471
4,950 Tyler Holdings Corporation - Refrigeration systems manufacturer................ Term 09/30/98 4,899,261
8,256 USG Corporation - Manufacturer of building materials/gypsum wallboard.......... Term 12/31/00 8,371,969
-----------
199,128,834
-----------
PAPER 10.7%
19,125 Fort Howard Corporation - Paper manufacturer.................................. Term 05/01/97 18,927,051
4,023 Fort Howard Corporation....................................................... Term 12/31/96 4,009,809
54,000 Jefferson Smurfit Corporation - Corrugated paper products manufacturer........ Term 04/30/02 54,813,964
14,257 Stone Container Corporation - Paper products manufacturer..................... Term 03/01/97 14,372,926
25,641 Stone Savannah River Corporation - Paper products manufacturer................ Term 03/01/97 26,596,249
12,500 Sweetheart Holdings, Incorporated - Paper and disposable container and
utensil manufacturer.......................................................... Term 08/30/98 12,457,235
------------
131,177,234
------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS

B-39
<PAGE> 90
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

PORTFOLIO OF INVESTMENTS (CONTINUED)
July 31, 1994

<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) BORROWER LOAN TYPE STATED MATURITY* VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
VARIABLE RATE** SENIOR LOAN INTERESTS (CONTINUED)
PRINTING 0.3%
$ 4,500 Enquirer/Star Incorporated - Magazine/newspaper publisher............... Term 02/15/97 $ 4,456,727
---------------
RESTAURANTS 1.8%
13,711 America's Favorite Chicken Company - Church's and Popeye's Fried
Chicken restaurants..................................................... Term 11/05/98 13,711,084
8,419 Long John Silvers - Retail seafood restaurant owner/operator............ Term 09/30/97 8,346,339
---------------
22,057,423
RETAIL 15.2%
32,500 Camelot Music - Retail distributor of music and video cassettes......... Term 02/28/02 33,011,950
20,000 CK Acquisition - Convenience store operator............................. Term 04/30/00 20,148,767
10,000 Duane Reade - Retail drug store......................................... Term 09/30/99 10,007,648
25,000 General Nutrition, Incorporated - Vitamin, mineral and food supplement
manufacturer and retailer............................................... Term 06/30/01 24,998,904
32,052 Jack Eckerd Corporation - Retail drug store............................. Term 06/15/00 32,121,106
7,837 Jack Eckerd Corporation................................................. Term 07/31/99 7,837,412
918 Payless Cashways - Kansas City based retail hardware/lumber operator.... Term 09/25/98 918,206
30,000 Payless Cashways........................................................ Term 05/25/00 30,000,364
4,000 Petro PSC Properties - Multi-service truckstop operator................. Term 05/18/01 4,076,493
19,923 Saks & Company - Retail fashions and accessories........................ Term 06/30/00 20,074,511
3,562 Truckstops of America - Interstate fueling stations operator............ Term 12/10/00 3,550,619
---------------
186,745,980
---------------
TEXTILES 5.5%
9,532 Bidermann Industries Corporation - Apparel manufacturer................. Term 03/31/97 9,435,168
18 Bidermann Industries Corporation........................................ Revolving Credit 03/31/97 17,141
9,688 Ithaca Holdings Incorporated - Undergarment and hosiery manufacturer.... Term 10/31/98 9,738,546
6,116 Lincoln Group Holdings Corporation - Book binding material
manufacturer............................................................ Term 09/30/97 6,085,615
12,000 London Fog Industries - Rainwear and outerwear manufacturer............. Term 06/30/01 12,064,133
30,000 London Fog Industries................................................... Term 06/30/02 30,116,242
---------------
67,456,845
---------------
TRANSPORTATION 1.8%
22,795 Wings Holding Incorporated - Consumer airline carrier................... Term 06/15/97 22,560,770
---------------
OTHER 0.5%
3,771 Donnelley Marketing - Direct marketing company.......................... Term 06/30/96 3,769,760
2,226 Healthco International - Dental products supplier(d).................... Revolving Credit 06/30/95 888,254
3,170 Healthco International(d)............................................... Term 06/30/95 1,265,009
---------------
5,923,023
---------------
TOTAL VARIABLE RATE SENIOR LOAN INTERESTS 82.2%................................................................. 1,010,147,537
---------------
</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS

