PAGE 1
Prospectus for the T. Rowe Price U.S. Treasury Funds, Inc., dated July 1,
1994, should be inserted here.
<PAGE>
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U.S. TREASURY
FUNDS
PROSPECTUS
JULY 1, 1994
T. ROWE PRICE
U.S. TREASURY FUNDS, INC.
TABLE OF CONTENTS
FUND INFORMATION
Investment Objectives and Programs...........................................2
Summary of Funds' Fees and Expenses..........................................3
Financial Highlights.........................................................4
Investment Policies..........................................................5
Performance Information......................................................7
Capital Stock................................................................8
Debt Securities..............................................................9
NAV, Pricing, and Effective Date............................................10
Receiving Your Proceeds.....................................................10
Dividends and Distributions.................................................11
Taxes.......................................................................11
Management of the Fund......................................................12
Expenses and Management Fee.................................................12
HOW TO INVEST
Shareholder Services........................................................13
Conditions of Your Purchase.................................................14
Completing the New Account Form.............................................16
Opening a New Account.......................................................16
Purchasing Additional Shares................................................17
Exchanging and Redeeming Shares.............................................18
INVESTMENT SUMMARY
The Funds invest in securities backed by the full faith and credit of the U.S.
Government, primarily U.S. Treasury securities. The Intermediate and Long-Term
Funds may also make other investments collateralized by such securities. The
Funds are designed for investors seeking the highest level of current income
with minimum credit risk. YOUR INVESTMENT IN THE FUNDS IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT, AND THERE IS NO ASSURANCE THE MONEY FUND
WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
The three U.S. Treasury Funds differ in average portfolio maturity, which
affects the level of income and degree of share price fluctuation. Generally,
the longer the maturity, the greater the volatility in response to interest
rate changes, and the higher the yield. The Funds' dividends earned from U.S.
Treasury securities are exempt from state and local taxes in most states.
U.S. TREASURY MONEY FUND[registered trademark] will have an average maturity
of no more than 90 days. It is a money market fund which seeks to maintain a
stable share price of $1.00.
U.S. TREASURY INTERMEDIATE FUND is generally expected to have an average
maturity ranging between three and seven years. The Fund is generally expected
to provide a higher income than the Money Fund and have less price volatility
than the Long-Term Fund.
U.S. TREASURY LONG-TERM FUND is generally expected to have an average maturity
of 15 to 20 years, resulting in the highest potential level of income and the
greatest share price fluctuation.
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T. ROWE PRICE
100% No Load. The Funds have no sales charges, no redemption fees, and no
12b-1 fees. 100% of your investment is credited to your account.
Services. T. Rowe Price provides easy access to your money through
checkwriting, bank wires, or telephone redemptions and offers easy exchange to
other T. Rowe Price Funds.
T. Rowe Price Associates, Inc. (T. Rowe Price) was founded in 1937 by the late
Thomas Rowe Price, Jr. As of February 28, 1994, the firm and its affiliates
managed over $54 billion for approximately three million individual and
institutional investors.
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This prospectus contains information you should know about the Funds before
you invest. PLEASE KEEP IT FOR FUTURE REFERENCE. A Statement of Additional
Information for the Funds (dated July 1, 1994) has been filed with the
Securities and Exchange Commission and is incorporated by reference in this
prospectus. It is available at no charge by calling: 1-800-638-5660.
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.
<PAGE>
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INVESTMENT
OBJECTIVES
AND PROGRAMS
SUMMARY OF
PROGRAMS
The following table summarizes the expected differences among these Funds.
Share price Expected
Fund Yield fluctuation (NAV) average maturity
- ------------------------------------------------------------
Money Low Stable No more than 90 days
- ------------------------------------------------------------
Intermediate Moderate Moderate 3-7 years
- ------------------------------------------------------------
Long-Term High Highest 15-20 years
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U.S. TREASURY MONEY FUND. The Fund's investment objectives are to seek to
maximize safety of capital, liquidity, and, consistent with these objectives,
the highest available current income. As a matter of fundamental policy, the
Fund will invest at least 80% of its total assets in U.S. Treasury securities
and repurchase agreements thereon. However, as an operating policy, the Fund
has decided not to invest in repurchase agreements. The Fund may also invest
in other securities directly guaranteed by the U.S. Government. The Fund
invests primarily in securities which mature in 13 months or less, although
the Fund may also purchase U.S. government securities which mature in 25
months or less. The weighted average portfolio maturity will not be greater
than 90 days. The policy of the Fund is to maintain a stable share price of
$1.00 and the Fund's manager makes every effort to continue to meet this
objective. However, the constant share price is not guaranteed or insured, by
the U.S. Government and could fall below $1.00 under certain circumstances,
for example, as a result of a major change in interest rates.
U.S. TREASURY INTERMEDIATE FUND. The Fund's investment objective is to seek a
high level of current income consistent with maximum credit protection and
moderate price fluctuation. The weighted average portfolio maturity for the
Fund may range between three to seven years; however, no individual security
will have an effective remaining maturity of more than seven and one-half
years from the time of purchase. The Fund will invest at least 85% of its
assets in U.S. Treasury securities and repurchase agreements thereon. The
remaining assets of the Fund will be invested in other securities backed by
the full faith and credit of the U.S. Government and repurchase agreements
thereon. Share price fluctuation and yield are expected to be greater than for
the Money Fund but lower than for the Long-Term Fund.
U.S. TREASURY LONG-TERM FUND. The Fund's investment objective is to seek the
highest level of current income consistent with maximum credit protection. The
weighted average portfolio maturity for the Fund may range from ten to thirty
years. It will invest at least 85% of its assets in U.S. Treasury securities
and repurchase agreements thereon. The remaining assets of the Fund will be
invested in other securities backed by the full faith and credit of the U.S.
Government and repurchase agreements thereon. Of the three Treasury Funds,
this Fund is expected to have the highest potential income and the greatest
share price fluctuation.
All of the Funds invest in securities backed by the full faith and credit
of the U.S. Government, primarily U.S. Treasury securities. The Intermediate
and Long-Term Funds may also invest in other investments collateralized by
such securities. The yield of each Fund will fluctuate with changes in overall
interest rate levels. Although payment of interest and principal on securities
backed by the full faith and credit of the U.S. Government is guaranteed by
the U.S. Government, the share price of the Intermediate and Long-Term Funds
will fluctuate with changing market conditions and your investment may be
worth more or less when redeemed than when purchased. The Funds should not be
relied upon as complete investment programs, nor used to play short-term
swings in the bond market. The Funds cannot guarantee they will achieve their
objectives.
<PAGE>
Monthly dividends paid by the Funds from income earned on U.S. Treasury
securities are exempt from state and local taxes in most states. Dividends
derived from the Funds' other investments may not be exempt from such taxes.
Please see INVESTMENT POLICIES for a more complete description of the
Funds' investments.
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SUMMARY OF
FUNDS' FEES
AND EXPENSES
THE FUNDS ARE IS 100% NO-LOAD . . . you pay no fees to purchase, exchange or
redeem shares, nor any ongoing marketing (12b-1) expenses. Lower expenses
benefit you by increasing your investment return from a Fund.
Shown below are ALL expenses and fees each Fund incurred during its 1994
fiscal year. Where applicable, expenses were restated to reflect current fees.
Expenses are expressed as a percent of fiscal 1994 average Fund net assets.
Organizational expenses of the Intermediate and Long-Term Funds will be
charged to each Fund's operations over a period not to exceed 60 months. More
information about these expenses may be found below and under EXPENSES AND
MANAGEMENT FEE and in the Statement of Additional Information under MANAGEMENT
FEE AND LIMITATION ON FUND EXPENSES.
<TABLE>
<CAPTION>
Money Intermediate Long-Term
----- ------------- ---------------------
<S> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
Sales load "charge" on purchases NONE NONE NONE
Sales load "charge" on reinvested dividends NONE NONE NONE
Redemption fees NONE NONE NONE
Exchange fees NONE NONE NONE
ANNUAL FUND EXPENSES
Management fee (after reduction) 0.35% 0.44%[dagger] 0.30%[dagger][dagger]
Total other (Shareholder servicing,
custodial, auditing, etc.)
[dagger][dagger][dagger] 0.29% 0.35% 0.50%
NONE NONE NONE
Distribution fees (12b-1) ----- ------------- ---------------------
TOTAL FUND EXPENSES 0.64% 0.79%[dagger] 0.80%[dagger][dagger]
</TABLE>
[dagger] The Intermediate Fund's management fee presented
includes 0.04% of management fees repaid from prior
years pursuant to the expense limitation. The Fund's
managment fee and its total expense ratio would have
been 0.40% and 0.75%, respectively, without this
repayment.
[dagger][dagger] The Long-Term Fund's management fee and total expense
ratio of the Long-Term Fund would have been 0.50% and
1.37%, respectively, had T. Rowe Price not agreed to
reduce management fees and assume other expenses as a
result of the expense limitation.
[dagger][dagger][dagger] The Funds charge a $5.00 fee for wire redemptions
under $5,000, subject to change without notice.
Example of
Fund expenses.
The following example illustrates the expenses you would incur on a $1,000
investment, assuming a 5% annual rate of return and redemption at the end of
each period shown. For example, expenses for the first year in the Money Fund
would be $7. THIS IS AN ILLUSTRATION ONLY. Actual expenses and performance may
be more or less than shown.
Fund 1 Year 3 Years 5 Years 10 Years
- ------------ ------ ------- ------- --------
Money $7 $20 $36 $80
Intermediate $8 $25 $44 $98
Long-Term $8 $26 $44 $99
<PAGE>
MANAGEMENT FEE. The Intermediate and Long-Term Funds pay T. Rowe Price an
investment management fee consisting of a flat Individual Fund Fee of 0.05% of
each Fund's net assets and a Group Fee, defined on page 12 under EXPENSES AND
MANAGEMENT FEE, of 0.34% as of February 28, 1994. The Money Fund pays T. Rowe
Price a Group Fee of 0.34% only. Thus, the total combined management fee based
on net assets for the Money Fund would be 0.34% and 0.39% each for the
Intermediate and Long-Term Funds.
Effective March 1, 1991, T. Rowe Price agreed to extend the Intermediate
and Long-Term Funds' 0.80% expense limitation for a period of two years
through February 28, 1993. Effective March 1, 1993, T. Rowe Price agreed to
extend the Intermediate and Long-Term Funds' 0.80% expense limitation for a
period of two years through February 28, 1995. Expenses paid or assumed under
each agreement are subject to reimbursement to T. Rowe Price by the Funds
whenever a Fund's expense ratio is below 0.80%; however, no reimbursement will
be made after February 28, 1995 (for the first agreement) or February 28, 1997
(for the second agreement), or if it would result in the expense ratio
exceeding 0.80% for either Fund.
TRANSFER AGENT, SHAREHOLDER SERVICING, AND ADMINISTRATIVE COSTS. The Fund paid
fees to: (i) T. Rowe Price Services, Inc. (TRP Services) for transfer and
dividend disbursing agent functions and shareholder services for all accounts;
(ii) T. Rowe Price Retirement Plan Services, Inc. for subaccounting and
recordkeeping services for certain retirement accounts; and (iii) T. Rowe
Price for calculating the daily share price and maintaining the portfolio and
general accounting records of each Fund. For the fiscal year ended February
28, 1994, the approximate fees are set forth in the following chart:
Subaccounting
Fund Transfer Agent Services Accounting
- ------------ -------------- ------------- ----------
Money $256,000 $727,000 $60,000
Intermediate $111,000 $121,000 $60,000
Long-Term $61,000 $14,000 $60,000
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FINANCIAL
HIGHLIGHTS
The following table provides information about each Fund's financial history.
It is based on a single share outstanding throughout each fiscal year (which
ends on the last day of February). The respective table is part of each Fund's
financial statements which are included in the Funds' annual report and
incorporated by reference into the Statement of Additional Information, which
is available to shareholders. The financial statements in the annual report
have been audited by the Funds' independent accountants whose respective
unqualified reports cover the periods shown.
<PAGE>
<TABLE>
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<CAPTION>
Investment Activities Distributions End of Period
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Net
Real- Ratio
ized of Net
NET and Total Ratio Invest-
ASSET Unreal- TOTAL Return of ment
VALUE, ized FROM NET (Includes Net Expenses Income Port-
BEGIN- Net Gain INVEST- Net Net TOTAL ASSET Rein- Assets to to folio
Year NING Invest- (Loss) on MENT Invest- Real- DIS- VALUE, vested (in Average Average Turn-
Ended, OF ment Invest- ACTIVI- ment ized TRIBU- END OF Divi- thou- Net Net over
February 28 PERIOD Income ments TIES Income Gain TIONS PERIOD dends) sands) Assets Assets Rate
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
MONEY FUND
1985 $1.000 $.091 - $.091 $(.091) - $(.091) $1.000 9.4% $153,601 0.94% 9.10% -
1986 1.000 .069 - .069 (.069) - (.069) 1.000 7.1% 155,427 1.04% 6.89% -
1987 1.000 .053 - .053 (.053) - (.053) 1.000 5.4% 169,449 1.11% 5.26% -
1988! 1.000 .054 - .054 (.054) - (.054) 1.000 5.6% 259,618 1.01% 5.49% -
1989 1.000 .066 - .066 (.066) - (.066) 1.000 6.8% 290,527 0.88% 6.65% -
1990 1.000 .080 - .080 (.080) - (.080) 1.000 8.3% 361,013 0.85% 7.95% -
1991 1.000 .070 - .070 (.070) - (.070) 1.000 7.2% 578,362 0.75% 6.91% -
1992! 1.000 .049 - .049 (.049) - (.049) 1.000 5.1% 562,664 0.68% 4.93% -
1993 1.000 .029 - .029 (.029) - (.029) 1.000 3.0% 606,153 0.65% 2.92% -
1994 1.000 .025 - .025 (.025) - (.025) 1.000 2.5% 613,583 0.64% 2.48% -
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INTERMEDIATE FUND
1990 $5.00 $.17 $(.02) $.15 $(.17) - $(.17) $4.98 2.9% $10,917 0.80% 8.13% 194.6%
[dagger] [dagger] [dagger]
[dagger] [dagger]
1991 4.98 .40 .12 .52 (.40) - (.40) 5.10 10.9% 68,341 0.80% 7.71% 174.8%
[dagger] [dagger]
[dagger] [dagger]
1992! 5.10 .36 .21 .57 (.36) $(.03) (.39) 5.28 11.5% 123,807 0.80% 6.80% 91.4%
[dagger] [dagger]
[dagger] [dagger]
1993 5.28 .32 .27 .59 (.32) (.13) (.45) 5.42 11.8% 163,480 0.80% 5.98% 22.8%
1994 5.42 .29 (.09) .20 (.29) (.01) (.30) 5.32 3.8% 175,953 0.79% 5.41% 20.2%
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LONG-TERM FUND
1990 $10.00 $.35 $(.21) $.14 $(.35) - $(.35) $9.79 1.2% $11,204 0.80% 8.23% 316.1%
[dagger] [dagger] [dagger]
[dagger] [dagger]
1991 9.79 .80 .24 1.04 (.80) - (.80) 10.03 11.2% 43,260 0.80% 8.01% 158.5%
[dagger] [dagger]
[dagger] [dagger]
1992! 10.03 .78 .36 1.14 (.78) - (.78) 10.39 11.9% 52,926 0.80% 7.66% 162.4%
[dagger] [dagger]
[dagger] [dagger]
1993 10.39 .70 .68 1.38 (.70) $(.28) (.98) 10.79 14.1% 64,685 0.80% 6.75% 165.4%
[dagger] [dagger]
[dagger] [dagger]
1994 10.79 .68 (.04) .64 (.68) (.29) (.97) 10.46 5.9% 56,632 0.80% 6.17% 59.4%
[dagger] [dagger]
[dagger] [dagger]
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
! Year ended February 29.
[dagger] For the period September 29, 1989 (commencement of
operations) to February 28, 1990.
[dagger][dagger] Excludes expenses in excess of a 0.80% voluntary expense
limitation in effect through February 28, 1995.
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INVESTMENT
POLICIES
Each Fund's investment program and policies are subject to further
restrictions and risks which are described in the Statement of Additional
Information. The Funds will not make a material change in their investment
objectives or their fundamental policies without obtaining shareholder
approval. The Money Fund's investment objective is a fundamental policy,
however, the investment programs of all of the Funds, unless otherwise
specified, are not fundamental policies and may be changed without shareholder
approval. Shareholders will be notified of any material change in the
investment programs. The Funds adhere to applicable investment restrictions
and policies at the time they make an investment. A later change in
circumstances will not require the sale of an investment if it was proper at
the time it was made. The Funds' investments may include, but are not limited
to, those described below.
CASH RESERVES (INTERMEDIATE AND LONG-TERM FUNDS). Each Fund will hold a
portion of its assets in short-term money market securities maturing in one
year or less. The reserve position serves three principal purposes: first, it
provides flexibility in meeting redemptions, expenses, and the timing of new
investments, second, it can aid in structuring the Fund's weighted average
maturity, and third, it can serve as a short-term defense during periods of
unusual market volatility. Each Fund's investments in cash reserves will be
consistent with its investment objective and program and the quality standards
of the Fund.
<PAGE>
LENDING OF PORTFOLIO SECURITIES. As a fundamental policy, for the purpose of
realizing additional income, each Fund may lend securities with a value of up
to 33 1/3% of its total assets to broker-dealers, institutional investors, or
other persons. Any such loan will be continuously secured by collateral at
least equal to the value of the security loaned. Such lending could result in
delays in receiving additional collateral or in the recovery of the securities
or possible loss of rights in the collateral should the borrower fail
financially.
OTHER SECURITIES BACKED BY FULL FAITH AND CREDIT. These include, but are not
limited to, securities issued by the Government National Mortgage Association
(GNMA), General Services Administration, and Farmers Home Administration. No
more than 20% of the Money Fund's total assets and no more than 15% of each of
the Intermediate and Long-Term Funds' total assets will be maintained in this
category.