B-40

<PAGE> 91
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

PORTFOLIO OF INVESTMENTS (CONTINUED)
July 31, 1994
<TABLE>
<CAPTION>

BORROWER VALUE
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C>
EQUITIES 0.8%
America's Favorite Chicken Company (640,251 common shares) (b) . . . . . . . . . . . . . . . . . . . . . . $ 1,148,077
America's Favorite Chicken Company (34,864 preferred shares) (b) . . . . . . . . . . . . . . . . . . . . . 2,370,752
Best Products Company, Incorporated (297,480 common shares) . . . . . . . . . . . . . . . . . . . . . . . . 2,268,285
Best Products Company, Incorporated (warrants for 28,080 common shares) . . . . . . . . . . . . . . . . . . 0
Braelan Corporation (533 common shares) (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0
Core-Mark International, Incorporated, Preferred Stock
($2,782,512 par amount, 0% coupon, maturity 12/31/95) (b) . . . . . . . . . . . . . . . . . . . . . . . . 2,431,903
Core-Mark International, Incorporated (warrants for 18,365 common shares) (b) . . . . . . . . . . . . . . . 0
DM Holdings Incorporated (Series A) (warrants for 2,739 common shares) (b). . . . . . . . . . . . . . . . . 0
DM Holdings Incorporated (Series B) (warrants for 1,013 common shares) (b) . . . . . . . . . . . . . . . . 0
Flagstar Holdings, Incorporated (8,755 common shares) . . . . . . . . . . . . . . . . . . . . . . . . . . . 74,419
Katz Acquisition Corporation (warrants for 6,818 common shares) (b) . . . . . . . . . . . . . . . . . . . . 429,527
MICOM Communications, Incorporated (warrants for 114,035 common shares) . . . . . . . . . . . . . . . . . . 1,197,368
Nextel Communications, Incorporated (warrants for 60,000 common shares) (b) . . . . . . . . . . . . . . . . 753,750
Sun Pharmaceuticals (warrants for 120 common shares) (b). . . . . . . . . . . . . . . . . . . . . . . . . . 0
---------------
TOTAL EQUITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,674,081
---------------
CORPORATE BONDS 0.1%
Braelan Corporation ($827,469 par, 16.35% coupon, 09/03/95 maturity) (b) . . . . . . . . . . . . . . . . . 849,159
---------------
TOTAL LONG-TERM INVESTMENTS 83.1%
(Cost $1,015,141,258) (a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,021,670,777
---------------
SHORT-TERM INVESTMENTS AT AMORTIZED COST
COMMERCIAL PAPER 5.1%
American Telephone & Telegraph Company ($10,000,000 par, maturing 08/11/94, yielding 4.45%) . . . . . . . 9,987,639
Cargill Corporation ($10,000,000 par, maturing 08/08/94, yielding 4.22%) . . . . . . . . . . . . . . . . . 9,991,794
Coca-Cola Corporation ($10,000,000 par, maturing 08/22/94, yielding 4.32%) . . . . . . . . . . . . . . . . 9,974,800
Colonial Pipeline Company ($12,000,000 par, maturing 08/11/94, yielding 4.50%) . . . . . . . . . . . . . . 11,985,000
Daimler-Benz N.A., Incorporated ($5,000,000 par, maturing 08/12/94, yielding 4.40%) . . . . . . . . . . . . 4,993,278
Hewlett-Packard Company ($10,000,000 par, maturing 08/15/94, yielding 4.40%) . . . . . . . . . . . . . . . 9,982,889
Wal Mart Stores, Incorporated ($6,000,000 par, maturing 08/03/94, yielding 4.22%) . . . . . . . . . . . . . 5,998,593
---------------
TOTAL COMMERCIAL PAPER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,913,993
---------------

</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS

B-41

<PAGE> 92
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST
PORTFOLIO OF INVESTMENTS (CONTINUED)
July 31, 1994

<TABLE>
<CAPTION>
BORROWER VALUE
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C>
SHORT-TERM INVESTMENTS AT AMORTIZED COST (CONTINUED)
SHORT-TERM LOAN PARTICIPATIONS 10.5%
American Greetings Corporation ($10,000,000 par, maturing 08/04/94 through 08/10/94,
yielding 4.27% to 4.35%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,000,000
Ameritech Corporation ($20,000,000 par, maturing 08/15/94, yielding 4.45%) . . . . . . . . . . . . . . . . 20,000,000
Bell Atlantic Financial Services Corporation ($15,000,000 par, maturing 08/11/94, yielding 4.51%) . . . . 15,000,000
General Mills, Incorporated ($12,600,000 par, maturing 08/01/94, yielding 4.20%) . . . . . . . . . . . . . 12,600,000
Gillette Company ($10,000,000 par, maturing 08/01/94, yielding 4.24%) . . . . . . . . . . . . . . . . . . 10,000,000
Hertz Corporation ($5,000,000 par, maturing 08/08/94, yielding 4.51%) . . . . . . . . . . . . . . . . . . 5,000,000
ITT Hartford Group, Incorporated ($10,000,000 par, maturing 08/24/94, yielding 4.40%) . . . . . . . . . . 10,000,000
National Rural Utilities Finance Corporation ($19,600,000 par, maturing 08/09/94 through 08/22/94,
yielding 4.32% to 4.40%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,600,000
Paccar Financial Corporation ($6,000,000 par, maturing 08/10/94, yielding 4.45%) . . . . . . . . . . . . . 6,000,000
Sara Lee Corporation ($20,000,000 par, maturing 08/16/94, yielding 4.45%) . . . . . . . . . . . . . . . . 20,000,000
--------------
TOTAL SHORT-TERM LOAN PARTICIPATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128,200,000
--------------
TOTAL SHORT-TERM INVESTMENTS AT AMORTIZED COST 15.6% . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191,113,993
OTHER ASSETS IN EXCESS OF LIABILITIES 1.3% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,219,010
--------------
NET ASSETS 100.0% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,229,003,780
==============
</TABLE>

(a) At July 31, 1994, cost for federal income tax purposes is $1,015,141,258;
the aggregate gross unrealized appreciation is $15,533,857, and the
aggregate gross unrealized depreciation is $9,004,338, resulting in net
unrealized appreciation of $6,529,519.

(b) Restricted security.

(d) As of July 31, 1994, this Senior Loan is non-income producing. The
Borrower falls under the protection of the federal bankruptcy laws.

* Senior Loans in the Trust's portfolio generally are subject to mandatory
and/or optional prepayment. Because of these mandatory prepayment
conditions and because there may be significant economic incentives for a
Borrower to prepay, prepayments of Senior Loans in the Trust's portfolio
may occur. As a result, the actual remaining maturity of Senior Loans held
in the Trust's portfolio may be substantially less than the stated
maturities shown. Although the Trust is unable to accurately predict the
actual remaining maturity of individual Senior Loans, the Trust estimates
that the actual average maturity of the Senior Loans held in its portfolio
will be approximately 18-24 months.

** Senior Loans in which the Trust invests generally pay interest at rates
which are periodically redetermined by reference to a base lending rate
plus a premium. These base lending rates are generally (i) the prime rate
offered by one or more major United States banks, (ii) the lending rate
offered by one or more major European banks, such as the London Inter-Bank
Offered Rate ("LIBOR") and (iii) the certificate of deposit rate. Senior
Loans are generally considered to be restricted in that the Trust
ordinarily is contractually obligated to receive approval from the Agent
Bank and/or borrower prior to the disposition of a Senior Loan.

SEE NOTES TO FINANCIAL STATEMENTS

B-42

<PAGE> 93
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

STATEMENT OF ASSETS AND LIABILITIES
JULY 31, 1994

<TABLE>
<CAPTION>
ASSETS:
<S> <C>
Investments, at Market Value (Cost $1,015,141,258) (Note 1) . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,021,670,777
Short-Term Investments (Note 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191,113,993
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,518,061
Receivables:
Fund Shares Sold. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,533,019
Interest and Fees. . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 6,992,739
Unamortized Organizational Expenses and Initial Registration Costs (Note 1) . . . . . . . . . . . . . . . . . . 37,067
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229,244
----------------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,241,094,900
----------------
LIABILITIES:
Deferred Facility Fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,711,547
Payables:
Income Distributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,264,953
Investment Advisory Fee (Note 2). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 967,987
Administrative Fee (Note 2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254,739
Fund Shares Repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227,458
Accrued Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664,436
----------------
Total Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,091,120
----------------
NET ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,229,003,780
================
NET ASSETS CONSIST OF:
Common Shares ($.01 par value with an unlimited number of shares authorized,
122,267,677 shares issued and outstanding) (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,222,677
Paid in Surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,223,140,759
Net Unrealized Appreciation on Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,529,519
Accumulated Undistributed Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,388,421
Accumulated Net Realized Loss on Investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,277,596)
----------------
NET ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,229,003,780
================
NET ASSET VALUE PER COMMON SHARE ($1,229,003,780 divided by 122,267,677 shares outstanding) . . . . . . . . . . $ 10.05
================
</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS

B-43
<PAGE> 94
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

STATEMENT OF OPERATIONS
For the Year Ended July 31, 1994

<TABLE>
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME:
Interest.......................................................................................................... $ 65,525,573
Fees.............................................................................................................. 11,957,624
Accretion of Discount............................................................................................. 1,688,144
Other............................................................................................................. 1,133,244
--------------
Total Income.................................................................................................. 80,304,585
--------------
EXPENSES:
Investment Advisory Fee (Note 2).................................................................................. 9,867,144
Administrative Fee (Note 2)....................................................................................... 2,596,617
Shareholder Services (Note 2)..................................................................................... 1,274,916
Legal (Note 2).................................................................................................... 672,500
Amortization of Organizational Expenses and Initial Registration Costs (Note 1)................................... 207,400
Other............................................................................................................. 1,352,044
--------------
Total Expenses................................................................................................ 15,970,621
--------------
NET INVESTMENT INCOME............................................................................................. $ 64,333,964
==============
REALIZED AND UNREALIZED GAIN/LOSS ON INVESTMENTS:
Realized Gain/Loss on Investments:
Proceeds from Sales and Principal Repayments.................................................................... $ 623,304,531
Cost of Securities Sold and Repaid.............................................................................. (624,697,296)
--------------
Net Realized Loss on Investments.................................................................................. (1,392,765)
--------------
Net Unrealized Appreciation/Depreciation on Investments:
Beginning of the Period......................................................................................... 4,087,770
End of the Period............................................................................................... 6,529,519
--------------
Net Unrealized Appreciation on Investments During the Period...................................................... 2,441,749
--------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS................................................................... $ 1,048,984
==============
NET INCREASE IN NET ASSETS FROM OPERATIONS........................................................................ $ 65,382,948
==============
</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS

B-44
<PAGE> 95
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST
STATEMENT OF CHANGES IN NET ASSETS

For the Years Ended July 31, 1994 and 1993

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
JULY 31, 1994 JULY 31, 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Net Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 64,333,964 $ 56,554,773
Net Realized Loss on Investments . . . . . . . . . . . . . . . . . . . . . . . . . . (1,392,765) (3,627,832)
Net Unrealized Appreciation on Investments During the Period . . . . . . . . . . . . 2,441,749 4,266,633
-------------- --------------
Change in Net Assets from Operations . . . . . . . . . . . . . . . . . . . . . . . . 65,382,948 57,193,574
Distributions from Net Investment Income . . . . . . . . . . . . . . . . . . . . . . (60,454,184) (56,554,773)
Distributions in Excess of Net Investment Income (Note 1) . . . . . . . . . . . . . . -0- (243,403)
-------------- --------------
NET CHANGE IN NET ASSETS FROM INVESTMENT ACTIVITIES . . . . . . . . . . . . . . . . . 4,928,764 395,398
-------------- --------------
FROM CAPITAL TRANSACTIONS (NOTES 3 AND 5):
Proceeds from Common Shares Sold . . . . . . . . . . . . . . . . . . . . . . . . . . 355,652,204 136,322,943
Value of Shares Issued Through Dividend Reinvestment . . . . . . . . . . . . . . . . 33,006,495 30,050,618
Cost of Shares Repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (131,252,262) (128,411,869)
-------------- --------------
NET CHANGE IN NET ASSETS FROM CAPITAL TRANSACTIONS . . . . . . . . . . . . . . . . . 257,406,437 37,961,692
-------------- --------------
TOTAL INCREASE IN NET ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262,335,201 38,357,090
NET ASSETS:
Beginning of the Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 966,668,579 928,311,489
-------------- --------------
End of the Period (Including undistributed net investment income of
$3,388,421 and ($491,359), respectively) . . . . . . . . . . . . . . . . . . . . . $1,229,003,780 $ 966,668,579
============== ==============