The Funds' investments in GNMA mortgage securities will result in the
Funds receiving scheduled and unscheduled payments of principal (representing
payments on the underlying mortgages). Interest rates prevailing at the time
the Funds reinvest these amounts may be higher or lower than the Funds'
current yields at the time. In addition, as interest rates decline, these
securities will have less potential for capital appreciation due to the effect
of prepayments. Unscheduled prepayments on mortgage securities purchased at a
premium will cause such securities to be paid off at par, resulting in a loss
to the Funds. The Intermediate and Long-Term Funds may also invest in the
following types of mortgage securities:
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS). The Funds may invest in CMOs
which are obligations fully collateralized by a portfolio of mortgages or
mortgage-related securities. Depending on the type of CMOs in which the
Fund invests, the investment may be subject to a greater or lesser risk of
prepayment than other types of mortgage-related securities. CMO securities
may pay fixed or variable rates of interest. Variable rate securities may
be structured to adjust inversely with and more rapidly than short-term
interest rates. As a result, the market value of such securities tends to
be more volatile than other CMO securities the Funds may buy
GNMA STRIPPED CERTIFICATES. The Funds may invest in stripped mortgage
certificates issued and serviced by GNMA. These instruments are structured
so that all interest and no principal are paid on an Interest Only or "IO"
portion, while principal is paid to the Principal Only or "PO" holders.
"IOs" and "POs" can be extremely volatile and are likely to demonstrate
acute sensitivity to fluctuations in interest rates and prepayment rates.
The Funds could use the "IO" portion as a hedge against falling prepayment
rates and/or bear market conditions. Conversely, POs could be used as a
hedge against rising prepayment rates and/or a bull market environment.
There is, of course, no guarantee the Funds' use of these investments will
be successful and the Funds' total return could be adversely affected as a
result.
REPURCHASE AGREEMENTS (INTERMEDIATE AND LONG-TERM FUNDS). The Funds may enter
into repurchase agreements with a well-established securities dealer or a bank
which is a member of the Federal Reserve System. In the event of a bankruptcy
or default of certain sellers of repurchase agreements, the Funds could
experience costs and delays in liquidating the underlying security, which is
held as collateral, and the Funds might incur a loss if the value of the
collateral held declines during this period.
<PAGE>
WHEN-ISSUED SECURITIES (INTERMEDIATE AND LONG-TERM FUNDS). The Funds may
purchase securities on a when-issued or delayed delivery basis. When such
transactions are negotiated, the price is fixed at the time of the commitment,
but delivery and payment for the securities can take place a month or more
after the date of the commitment to purchase. The securities so purchased or
sold are subject to market fluctuations, and no interest accrues to the
purchaser during this period. At the time of delivery of the securities, their
value may be more or less than the purchase or sale price.
PORTFOLIO MANAGEMENT (MONEY FUND). To meet the Money Fund's objective of a
stable net asset value per share, T. Rowe Price will follow an investment
management approach whose key elements are prudent maturity structuring and
the elimination of credit risk. Average portfolio maturity will be managed
according to the Fund's outlook for short-term interest rates. During periods
of rising rates, a shorter average maturity may be expected, while a longer
maturity may be more appropriate when rates are falling. Typically, securities
will be bought and held until maturity, although opportunities to enhance
returns, significant changes in the investment environment, and other factors
may result in the sale of securities prior to their maturity.
PORTFOLIO TURNOVER (INTERMEDIATE AND LONG-TERM FUNDS). The Funds will not
generally trade in securities for short-term profits but, when circumstances
warrant, securities may be purchased and sold without regard to the length of
time held. As a result of their higher portfolio turnover rates, the Funds may
incur higher transaction costs and, to the extent of additional short-term
capital gains, greater taxable income than mutual funds with less aggressive
trading strategies. The following chart sets forth each Fund's portfolio
turnover rates for the fiscal years ended February 28, 1994, February 28,
1993, and February 29, 1992.
Fund 1994 1993 1992
------------ ----- ------ ------
Intermediate 20.2% 22.8% 91.4%
Long-Term 59.4% 165.4% 162.4%
FUNDAMENTAL INVESTMENT POLICIES. As a matter of fundamental policy, the Funds
will not, among other things, borrow money except for temporary non-leveraging
purposes from banks in amounts not exceeding 33 1/3% of its total assets to
facilitate redemption requests, or for emergency, administrative or other
proper purposes.
OTHER INVESTMENT POLICIES. As a matter of operating policy, the Funds will
not, among other things: (1) in any manner transfer as collateral for
indebtedness any securities owned by a Fund except in connection with
permissible borrowings or investments, but no such transfer will exceed 33
1/3% of a Fund's total assets, and (2) purchase additional securities when
money borrowed exceeds 5% of a Fund's total assets.
- ---------------------------------
PERFORMANCE
INFORMATION
TOTAL RETURN. (INTERMEDIATE AND LONG-TERM FUNDS). The Funds may advertise
total return figures on both a cumulative and compound average annual basis
and compare them to various indices (e.g., the S&P 500), other mutual funds or
other performance measures. Cumulative total return compares the amount
invested at the beginning of a period with the amount redeemed at the end of
the period, assuming the reinvestment of all dividends and capital gain
distributions. The compound average annual total return indicates a yearly
compound average of each Fund's performance, derived from the cumulative total
return. The annual compound rate of return for each Fund may vary from any
average. Further information about the Funds' performance is contained in
their annual report which is available free of charge.
<PAGE>
YIELD. From time to time, the Money Fund may advertise its "current yield" and
"effective yield." The "current yield" of the Fund refers to the annualized
income generated by an investment in the Fund over a seven-day period. The
"effective yield" is calculated similarly but, when annualized, the income
earned by an investment in the Fund is assumed to be reinvested. The
"effective yield" will be slightly higher than the "current yield" because of
the compounding effect of this assumed reinvestment.
The Intermediate and Long-Term Funds may advertise a yield figure derived
by dividing each Fund's net investment income per share (as defined by
applicable SEC regulations) during a 30-day base period by the per-share price
on the last day of the base period.
- ------------------------------------------------------------------------------
CAPITAL STOCK
The T. Rowe Price U.S. Treasury Funds, Inc. (the Corporation) is a Maryland
corporation organized in 1989. The T. Rowe Price U.S. Treasury Money Fund,
Inc. (Money Fund) was originally organized in 1982 as a Maryland corporation.
Effective July 1, 1990, the Money Fund was converted to a series of the
Corporation. Each series of the Corporation is registered with the Securities
and Exchange Commission under the Investment Company Act of 1940 as a
diversified, open-end investment company, commonly known as a "mutual fund."
Mutual funds, such as these, enable shareholders to: (1) obtain professional
management of investments, including T. Rowe Price's proprietary research; (2)
diversify their portfolio to a greater degree than would be generally possible
if they were investing as individuals and thereby reduce, but not eliminate
risks; and (3) simplify the recordkeeping and reduce transaction costs
associated with investments.
Currently, the Corporation consists of three series, the U.S. Treasury
Money Fund, U.S. Treasury Intermediate Fund and U.S. Treasury Long-Term Fund,
each of which represents a separate class of shares and has different
objectives and investment policies. The Corporation's Charter provides that
the Board of Directors may issue additional series of shares and/or additional
classes of shares for each series.
The Funds each have an Investment Advisory Committee composed of the
following members: Intermediate Fund---Charles P. Smith, Chairman, Robert P.
Campbell, Veena A. Kutler, Heather R. Landon, Edmund M. Notzon, Thomas E.
Tewksbury, and Peter Van Dyke; Long-Term Fund---Peter Van Dyke, Chairman,
Heather R. Landon, Edmund M. Notzon, Charles P. Smith, Thomas E. Tewksbury,
and Edward A. Wiese; Money Fund---Edward A. Wiese, Chairman, Patrice L.
Berchtenbreiter, Paul W. Boltz, Brian E. Burns, Robert P. Campbell, Laura L.
McAree, James M. McDonald, Joan R. Potee and Robert M. Rubino. The Committee
Chairman has day-to-day responsibility for managing a Fund and works with the
Committee in developing and executing the Fund's investment program. Mr. Smith
has been Chairman of the Intermediate Fund's Committee since 1990. He joined
T. Rowe Price in 1972 and has been managing investments since 1975. Mr. Van
Dyke has been Chairman of the Long-Term Fund's Committee since 1990. He has
been managing investments since joining T. Rowe Price in 1985. Mr. Wiese has
been Chairman of the Money Fund's Committee since 1990. He joined T. Rowe
Price in 1984 and has been managing investments since 1985.
SHAREHOLDER RIGHTS. All shares of the Corporation have equal rights with
regard to voting, redemptions, dividends, distributions, and liquidations.
Fractional shares have voting rights and participate in any distributions and
dividends. Shareholders have no preemptive or conversion rights; nor do they
have cumulative voting rights. When shares are issued, they are fully paid and
nonassessable. All shares of the Corporation may be voted in the election or
removal of directors and on other matters submitted to the vote of
shareholders of the Corporation. On matters affecting an individual series of
the Corporation, a separate vote of the particular series is required. The
individual series of the Corporation do not routinely hold annual meetings of
shareholders. However, if shareholders representing at least 10% of all votes
of the Corporation entitled to be cast so desire, they may call a special
meeting of shareholders of the Corporation for the purpose of voting on the
question of the removal of any director(s). The total authorized capital stock
of the Corporation consists of 1,000,000,000 shares, each having a par value
of $.01. As of February 28, 1994, there were 18,710 shareholders in the Money
Fund, 6,771 shareholders in the Intermediate Fund, 3,049 shareholders in the
Long-Term Fund and a total of 3,244,324 shareholders in the other 52 T. Rowe
Price Funds.
<PAGE>
- ------------------------------------------------------------------------------
DEBT
SECURITIES
TOTAL RETURN COMPONENTS. Since the Money Fund is managed to maintain a
constant share price, its total return should be composed entirely of income.
The total return from the Intermediate and Long-Term Funds, however, consists
of the income they generate and the change in their net asset values per
share. The net asset values of the Intermediate and Long-Term Funds will be
affected primarily by changes in interest rate levels and the maturity of
individual portfolio holdings.
A general explanation.
INTEREST RATES. A bond is a contractual obligation to repay a stated debt
amount (the principal) on a specified date (the maturity) plus a specified
rate of interest for the use of the money. Most bonds pay a fixed rate of
interest known as the coupon rate which is fixed for the term of the bond. A
bond's yield reflects the fixed annual interest as a percent of its current
price. This price (the bond's market value) must increase or decrease in order
to adjust the bond's yield to current interest rate levels. Therefore, bond
prices generally move in the opposite direction of interest rates.
MATURITY. Movements in interest rates typically have a greater effect on the
prices of longer term bonds than on those with shorter maturities. The
following table illustrates the effect of a change in interest rates on a
$1,000 bond with a 7% coupon.
Principal value if rates:
-----------------------------
Bond--Maturity Increase 1% Decrease 1%
- ----------------------------------------------------------
Short-intermediate---2 years $982 $1,019
Intermediate---5 years $959 $1,043
Long-term---20 years $901 $1,116
- ----------------------------------------------------------
This table is for illustrative purposes only and should not be taken as
representative of expected changes in the share price of the Funds.
CREDIT ANALYSIS. U.S. Treasury securities and other securities backed by the
full faith and credit of the U.S. Government are considered to be of the
highest possible quality.
<PAGE>
- ------------------------------------------------------------------------------
FUND OPERATIONS
AND SERVICES
The following sections apply to all taxable T. Rowe Price Bond and Money
Funds. Bond Funds include all T. Rowe Price fixed income funds with a
fluctuating NAV.
- ------------------------------------------------------------------------------
NAV,
PRICING, AND
EFFECTIVE
DATE
NET ASSET VALUE PER SHARE (NAV). The NAV per share, or share price, for the
Bond Funds is normally determined as of 4:00 pm Eastern Time (ET) each day the
New York Stock Exchange is open. The NAV for the Money Funds is also
calculated at 12:00 noon ET every day the Exchange is open. The Fund's share
price is calculated by subtracting its liabilities from its total assets and
dividing the result by the total number of shares outstanding. Among other
things, the Fund's liabilities include accrued expenses and dividends payable,
and its total assets include portfolio securities valued at market as well as
income accrued but not yet received. The Money Funds utilize amortized cost
value on those securities with remaining maturities of 60 days or less.
If your order is received in
good order before 4:00
pm ET, you will receive
that day's NAV.
PURCHASED SHARES are priced at that day's NAV if your request is received
before 4:00 pm ET in good order. (See Completing the New Account Form and
Opening A New Account.) If received later than 4:00 pm ET, shares will be
priced at the next business day's NAV.
REDEMPTIONS are priced at that day's NAV if your request is received
before 4:00 pm ET in good order at the transfer agent's offices at T. Rowe
Price Account Services, P.O. Box 89000, Baltimore, MD 21289-0220. If received
after 4:00 pm ET, shares will be priced at the next business day's NAV.
Also, we cannot accept requests which specify a particular date for a
purchase or redemption or which specify any special conditions. If your
redemption request cannot be accepted, you will be notified and given further
instructions.
EXCHANGES are normally priced in the same manner as purchases and
redemptions. However, if you are exchanging into a bond or money fund and the
release of your exchange proceeds is delayed for the allowable five business
days (see Receiving Your Proceeds), you will not begin to earn dividends until
the sixth business day after the exchange.
The Fund reserves the right to change the time at which purchases,
redemptions, and exchanges are priced if the New York Stock Exchange closes at
a time other than 4:00 pm ET or an emergency exists.
- ------------------------------------------------------------------------------
RECEIVING
YOUR
PROCEEDS
Redemption proceeds are mailed to the address or sent by wire or ACH transfer
to the bank account designated on your New Account Form. They are generally
sent the next business day after your redemption request is received in good
order. Proceeds sent by bank wire should be credited to your bank account the
next business day and proceeds sent by ACH transfer should be credited the
second day after the sale. In addition, under certain conditions and when
deemed to be in the best interests of the Fund, redemption proceeds may not be
sent for up to five business days after your request is received to allow for
the orderly liquidation of securities. Requests by mail for wire redemptions
(unless previously authorized) must have a signature guarantee.
ACH (Automated Clearing House) is an automated method of initiating
payments from and receiving payments in your financial institution account.
ACH is a payment system supported by over 20,000 credit unions, banks and
savings banks which electronically exchange the transactions primarily through
the Federal Reserve Banks.
<PAGE>
- ------------------------------------------------------------------------------
DIVIDENDS AND
DISTRIBUTIONS
The Fund distributes all net investment income and capital gains to
shareholders. Dividends are declared daily and paid monthly. Capital gain
distributions, if any, are normally paid in December and/or March. Dividends
and distributions declared by the Fund will be reinvested unless you choose an
alternative payment option on the New Account Form. Dividends not reinvested
are paid by check or transmitted to your bank account via ACH. If the U.S.
Postal Service cannot deliver your check, or if your check remains uncashed
for six months, the Fund reserves the right to reinvest your distribution
check in your account at the then current NAV and to reinvest all subsequent
distributions in shares of the Fund.
PURCHASES. Each day, the Money Funds declare a dividend to shareholders of
record as of 12:00 noon ET on that day; and the Bond Funds declare a dividend
to shareholders of record as of 4:00 pm ET on the previous day. For the Money
Funds, wire purchase orders effective before 12:00 noon ET receive the
dividend for that day; other purchase orders receive the dividend for the next
business day after receipt. For the Bond Funds, you will begin to earn
dividends on the first business day after shares are purchased unless shares
were not paid for, in which case dividends are not earned until the next
business day after payment is received.
REDEMPTIONS. Shares will earn dividends through the date of redemption; also,
shares redeemed on a Friday or prior to a holiday will continue to earn
dividends until the next business day. Generally, if you redeem all of your
shares at any time during the month, you will also receive all dividends
earned through the date of redemption in the same check. When you redeem only
a portion of your shares, all dividends accrued on those shares will be
reinvested, or paid in cash, on the next dividend payment date.
- ------------------------------------------------------------------------------
TAXES
Form 1099-DIV
will be mailed
to you in January.
DIVIDENDS AND DISTRIBUTIONS. In January, the Fund will mail you Form 1099-DIV
indicating the federal tax status of your dividends and capital gain
distributions. Generally, dividends and distributions are taxable in the year
they are paid. However, any dividends and distributions paid in January but
declared during the prior three months are taxable in the year they are
declared. Dividends and distributions are taxable to you regardless of whether
they are taken in cash or reinvested. Dividends and short-term capital gain
distributions are taxable as ordinary income; long-term capital gain
distributions are taxable as long-term capital gains. The capital gain holding
period is determined by the length of time the Fund has held the securities,
not the length of time you have owned Fund shares.
SHARES SOLD (EXCLUDING MONEY FUNDS). A redemption or exchange of Fund shares
is treated as a sale for tax purposes which will result in a short or
long-term capital gain or loss, depending on how long you have owned the
shares. If you realize a loss on the sale or exchange of Fund shares held six
months or less, your short-term loss recognized is reclassified to long-term
to the extent of any capital gain distribution received. In January, the Bond
Funds will mail you Form 1099-B indicating the trade date and proceeds from
all sales and exchanges.
UNDISTRIBUTED GAINS (EXCLUDING MONEY FUNDS). At the time of purchase, the
share price of a Bond Fund may reflect undistributed capital gains or
unrealized appreciation of securities. Any capital gains from these amounts
which are later distributed to you are fully taxable.
<PAGE>
FOREIGN TRANSACTIONS (NEW INCOME, SHORT-TERM BOND AND HIGH YIELD FUNDS).
Distributions resulting from the sale of certain foreign currencies and debt
securities, to the extent of foreign exchange gains, are taxed as ordinary
income or loss. If these transactions result in reducing a Fund's net income,
a portion of the dividends may be classified as a return of capital (which
lowers your tax basis). If the Fund pays nonrefundable taxes to foreign
governments during the year, the taxes will reduce that Fund's dividends.
TAX-QUALIFIED RETIREMENT PLANS. Tax-qualified retirement plans generally will
not be subject to federal tax liability on either distributions from the Fund
or redemption of shares of the Fund. Rather, participants in such plans will
be taxed when they begin taking distributions from the plans.