</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS

B-45

<PAGE> 96
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

STATEMENT OF CASH FLOWS
For the Year Ended July 31, 1994

<TABLE>
<S> <C>
CHANGE IN NET ASSETS FROM OPERATIONS....................................................... $ 65,382,948
-------------
Adjustments to Reconcile the Change in Net Assets from
Operations to Net Cash Provided by Operating Activities:

Increase in Investments at Value......................................................... (232,789,433)

Increase in Short-Term Investments at Amortized Cost..................................... (9,826,034)

Increase in Interest and Fee Receivables................................................. (2,241,904)

Decrease in Receivable for Investments Sold.............................................. 2,626,338

Decrease in Unamortized Organizational Expenses and Initial Registration Costs........... 207,400

Increase in Other Assets................................................................. (203,790)

Increase in Investment Advisory and Administrative Fees Payable.......................... 43,415

Decrease in Deferred Facility Fees....................................................... (1,471,811)

Increase in Accrued Expenses............................................................. 16,667
------------
Total Adjustments..................................................................... (243,639,152)
------------
NET CASH USED FOR OPERATING ACTIVITIES...................................................... (178,256,204)
------------

CASH FLOWS FROM FINANCIING ACTIVITIES (NOTES 3 AND 5):

Proceeds from Shares Sold................................................................... 340,530,338

Payments on Shares Repurchased.............................................................. (131,029,233)

Proceeds from/Payments on Intra-day Credit Line............................................. (1,426,956)

Cash Dividends Paid......................................................................... (27,299,884)
------------
Net Cash Provided by Financing Activities............................................. 180,774,265
------------
NET INCREASE IN CASH........................................................................ 2,518,061

Cash at Beginning of Period................................................................. -0-
------------

CASH AT END OF PERIOD....................................................................... $ 2,518,061
============

</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS

B-46

<PAGE> 97

VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

NOTES TO FINANCIAL STATEMENTS
July 31, 1994

1. SIGNIFICANT ACCOUNTING POLICIES
Van Kampen Merritt Prime Rate Income Trust (the "Trust) is registered as a
non-diversified closed-end management investment company under the Investment
Company Act of 1940, as amended. The Trust commenced investment operations on
October 4, 1989.
The following is a summary of significant accounting policies
consistently followed by the Trust in the preparation of its financial
statements.

A. SECURITY VALUATION -- The value of the Trust's portfolio is determined by
Van Kampen Merritt Investment Advisory Corp. (the "Adviser") following
guidelines and procedures established, and periodically reviewed, by the Board
of Trustees. The value of a Variable Rate Senior Loan interest in the Trust's
portfolio is determined with reference to changes in market interest rates and
to the creditworthiness of the underlying obligor. In valuing Variable Rate
Senior Loan interests, the Adviser considers market quotations and transactions
in instruments that the Adviser believes may be comparable to such Variable
Rate Senior Loan interests. In determining the relationship between such
instruments and the Variable Rate Senior Loan interests, the Adviser considers
such factors as the creditworthiness of the underlying obligor, the current
interest rate, the interest rate redetermination period and maturity date. To
the extent that reliable market transactions in Variable Rate Senior Loan
interests have occurred, the Adviser also considers pricing information derived
from such secondary market transactions in valuing Variable Rate Senior Loan
interests. Other portfolio securities are valued on the basis of prices
furnished by pricing services or as determined in good faith by the Adviser.
Short-term securities are valued at amortized cost.

B. SECURITY TRANSACTIONS -- Investment transactions are recorded on a trade
date basis. Realized gains and losses are determined on an identified cost
basis. The Trust may purchase and sell interests in Variable Rate Senior Loans
and other portfolio securities on a "when issued" and "delayed delivery" basis,
with settlement to occur at a later date. The value of the security so
purchased is subject to market fluctuations during this period. The Trust will
maintain, in a segregated account with its custodian, assets having an
aggregate value at least equal to the amount of the when issued or delayed
delivery purchase commitments until payment is made. At July 31, 1994, there
were no when issued or delayed delivery purchase commitments.

C. INVESTMENT INCOME -- Interest income is recorded on an accrual basis:
Facility fees received are recognized as income ratably over the expected life
of the loan. Market discounts are accreted over the stated life of each
applicable security.

D. ORGANIZATIONAL EXPENSES AND INITIAL REGISTRATION COSTS -- The Trust has
reimbursed Van Kampen Merritt Inc. ("Van Kampen Merritt") for costs incurred in
connection with the Trust's organization and its initial registration of the
common shares in the amount of $1,037,578. These costs are being amortized on a
straight line basis over the 60 month period ending October 4, 1994. The
Adviser has agreed that in the event any of the initial shares of the Trust
originally purchased by Van Kampen Merritt are redeemed during the amortization
period, the Trust will be reimbursed for any unamortized organizational
expenses and initial registration costs in the same proportion as the number of
shares redeemed bears to the number of initial shares held at the time of
redemption.