- ------------------------------------------------------------------------------
MANAGEMENT OF
THE FUND
INVESTMENT MANAGER. T. Rowe Price is responsible for selection and management
of the Fund's portfolio investments. T. Rowe Price serves as investment
manager to a variety of individual and institutional investors, including
limited and real estate partnerships and other mutual funds.
BOARD OF DIRECTORS/TRUSTEES. The management of the Fund's business and affairs
is the responsibility of the Fund's Board of Directors/Trustees.
PORTFOLIO TRANSACTIONS. Decisions with respect to the purchase and sale of the
Fund's portfolio securities are made by T. Rowe Price.
New Income, Short-Term Bond and High Yield Funds. The Fund's Board of
Directors/Trustees has authorized T. Rowe Price to utilize certain brokers
indirectly related to T. Rowe Price in the capacity of broker in connection
with the execution of the Fund's portfolio transactions.
INVESTMENT SERVICES. T. Rowe Price Investment Services, Inc., a wholly-owned
subsidiary of T. Rowe Price, is the distributor for this Fund as well as all
other T. Rowe Price Funds.
TRANSFER AND DIVIDEND DISBURSING AGENT, SHAREHOLDER SERVICING AND
ADMINISTRATIVE. TRP Services, a wholly-owned subsidiary of T. Rowe Price,
serves the Fund as transfer and dividend disbursing agent. T. Rowe Price
Retirement Plan Services, Inc., a wholly-owned subsidiary of T. Rowe Price,
performs subaccounting and recordkeeping services for shareholder accounts in
certain retirement plans investing in the Price Funds. T. Rowe Price
calculates the daily share price and maintains the portfolio and general
accounting records of the Fund. The address for TRP Services and T. Rowe Price
Retirement Plan Services, Inc. is 100 East Pratt Street, Baltimore, Maryland
21202.
- ------------------------------------------------------------------------------
EXPENSES AND
MANAGEMENT
FEE
The Fund bears all expenses of its operations other than those incurred by T.
Rowe Price under its Investment Management Agreement with T. Rowe Price. Fund
expenses include: the management fee; shareholder servicing fees and expenses;
custodian and accounting fees and expenses; legal and auditing fees; expenses
of preparing and printing prospectuses and shareholder reports; registration
fees and expenses; proxy and annual meeting expenses, if any; and
directors'/trustees' fees and expenses.
MANAGEMENT FEE. The Fund pays T. Rowe Price an investment management fee
consisting of an Individual Fund Fee and a Group Fee. See Summary of Fund Fees
and Expenses for the Individual Fund Fee. The Group Fee varies and is based on
the combined net assets of all mutual funds sponsored and managed by T. Rowe
Price and Rowe Price-Fleming International, Inc., excluding T. Rowe Price
Spectrum Fund, Inc., and any institutional or private label mutual funds, and
distributed by T. Rowe Price Investment Services, Inc.
<PAGE>
The Fund pays, as its portion of the Group Fee, an amount equal to the
ratio of its daily net assets to the daily net assets of all the Price Funds.
The table below shows the annual Group Fee rate at various asset levels of the
combined Price Funds:
0.480% First $1 billion 0.350% Next $2 billion
0.450% Next $1 billion 0.340% Next $5 billion
0.420% Next $1 billion 0.330% Next $10 billion
0.390% Next $1 billion 0.320% Next $10 billion
0.370% Next $1 billion 0.310% Thereafter
0.360% Next $2 billion
Based on combined Price Funds' assets of approximately $36.1 billion at
February 28, 1994, the Group Fee was 0.34%.
- -------------------------------------------------------------------
SHAREHOLDER
SERVICES
The following is a brief summary of services available to shareholders in the
T. Rowe Price Funds, some of which may be restricted or unavailable to
retirement plan accounts. You must authorize most of these services on a New
Account or Shareholder Services Form. Services may be modified or withdrawn at
any time without notice. Please verify all transactions on your confirmation
statements promptly after receiving them. Any discrepancies must be reported
to Shareholder Services immediately.
AUTOMATIC ASSET BUILDER. You can have us move $50 or more on the same day each
month from your bank account or invest $50 or more from your paycheck into any
T. Rowe Price Fund.
CHECKWRITING SERVICE (NOT AVAILABLE IN HIGH YIELD FUND). There is no charge
for this service and you may write an unlimited number of checks. Minimum
check amount is $500. Remember that a checkwriting redemption in the Bond
Funds will be treated as a capital gain or loss transaction for tax purposes.
This service is subject to State Street Bank's rules and regulations and
is governed by Massachusetts Uniform Commercial Code. Stop payment
instructions must be given by calling Shareholder Services.
Investor Services
1-800-638-5660
1-410-547-2308
DISCOUNT BROKERAGE SERVICE. You can trade stocks, bonds, options, CDs,
Treasury Bills, and precious metals at substantial savings through our
Discount Brokerage Service. Call Investor Services for more information.
EXCHANGE SERVICE. You can move money from one account to an existing
identically registered account or open a new identically registered account.
Remember that, for tax purposes, an exchange is treated as a redemption and a
new purchase. Exchanges into a state tax-free fund are limited to investors
residing in states where those funds are qualified for sale. Some of the T.
Rowe Price Funds may impose a redemption fee of .50-2%, payable to such Funds,
on shares held for less than one year, or in some funds, six months.
RETIREMENT PLANS. For details on IRAs, please call Investor Services. For
details on all other retirement plans, please call our Trust Company at
1-800-492-7670.
<PAGE>
Shareholder Services
1-800-225-5132
1-410-625-6500
TELEPHONE SERVICES. The following services are explained fully in the Services
Guide, which is mailed to new T. Rowe Price investors. If you don't have a
copy, please call Shareholder Services. (All telephone calls to Shareholder
Services and Investor Services are recorded in order to protect you, the Fund,
and its agents.)
24-HOUR SERVICE. Tele*Access[registered trademark] provides information on
yields, prices, latest dividends, account balances, and last transaction
as well as the ability to request prospectuses and account forms and
initiate purchase, redemption and exchange orders (if you have established
Telephone Services). Just call 1-800-638-2587 and press the appropriate
codes into your touch-tone phone. PC*Access[registered trademark] provides
the same information as Tele*Access, but on a personal computer.
ELECTRONIC TRANSFERS. We offer three free methods for purchasing or
redeeming Fund shares in amounts of $100 to $100,000 through ACH transfers
between your bank checking and fund accounts:
---By calling Shareholder Services during business hours
(Tele-Connect[registered trademark]);
---By touch-tone phone any day, any time (Tele*Access);
---By personal computer any day, any time (PC*Access).
If your bank checking and fund account are not identically registered, you
will need a signature guarantee to establish this service.
WIRE TRANSFERS. Wire transfers can be processed through bank wires (a $5
charge applies to redemption amounts under $5,000, and your bank may
charge you for receiving wires). While this is usually the quickest
transfer method, the Fund reserves the right to temporarily suspend wires
under unusual circumstances.
- ------------------------------------------------------------------------------
CONDITIONS
OF YOUR
PURCHASE
ACCOUNT BALANCE. If your account drops below $1,000 for three months or more,
the Fund has the right to close your account, after giving 60 days' notice,
unless you make additional investments to bring your account value to $1,000
or more.
BROKER-DEALERS. Purchases or redemptions through broker-dealers, banks, and
other institutions may be subject to service fees imposed by those entities.
No such fees are charged by T. Rowe Price Investment Services or the Fund if
shares are purchased or redeemed directly from the Fund.
EXCESSIVE TRADING AND EXCHANGE LIMITATIONS. To protect Fund shareholders
against disruptions in portfolio management which might occur as a result of
too frequent buy and sell activity and to minimize Fund expenses associated
with such transaction activity, the Fund prohibits excessive trading in any
account (or group of accounts managed by the same person). Within any 120
consecutive-day period, investors may not exchange between Price Funds more
than twice or buy and sell the Price Funds more than once, if the transactions
involve substantial assets or a substantial portion of the assets in the
account or accounts. This policy is applied on a multi-fund basis. Any
transactions above and beyond these guidelines will be considered to be
excessive trading, and the investor may be prohibited from making additional
purchases or exercising the exchange privilege.
This policy does not apply to exchanges solely between, or purchases and sales
solely of, the Price Money Funds, nor does it apply to simple redemptions from
any Fund.
NONPAYMENT. If your check, wire or ACH transfer does not clear, or if payment
is not received for any telephone purchase, the transaction will be cancelled
and you will be responsible for any loss the Fund or Investment Services
incurs. If you are already a shareholder, the Fund can redeem shares from any
identically registered account in this Fund or any other T. Rowe Price Fund as
reimbursement for any loss incurred. You may be prohibited or restricted from
making future purchases in any of the T. Rowe Price Funds.
<PAGE>
U.S. DOLLARS. All purchases must be paid for in U.S. dollars, and checks must
be drawn on U.S. banks.
REDEMPTIONS IN EXCESS OF $250,000. Redemption proceeds are normally paid in
cash. However, if you redeem more than $250,000, or 1% of the Fund's net
assets, in any 90-day period, the Fund may in its discretion: (1) pay the
difference between the redemption amount and the lesser of these two figures
with securities of the Fund or (2) delay the transmission of your proceeds for
up to five business days after your request is received.
SIGNATURE GUARANTEES. A signature guarantee is designed to protect you and the
Fund by verifying your signature. You will need one to:
(1) Establish certain services after the account is opened.
(2) Redeem over $50,000 by written request (unless you have authorized
Telephone Services).
(3) Redeem shares when proceeds are: (i) being mailed to an address other
than the address of record, (ii) made payable to other than the
registered owner(s), or (iii) being sent to a bank account other than
the bank account listed on your fund account.
(4) Transfer shares to another owner.
(5) Send us written instructions asking us to wire redemption proceeds
(unless previously authorized).
(6) Establish Electronic Transfers when your bank checking and fund
account are not identically registered.
These requirements may be waived or modified in certain instances.
Acceptable guarantors are all eligible guarantor institutions as defined
by the Securities Exchange Act of 1934 such as: commercial banks which are
FDIC members, trust companies, firms which are members of a domestic stock
exchange, and foreign branches of any of the above. We cannot accept
guarantees from institutions or individuals who do not provide reimbursement
in the case of fraud, such as notaries public.
TELEPHONE EXCHANGE AND REDEMPTION. Telephone exchange and redemption are
established automatically when you sign the New Account Form unless you check
the box which states that you do not want these services. The Fund uses
reasonable procedures (including shareholder identity verification) to confirm
that instructions given by telephone are genuine. If these procedures are not
followed, it is the opinion of certain regulatory agencies that the Fund may
be liable for any losses that may result from acting on the instructions
given. All conversations are recorded, and a confirmation is sent within five
business days after the telephone transaction.
TEN-DAY HOLD. The mailing of proceeds for redemption requests involving any
shares purchased by personal, corporate or government check, or ACH transfer
is generally subject to a 10-calendar day delay to allow the check or transfer
to clear. The 10-day clearing period does not affect the trade date on which
your purchase or redemption order is priced, or any dividends and capital gain
distributions to which you may be entitled through the date of redemption. If
your redemption request was sent by mail or mailgram, proceeds will be mailed
no later than the seventh calendar day following receipt unless the check or
ACH transfer has not cleared. The 10-day hold does not apply to purchases made
by wire, Automatic Asset Builder-Paycheck, or cashier's, treasurer's, or
certified checks.
<PAGE>
THE FUND AND ITS AGENTS RESERVE THE RIGHT TO: (1) reject any purchase or
exchange, cancel any purchase due to nonpayment, or reject any exchange or
redemption where the Fund has not received payment; (2)waive or lower the
investment minimums; (3) accept initial purchases by telephone or mailgram;
(4) waive the limit on subsequent purchases by telephone; (5) reject any
purchase or exchange prior to receipt of the confirmation statement; (6)
redeem your account (see Tax Identification Number); (7) modify the conditions
of purchase at any time; (8) reject any check not made directly payable to the
Fund or T. Rowe Price (call Shareholder Services for more information) and (9)
act on any instruction believed to be genuine.
- ------------------------------------------------------------------------------
COMPLETING
THE NEW
ACCOUNT FORM
TAX IDENTIFICATION NUMBER. We must have your correct social security or
corporate tax identification number and a signed New Account Form or W-9 Form.
Otherwise, federal law requires the Fund to withhold a percentage (currently
31%) of your dividends, capital gain distributions, and redemptions, and may
subject you to a fine. You also will be prohibited from opening another
account by exchange. If this information is not received within 60 days after
your account is established, your account may be redeemed, priced at the NAV
on the date of redemption.
You must provide your
tax ID number and sign
the New Account Form.
Unless you otherwise request, one shareholder report will be mailed to
multiple account owners with the same tax identification number and same zip
code and to those shareholders who have requested that their accounts be
combined with someone else's for financial reporting.
ACCOUNT REGISTRATION. If you own other T. Rowe Price Funds, make certain the
registration (name and account type) is identical to your other funds for easy
exchange. REMEMBER TO SIGN THE FORM EXACTLY AS THE NAME APPEARS IN THE
REGISTRATION SECTION.
SERVICES. By signing up for services on the New Account Form, rather than
after the account is opened, you will avoid having to complete a separate form
and obtain a signature guarantee (see Conditions of Your Purchase).
- ------------------------------------------------------------------------------
OPENING A NEW
ACCOUNT
Checks payable to
T. Rowe Price Funds.
Minimum initial investment: $2,500; $1,000 for retirement plans and gifts or
transfers to minors (UGMA/UTMA) accounts; $50 per month for Automatic Asset
Builder accounts---see Shareholder Services
By Mail Send your New Account Form and check to:
REGULAR MAIL MAILGRAM, EXPRESS, REGISTERED, OR
CERTIFIED MAIL
T. Rowe Price Account T. Rowe Price Account Services
Services
P.O. Box 17300 10090 Red Run Boulevard
Baltimore, MD 21298-9353 Owings Mills, MD 21117
- ------------------------------------------------------------------------------
Investor Services
1-800-638-5660
1-410-547-2308
By Wire Call Investor Services for an account number and use Wire Address
below. Then, complete the New Account Form and mail it to one of the
addresses above. (Not applicable to retirement plans.)
WIRE ADDRESS Morgan Guaranty Trust Company of New York
(to give to your bank): ABA #021000238
T. Rowe Price (fund name)/AC-00153938
Account name(s) and account number
<PAGE>
- ------------------------------------------------------------------------------
Shareholder Services
1-800-225-5132
1-410-625-6500
By Call Shareholder Services. The new account will have the same
Exchange registration as the account from which you are exchanging. Services
for the new account may be carried over by telephone request if
preauthorized on the existing account. See Excessive Trading and
Exchange Limitations under Conditions of Your Purchase.
- ------------------------------------------------------------------------------
In Drop off your New Account Form and obtain a receipt at a T. Rowe
Person Price Investor Center:
101 East Lombard Street T. Rowe Price Financial Center
First Floor First Floor
Baltimore, MD 10090 Red Run Boulevard
Owings Mills, MD
Farragut Square ARCO Tower
First Floor 31st Floor
900 17th Street, NW 515 South Flower Street
Washington, DC Los Angeles, CA
- ------------------------------------------------------------------------------
PURCHASING
ADDITIONAL
SHARES
Minimum: $100 ($50 for retirement plans)
Shareholder Services
1-800-225-5132
1-410-625-6500
By Wire Call Shareholder Services or use the Wire Address (see Opening a New
Account).
- ------------------------------------------------------------------------------
By Mail Indicate your account number and the Fund name on your check. Mail
the check to us at the address below either with a reinvestment slip
or a note indicating the Fund and account number in which you wish
to purchase shares.
T. Rowe Price Funds
Account Services
P.O. Box 89000
Baltimore, MD 21289-1500
- ------------------------------------------------------------------------------
By ACH Use Tele*Access, PC*Access or call Shareholder Services (if you have
Transfer established Telephone Services) for ACH transfers.
- ------------------------------------------------------------------------------
By Fill out the Automatic Asset Builder section on the New Account or
Automatic Shareholder Services Form.
Asset
Builder
- ------------------------------------------------------------------------------
Minimum: $5,000
By Phone Call Shareholder Services.
<PAGE>
- ------------------------------------------------------------------------------
EXCHANGING
AND REDEEMING
SHARES
By Phone Call Shareholder Services. If you find our phones busy during
unusually volatile markets, please consider placing your order by
express mail, mailgram, Tele*Access or PC*Access if you have
authorized Telephone Services. For exchange policy, see Excessive
Trading and Exchange Limitations under Conditions of Your Purchase.
Redemption proceeds can be mailed, sent by Electronic Transfer, or
wired to your bank. The Fund charges a $5.00 fee for wire
redemptions under $5,000, subject to change without notice. Your
bank may also charge you for receiving wires.
- ------------------------------------------------------------------------------
Shareholder
Services
1-800-225-5132
1-410-625-6500
By Mail Indicate account name(s) and numbers, fund name(s), and exchange or
redemption amount. For exchanges, indicate the accounts you are
exchanging from and to along with the amount. We require the
signature of all owners exactly as registered, and possibly a
signature guarantee (see Signature Guarantees under Conditions of
Your Purchase).
T. Rowe Price Trust Company
1-800-492-7670
1-410-625-6585
NOTE: Distributions from retirement accounts, including IRAs, must
be in writing. Please call Shareholder Services to obtain an IRA
Distribution Request Form. For employer-sponsored retirement
accounts, call T. Rowe Price Trust Company or your plan
administrator for instructions. Shareholders holding previously
issued certificates must conduct transactions by mail.
If you lose a stock certificate, you may incur an expense to replace
it. Call Shareholder Services for further information.
MAILING ADDRESSES:
REGULAR MAIL MAILGRAM, EXPRESS, REGISTERED, OR
CERTIFIED MAIL
Non-Retirement All Accounts
and IRA Accounts T. Rowe Price Account Services
T. Rowe Price Account 10090 Red Run Boulevard
Services
P.O. Box 89000 Owings Mills, MD 21117
Baltimore, MD 21289-0220
Employer-Sponsored
Retirement Accounts
T. Rowe Price Trust Company
P.O. Box 89000
Baltimore, MD 21289-0300
PAGE 2
The Statement of Additional Information for the T. Rowe Price U.S. Treasury
Funds, Inc., dated July 1, 1994, should be inserted here.