E. FEDERAL INCOME TAXES -- It is the Trust's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Therefore, no provision for federal income taxes is required.
The Trust intends to utilize provisions of the federal income tax laws
which allow it to carry a realized capital loss forward for eight years
following the year of loss and offset such losses against any future realized
capital gains. At July 31, 1994, the Trust had an accumulated capital loss
carryforward of $1,837,054 which will expire on July 31, 2002. Net realized
gains or losses may differ for financial and tax reporting purposes primarily
as a result of post October 31 losses which are not recognized for tax purposes
until the first day of the following fiscal year.

F. DISTRIBUTION OF INCOME AND GAINS -- The Trust declares daily and pays
monthly dividends from net investment income. Net realized gains, if any, are
distributed annually. Due to inherent differences in the recognition of
interest income under generally accepted accounting principles and federal
income tax purposes, for those securities which the Trust has placed on
non-accrual status, the amount of distributable net investment income may
differ between book and federal income tax purposes for a particular period.
These differences are temporary in nature, but may result in book basis
distributions in excess of net investment income for certain periods.

B-47
<PAGE> 98
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
July 31, 1994

2. INVESTMENT ADVISORY AGREEMENT AND OTHER AGREEMENTS
Under the terms of the Trust's Investment Advisory Agreement, the Adviser will
provide investment advice and facilities to the Trust for an annual fee payable
monthly of .95% of the average net assets of the Trust. In addition, the Trust
will pay a monthly administrative fee to Van Kampen Merritt, the Trust's
Administrator, at an annual rate of .25% of the average net assets of the
Trust. The administrative services to be provided by the Administrator include
monitoring the provisions of the loan agreements and any agreements with
respect to participations and assignments, record keeping responsibilities with
respect to interests in Variable Rate Senior Loans in the Trust's portfolio and
providing certain services to the holders of the Trust's securities.
Certain legal expenses are paid to Skadden, Arps, Slate, Meagher & Flom,
counsel to the Trust, of which a trustee of the Trust is an affiliated person.
Certain officers and trustees of the Trust are also officers and directors
of the Adviser and Van Kampen Merritt. The Trust does not compensate its
officers or trustees who are officers of the Adviser or Van Kampen Merritt.
For the year ended July 31, 1994, the Trust recognized expenses of
approximately $172,000 representing Van Kampen Merritt's or the Adviser's cost
of providing legal and certain shareholder services to the Trust.
At July 31, 1994, Van Kampen Merritt owned 14,329 shares of beneficial
interest of the Trust.

3. CAPITAL TRANSACTIONS
At July 31, 1994 and 1993, paid in surplus aggregated $1,223,140,759 and
$965,990,751, respectively.
Transactions in common shares were as follows:

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
JULY 31, 1994 JULY 31, 1993
- ------------------------------------------------------------------------------
<S> <C> <C>
Beginning Shares........................... 96,624,807 92,847,115
----------- -----------
Shares Sold................................ 35,430,303 13,600,794
Shares Issued Through Dividend
Reinvestment............................. 3,287,782 2,998,569
Shares Repurchased......................... (13,075,215) (12,821,671)
----------- -----------
Net Increase in Shares Outstanding......... 25,642,870 3,777,692
----------- -----------
Ending Shares.............................. 122,267,677 96,624,807
=========== ===========

</TABLE>

4. INVESTMENT TRANSACTIONS
Aggregate purchases and the cost of securities sold and repaid, excluding
short-term notes, for the year ended July 31, 1994, were $853,406,882 and
$624,697,296, respectively.

5. TENDER OF SHARES
The Board of Trustees currently intends, each quarter, to consider authorizing
the Trust to make tender offers for all or a portion of its then outstanding
common shares at the then net asset value of the common shares. For the year
ended July 31, 1994, 13,075,215 shares were tendered and repurchased by the
Trust.

6. EARLY WITHDRAWAL CHARGE
An early withdrawal charge to recover offering expenses will be imposed in
connection with most common shares held for less than five years which are
accepted by the Trust for repurchase pursuant to tender offers. The early
withdrawal charge will be imposed on the number of common shares accepted for
payment from a record holder of common shares, the value of which exceeds the
aggregate value at the time the tender is accepted of (a) all common shares
owned by such holder that were purchased more than five years prior to such
acceptance, (b) all common shares owned by such holder that were acquired
through dividend reinvestment and (c) the increase, if any, of value of all
other common shares owned by such holder (namely those purchased within the
five years preceding the acceptance) over the purchase price of such common
shares. The early withdrawal charge will be payable to Van Kampen Merritt. Any
early withdrawal charge which is required to be imposed will be made in
accordance with the following schedule.

<TABLE>
<CAPTION>
YEAR OF REPURCHASE WITHDRAWAL CHARGE
- -------------------------------------------------------------------------------
<S> <C>
First.................................................................. 3.0%
Second................................................................. 2.5%
Third.................................................................. 2.0%
Fourth................................................................. 1.5%
Fifth.................................................................. 1.0%
Sixth and following.................................................... 0.0%

</TABLE>

For the year ended July 31, 1994, Van Kampen Merritt received early
withdrawal charges of approximately $2,100,000 in connection with tendered
shares of the Trust.