PAGE 1
STATEMENT OF ADDITIONAL INFORMATION
T. ROWE PRICE ADJUSTABLE RATE U.S. GOVERNMENT FUND, INC.
T. ROWE PRICE GNMA FUND
T. ROWE PRICE HIGH YIELD FUND, INC.
T. ROWE PRICE NEW INCOME FUND, INC.
T. ROWE PRICE PRIME RESERVE FUND, INC.
T. ROWE PRICE SHORT-TERM BOND FUND, INC.
T. ROWE PRICE U.S. TREASURY FUNDS, INC.
U.S. Treasury Intermediate Fund
U.S. Treasury Long-Term Fund
U.S. Treasury Money Fund
(collectively the "Funds" and individually the "Fund")
This Statement of Additional Information is not a
prospectus but should be read in conjunction with the appropriate
Fund's prospectus dated July 1, 1994, which may be obtained from
T. Rowe Price Investment Services, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202.
If you would like a prospectus for a Fund of which you are
not a shareholder, please call 1-800-638-5660. A prospectus with
more complete information, including management fees and expenses
will be sent to you. Please read it carefully.
The date of this Statement of Additional Information is
July 1, 1994.
PAGE 2
TABLE OF CONTENTS
Page Page
Asset-Backed Securities. .15 Lending of Portfolio
Capital Stock. . . . . . .81 Securities . . . . . . . 26
Code of Ethics . . . . . .59 Management of Fund. . . . 48
Custodian. . . . . . . . .58 Mortgage-Related
Description of the Fund. .82 Securities . . . . . . . .9
Distributor for Fund . . .58 Net Asset Value Per Share 68
Dividends and Options . . . . . . . . . 28
Distributions . . . . . .69 Portfolio Transactions. . 59
Federal and State Pricing of Securities . . 66
Registration of Shares. .83 Principal Holders of
Foreign Currency Securities . . . . . . . 54
Transactions. . . . . . .41 Ratings of Commercial
Foreign Futures and Paper. . . . . . . . . . 85
Options . . . . . . . . .40 Ratings of Corporate
Futures Contracts. . . . .34 Debt Securities. . . . . 86
Hybrid Instruments . . . .21 Repurchase Agreements . . 26
Independent Accountants. .83 Risk Factors. . . . . . . .3
Illiquid or Restricted Tax Status. . . . . . . . 69
Securities. . . . . . . .24 Taxation of Foreign
Investment Management Shareholders . . . . . . 70
Services. . . . . . . . .54 Warrants. . . . . . . . . 21
Investment Objectives When-Issued Securities and
and Policies. . . . . . . 2 Forward Commitment
Investment Performance . .72 Contracts. . . . . . . . 23
Investment Program . . . . 8 Yield Information . . . . 70
Investment Restrictions. .44
Legal Counsel. . . . . . .83
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of each
Fund's investment objectives and policies discussed in each
Fund's prospectus. The Funds will not make a material change in
their investment objectives without obtaining shareholder
approval. Unless otherwise specified, the investment programs
and restrictions of the Funds are not fundamental policies. Each
Fund's operating policies are subject to change by each Board of
Directors/Trustees without shareholder approval. However,
shareholders will be notified of a material change in an
operating policy. Each Fund's fundamental policies may not be
changed without the approval of at least a majority of the
outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the
holders of 50% or more of the shares are represented.
Throughout this Statement of Additional Information, "the
Fund" is intended to refer to each Fund listed on the cover page,
unless otherwise indicated.
PAGE 3
RISK FACTORS
All Funds
Debt Obligations
Yields on short, intermediate, and long-term securities are
dependent on a variety of factors, including the general
conditions of the money and bond markets, the size of a
particular offering, the maturity of the obligation, and the
credit quality and rating of the issue. Debt securities with
longer maturities tend to have higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter maturities and lower
yields. The market prices of debt securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio debt securities, and
a decline in interest rates will generally increase the value of
portfolio debt securities. The ability of the Fund to achieve
its investment objective is also dependent on the continuing
ability of the issuers of the debt securities in which the Fund
invests to meet their obligations for the payment of interest and
principal when due. Although the Fund seeks to reduce risk by
portfolio diversification, credit analysis, and attention to
trends in the economy, industries and financial markets, such
efforts will not eliminate all risk. There can, of course, be no
assurance that the Fund will achieve its investment objective.
After purchase by the Fund, a debt security may cease to be
rated or its rating may be reduced below the minimum required for
purchase by the Fund. For the Prime Reserve and U.S. Treasury
Money Funds, the procedures set forth in Rule 2a-7, under the
Investment Company Act of 1940, may require the prompt sale of
any such security. For the other Funds, neither event will
require a sale of such security by the Fund. However, T. Rowe
Price will consider such event in its determination of whether
the Fund should continue to hold the security. To the extent
that the ratings given by Moody's or S&P may change as a result
of changes in such organizations or their rating systems, the
Fund will attempt to use comparable ratings as standards for
investments in accordance with the investment policies contained
in the prospectus. When purchasing unrated securities, T. Rowe
Price, under the supervision of the Fund's Board of Directors,
determines whether the unrated security is of a qualify
comparable to that which the Fund is allowed to purchase.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
of the risks associated with the investments and practices
described therein as they apply to the Fund.
PAGE 4
All Funds, (except Prime Reserve and U.S. Treasury Money Funds)
Because of its investment policy, the Fund may or may not be
suitable or appropriate for all investors. The Fund is not a
money market fund and is not an appropriate investment for those
whose primary objective is principal stability. The value of the
portfolio securities of the Fund will fluctuate based upon market
conditions. Although the Fund seeks to reduce risk by investing
in a diversified portfolio, such diversification does not
eliminate all risk. There can, of course, be no assurance that
the Fund will achieve its investment objective.
Prime Reserve and U.S. Treasury Money Funds
There can be no assurance that the Funds will achieve their
investment objectives or be able to maintain their net asset
value per share at $1.00. The price of the Fund is not
guaranteed or insured by the U.S. Government and its yield is not
fixed. An increase in interest rates could reduce the value of
the Fund's portfolio investments, and a decline in interest rates
could increase the value.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Mortgage securities differ from conventional bonds in that
principal is paid back over the life of the security rather than
at maturity. As a result, the holder of a mortgage security
(i.e., the Fund) receives monthly scheduled payments of principal
and interest, and may receive unscheduled principal payments
representing prepayments on the underlying mortgages. The
incidence of unscheduled principal prepayments is also likely to
increase in mortgage pools owned by the Fund when prevailing
mortgage loan rates fall below the mortgage rates of the
securities underlying the individual pool. The effect of such
prepayments in a falling rate environment is to (1) cause the
Fund to reinvest principal payments at the then lower prevailing
interest rate, and (2) reduce the potential for capital
appreciation beyond the face amount of the security. Conversely,
the Fund may realize a gain on prepayments of mortgage pools
trading at a discount. Such prepayments will provide an early
return of principal which may then be reinvested at the then
higher prevailing interest rate.
The market value of adjustable rate mortgage securities
("ARMs"), like other U.S. government securities, will generally
vary inversely with changes in market interest rates, declining
when interest rates rise and rising when interest rates decline.
Because of their periodic adjustment feature, ARMs should be more
sensitive to short-term interest rates than long-term rates.
They should also display less volatility than long-term mortgage
securities. Thus, while having less risk of a decline during
periods of rapidly rising rates, ARMs may also have less
potential for capital appreciation than other investments of
PAGE 5
comparable maturities. Interest rate caps on mortgages
underlying ARM securities may prevent income on the ARM from
increasing to prevailing interest rate levels and cause the
securities to decline in value. In addition, to the extent ARMs
are purchased at a premium, mortgage foreclosures and unscheduled
principal prepayments may result in some loss of the holders'
principal investment to the extent of the premium paid. On the
other hand, if ARMs are purchased at a discount, both a scheduled
payment of principal and an unscheduled prepayment of principal
will increase current and total returns and will accelerate the
recognition of income which when distributed to shareholders will
be taxable as ordinary income.
High Yield, New Income and Short-Term Bond Funds
Risk Factors of Foreign Investing
There are special risks in foreign investing. Certain of
these risks are inherent in any mutual fund investing in foreign
securities while others relate more to the countries in which the
Funds will invest. Many of the risks are more pronounced for
investments in developing or emerging countries, such as many of
the countries of Southeast Asia, Latin America, Eastern Europe
and the Middle East. Although there is no universally accepted
definition, a developing country is generally considered to be a
country which is in the initial stages of its industrialization
cycle with a per capita gross national product of less than
$8,000.
Political and Economic Factors. Individual foreign
economies of certain countries may differ favorably or
unfavorably from the United States' economy in such respects as
growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments
position. The internal politics of certain foreign countries are
not as stable as in the United States. For example, in 1991, the
existing government in Thailand was overthrown in a military
coup. In 1992, there were two military coup attempts in
Venezuela and in 1992 the President of Brazil was impeached. In
addition, significant external political risks currently affect
some foreign countries. Both Taiwan and China still claim
sovereignty of one another and there is a demilitarized border
between North and South Korea.
Governments in certain foreign countries continue to
participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these
governments could have a significant effect on market prices of
securities and payment of dividends. The economies of many
foreign countries are heavily dependent upon international trade
and are accordingly affected by protective trade barriers and
economic conditions of their trading partners. The enactment by
these trading partners of protectionist trade legislation could
PAGE 6
have a significant adverse effect upon the securities markets of
such countries.
Currency Fluctuations. The Funds will invest in securities
denominated in various currencies. Accordingly, a change in the
value of any such currency against the U.S. dollar will result in
a corresponding change in the U.S. dollar value of the Funds'
assets denominated in that currency. Such changes will also
affect the Funds' income. Generally, when a given currency
appreciates against the dollar (the dollar weakens) the value of
the Fund's securities denominated in that currency will rise.
When a given currency depreciates against the dollar (the dollar
strengthens) the value of the Funds' securities denominated in
that currency would be expected to decline.
Investment and Repatriation of Restrictions. Foreign
investment in the securities markets of certain foreign countries
is restricted or controlled in varying degrees. These
restrictions may limit at times and preclude investment in
certain of such countries and may increase the cost and expenses
of the Funds. Investments by foreign investors are subject to a
variety of restrictions in many developing countries. These
restrictions may take the form of prior governmental approval,
limits on the amount or type of securities held by foreigners,
and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at
any time by these or other countries in which the Funds invest.
In addition, the repatriation of both investment income and
capital from several foreign countries is restricted and
controlled under certain regulations, including in some cases the
need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one year.
Market Characteristics. Foreign stock and bond markets are
generally not as developed or efficient as, and may be more
volatile than, those in the United States. While growing in
volume, they usually have substantially less volume than U.S.
markets and the Funds' portfolio securities may be less liquid
and subject to more rapid and erratic price movements than
securities of comparable U.S. companies. Equity securities may
trade at price/earnings multiples higher than comparable United
States securities and such levels may not be sustainable. Fixed
commissions on foreign stock exchanges are generally higher than
negotiated commissions on United States exchanges, although the
Funds will endeavor to achieve the most favorable net results on
their portfolio transactions. There is generally less government
supervision and regulation of foreign stock exchanges, brokers
and listed companies than in the United States. Moreover,
settlement practices for transactions in foreign markets may
differ from those in United States markets. Such differences may
include delays beyond periods customary in the United States and
practices, such as delivery of securities prior to receipt of
PAGE 7
payment, which increase the likelihood of a "failed settlement."
Failed settlements can result in losses to a Fund.
Investment Funds. The Funds may invest in investment funds
which have been authorized by the governments of certain
countries specifically to permit foreign investment in securities
of companies listed and traded on the stock exchanges in these
respective countries. The Funds' investment in these funds is
subject to the provisions of the 1940 Act. If the Funds invest
in such investment funds, the Funds' shareholders will bear not
only their proportionate share of the expenses of the Funds
(including operating expenses and the fees of the investment
manager), but also will bear indirectly similar expenses of the
underlying investment funds. In addition, the securities of
these investment funds may trade at a premium over their net
asset value.
Information and Supervision. There is generally less
publicly available information about foreign companies comparable
to reports and ratings that are published about companies in the
United States. Foreign companies are also generally not subject
to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those
applicable to United States companies. It also may be more
difficult to keep currently informed of corporate actions which
affect the prices of portfolio securities.
Taxes. The dividends and interest payable on certain of the
Funds' foreign portfolio securities may be subject to foreign
withholding taxes, thus reducing the net amount of income
available for distribution to the Funds' shareholders.
Other. With respect to certain foreign countries,
especially developing and emerging ones, there is the possibility
of adverse changes in investment or exchange control regulations,
expropriation or confiscatory taxation, limitations on the
removal of funds or other assets of the Funds, political or
social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
Eastern Europe and Russia. Changes occurring in Eastern
Europe and Russia today could have long-term potential
consequences. As restrictions fall, this could result in rising
standards of living, lower manufacturing costs, growing consumer
spending, and substantial economic growth. However, investment
in the countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too
recent to establish a definite trend away from centrally-planned
economies and state owned industries. In many of the countries
of Eastern Europe and Russia, there is no stock exchange or
formal market for securities. Such countries may also have
government exchange controls, currencies with no recognizable
market value relative to the established currencies of western
PAGE 8
market economies, little or no experience in trading in
securities, no financial reporting standards, a lack of a banking
and securities infrastructure to handle such trading, and a legal
tradition which does not recognize rights in private property.
In addition, these countries may have national policies which
restrict investments in companies deemed sensitive to the
country's national interest. Further, the governments in such
countries may require governmental or quasi-governmental
authorities to act as custodian of a Fund's assets invested in
such countries and these authorities may not qualify as a foreign
custodian under the Investment Company Act of 1940 and exemptive
relief from such Act may be required. All of these
considerations are among the factors which could cause
significant risks and uncertainties to investment in Eastern
Europe and Russia. Each Fund will only invest in a company
located in, or a government of, Eastern Europe and Russia, if it
believes the potential return justifies the risk. To the extent
any securities issued by companies in Eastern Europe and Russia
are considered illiquid, each Fund will be required to include
such securities within its 15% restriction on investing in
illiquid securities.
High Yield Fund
Special Risks of Investing in Junk Bonds
The following special considerations are additional risk
factors associated with the Fund's investments in lower rated
debt securities.
Youth and Growth of the Lower Rated Debt Securities Market.
The market for lower rated debt securities is relatively new and
its growth has paralleled a long economic expansion. Past
experience may not, therefore, provide an accurate indication of
future performance of this market, particularly during periods of
economic recession. An economic downturn or increase in interest
rates is likely to have a greater negative effect on this market,
the value of lower rated debt securities in the Fund's portfolio,
the Fund's net asset value and the ability of the bonds' issuers
to repay principal and interest, meet projected business goals
and obtain additional financing than on higher rated securities.
These circumstances also may result in a higher incidence of
defaults than with respect to higher rated securities. An
investment in this Fund is more speculative than investment in
shares of a fund which invests only in higher rated debt
securities.
Sensitivity to Interest Rate and Economic Changes. Prices
of lower rated debt securities may be more sensitive to adverse
economic changes or corporate developments than higher rated
investments. Debt securities with longer maturities, which may
have higher yields, may increase or decrease in value more than
debt securities with shorter maturities. Market prices of lower
PAGE 9
rated debt securities structured as zero coupon or pay-in-kind
securities are affected to a greater extent by interest rate
changes and may be more volatile than securities which pay
interest periodically and in cash. Where it deems it appropriate
and in the best interests of Fund shareholders, the Fund may
incur additional expenses to seek recovery on a debt security on
which the issuer has defaulted and to pursue litigation to
protect the interests of security holders of its portfolio
companies.
Liquidity and Valuation. Because the market for lower rated
securities may be thinner and less active than for higher rated
securities, there may be market price volatility for these
securities and limited liquidity in the resale market. Nonrated
securities are usually not as attractive to as many buyers as
rated securities are, a factor which may make nonrated securities
less marketable. These factors may have the effect of limiting
the availability of the securities for purchase by the Fund and
may also limit the ability of the Fund to sell such securities at
their fair value either to meet redemption requests or in
response to changes in the economy or the financial markets.
Adverse publicity and investor perceptions, whether or not based
on fundamental analysis, may decrease the values and liquidity of
lower rated debt securities, especially in a thinly traded
market. To the extent the Fund owns or may acquire illiquid or
restricted lower rated securities, these securities may involve
special registration responsibilities, liabilities and costs, and
liquidity and valuation difficulties. Changes in values of debt
securities which the Fund owns will affect its net asset value
per share. If market quotations are not readily available for
the Fund's lower rated or nonrated securities, these securities
will be valued by a method that the Fund's Board of Directors
believes accurately reflects fair value. Judgment plays a
greater role in valuing lower rated debt securities than with
respect to securities for which more external sources of
quotations and last sale information are available.
Congressional Action. New and proposed laws may have an
impact on the market for lower rated debt securities. For
example, as a result of the Financial Institution's Reform,
Recovery, and Enforcement Act of 1989, savings and loan
associations were required to dispose of their high yield bonds
no later than July 1, 1994. Qualified affiliates of savings and
loan associations, however, may purchase and retain these
securities, and savings and loan associations may divest these
securities by sale to their qualified affiliates. T. Rowe Price
is unable at this time to predict what effect, if any, the
legislation may have on the market for lower rated debt
securities.
Taxation. Special tax considerations are associated with
investing in lower rated debt securities structured as zero
coupon or pay-in-kind securities. The Fund accrues income on
PAGE 10
these securities prior to the receipt of cash payments. The Fund
must distribute substantially all of its income to its
shareholders to qualify for pass-through treatment under the tax
laws and may, therefore, have to dispose of its portfolio
securities to satisfy distribution requirements.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions
of the risks associated with the investments and practices
described therein as they apply to the Fund.
INVESTMENT PROGRAM
Types of Securities
Set forth below is additional information about certain of
the investments described in the Fund's prospectus.
Debt Securities
Fixed income securities in which the Fund may invest
include, but are not limited to, those described below.
All Funds
U.S. Government Obligations. Bills, notes, bonds and other
debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S. Government and differ mainly in the
length of their maturities.
U.S. Government Agency Securities. Issued or guaranteed by
U.S. Government sponsored enterprises and federal agencies.
These include securities issued by the Federal National Mortgage
Association, Government National Mortgage Association, Federal
Home Loan Bank, Federal Land Banks, Farmers Home Administration,
Banks for Cooperatives, Federal Intermediate Credit Banks,
Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; and the remainder are supported only by the credit of
the instrumentality, which may or may not include the right of
the issuer to borrow from the Treasury.
The GNMA, U.S. Treasury Money, Intermediate, and Long-Term
Funds may only invest in these securities if they are supported
by the full faith and credit of the U.S. government.
PAGE 11
All Funds, except GNMA, U.S. Treasury Money, Intermediate and
Long-Term Funds
Bank Obligations. Certificates of deposit, bankers'
acceptances, and other short-term debt obligations. Certificates
of deposit are short-term obligations of commercial banks. A
bankers' acceptance is a time draft drawn on a commercial bank by
a borrower, usually in connection with international commercial
transactions. Certificates of deposit may have fixed or variable
rates. The Fund may invest in U.S. banks, foreign branches of
U.S. banks, U.S. branches of foreign banks, and foreign branches
of foreign banks.
Corporate Debt Securities. Outstanding nonconvertible
corporate debt securities (e.g., bonds and debentures).
Corporate notes may have fixed, variable, or floating rates.
Commercial Paper. Short-term promissory notes issued by
corporations primarily to finance short-term credit needs.
Certain notes may have floating or variable rates.
Foreign Government Securities. Issued or guaranteed by a
foreign government, province, instrumentality, political
subdivision or similar unit thereof.
Savings and Loan Obligations. Negotiable certificates of
deposit and other short-term debt obligations of savings and loan
associations.
Supranational Agencies. Securities of certain supranational
entities, such as the International Development Bank.
All Funds, (except Prime Reserve and U.S. Treasury Money Funds)
Mortgage-Related Securities
Mortgage-related securities in which the Fund may invest
include, but are not limited to, those described below. The
GNMA, U.S. Treasury Intermediate and U.S. Treasury Long-Term
Funds may only invest in these securities to the extent they are
backed by the full faith and credit of the U.S. Government.
Mortgage-Backed Securities. Mortgage-backed securities are
securities representing an interest in a pool of mortgages. The
mortgages may be of a variety of types, including adjustable
rate, conventional 30-year fixed rate, graduated payment, and 15-
year. Principal and interest payments made on the mortgages in
the underlying mortgage pool are passed through to the Fund. This
is in contrast to traditional bonds where principal is normally
paid back at maturity in a lump sum. Unscheduled prepayments of
principal shorten the securities' weighted average life and may
lower their total return. (When a mortgage in the underlying
mortgage pool is prepaid, an unscheduled principal prepayment is
PAGE 12
passed through to the Fund. This principal is returned to the
Fund at par. As a result, if a mortgage security were trading at
a premium, its total return would be lowered by prepayments, and
if a mortgage security were trading at a discount, its total
return would be increased by prepayments.) The value of these
securities also may change because of changes in the market's
perception of the creditworthiness of the federal agency that
issued them. In addition, the mortgage securities market in
general may be adversely affected by changes in governmental
regulation or tax policies.
U.S. Government Agency Mortgage-Backed Securities. These
are obligations issued or guaranteed by the United States
Government or one of its agencies or instrumentalities, such as
the Government National Mortgage Association ("Ginnie Mae" or
"GNMA"), the Federal National Mortgage Association ("Fannie Mae"
or "FNMA") and the Federal Home Loan Mortgage Corporation
("Freddie Mac" or "FHLMC"). FNMA and FHLMC obligations are not
backed by the full faith and credit of the U.S. Government as
GNMA certificates are, but FNMA and FHLMC securities are
supported by the instrumentality's right to borrow from the
United States Treasury. U.S. Government Agency Mortgage-Backed
Certificates provide for the pass-through to investors of their
pro-rata share of monthly payments (including any prepayments)
made by the individual borrowers on the pooled mortgage loans,
net of any fees paid to the guarantor of such securities and the
servicer of the underlying mortgage loans. Each of GNMA, FNMA
and FHLMC guarantees timely distributions of interest to
certificate holders. GNMA and FNMA guarantee timely
distributions of scheduled principal. FHLMC has in the past
guaranteed only the ultimate collection of principal of the
underlying mortgage loan; however, FHLMC now issues
Mortgage-Backed Securities (FHLMC Gold PCs) which also guarantee
timely payment of monthly principal reductions.
Ginnie Mae Certificates. Ginnie Mae is a wholly-owned
corporate instrumentality of the United States within the
Department of Housing and Urban Development. The National
Housing Act of 1934, as amended (the "Housing Act"), authorizes
Ginnie Mae to guarantee the timely payment of the principal of
and interest on certificates that are based on and backed by a
pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing
Act of 1949 ("FHA Loans"), or guaranteed by the Department of
Veterans Affairs under the Servicemen's Readjustment Act of 1944,
as amended ("VA Loans"), or by pools of other eligible mortgage
loans. The Housing Act provides that the full faith and credit
of the United States government is pledged to the payment of all
amounts that may be required to be paid under any guaranty. In
order to meet its obligations under such guaranty, Ginnie Mae is
authorized to borrow from the United States Treasury with no
limitations as to amount.
PAGE 13
Fannie Mae Certificates. Fannie Mae is a federally
chartered and privately owned corporation organized and existing
under the Federal National Mortgage Association Charter Act of
1938. FNMA Certificates represent a pro-rata interest in a group
of mortgage loans purchased by Fannie Mae. FNMA guarantees the
timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith
and credit of the U.S. Government.
Freddie Mac Certificates. Freddie Mac is a corporate
instrumentality of the United States created pursuant to the
Emergency Home Finance Act of 1970, as amended (the "FHLMC Act").
Freddie Mac Certificates represent a pro-rata interest in a group
of mortgage loans (a "Freddie Mac Certificate group") purchased
by Freddie Mac. Freddie Mac guarantees timely payment of
interest and principal on certain securities it issues and timely
payment of interest and eventual payment of principal on other
securities is issues. The obligations of Freddie Mac are
obligations solely of Freddie Mac and are not backed by the full
faith and credit of the U.S. Government.
When mortgages in the pool underlying a Mortgage-Backed
Security are prepaid by mortgagors or by result of foreclosure,
such principal payments are passed through to the certificate
holders. Accordingly, the life of the Mortgage-Backed Security
is likely to be substantially shorter than the stated maturity of
the mortgages in the underlying pool. Because of such variation
in prepayment rates, it is not possible to predict the life of a
particular Mortgage-Backed Security, but FHA statistics indicate
that 25- to 30-year single family dwelling mortgages have an
average life of approximately 12 years. The majority of Ginnie
Mae Certificates are backed by mortgages of this type, and,
accordingly, the generally accepted practice treats Ginnie Mae
Certificates as 30-year securities which prepay full in the 12th
year. FNMA and Freddie Mac Certificates may have differing
prepayment characteristics.
Fixed Rate Mortgage-Backed Securities bear a stated "coupon
rate" which represents the effective mortgage rate at the time of
issuance, less certain fees to GNMA, FNMA and FHLMC for providing
the guarantee, and the issuer for assembling the pool and for
passing through monthly payments of interest and principal.
Payments to holders of Mortgage-Backed Securities consist of
the monthly distributions of interest and principal less the
applicable fees. The actual yield to be earned by a holder of
Mortgage-Backed Securities is calculated by dividing interest
payments by the purchase price paid for the Mortgage-Backed
Securities (which may be at a premium or a discount from the face
value of the certificate).
Monthly distributions of interest, as contrasted to semi-
annual distributions which are common for other fixed interest
PAGE 14
investments, have the effect of compounding and thereby raising
the effective annual yield earned on Mortgage-Backed Securities.
Because of the variation in the life of the pools of mortgages
which back various Mortgage-Backed Securities, and because it is
impossible to anticipate the rate of interest at which future
principal payments may be reinvested, the actual yield earned
from a portfolio of Mortgage-Backed Securities will differ
significantly from the yield estimated by using an assumption of
a certain life for each Mortgage-Backed Security included in such
a portfolio as described above.
U.S. Government Agency Multiclass Pass-Through Securities.
Unlike CMOs, U.S. Government Agency Multiclass Pass-Through
Securities, which include FNMA Guaranteed REMIC Pass-Through
Certificates and FHLMC Multi-Class Mortgage Participation
Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references
herein to CMOs include multiclass pass-through securities.
Multi-Class Residential Mortgage Securities. Such
securities represent interests in pools of mortgage loans to
residential home buyers made by commercial banks, savings and
loan associations or other financial institutions. Unlike GNMA,
FNMA and FHLMC securities, the payment of principal and interest
on Multi-Class Residential Mortgage Securities is not guaranteed
by the U.S. Government or any of its agencies. Accordingly,
yields on Multi-Class Residential Mortgage Securities have been
historically higher than the yields on U.S. government mortgage
securities. However, the risk of loss due to default on such
instruments is higher since they are not guaranteed by the U.S.
Government or its agencies. Additionally, pools of such
securities may be divided into senior or subordinated segments.
Although subordinated mortgage securities may have a higher yield
than senior mortgage securities, the risk of loss of principal is
greater because losses on the underlying mortgage loans must be
borne by persons holding subordinated securities before those
holding senior mortgage securities.
Privately-Issued Mortgage-Backed Certificates. These are
pass-through certificates issued by non-governmental issuers.
Pools of conventional residential mortgage loans created by such
issuers generally offer a higher rate of interest than government
and government-related pools because there are no direct or
indirect government guarantees of payment. Timely payment of
interest and principal of these pools is, however, generally
supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance. The insurance
and guarantees are issued by government entities, private
insurance or the mortgage poolers. Such insurance and guarantees
and the creditworthiness of the issuers thereof will be
considered in determining whether a mortgage-related security
meets the Fund's quality standards. The Fund may buy mortgage-
related securities without insurance or guarantees if through an
PAGE 15
examination of the loan experience and practices of the poolers,
the investment manager determines that the securities meet the
Fund's quality standards.
Collateralized Mortgage Obligations (CMOs). CMOs are bonds
that are collateralized by whole loan mortgages or mortgage pass-
through securities. The bonds issued in a CMO deal are divided
into groups, and each group of bonds is referred to as a
"tranche." Under the traditional CMO structure, the cash flows
generated by the mortgages or mortgage pass-through securities in
the collateral pool are used to first pay interest and then pay
principal to the CMO bondholders. The bonds issued under a CMO
structure are retired sequentially as opposed to the pro rata
return of principal found in traditional pass-through
obligations. Subject to the various provisions of individual CMO
issues, the cash flow generated by the underlying collateral (to
the extent it exceeds the amount required to pay the stated
interest) is used to retire the bonds. Under the CMO structure,
the repayment of principal among the different tranches is
prioritized in accordance with the terms of the particular CMO
issuance. The "fastest-pay" tranche of bonds, as specified in
the prospectus for the issuance, would initially receive all
principal payments. When that tranche of bonds is retired, the
next tranche, or tranches, in the sequence, as specified in the
prospectus, receive all of the principal payments until they are
retired. The sequential retirement of bond groups continues
until the last tranche, or group of bonds, is retired.
Accordingly, the CMO structure allows the issuer to use cash
flows of long maturity, monthly-pay collateral to formulate
securities with short, intermediate and long final maturities and
expected average lives.
In recent years, new types of CMO structures have evolved.
These include floating rate CMOs, planned amortization classes,
accrual bonds and CMO residuals. These newer structures affect
the amount and timing of principal and interest received by each
tranche from the underlying collateral. Under certain of these
new structures, given classes of CMOs have priority over others
with respect to the receipt of prepayments on the mortgages.
Therefore, depending on the type of CMOs in which the Fund
invests, the investment may be subject to a greater or lesser
risk of prepayment than other types of mortgage-related
securities.
The primary risk of any mortgage security is the uncertainty
of the timing of cash flows. For CMOs, the primary risk results
from the rate of prepayments on the underlying mortgages serving
as collateral. An increase or decrease in prepayment rates
(resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs.
The prices of certain CMOs, depending on their structure and the
rate of prepayments, can be volatile. Some CMOs may also not be
as liquid as other securities.
PAGE 16
Stripped Agency Mortgage-Backed Securities. Stripped Agency
Mortgage-Backed securities represent interests in a pool of
mortgages, the cash flow of which has been separated into its
interest and principal components. "IOs" (interest only
securities) receive the interest portion of the cash flow while
"POs" (principal only securities) receive the principal portion.
Stripped Agency Mortgage-Backed Securities may be issued by U.S.
Government Agencies or by private issuers similar to those
described below with respect to CMOs and privately-issued
mortgage-backed certificates. As interest rates rise and fall,
the value of IOs tends to move in the same direction as interest
rates. The value of the other mortgage-backed securities
described herein, like other debt instruments, will tend to move
in the opposite direction compared to interest rates. Under the
Internal Revenue Code of 1986, as amended (the "Code"), POs may
generate taxable income from the current accrual of original
issue discount, without a corresponding distribution of cash to
the Fund.
The cash flows and yields on IO and PO classes are extremely
sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets. For
example, a rapid or slow rate of principal payments may have a
material adverse effect on the prices of IOs or POs,
respectively. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, an investor
may fail to recoup fully its initial investment in an IO class of
a stripped mortgage-backed security, even if the IO class is
rated AAA or Aaa or is derived from a full faith and credit
obligation. Conversely, if the underlying mortgage assets
experience slower than anticipated prepayments of principal, the
price on a PO class will be affected more severely than would be
the case with a traditional mortgage-backed security.
The staff of the Securities and Exchange Commission has
advised the Fund that it believes the Fund should treat IOs and
POs, other than government-issued IOs or POs backed by fixed rate
mortgages, as illiquid securities and, accordingly, limit its
investments in such securities, together with all other illiquid
securities, to 15% of the Fund's net assets. Under the Staff's
position, the determination of whether a particular
government-issued IO and PO backed by fixed rate mortgages may be
made on a case by case basis under guidelines and standards
established by the Fund's Board of Directors/Trustees. The
Fund's Board of Directors/Trustees has delegated to T. Rowe Price
the authority to determine the liquidity of these investments
based on the following guidelines: the type of issuer; type of
collateral, including age and prepayment characteristics; rate of
interest on coupon relative to current market rates and the
effect of the rate on the potential for prepayments; complexity
of the issue's structure, including the number of tranches; size
of the issue and the number of dealers who make a market in the
PAGE 17
IO or PO. The Fund will treat non-government-issued IOs and POs
not backed by fixed or adjustable rate mortgages as illiquid
unless and until the Securities and Exchange Commission modifies
its position.
Adjustable Rate Mortgages. Adjustable rate mortgage (ARM)
securities are collateralized by adjustable rate, rather than
fixed rate, mortgages.
ARMs, like fixed rate mortgages, have a specified maturity
date, and the principal amount of the mortgage is repaid over the
life of the mortgage. Unlike fixed rate mortgages, the interest
rate on ARMs is adjusted at regular intervals based on a
specified, published interest rate "index" such as a Treasury
rate index. The new rate is determined by adding a specific
interest amount, the "margin," to the interest rate of the index.
Investment in ARM securities allows the Fund to participate in
changing interest rate levels through regular adjustments in the
coupons of the underlying mortgages, resulting in more variable
current income and lower price volatility than longer term fixed
rate mortgage securities. The ARM securities in which the Fund
expects to invest will generally adjust their interest rates at
regular intervals of one year or less. ARM securities are a less
effective means of locking in long-term rates than fixed rate
mortgages since the income from adjustable rate mortgages will
increase during periods of rising interest rates and decline
during periods of falling rates.
Characteristics of Adjustable Rate Mortgage Securities -
Interest Rate Indices. The interest rates paid on adjustable
rate securities are readjusted periodically to an increment over
some predetermined interest rate index. Such readjustments occur
at intervals ranging from one to 60 months. There are three main
categories of indexes: (1) those based on U.S. Treasury
securities (2) those derived from a calculated measure such as a
cost of funds index ("COFI") or a moving average of mortgage
rates and (3) those based on actively traded or prominently
posted short-term, interest rates. Commonly utilized indexes
include the one-year, three-year and five-year constant maturity
Treasury rates, the three-month Treasury bill rate, the 180-day
Treasury bill rate, rates on longer-term Treasury securities, the
11th District Federal Home Loan Bank Cost of Funds, the National
Median Cost of Funds, the one-month, three-month, six-month or
one-year London Interbank Offered Rate (LIBOR), the prime rate of
a specific bank, or commercial paper rates. Some indexes, such
as the one-year constant maturity Treasury rate, closely mirror
changes in market interest rate levels. Others, such as the 11th
District Home Loan Bank Cost of Funds index, tend to lag behind
changes in market rate levels. The market value of the Fund's
assets and of the net asset value of the Fund's shares will be
affected by the length of the adjustment period, the degree of
volatility in the applicable indexes and the maximum increase or
decrease of the interest rate adjustment on any one adjustment
PAGE 18
date, in any one year and over the life of the securities. These
maximum increases and decreases are typically referred to as
"caps" and "floors", respectively.
A number of factors affect the performance of the Cost of
Funds Index and may cause the Cost of Funds Index to move in a
manner different from indices based upon specific interest rates,
such as the One Year Treasury Index. Additionally, there can be
no assurance that the Cost of Funds Index will necessarily move
in the same direction or at the same rate as prevailing interest
rates. Furthermore, any movement in the Cost of Funds Index as
compared to other indices based upon specific interest rates may
be affected by changes instituted by the FHLB of San Francisco in
the method used to calculate the Cost of Funds Index. To the
extent that the Cost of Funds Index may reflect interest changes
on a more delayed basis than other indices, in a period of rising
interest rates, any increase may produce a higher yield later
than would be produced by such other indices, and in a period of
declining interest rates, the Cost of Funds Index may remain
higher than other market interest rates which may result in a
higher level of principal prepayments on mortgage loans which
adjust in accordance with the Cost of Funds Index than mortgage
loans which adjust in accordance with other indices.