7. COMMITMENTS
Pursuant to the terms of certain of the Variable Rate Senior Loan agreements,
the Trust had unfunded loan commitments of approximately $51,414,000 as of July
31, 1994.
The Trust has entered into revolving credit agreements with Morgan Guaranty
Trust Company of New York, Bank of America and State Street Bank and Trust
Company for up to $50,000,000, $25,000,000 and $25,000,000, respectively. The
proceeds of any borrowing by the Trust under the revolving credit agreements
may only be used, directly or indirectly, in connection with the consummation
of a tender offer by the Trust for its shares. Annual commitment fees ranging
from 1/4 to 3/8 of 1% will be charged on the unused portion of the credit
lines. Borrowings under these facilities will bear interest at either the
banks' prime rate or the Federal Funds rate plus 1/4 to 1/2 of 1%. There have
been no borrowings under these agreements to date.

B-48

<PAGE> 99
VAN KAMPEN MERRITT PRIME RATE INCOME TRUST

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
July 31, 1994

8. SENIOR LOAN PARTICIPATION COMMITMENTS
The Trust invests primarily in participations, assignments, or acts as a party
to the primary lending syndicate of a variable Rate Senior Loan interest to
United States corporations, partnerships, and other entities. When the Trust
purchases a participation of a Senior Loan interest, the Trust typically enters
into a contractual agreement with the lender or other third party selling the
participation, but not with the borrower directly. As such, the Trust assumes
the credit risk of the Borrower, Selling Participant or other persons
interpositioned between the Trust and the Borrower. Since the Trust invests in
participations where the third party is a financial institution, the Trust may
be considered to have a concentration of credit risk in the banking industry.
At July 31, 1994, the following sets forth the selling participants
with respect to interests in Senior Loans purchased by the Trust on a
participation basis.

<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
SELLING PARTICIPANT (000) VALUE
- ------------------- --------- -----
<S> <C> <C>
Bankers Trust . . . . . . . . . . . . . . . . . . $ 72,899 $ 73,171,344
National Westminster . . . . . . . . . . . . . . 9,697 9,567,455
Continental Bank . . . . . . . . . . . . . . . . 7,769 8,151,812
Chase Manhattan . . . . . . . . . . . . . . . . . 5,188 5,163,660
Canadian Imperial Bank of Commerce . . . . . . . 5,078 5,023,950
Chemical Bank . . . . . . . . . . . . . . . . . . 9,842 5,021,814
Banque Paribas . . . . . . . . . . . . . . . . . 4,638 4,618,833
FNB Canada . . . . . . . . . . . . . . . . . . . 3,613 3,608,121
Osterreichische Landerbank . . . . . . . . . . . 2,469 2,449,977
Union Bank . . . . . . . . . . . . . . . . . . . 446 444,264
--------- ------------
Totals . . . . . . . . . . . . . . . . . . . . . $ 121,639 $117,221,230
========= ============
</TABLE>

B-49
<PAGE> 100

PART C--OTHER INFORMATION

ITEM 1: MARKETING ARRANGEMENTS

See Exhibit h to this Registration Statement.

ITEM 2: OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

<TABLE>
<S> <C>
Securities and Exchange Commission fees..................... $484,693.05
National Association of Securities Dealers, Inc. fees....... $ 30,500.00
Printing and engraving expenses*............................ $ 70,000.00
Legal fees*................................................. $ 30,000.00
Accounting expenses*........................................ $ 3,000.00
Transfer agent and registrar fees*.......................... $236,728.06
Blue Sky filing fees and expenses*.......................... $ 10,000.00
Miscellaneous expenses*..................................... $ 78.89
-----------
Total........................................ $865,000.00
===========
---------------
* Estimates.
</TABLE>

ITEM 3: INDEMNIFICATION

Please see Article 5.3 of the Registrant's Amended and Restated Declaration
of Trust (Exhibit 1) for indemnification of officers and trustees. Registrant's
trustees and officers are also covered by an Errors and Omissions Policy.
Section 5 of the proposed Investment Advisory Agreement between the Fund and the
Adviser provides that in the absence of willful misfeasance, bad faith or gross
negligence in connection with the obligations or duties under the Investment
Advisory Agreement or on the part of the Adviser, the Adviser shall not be
liable to the Fund or to any Common Shareholder of the Fund for any act or
omission in the course of or connected in any way with rendering services or for
any losses that may be sustained in the purchase, holding or sale of any
security. The Distribution Agreement provides that the Registrant shall
indemnify the Distributor (as defined therein) and certain persons related
thereto for any loss or liability arising from any alleged misstatement of a
material fact (or alleged omission to state a material fact) contained in, among
other things, the Registration Statement or Prospectus except to the extent the
misstated fact or omission was made in reliance upon information provided by or
on behalf of the Distributor. (See Section 7 of the Distribution Agreement.)

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to trustees, officers and controlling persons of the
Registrant and the Adviser and any underwriter pursuant to the foregoing
provisions or otherwise, the Registrant has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in such Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a trustee, officer, or
controlling person or the Registrant and the principal underwriter in connection
with the successful defense of any action, suit or proceeding) is asserted
against the Registrant by such trustee, officer or controlling person or the
Distributor in connection with the Common Shares being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in such Act and will be governed by the final adjudication of such
issue.