LIBOR, the London interbank offered rate, is the interest
rate that the most creditworthy international banks dealing in
U.S. dollar-denominated deposits and loans charge each other for
large dollar-denominated loans. LIBOR is also usually the base
rate for large dollar-denominated loans in the international
market. LIBOR is generally quoted for loans having rate
adjustments at one, three, six or 12 month intervals.
Caps and Floors. ARMs will frequently have caps and floors
which limit the maximum amount by which the interest rate to the
residential borrower may move up or down, respectively, each
adjustment period and over the life of the loan. Interest rate
caps on ARM securities may cause them to decrease in value in an
increasing interest rate environment. Such caps may also prevent
their income from increasing to levels commensurate with
prevailing interest rates. Conversely, interest rate floors on
ARM securities may cause their income to remain higher than
prevailing interest rate levels and result in an increase in the
value of such securities. However, this increase may be tempered
by the acceleration of prepayments.
Mortgage securities generally have a maximum maturity of up
to 30 years. However, due to the adjustable rate feature of ARM
securities, their prices are considered to have volatility
characteristics which approximate the average period of time
until the next adjustment of the interest rate. As a result, the
principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer term fixed
rate mortgage securities. Prepayments however, will increase
PAGE 19
their principal volatility. See also the discussion of Mortgage-
Backed Securities on page 9.
Other Mortgage Related Securities. The Fund expects that
governmental, government-related or private entities may create
mortgage loan pools offering pass-through investments in addition
to those described above. The mortgages underlying these
securities may be alternative mortgage instruments, that is,
mortgage instruments whose principal or interest payments may
vary or whose terms to maturity may differ from customary long-
term fixed rate mortgages. As new types of mortgage-related
securities are developed and offered to investors, the investment
manager will, consistent with the Fund's objective, policies and
quality standards, consider making investments in such new types
of securities.
All Funds (except GNMA, U.S. Treasury Money, Intermediate and
Long-Term Funds)
Asset-Backed Securities
The credit quality of most asset-backed securities depends
primarily on the credit quality of the assets underlying such
securities, how well the entity issuing the security is insulated
from the credit risk of the originator or any other affiliated
entities and the amount and quality of any credit support
provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of
principal payments received on the underlying assets which in
turn may be affected by a variety of economic and other factors.
As a result, the yield on any asset-backed security is difficult
to predict with precision and actual yield to maturity may be
more or less than the anticipated yield to maturity. Asset-
backed securities may be classified as pass-through certificates
or collateralized obligations.
Pass-through certificates are asset-backed securities which
represent an undivided fractional ownership interest in an
underlying pool of assets. Pass-through certificates usually
provide for payments of principal and interest received to be
passed through to their holders, usually after deduction for
certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest
in the underlying assets, the holders thereof bear directly the
risk of any defaults by the obligors on the underlying assets not
covered by any credit support. See "Types of Credit Support".
Asset-backed securities issued in the form of debt
instruments, also known as collateralized obligations, are
generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and
issuing such debt. Such assets are most often trade, credit card
or automobile receivables. The assets collateralizing such
PAGE 20
asset-backed securities are pledged to a trustee or custodian for
the benefit of the holders thereof. Such issuers generally hold
no assets other than those underlying the asset-backed securities
and any credit support provided. As a result, although payments
on such asset-backed securities are obligations of the issuers,
in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing
entities are unlikely to have sufficient assets to satisfy their
obligations on the related asset-backed securities.
Methods of Allocating Cash Flows. While many asset-backed
securities are issued with only one class of security, many
asset-backed securities are issued in more than one class, each
with different payment terms. Multiple class asset-backed
securities are issued for two main reasons. First, multiple
classes may be used as a method of providing credit support.
This is accomplished typically through creation of one or more
classes whose right to payments on the asset-backed security is
made subordinate to the right to such payments of the remaining
class or classes. See "Types of Credit Support". Second,
multiple classes may permit the issuance of securities with
payment terms, interest rates or other characteristics differing
both from those of each other and from those of the underlying
assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests
with respect to the allocation of interest and principal of the
assets backing the security), and securities with class or
classes having characteristics which mimic the characteristics of
non-asset-backed securities, such as floating interest rates
(i.e., interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
Asset-backed securities in which the payment streams on the
underlying assets are allocated in a manner different than those
described above may be issued in the future. The Fund may invest
in such asset-backed securities if such investment is otherwise
consistent with its investment objectives and policies and with
the investment restrictions of the Fund.
Types of Credit Support. Asset-backed securities are often
backed by a pool of assets representing the obligations of a
number of different parties. To lessen the effect of failures by
obligors on underlying assets to make payments, such securities
may contain elements of credit support. Such credit support
falls into two classes: liquidity protection and protection
against ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to
ensure that scheduled payments on the underlying pool are made in
a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through
PAGE 21
guarantees, insurance policies or letters of credit obtained from
third parties, through various means of structuring the
transaction or through a combination of such approaches.
Examples of asset-backed securities with credit support arising
out of the structure of the transaction include "senior-
subordinated securities" (multiple class asset-backed securities
with certain classes subordinate to other classes as to the
payment of principal thereon, with the result that defaults on
the underlying assets are borne first by the holders of the
subordinated class) and asset-backed securities that have
"reserve funds" (where cash or investments, sometimes funded from
a portion of the initial payments on the underlying assets, are
held in reserve against future losses) or that have been "over
collateralized" (where the scheduled payments on, or the
principal amount of, the underlying assets substantially exceeds
that required to make payment of the asset-backed securities and
pay any servicing or other fees). The degree of credit support
provided on each issue is based generally on historical
information respecting the level of credit risk associated with
such payments. Delinquency or loss in excess of that anticipated
could adversely affect the return on an investment in an asset-
backed security.
Automobile Receivable Securities. The Fund may invest in
Asset Backed Securities which are backed by receivables from
motor vehicle installment sales contracts or installment loans
secured by motor vehicles ("Automobile Receivable Securities").
Since installment sales contracts for motor vehicles or
installment loans related thereto ("Automobile Contracts")
typically have shorter durations and lower incidences of
prepayment, Automobile Receivable Securities generally will
exhibit a shorter average life and are less susceptible to
prepayment risk.
Most entities that issue Automobile Receivable Securities
create an enforceable interest in their respective Automobile
Contracts only by filing a financing statement and by having the
servicer of the Automobile Contracts, which is usually the
originator of the Automobile Contracts, take custody thereof. In
such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in
violation of its obligation not to do so, there is a risk that
such party could acquire an interest in the Automobile Contracts
superior to that of the holders of Automobile Receivable
Securities. Also although most Automobile Contracts grant a
security interest in the motor vehicle being financed, in most
states the security interest in a motor vehicle must be noted on
the certificate of title to create an enforceable security
interest against competing claims of other parties. Due to the
large number of vehicles involved, however, the certificate of
title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually
PAGE 22
is not amended to reflect the assignment of the seller's security
interest for the benefit of the holders of the Automobile
Receivable Securities. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be
available to support payments on the securities. In addition,
various state and federal securities laws give the motor vehicle
owner the right to assert against the holder of the owner's
Automobile Contract certain defenses such owner would have
against the seller of the motor vehicle. The assertion of such
defenses could reduce payments on the Automobile Receivable
Securities.
Credit Card Receivable Securities. The Fund may invest in
Asset Backed Securities backed by receivables from revolving
credit card agreements ("Credit Card Receivable Securities").
Credit balances on revolving credit card agreements ("Accounts")
are generally paid down more rapidly than are Automobile
Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order
to lengthen the maturity of Credit Card Receivable Securities,
most such securities provide for a fixed period during which only
interest payments on the underlying Accounts are passed through
to the security holder and principal payments received on such
Accounts are used to fund the transfer to the pool of assets
supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial
fixed period usually may be shortened upon the occurrence of
specified events which signal a potential deterioration in the
quality of the assets backing the security, such as the
imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable
Securities thus depends upon the continued generation of
additional principal amounts in the underlying accounts during
the initial period and the non-occurrence of specified events.
An acceleration in cardholders' payment rates or any other event
which shortens the period during which additional credit card
charges on an Account may be transferred to the pool of assets
supporting the related Credit Card Receivable Security could
shorten the weighted average life and yield of the Credit Card
Receivable Security.
Credit cardholders are entitled to the protection of a
number of state and federal consumer credit laws, many of which
give such holder the right to set off certain amounts against
balances owed on the credit card, thereby reducing amounts paid
on Accounts. In addition, unlike most other Asset Backed
Securities, Accounts are unsecured obligations of the cardholder.
Other Assets. T. Rowe Price anticipates that Asset Backed
Securities backed by assets other than those described above will
be issued in the future. The Fund may invest in such securities
in the future if such investment is otherwise consistent with its
investment objective and policies.
PAGE 23
There are, of course, other types of securities that are, or
may become available, which are similar to the foregoing and the
Fund reserves the right to invest in these securities.
High Yield Fund
Collateralized Bond or Loan Obligations
CBOs are bonds collateralized by corporate bonds and CLOs
are bonds collateralized by bank loans. CBOs and CLOs are
structured into tranches, and payments are allocated such that
each tranche has a predictable cash flow stream and average life.
CBOs are fairly recent entrants to the fixed income market. Most
issues to date have been collateralized by high yield bonds or
loans, with heavy credit enhancement.
Loan Participations and Assignments
Loan participations and assignments (collectively
"participations") will typically be participating interests in
loans made by a syndicate of banks, represented by an agent bank
which has negotiated and structured the loan, to corporate
borrowers to finance internal growth, mergers, acquisitions,
stock repurchases, leveraged buy-outs and other corporate
activities. Such loans may also have been made to governmental
borrowers, especially governments of developing countries (LDC
debt). LDC debt will involve the risk that the governmental
entity responsible for the repayment of the debt may be unable or
unwilling to do so when due. The loans underlying such
participations may be secured or unsecured, and the Fund may
invest in loans collateralized by mortgages on real property or
which have no collateral. The loan participations themselves may
extend for the entire term of the loan or may extend only for
short "strips" that correspond to a quarterly or monthly floating
rate interest period on the underlying loan. Thus, a term or
revolving credit that extends for several years may be subdivided
into shorter periods.
The loan participations in which the Fund will invest will
also vary in legal structure. Occasionally, lenders assign to
another institution both the lender's rights and obligations
under a credit agreement. Since this type of assignment relieves
the original lender of its obligations, it is call a novation.
More typically, a lender assigns only its right to receive
payments of principal and interest under a promissory note,
credit agreement or similar document. A true assignment shifts
to the assignee the direct debtor-creditor relationship with the
underlying borrower. Alternatively, a lender may assign only
part of its rights to receive payments pursuant to the underlying
instrument or loan agreement. Such partial assignments, which
are more accurately characterized as "participating interests,"
do not shift the debtor-creditor relationship to the assignee,
PAGE 24
who must rely on the original lending institution to collect sums
due and to otherwise enforce its rights against the agent bank
which administers the loan or against the underlying borrower.
Pursuant to an SEC no-action letter, and because the Fund is
allowed to purchase debt and debt securities, including debt
securities at private placement, the Fund will treat loan
participations as securities and not subject to its fundamental
investment restriction prohibiting the Fund from making loans.
There may not be a recognizable, liquid public market for
loan participations. To the extent this is the case, the Fund
would consider the loan participation as illiquid and subject to
the Fund's restriction on investing no more than 15% of its net
assets in illiquid securities.
Where required by applicable SEC positions, the Fund will
treat both the corporate borrower and the bank selling the
participation interest as an issuer for purposes of its
fundamental investment restriction on diversification.
Various service fees received by the Fund from loan
participations, may be treated as non-interest income depending
on the nature of the fee (commitment, takedown, commission,
service or loan origination). To the extent the service fees are
not interest income, they will not qualify as income under
Section 851(b) of the Internal Revenue Code. Thus the sum of
such fees plus any other non-qualifying income earned by the Fund
cannot exceed 10% of total income.
Trade Claims
Trade claims are non-securitized rights of payment arising
from obligations other than borrowed funds. Trade claims
typically arise when, in the ordinary course of business, vendors
and suppliers extend credit to a company by offering payment
terms. Generally, when a company files for bankruptcy protection
payments on these trade claims cease and the claims are subject
to compromise along with the other debts of the company. Trade
claims typically are bought and sold at a discount reflecting the
degree of uncertainty with respect to the timing and extent of
recovery. In addition to the risks otherwise associated with
low-quality obligations, trade claims have other risks, including
the possibility that the amount of the claim may be disputed by
the obligor.
Over the last few years a market for the trade claims of
bankrupt companies has developed. Many vendors are either
unwilling or lack the resources to hold their claim through the
extended bankruptcy process with an uncertain outcome and timing.
Some vendors are also aggressive in establishing reserves against
these receivables, so that the sale of the claim at a discount
may not result in the recognition of a loss.
PAGE 25
Trade claims can represent an attractive investment
opportunity because these claims typically are priced at a
discount to comparable public securities. This discount is a
reflection of both a less liquid market, a smaller universe of
potential buyers and the risks peculiar to trade claim investing.
It is not unusual for trade claims to be priced at a discount to
public securities that have an equal or lower priority claim.
As noted above, investing in trade claims does carry some
unique risks which include:
o Establishing the Amount of the Claim. Frequently, the
supplier's estimate of its receivable will differ from
the customer's estimate of its payable. Resolution of
these differences can result in a reduction in the amount
of the claim. This risk can be reduced by only
purchasing scheduled claims (claims already listed as
liabilities by the debtor) and seeking representations
from the seller.
o Defenses to Claims. The debtor has a variety of defenses
that can be asserted under the bankruptcy code against
any claim. Trade claims are subject to these defenses,
the most common of which for trade claims relates to
preference payments. (Preference payments are all
payments made by the debtor during the 90 days prior to
the filing. These payments are presumed to have
benefited the receiving creditor at the expense of the
other creditors. The receiving creditor may be required
to return the payment unless it can show the payments
were received in the ordinary course of business.) While
none of these defenses can result in any additional
liability of the purchaser of the trade claim, they can
reduce or wipe out the entire purchased claim. This risk
can be reduced by seeking representations and
indemnification from the seller.
o Documentation/Indemnification. Each trade claim
purchased requires documentation that must be negotiated
between the buyer and seller. This documentation is
extremely important since it can protect the purchaser
from losses such as those described above. Legal
expenses in negotiating a purchase agreement can be
fairly high. Additionally, it is important to note that
the value of an indemnification depends on the sellers
credit.
o Volatile Pricing Due to Illiquid Market. There are only
a handful of brokers for trade claims and the quoted
price of these claims can be volatile. Generally, it is
expected that Trade Claims would be considered illiquid
investments.
PAGE 26
o No Current Yield/Ultimate Recovery. Trade claims are
almost never entitled to earn interest. As a result, the
return on such an investment is very sensitive to the
length of the bankruptcy, which is uncertain. Although
not unique to trade claims, it is worth noting that the
ultimate recovery on the claim is uncertain and there is
no way to calculate a conventional yield to maturity on
this investment. Additionally, the exit for this
investment is a plan of reorganization which may include
the distribution of new securities. These securities may
be as illiquid as the original trade claim investment.
o Tax Issue. Although the issue is not free from doubt, it
is likely that Trade Claims would be treated as non-
securities investments. As a result, any gains would be
considered "non-qualifying" under the Internal Revenue
Code. The Fund may have up to 10% of its gross income
(including capital gains) derived from non-qualifying
sources.
Zero Coupon and Pay-in-Kind Bonds
A zero coupon security has no cash coupon payments.
Instead, the issuer sells the security at a substantial discount
from its maturity value. The interest received by the investor
from holding this security to maturity is the difference between
the maturity value and the purchase price. The advantage to the
investor is that reinvestment risk of the income received during
the life of the bond is eliminated. However, zero-coupon bonds
like other bonds retain interest rate and credit risk and usually
display more price volatility than those securities that pay a
cash coupon.
Pay-in-Kind (PIK) Instruments are securities that pay
interest in either cash or additional securities, at the issuer's
option, for a specified period. PIK's, like zero coupon bonds,
are designed to give an issuer flexibility in managing cash flow.
PIK bonds can be either senior or subordinated debt and trade
flat (i.e., without accrued interest). The price of PIK bonds is
expected to reflect the market value of the underlying debt plus
an amount representing accrued interest since the last payment.
PIK's are usually less volatile than zero coupon bonds, but more
volatile than cash pay securities.
For federal income tax purposes, these types of bonds will
require the recognition of gross income each year even though no
cash may be paid to the Fund until the maturity or call date of
the bond. The Fund will nonetheless be required to distribute
substantially all of this gross income each year to comply with
the Internal Revenue Code, and such distributions could reduce
the amount of cash available for investment by the Fund.
PAGE 27
High Yield and New Income Funds
Warrants
The Fund may acquire warrants. Warrants are pure
speculation in that they have no voting rights, pay no dividends
and have no rights with respect to the assets of the corporation
issuing them. Warrants basically are options to purchase equity
securities at a specific price valid for a specific period of
time. They do not represent ownership of the securities, but
only the right to buy them. Warrants differ from call options in
that warrants are issued by the issuer of the security which may
be purchased on their exercise, whereas call options may be
written or issued by anyone. The prices of warrants do not
necessarily move parallel to the prices of the underlying
securities.
Adjustable Rate, High Yield, New Income and Short-Term Bond Funds
Hybrid Instruments
Hybrid Instruments have been developed and combine the
elements of futures contracts or options with those of debt,
preferred equity or a depository instrument (hereinafter "Hybrid
Instruments"). Generally, a Hybrid Instrument will be a debt
security, preferred stock, depository share, trust certificate,
certificate of deposit or other evidence of indebtedness on which
a portion of or all interest payments, and/or the principal or
stated amount payable at maturity, redemption or retirement, is
determined by reference to prices, changes in prices, or
differences between prices, of securities, currencies,
intangibles, goods, articles or commodities (collectively
"Underlying Assets") or by another objective index, economic
factor or other measure, such as interest rates, currency
exchange rates, commodity indices, and securities indices
(collectively "Benchmarks"). Thus, Hybrid Instruments may take a
variety of forms, including, but not limited to, debt instruments
with interest or principal payments or redemption terms
determined by reference to the value of a currency or commodity
or securities index at a future point in time, preferred stock
with dividend rates determined by reference to the value of a
currency, or convertible securities with the conversion terms
related to a particular commodity.
Hybrid Instruments can be an efficient means of creating
exposure to a particular market, or segment of a market, with the
objective of enhancing total return. For example, a Fund may
wish to take advantage of expected declines in interest rates in
several European countries, but avoid the transactions costs
associated with buying and currency-hedging the foreign bond
positions. One solution would be to purchase a U.S. dollar-
denominated Hybrid Instrument whose redemption price is linked to
the average three year interest rate in a designated group of
PAGE 28
countries. The redemption price formula would provide for
payoffs of greater than par if the average interest rate was
lower than a specified level, and payoffs of less than par if
rates were above the specified level. Furthermore, the Fund
could limit the downside risk of the security by establishing a
minimum redemption price so that the principal paid at maturity
could not be below a predetermined minimum level if interest
rates were to rise significantly. The purpose of this
arrangement, known as a structured security with an embedded put
option, would be to give the Fund the desired European bond
exposure while avoiding currency risk, limiting downside market
risk, and lowering transactions costs. Of course, there is no
guarantee that the strategy will be successful and the Fund could
lose money if, for example, interest rates do not move as
anticipated or credit problems develop with the issuer of the
Hybrid.
The risks of investing in Hybrid Instruments reflect a
combination of the risks of investing in securities, options,
futures and currencies. Thus, an investment in a Hybrid
Instrument may entail significant risks that are not associated
with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars or
bears interest either at a fixed rate or a floating rate
determined by reference to a common, nationally published
Benchmark. The risks of a particular Hybrid Instrument will, of
course, depend upon the terms of the instrument, but may include,
without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the
instrument is linked. Such risks generally depend upon factors
which are unrelated to the operations or credit quality of the
issuer of the Hybrid Instrument and which may not be readily
foreseen by the purchaser, such as economic and political events,
the supply and demand for the Underlying Assets and interest rate
movements. In recent years, various Benchmarks and prices for
Underlying Assets have been highly volatile, and such volatility
may be expected in the future. Reference is also made to the
discussion of futures, options, and forward contracts herein for
a discussion of the risks associated with such investments.
Hybrid Instruments are potentially more volatile and carry
greater market risks than traditional debt instruments.
Depending on the structure of the particular Hybrid Instrument,
changes in a Benchmark may be magnified by the terms of the
Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices
of the Hybrid Instrument and the Benchmark or Underlying Asset
may not move in the same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred
dividends at below market (or even relatively nominal) rates.
Alternatively, Hybrid Instruments may bear interest at above
market rates but bear an increased risk of principal loss (or
PAGE 29
gain). The latter scenario may result if "leverage" is used to
structure the Hybrid Instrument. Leverage risk occurs when the
Hybrid Instrument is structured so that a given change in a
Benchmark or Underlying Asset is multiplied to produce a greater
value change in the Hybrid Instrument, thereby magnifying the
risk of loss as well as the potential for gain.
Hybrid Instruments may also carry liquidity risk since the
instruments are often "customized" to meet the portfolio needs of
a particular investor, and therefore, the number of investors
that are willing and able to buy such instruments in the
secondary market may be smaller than that for more traditional
debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market
without the guarantee of a central clearing organization or in a
transaction between the Fund and the issuer of the Hybrid
Instrument, the creditworthiness of the counter party or issuer
of the Hybrid Instrument would be an additional risk factor which
the Fund would have to consider and monitor. Hybrid Instruments
also may not be subject to regulation of the Commodities Futures
Trading Commission ("CFTC"), which generally regulates the
trading of commodity futures by U.S. persons, the SEC, which
regulates the offer and sale of securities by and to U.S.
persons, or any other governmental regulatory authority.
The various risks discussed above, particularly the market
risk of such instruments, may in turn cause significant
fluctuations in the net asset value of the Fund. Accordingly,
the Fund will limit its investments in Hybrid Instruments to 10%
of net assets. However, because of their volatility, it is
possible that the Fund's investment in Hybrid Instruments will
account for more than 10% of the Fund's return (positive or
negative).
All Funds
When-Issued Securities and Forward Commitment Contracts
The Fund may purchase securities on a "when-issued" or
delayed delivery basis ("When-Issueds") and may purchase
securities on a forward commitment basis ("Forwards"). Any or
all of the Fund's investments in debt securities may be in the
form of When-Issueds and Forwards. The price of such securities,
which may be expressed in yield terms, is fixed at the time the
commitment to purchase is made, but delivery and payment take
place at a later date. Normally, the settlement date occurs
within 90 days of the purchase for When-Issueds, but may be
substantially longer for Forwards. During the period between
purchase and settlement, no payment is made by the Fund to the
issuer and no interest accrues to the Fund. The purchase of
these securities will result in a loss if their value declines
prior to the settlement date. This could occur, for example, if
interest rates increase prior to settlement. The longer the
PAGE 30
period between purchase and settlement, the greater the risks
are. At the time the Fund makes the commitment to purchase these
securities, it will record the transaction and reflect the value
of the security in determining its net asset value. The Fund
will cover these securities by maintaining cash and/or liquid,
high-grade debt securities with its custodian bank equal in value
to commitments for them during the time between the purchase and
the settlement. Therefore, the longer this period, the longer
the period during which alternative investment options are not
available to the Fund (to the extent of the securities used for
cover). Such securities either will mature or, if necessary, be
sold on or before the settlement date.
To the extent the Fund remains fully or almost fully
invested (in securities with a remaining maturity of more than
one year) at the same time it purchases these securities, there
will be greater fluctuations in the Fund's net asset value than
if the Fund did not purchase them.
Additional Adjustable Rate Securities
Certain securities may be issued with adjustable interest
rates that are reset periodically by pre-determined formulas or
indexes in order to minimize movements in the principal value of
the investment. Such securities may have long-term maturities,
but may be treated as a short-term investment under certain
conditions. Generally, as interest rates decrease or increase,
the potential for capital appreciation or depreciation on these
securities is less than for fixed-rate obligations. These
securities may take the following forms:
Variable Rate Securities. Variable rate instruments are
those whose terms provide for the adjustment of their interest
rates on set dates and which, upon such adjustment, can
reasonably be expected to have a market value that approximates
its par value. A variable rate instrument, the principal amount
of which is scheduled to be paid in 397 days or less, is deemed
to have a maturity equal to the period remaining until the next
readjustment of the interest rate. A variable rate instrument
which is subject to a demand feature entitles the purchaser to
receive the principal amount of the underlying security or
securities, either (i) upon notice of no more than 30 days or
(ii) at specified intervals not exceeding 397 days and upon no
more than 30 days' notice, is deemed to have a maturity equal to
the longer of the period remaining until the next readjustment of
the interest rate or the period remaining until the principal
amount can be recovered through demand.
Floating Rate Securities. Floating rate instruments are
those whose terms provide for the adjustment of their interest
rates whenever a specified interest rate changes and which, at
any time, can reasonably be expected to have a market value that
approximates its par value. The maturity of a floating rate
PAGE 31
instrument is deemed to be the period remaining until the date
(noted on the face of the instrument) on which the principal
amount must be paid, or in the case of an instrument called for
redemption, the date on which the redemption payment must be
made. Floating rate instruments with demand features are deemed
to have a maturity equal to the period remaining until the
principal amount can be recovered through demand.
Put Option Bonds. Long-term obligations with maturities
longer than one year may provide purchasers an optional or
mandatory tender of the security at par value at predetermined
intervals, often ranging from one month to several years (e.g., a
30-year bond with a five-year tender period). These instruments
are deemed to have a maturity equal to the period remaining to
the put date.
Adjustable Rate, High Yield, New Income, Prime Reserve and Short-
Term Bond Funds
Illiquid or Restricted Securities
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act of 1933 (the "1933 Act"). Where registration is required,
the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop,
the Fund might obtain a less favorable price than prevailed when
it decided to sell. Restricted securities will be priced at fair
value as determined in accordance with procedures prescribed by
the Fund's Board of Directors/Trustees. If through the
appreciation of illiquid securities or the depreciation of liquid
securities, the Fund should be in a position where more than 15%
of the value of its net assets is invested in illiquid assets,
including restricted securities, the Fund will take appropriate
steps to protect liquidity.
Notwithstanding the above, the Fund may purchase securities
which, while privately placed, are eligible for purchase and sale
under Rule 144A under the 1933 Act. This rule permits certain
qualified institutional buyers, such as the Fund, to trade in
privately placed securities even though such securities are not
registered under the 1933 Act. T. Rowe Price under the
supervision of the Fund's Board of Directors/Trustees, will
consider whether securities purchased under Rule 144A are
illiquid and thus subject to the Fund's restriction of investing
no more than 15% (10% for Prime Reserve Fund) of its net assets
in illiquid securities. A determination of whether a Rule 144A
security is liquid or not is a question of fact. In making this
determination, T. Rowe Price will consider the trading markets
PAGE 32
for the specific security taking into account the unregistered
nature of a Rule 144A security. In addition, T. Rowe Price could
consider the (1) frequency of trades and quotes, (2) number of
dealers and potential purchases, (3) dealer undertakings to make
a market, and (4) the nature of the security and of marketplace
trades (e.g., the time needed to dispose of the security, the
method of soliciting offers and the mechanics of transfer). The
liquidity of Rule 144A securities would be monitored, and if as a
result of changed conditions it is determined that a Rule 144A
security is no longer liquid, the Fund's holdings of illiquid
securities would be reviewed to determine what, if any, steps are
required to assure that the Fund does not invest more than 15%
(10% for Prime Reserve and U.S. Treasury Money Funds) of its net
assets in illiquid securities. Investing in Rule 144A securities
could have the effect of increasing the amount of the Fund's
assets invested in illiquid securities if qualified institutional
buyers are unwilling to purchase such securities.
New Income and Short-Term Bond Funds
Industry Concentration
When the market for corporate debt securities is dominated
by issues in the gas utility, gas transmission utility, electric
utility, telephone utility, or petroleum industry, the Fund will
as a matter of fundamental policy concentrate more than 25%, but
not more than 50%, of its assets, in any one such industry, if
the Fund has cash for such investment (i.e., will not sell
portfolio securities to raise cash) and, if in T. Rowe Price's
judgment, the return available and the marketability, quality,
and availability of the debt securities of such industry
justifies such concentration in light of the Fund's investment
objective. Domination would exist with respect to any one such
industry, when, in the preceding 30-day period, more than 25% of
all new-issue corporate debt offerings (within the four highest
grades of Moody's or S&P and with maturities of 10 years or less)
of $25,000,000 or more consisted of issues in such industry.
Although the Fund will normally purchase corporate debt
securities in the secondary market as opposed to new offerings,
T. Rowe Price believes that the new issue-based dominance
standard, as defined above, is appropriate because it is easily
determined and represents an accurate correlation to the
secondary market. Investors should understand that concentration
in any industry may result in increased risk. Investments in any
of these industries may be affected by environmental conditions,
energy conservation programs, fuel shortages, difficulty in
obtaining adequate return on capital in financing operations and
large construction programs, and the ability of the capital
markets to absorb debt issues. In addition, it is possible that
the public service commissions which have jurisdiction over these
industries may not grant future increases in rates sufficient to
offset increases in operating expenses. These industries also
face numerous legislative and regulatory uncertainties at both
PAGE 33
federal and state government levels. Management believes that
any risk to the Fund which might result from concentration in any
industry will be minimized by the Fund's practice of diversifying
its investments in other respects. The Fund's policy with
respect to industry concentration is a fundamental policy. (For
investment restriction on industry concentration, see Investment
Restriction (3) on page 45.)
PORTFOLIO MANAGEMENT PRACTICES
Lending of Portfolio Securities
Securities loans are made to broker-dealers or institutional
investors or other persons, pursuant to agreements requiring that
the loans be continuously secured by collateral at least equal at
all times to the value of the securities lent marked to market on
a daily basis. The collateral received will consist of cash,
U.S. government securities, letters of credit or such other
collateral as may be permitted under its investment program.
While the securities are being lent, the Fund will continue to
receive the equivalent of the interest or dividends paid by the
issuer on the securities, as well as interest on the investment
of the collateral or a fee from the borrower. The Fund has a
right to call each loan and obtain the securities on five
business days' notice or, in connection with securities trading
on foreign markets, within such longer period of time which
coincides with the normal settlement period for purchases and
sales of such securities in such foreign markets. The Fund will
not have the right to vote securities while they are being lent,
but it will call a loan in anticipation of any important vote.
The risks in lending portfolio securities, as with other
extensions of secured credit, consist of possible delay in
receiving additional collateral or in the recovery of the
securities or possible loss of rights in the collateral should
the borrower fail financially. Loans will only be made to firms
deemed by T. Rowe Price to be of good standing and will not be
made unless, in the judgment of T. Rowe Price, the consideration
to be earned from such loans would justify the risk.
Other Lending/Borrowing
Subject to approval by the Securities and Exchange
Commission and certain state regulatory agencies, the Fund may
make loans to, or borrow funds from, other mutual funds sponsored
or advised by T. Rowe Price or Rowe Price-Fleming International,
Inc. (collectively, "Price Funds"). The Fund has no current
intention of engaging in these practices at this time.
PAGE 34
Repurchase Agreements
The Fund may enter into a repurchase agreement through which
an investor (such as the Fund) purchases a security (known as the
"underlying security") from a well-established securities dealer
or a bank that is a member of the Federal Reserve System. Any
such dealer or bank will be on T. Rowe Price's approved list. At
that time, the bank or securities dealer agrees to repurchase the
underlying security at the same price, plus specified interest.
Repurchase agreements are generally for a short period of time,
often less than a week. Repurchase agreements which do not
provide for payment within seven days will be treated as illiquid
securities. The Fund will only enter into repurchase agreements
where (i) (A) Prime Reserve and U.S. Treasury Money Funds--the
underlying securities are either U.S. government securities or
securities that, at the time the repurchase agreement is entered
into, are rated in the highest rating category by the requisite
number of NRSROs (as required by Rule 2a-7 under the 1940 Act)
and otherwise are of the type (excluding maturity limitations)
which the Fund's investment guidelines would allow it to purchase
directly, (B) Adjustable Rate, GNMA, High Yield, New Income,
Short-Term Bond, and U.S. Treasury Intermediate and Long-Term
Funds--the underlying securities are of the type (excluding
maturity limitations) which the Fund's investment guidelines
would allow it to purchase directly, (ii) the market value of the
underlying security, including interest accrued, will be at all
times equal to or exceed the value of the repurchase agreement,
and (iii) payment for the underlying security is made only upon
physical delivery or evidence of book-entry transfer to the
account of the custodian or a bank acting as agent. In the event
of a bankruptcy or other default of a seller of a repurchase
agreement, the Fund could experience both delays in liquidating
the underlying security and losses, including: (a) possible
decline in the value of the underlying security during the period
while the Fund seeks to enforce its rights thereto; (b) possible
subnormal levels of income and lack of access to income during
this period; and (c) expenses of enforcing its rights.
Reverse Repurchase Agreements
Although the Fund has no current intention, in the
foreseeable future, of engaging in reverse repurchase agreements,
the Fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a Fund is
the seller of, rather than the investor in, securities, and
agrees to repurchase them at an agreed upon time and price. Use
of a reverse repurchase agreement may be preferable to a regular
sale and later repurchase of the securities because it avoids
certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the Fund,
subject to Investment Restriction (1). (See "Investment
Restrictions," page 44.)
PAGE 35
High Yield Fund
Short Sales
The Fund may make short sales for hedging purposes to
protect the Fund against companies whose credit is deteriorating.
Short sales are transactions in which the Fund sells a security
it does not own in anticipation of a decline in the market value
of that security. The Fund's short sales would be limited to
situations where the Fund owns a debt security of a company and
would sell short the common or preferred stock or another debt
security at a different level of the capital structure of the
same company. No securities will be sold short if, after the
effect is given to any such short sale, the total market value of
all securities sold short would exceed 2% of the value of the
Fund's net assets.
To complete a short sale transaction, the Fund must borrow
the security to make delivery to the buyer. The Fund then is
obligated to replace the security borrowed by purchasing it at
the market price at the time of replacement. The price at such
time may be more or less than the price at which the security was
sold by the Fund. Until the security is replaced, the Fund is
required to pay to the lender amounts equal to any dividends or
interest which accrue during the period of the loan. To borrow
the security, the Fund also may be required to pay a premium,
which would increase the cost of the security sold. The proceeds
of the short sale will be retained by the broker, to the extent
necessary to meet margin requirements, until the short position
is closed out.
Until the Fund replaces a borrowed security in connection
with a short sale, the Fund will: (a) maintain daily a segregated
account, containing cash or U.S. government securities, at such a
level that (i) the amount deposited in the account plus the
amount deposited with the broker as collateral will equal the
current value of the security sold short and (ii) the amount
deposited in the segregated account plus the amount deposited
with the broker as collateral will not be less than the market
value of the security at the time its was sold short; or (b)
otherwise cover its short position.
The Fund will incur a loss as a result of the short sale if
the price of the security sold short increases between the date
of the short sale and the date on which the Fund replaces the
borrowed security. The Fund will realize a gain if the security
sold short declines in price between those dates. This result is
the opposite of what one would expect from a cash purchase of a
long position in a security. The amount of any gain will be
decreased, and the amount of any loss increased, by the amount of
any premium, dividends or interest the Fund may be required to
pay in connection with a short sale. Any gain or loss on the
PAGE 36
security sold short would be separate from a gain or loss on the
Fund security being hedged by the short sale.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Options
Writing Covered Call Options
The Fund may write (sell) American or European style
"covered" call options and purchase options to close out options
previously written by a Fund. In writing covered call options,
the Fund expects to generate additional premium income which
should serve to enhance the Fund's total return and reduce the
effect of any price decline of the security or currency involved
in the option. Covered call options will generally be written on
securities or currencies which, in T. Rowe Price's opinion, are
not expected to have any major price increases or moves in the
near future but which, over the long term, are deemed to be
attractive investments for the Fund.