C-1
<PAGE> 101

ITEM 4: FINANCIAL STATEMENTS AND EXHIBITS

(A) FINANCIAL STATEMENTS:

Part I:

(A) Portfolio of Investments as of January 31, 1995; Statement of
Assets and Liabilities as of January 31, 1995; Statement of
Operations for the six months ended January 31, 1995; Statement
of Changes in Net Assets for the six months ended January 31,
1995 and the year ended July 31, 1994; and Statement of Cash
Flows for the six months ended January 31, 1995 (Unaudited)

Notes to Unaudited Financial Statements

(B) Portfolio of Investments as of July 31, 1994; Statement of Assets
and Liabilities as of July 31, 1994; Statement of Operations
for the year ended July 31, 1994; Statement of Changes in Net
Assets for the fiscal years ended July 31, 1994 and 1993; and
Statement of Cash Flows for the year ended July 31, 1994
(Audited)

Notes to Financial Statements

Part II:

None.

(B) EXHIBITS

<TABLE>
<S> <C>
(a) Amended and Restated Declaration of Trust(1)
(b) By-laws(2)
(d) Specimen Certificate of Common Shares of Beneficial Interest of Registrant(1)
(g) Investment Advisory Agreement(3)
(h(1)) Offering Agreement(4)
(h(2)) Dealer Agreement(4)
(h(3)) Broker Agreement(4)
(h(4)) Bank Agreement(4)
(j(1)) Custodian Agreement(3)
(j(2)) Transfer Agency Agreement(3)
(k(1)) Administration Agreement(3)
(k(2)) Legal Services Agreement(3)
(k(3)) Support Services Agreement(3)
(l) Opinion and Consent of Skadden, Arps, Slate, Meagher & Flom(4)
(n) Consent of KPMG Peat Marwick LLP+
(p) Letter of Investment Intent(3)
(q) Model Retirement Plan(3)
Powers of Attorney(4)
(27) Financial Data Schedule+
</TABLE>

- ---------------

(1) Incorporated by reference to the Fund's Registration Statement on Form N-2,
File No. 33-30011, filed on September 27, 1989.

(2) Incorporated by reference to the Fund's Registration Statement on Form N-2,
File No. 33-30060, filed on July 21, 1989.

(3) Incorporated by reference to the Fund's Registration Statement on Form N-2,
File Nos. 33-81076, 811-5845, filed on July 1, 1994.

(4) Incorporated by reference to the Fund's Registration Statement on Form N-2,
File No. 33-87032, 811-5845 filed on December 5, 1994.

+ Filed herewith

ITEM 5: PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT

Not applicable

C-2
<PAGE> 102

ITEM 6: NUMBER OF HOLDERS OF SECURITIES

At March 10, 1995

<TABLE>
<CAPTION>
TITLE OF CLASS NUMBER OF RECORD HOLDERS
--------------------------------------------------- ------------------------
<S> <C>
Common Shares of Beneficial Interest, par value
$.01 per share................................... 83,782
</TABLE>

ITEM 7: LOCATION OF ACCOUNTS AND RECORDS

All accounts, books and other documents required by Section 31(a) of the
Investment Company Act of 1940 and the Rules thereunder to be maintained (i) by
Registrant will be maintained at its offices, located at One Parkview Plaza,
Oakbrook Terrace, Illinois 60181 or at the State Street Bank and Trust Company,
1776 Heritage Drive, North Quincy, Massachusetts; (ii) by the Adviser, will be
maintained at its offices, located at One Parkview Plaza, Oakbrook Terrace,
Illinois 60181; and (iii) all such accounts, books and other documents required
to be maintained by the principal underwriter will be maintained by Van Kampen
American Capital Distributors, Inc., at One Parkview Plaza, Oakbrook Terrace,
Illinois 60181.

ITEM 8: BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER

For information as to the business, profession, vocation or employment of a
substantial nature of each of the officers and directors of the Adviser,
reference is made to the Adviser's current Form ADV (File No. 801-18161) filed
under the Investment Advisers Act of 1940, as amended, incorporated herein by
reference.

ITEM 9: MANAGEMENT SERVICES

Not applicable

ITEM 10: UNDERTAKINGS

1. Registrant undertakes to suspend offering of its Common Shares until it
amends its prospectus if (1) subsequent to the effective date of its
Registration Statement, the net asset value declines more than 10 percent from
its net asset value as of the effective date of the Registration Statement, or
(2) the net asset value increases to an amount greater than its net proceeds as
stated in the prospectus.

2. Not applicable

3. Not applicable

4. (1) to file during any period in which offers or sales are being made, a
post-effective amendment to this registration statement: (i) to include any
prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) to
reflect in the Prospectus any facts or events arising after the effective date
of the registration statement (or the most recent post-effective amendment
thereof) which, individually or in the aggregate, represent a fundamental change
in the information set forth in the registration statement; and (iii) to include
any material information with respect to the plan of distribution not previously
disclosed in the registration statement or any material change to such
information in the registration statement; (2) that, for the purpose of
determining any liability under the Securities Act of 1933, each such
post-effective amendment shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof; and
(3) To remove from registration by means of post-effective amendment any of the
securities being registered which remain unsold at the termination of the
offering.

5. If applicable:

(a) For purpose of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of a registration statement in reliance upon Rule 430A and contained in the
form of prospectus filed by the Registrant pursuant to Rule 497(h) under
the Securities Act of 1933, shall be deemed to be part of this Registration
Statement as of the time it was declared effective.

(b) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration

C-3
<PAGE> 103

statement relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial bona fide
offering thereof.

6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, its Statement of Additional Information.

C-4
<PAGE> 104

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933 AND THE
INVESTMENT COMPANY ACT OF 1940, THE REGISTRANT HAS DULY CAUSED THIS REGISTRATION
STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THERETO DULY AUTHORIZED
IN THE CITY OF OAKBROOK TERRACE, AND THE STATE OF ILLINOIS, ON THE 23RD DAY OF
MARCH, 1995.

VAN KAMPEN MERRITT
PRIME RATE INCOME TRUST

By: /s/ RONALD A. NYBERG
Ronald A. Nyberg
Vice President and Secretary

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED ON MARCH 23, 1995 BY THE FOLLOWING
PERSONS IN THE CAPACITIES INDICATED:

<TABLE>
<CAPTION>
SIGNATURES TITLE
- --------------------------------------------- -----------------------------------------------
<S> <C>

- --------------------------------------------- Chairman and Trustee
Don G. Powell

/s/ DENNIS J. McDONNELL* President (Chief Executive Officer) and Trustee
- ---------------------------------------------
Dennis J. McDonnell

/s/ THEODORE A. MYERS* Trustee
- ---------------------------------------------
Theodore A. Myers

/s/ ROD DAMMEYER* Trustee
- ---------------------------------------------
Rod Dammeyer

/s/ DAVID C. ARCH* Trustee
- ---------------------------------------------
David C. Arch

/s/ HUGO F. SONNENSCHEIN Trustee
- ---------------------------------------------
Hugo F. Sonnenschein

/s/ HOWARD J KERR Trustee
- ---------------------------------------------
Howard J Kerr

/s/ WAYNE W. WHALEN* Trustee
- ---------------------------------------------
Wayne W. Whalen

/s/ EDWARD C. WOOD, III* Vice President and Treasurer
- --------------------------------------------- (Chief Financial Officer and Accounting
Edward C. Wood, III Officer)

/s/ RONALD A. NYBERG
- ---------------------------------------------
Ronald A. Nyberg
Attorney-in-Fact
</TABLE>

March 23, 1995

* Signed by Ronald A. Nyberg pursuant to a Power of Attorney, a copy of which
was previously filed.

C-5
<PAGE> 105

EXHIBIT INDEX

<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBIT PAGE
- -------- --------------------------------------------------------------------- -----------
<S> <C> <C>
(a) Amended and Restated Declaration of Trust(1).........................
(b) By-laws(2)...........................................................
(d) Specimen Certificate of Common Shares of Beneficial Interest of
Registrant(1)........................................................
(g) Investment Advisory Agreement(3).....................................
(h(1)) Offering Agreement(4)................................................
(h(2)) Dealer Agreement(4)..................................................
(h(3)) Broker Agreement(4)..................................................
(h(4)) Bank Agreement(4)....................................................
(j(1)) Custodian Agreement(3)...............................................
(j(2)) Transfer Agency Agreement(3).........................................
(k(1)) Administration Agreement(3)..........................................
(k(2)) Legal Services Agreement(3)..........................................
(k(3)) Support Services Agreement(3)........................................
(l) Opinion and Consent of Skadden, Arps, Slate, Meagher & Flom(4).......
(n) Consent of KPMG Peat Marwick LLP+....................................
(p) Letter of Investment Intent(3).......................................
(q) Model Retirement Plan(3).............................................
Powers of Attorney(4)................................................
(27) Financial Data Schedule+
</TABLE>

- ---------------

(1) Incorporated by reference to the Fund's Registration Statement on Form N-2,
File No. 33-30011, filed on September 27, 1989.

(2) Incorporated by reference to the Fund's Registration Statement on Form N-2,
File No. 33-30060, filed on July 21, 1989.

(3) Incorporated by reference to the Fund's Registration Statement on Form N-2,
File Nos. 33-81076, 811-5845, filed on July 1, 1994.

(4) Incorporated by reference to Fund's Registration Statement on Form N-2, File
Nos. 33-87032, 811-5845, filed on December 5, 1994.

+ Filed herewith.

<PAGE> 1
EXHIBIT (n)

[KPMG PEAT MARWICK LLP LETTERHEAD]

CONSENT OF INDEPENDENT AUDITORS

The Board of Trustees and Shareholders
Van Kampen Merritt Prime Rate Income Trust:

We consent to the use of our report included in the Statement of Additional
Information which is incorporated by reference into the Prospectus and to the
reference to our Firm under the headings "Financial Highlights" and "Experts"
in the Prospectus.

/s/ KPMG Peat Marwick LLP
KPMG PEAT MARWICK LLP

Chicago, Illinois
April 5, 1995

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUL-31-1994
<PERIOD-END> JUL-31-1994
<INVESTMENTS-AT-COST> 1,206,255,251
<INVESTMENTS-AT-VALUE> 1,212,784,770
<RECEIVABLES> 25,525,758
<ASSETS-OTHER> 266,311
<OTHER-ITEMS-ASSETS> 2,518,061
<TOTAL-ASSETS> 1,241,094,900
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 12,091,120
<TOTAL-LIABILITIES> 12,091,120
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 1,224,363,436
<SHARES-COMMON-STOCK> 122,267,677
<SHARES-COMMON-PRIOR> 96,624,807
<ACCUMULATED-NII-CURRENT> 3,388,421
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (5,277,596)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 6,529,519
<NET-ASSETS> 1,229,003,780
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 65,525,573
<OTHER-INCOME> 14,779,012
<EXPENSES-NET> 15,970,621
<NET-INVESTMENT-INCOME> 64,333,964
<REALIZED-GAINS-CURRENT> (1,392,765)
<APPREC-INCREASE-CURRENT> 2,441,749
<NET-CHANGE-FROM-OPS> 65,382,948
<EQUALIZATION> 0
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<PER-SHARE-NAV-BEGIN> 10.004
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</TABLE>