A call option gives the holder (buyer) the "right to
purchase" a security or currency at a specified price (the
exercise price) at expiration of the option (European style) or
at any time until a certain date (the expiration date) (American
style). So long as the obligation of the writer of a call option
continues, he may be assigned an exercise notice by the broker-
dealer through whom such option was sold, requiring him to
deliver the underlying security or currency against payment of
the exercise price. This obligation terminates upon the
expiration of the call option, or such earlier time at which the
writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his
obligation to deliver the underlying security or currency in the
case of a call option, a writer is required to deposit in escrow
the underlying security or currency or other assets in accordance
with the rules of a clearing corporation.
The Fund will write only covered call options. This means
that the Fund will own the security or currency subject to the
option or an option to purchase the same underlying security or
currency, having an exercise price equal to or less than the
exercise price of the "covered" option, or will establish and
maintain with its custodian for the term of the option, an
account consisting of cash, U.S. government securities or other
liquid high-grade debt obligations having a value equal to the
fluctuating market value of the optioned securities or
currencies.
Portfolio securities or currencies on which call options may
be written will be purchased solely on the basis of investment
considerations consistent with the Fund's investment objective.
The writing of covered call options is a conservative investment
PAGE 37
technique believed to involve relatively little risk (in contrast
to the writing of naked or uncovered options, which the Fund will
not do), but capable of enhancing the Fund's total return. When
writing a covered call option, a Fund, in return for the premium,
gives up the opportunity for profit from a price increase in the
underlying security or currency above the exercise price, but
conversely retains the risk of loss should the price of the
security or currency decline. Unlike one who owns securities or
currencies not subject to an option, the Fund has no control over
when it may be required to sell the underlying securities or
currencies, since it may be assigned an exercise notice at any
time prior to the expiration of its obligation as a writer. If a
call option which the Fund has written expires, the Fund will
realize a gain in the amount of the premium; however, such gain
may be offset by a decline in the market value of the underlying
security or currency during the option period. If the call
option is exercised, the Fund will realize a gain or loss from
the sale of the underlying security or currency. The Fund does
not consider a security or currency covered by a call to be
"pledged" as that term is used in the Fund's policy which limits
the pledging or mortgaging of its assets.
The premium received is the market value of an option. The
premium the Fund will receive from writing a call option will
reflect, among other things, the current market price of the
underlying security or currency, the relationship of the exercise
price to such market price, the historical price volatility of
the underlying security or currency, and the length of the option
period. Once the decision to write a call option has been made,
T. Rowe Price, in determining whether a particular call option
should be written on a particular security or currency, will
consider the reasonableness of the anticipated premium and the
likelihood that a liquid secondary market will exist for those
options. The premium received by the Fund for writing covered
call options will be recorded as a liability of the Fund. This
liability will be adjusted daily to the option's current market
value, which will be the latest sale price at the time at which
the net asset value per share of the Fund is computed (close of
the New York Stock Exchange), or, in the absence of such sale,
the latest asked price. The option will be terminated upon
expiration of the option, the purchase of an identical option in
a closing transaction, or delivery of the underlying security or
currency upon the exercise of the option.
Closing transactions will be effected in order to realize a
profit on an outstanding call option, to prevent an underlying
security or currency from being called, or, to permit the sale of
the underlying security or currency. Furthermore, effecting a
closing transaction will permit the Fund to write another call
option on the underlying security or currency with either a
different exercise price or expiration date or both. If the Fund
desires to sell a particular security or currency from its
portfolio on which it has written a call option, or purchased a
PAGE 38
put option, it will seek to effect a closing transaction prior
to, or concurrently with, the sale of the security or currency.
There is, of course, no assurance that the Fund will be able to
effect such closing transactions at favorable prices. If the
Fund cannot enter into such a transaction, it may be required to
hold a security or currency that it might otherwise have sold.
When the Fund writes a covered call option, it runs the risk of
not being able to participate in the appreciation of the
underlying securities or currencies above the exercise price, as
well as the risk of being required to hold on to securities or
currencies that are depreciating in value. This could result in
higher transaction costs. The Fund will pay transaction costs in
connection with the writing of options to close out previously
written options. Such transaction costs are normally higher than
those applicable to purchases and sales of portfolio securities.
Call options written by the Fund will normally have
expiration dates of less than nine months from the date written.
The exercise price of the options may be below, equal to, or
above the current market values of the underlying securities or
currencies at the time the options are written. From time to
time, the Fund may purchase an underlying security or currency
for delivery in accordance with an exercise notice of a call
option assigned to it, rather than delivering such security or
currency from its portfolio. In such cases, additional costs may
be incurred.
The Fund will realize a profit or loss from a closing
purchase transaction if the cost of the transaction is less or
more than the premium received from the writing of the option.
Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a
call option is likely to be offset in whole or in part by
appreciation of the underlying security or currency owned by the
Fund.
In order to comply with the requirements of several states,
the Fund will not write a covered call option if, as a result,
the aggregate market value of all portfolio securities or
currencies covering call or put options exceeds 25% of the market
value of the Fund's net assets. Should these state laws change
or should the Fund obtain a waiver of its application, the Fund
reserves the right to increase this percentage. In calculating
the 25% limit, the Fund will offset, against the value of assets
covering written calls and puts, the value of purchased calls and
puts on identical securities or currencies with identical
maturity dates.
Writing Covered Put Options
The Fund may write American or European style covered put
options and purchase options to close out options previously
PAGE 39
written by the Fund. A put option gives the purchaser of the
option the right to sell, and the writer (seller) has the
obligation to buy, the underlying security or currency at the
exercise price during the option period (American style) or at
the expiration of the option (European style). So long as the
obligation of the writer continues, he may be assigned an
exercise notice by the broker-dealer through whom such option was
sold, requiring him to make payment of the exercise price against
delivery of the underlying security or currency. The operation
of put options in other respects, including their related risks
and rewards, is substantially identical to that of call options.
The Fund would write put options only on a covered basis,
which means that the Fund would maintain in a segregated account
cash, U.S. government securities or other liquid high-grade debt
obligations in an amount not less than the exercise price or the
Fund will own an option to sell the underlying security or
currency subject to the option having an exercise price equal to
or greater than the exercise price of the "covered" option at all
times while the put option is outstanding. (The rules of a
clearing corporation currently require that such assets be
deposited in escrow to secure payment of the exercise price.)
The Fund would generally write covered put options in
circumstances where T. Rowe Price wishes to purchase the
underlying security or currency for the Fund's portfolio at a
price lower than the current market price of the security or
currency. In such event the Fund would write a put option at an
exercise price which, reduced by the premium received on the
option, reflects the lower price it is willing to pay. Since the
Fund would also receive interest on debt securities or currencies
maintained to cover the exercise price of the option, this
technique could be used to enhance current return during periods
of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency
would decline below the exercise price less the premiums
received. Such a decline could be substantial and result in a
significant loss to the Fund. In addition, the Fund, because it
does not own the specific securities or currencies which it may
be required to purchase in exercise of the put, cannot benefit
from appreciation, if any, with respect to such specific
securities or currencies.
In order to comply with the requirements of several states,
the Fund will not write a covered put option if, as a result, the
aggregate market value of all portfolio securities or currencies
covering put or call options exceeds 25% of the market value of
the Fund's net assets. Should these state laws change or should
the Fund obtain a waiver of its application, the Fund reserves
the right to increase this percentage. In calculating the 25%
limit, the Fund will offset, against the value of assets covering
written puts and calls, the value of purchased puts and calls on
identical securities or currencies with identical maturity dates.
PAGE 40
Purchasing Put Options
The Fund may purchase American or European style put
options. As the holder of a put option, the Fund has the right
to sell the underlying security or currency at the exercise price
at any time during the option period (American style) or at the
expiration of the option (European style). The Fund may enter
into closing sale transactions with respect to such options,
exercise them or permit them to expire. The Fund may purchase
put options for defensive purposes in order to protect against an
anticipated decline in the value of its securities or currencies.
An example of such use of put options is provided below.
The Fund may purchase a put option on an underlying security
or currency (a "protective put") owned by the Fund as a defensive
technique in order to protect against an anticipated decline in
the value of the security or currency. Such hedge protection is
provided only during the life of the put option when the Fund, as
the holder of the put option, is able to sell the underlying
security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's
exchange value. For example, a put option may be purchased in
order to protect unrealized appreciation of a security or
currency where T. Rowe Price deems it desirable to continue to
hold the security or currency because of tax considerations. The
premium paid for the put option and any transaction costs would
reduce any capital gain otherwise available for distribution when
the security or currency is eventually sold.
The Fund may also purchase put options at a time when the
Fund does not own the underlying security or currency. By
purchasing put options on a security or currency it does not own,
the Fund seeks to benefit from a decline in the market price of
the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the
underlying security or currency remains equal to or greater than
the exercise price during the life of the put option, the Fund
will lose its entire investment in the put option. In order for
the purchase of a put option to be profitable, the market price
of the underlying security or currency must decline sufficiently
below the exercise price to cover the premium and transaction
costs, unless the put option is sold in a closing sale
transaction.
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing put and call options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The premium paid
by the Fund when purchasing a put option will be recorded as an
asset of the Fund. This asset will be adjusted daily to the
PAGE 41
option's current market value, which will be the latest sale
price at the time at which the net asset value per share of the
Fund is computed (close of New York Stock Exchange), or, in the
absence of such sale, the latest bid price. This asset will be
terminated upon expiration of the option, the selling (writing)
of an identical option in a closing transaction, or the delivery
of the underlying security or currency upon the exercise of the
option.
Purchasing Call Options
The Fund may purchase American or European style call
options. As the holder of a call option, the Fund has the right
to purchase the underlying security or currency at the exercise
price at any time during the option period (American style) or at
the expiration of the option (European style). The Fund may
enter into closing sale transactions with respect to such
options, exercise them or permit them to expire. The Fund may
purchase call options for the purpose of increasing its current
return or avoiding tax consequences which could reduce its
current return. The Fund may also purchase call options in order
to acquire the underlying securities or currencies. Examples of
such uses of call options are provided below.
Call options may be purchased by the Fund for the purpose of
acquiring the underlying securities or currencies for its
portfolio. Utilized in this fashion, the purchase of call
options enables the Fund to acquire the securities or currencies
at the exercise price of the call option plus the premium paid.
At times the net cost of acquiring securities or currencies in
this manner may be less than the cost of acquiring the securities
or currencies directly. This technique may also be useful to the
Fund in purchasing a large block of securities or currencies that
would be more difficult to acquire by direct market purchases.
So long as it holds such a call option rather than the underlying
security or currency itself, the Fund is partially protected from
any unexpected decline in the market price of the underlying
security or currency and in such event could allow the call
option to expire, incurring a loss only to the extent of the
premium paid for the option.
To the extent required by the laws of certain states, the
Fund may not be permitted to commit more than 5% of its assets to
premiums when purchasing call and put options. Should these
state laws change or should the Fund obtain a waiver of its
application, the Fund may commit more than 5% of its assets to
premiums when purchasing call and put options. The Fund may also
purchase call options on underlying securities or currencies it
owns in order to protect unrealized gains on call options
previously written by it. A call option would be purchased for
this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call
options may also be purchased at times to avoid realizing losses.
PAGE 42
Dealer (Over-the-Counter) Options
The Fund may engage in transactions involving dealer
options. Certain risks are specific to dealer options. While
the Fund would look to a clearing corporation to exercise
exchange-traded options, if the Fund were to purchase a dealer
option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the
dealer to do so would result in the loss of the premium paid by
the Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous liquid
market while dealer options have none. Consequently, the Fund
will generally be able to realize the value of a dealer option it
has purchased only by exercising it or reselling it to the dealer
who issued it. Similarly, when the Fund writes a dealer option,
it generally will be able to close out the option prior to its
expiration only by entering into a closing purchase transaction
with the dealer to which the Fund originally wrote the option.
While the Fund will seek to enter into dealer options only with
dealers who will agree to and which are expected to be capable of
entering into closing transactions with the Fund, there can be no
assurance that the Fund will be able to liquidate a dealer option
at a favorable price at any time prior to expiration. Until the
Fund, as a covered dealer call option writer, is able to effect a
closing purchase transaction, it will not be able to liquidate
securities (or other assets) or currencies used as cover until
the option expires or is exercised. In the event of insolvency
of the contra party, the Fund may be unable to liquidate a dealer
option. With respect to options written by the Fund, the
inability to enter into a closing transaction may result in
material losses to the Fund. For example, since the Fund must
maintain a secured position with respect to any call option on a
security it writes, the Fund may not sell the assets which it has
segregated to secure the position while it is obligated under the
option. This requirement may impair a Fund's ability to sell
portfolio securities or currencies at a time when such sale might
be advantageous.
The Staff of the SEC has taken the position that purchased
dealer options and the assets used to secure the written dealer
options are illiquid securities. The Fund may treat the cover
used for written OTC options as liquid if the dealer agrees that
the Fund may repurchase the OTC option it has written for a
maximum price to be calculated by a predetermined formula. In
such cases, the OTC option would be considered illiquid only to
the extent the maximum repurchase price under the formula exceeds
the intrinsic value of the option. Accordingly, the Fund will
treat dealer options as subject to the Fund's limitation on
illiquid securities. If the SEC changes its position on the
PAGE 43
liquidity of dealer options, the Fund will change its treatment
of such instrument accordingly.
High Yield Fund
Spread Option Transactions
The Fund may purchase from and sell to securities dealers
covered spread options. Such covered spread options are not
presently exchange listed or traded. The purchase of a spread
option gives the Fund the right to put, or sell, a security that
it owns at a fixed dollar spread or fixed yield spread in
relationship to another security that the Fund does not own, but
which is used as a benchmark. The risk to the Fund in purchasing
covered spread options is the cost of the premium paid for the
spread option and any transaction costs. In addition, there is
no assurance that closing transactions will be available. The
purchase of spread options will be used to protect the Fund
against adverse changes in prevailing credit quality spreads,
i.e., the yield spread between high quality and lower quality
securities. Such protection is only provided during the life of
the spread option. The security covering the spread option will
be maintained in a segregated account by the Fund's custodian.
The Fund does not consider a security covered by a spread option
to be "pledged" as that term is used in the Fund's policy
limiting the pledging or mortgaging of its assets. The Fund may
also buy and sell uncovered spread options. Such options would
be used for the same purposes and be subject to similar risks as
covered spread options. However, in an uncovered spread option,
the Fund would not own either of the securities involved in the
spread.
All Funds (except Prime Reserve and U.S. Treasury Money Funds)
Futures Contracts
Transactions in Futures
The Fund may enter into futures contracts, including stock
index, interest rate and currency futures ("futures or futures
contracts").
Stock index futures contracts may be used to provide a hedge
for a portion of the Fund's portfolio, as a cash management tool,
or as an efficient way for T. Rowe Price to implement either an
increase or decrease in portfolio market exposure in response to
changing market conditions. The Fund may purchase or sell
futures contracts with respect to any stock index. Nevertheless,
to hedge the Fund's portfolio successfully, the Fund must sell
futures contacts with respect to indices or subindices whose
movements will have a significant correlation with movements in
the prices of the Fund's portfolio securities.
PAGE 44
Interest rate or currency futures contracts may be used as a
hedge against changes in prevailing levels of interest rates or
currency exchange rates in order to establish more definitely the
effective return on securities or currencies held or intended to
be acquired by the Fund. In this regard, the Fund could sell
interest rate or currency futures as an offset against the effect
of expected increases in interest rates or currency exchange
rates and purchase such futures as an offset against the effect
of expected declines in interest rates or currency exchange
rates.
The Fund will enter into futures contracts which are traded
on national or foreign futures exchanges, and are standardized as
to maturity date and underlying financial instrument. Futures
exchanges and trading in the United States are regulated under
the Commodity Exchange Act by the CFTC. Futures are traded in
London, at the London International Financial Futures Exchange,
in Paris, at the MATIF, and in Tokyo, at the Tokyo Stock
Exchange. Although techniques other than the sale and purchase
of futures contracts could be used for the above-referenced
purposes, futures contracts offer an effective and relatively low
cost means of implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC and applicable state law.
The Fund may not purchase or sell futures contracts or
related options if, with respect to positions which do not
qualify as bona fide hedging under applicable CFTC rules, the sum
of the amounts of initial margin deposits and premiums paid on
those positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized
losses on any such contracts it has entered into; provided,
however, that in the case of an option that is in-the-money at
the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation. For purposes of this policy
options on futures contracts and foreign currency options traded
on a commodities exchange will be considered "related options".
This policy may be modified by the Board of Directors/Trustees
without a shareholder vote and does not limit the percentage of
the Fund's assets at risk to 5%.
In accordance with the rules of the State of California, the
Fund may have to apply the above 5% test without excluding the
value of initial margin and premiums paid for bona fide hedging
positions.
The Fund's use of futures contracts will not result in
leverage. Therefore, to the extent necessary, in instances
PAGE 45
involving the purchase of futures contracts or the writing of
call or put options thereon by the Fund, an amount of cash, U.S.
government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts
and options thereon (less any related margin deposits), will be
identified in an account with the Fund's custodian to cover the
position, or alternative cover (such as owning an offsetting
position) will be employed. Assets used as cover or held in an
identified account cannot be sold while the position in the
corresponding option or future is open, unless they are replaced
with similar assets. As a result, the commitment of a large
portion of a Fund's assets to cover or identified accounts could
impede portfolio management or the fund's ability to meet
redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund
would comply with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party
and purchase by another party of a specified amount of a specific
financial instrument (e.g., units of a debt security) for a
specified price, date, time and place designated at the time the
contract is made. Brokerage fees are incurred when a futures
contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
Unlike when the Fund purchases or sells a security, no price
would be paid or received by the Fund upon the purchase or sale
of a futures contract. Upon entering into a futures contract,
and to maintain the Fund's open positions in futures contracts,
the Fund would be required to deposit with its custodian in a
segregated account in the name of the futures broker an amount of
cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as
"initial margin." The margin required for a particular futures
contract is set by the exchange on which the contract is traded,
and may be significantly modified from time to time by the
exchange during the term of the contract. Futures contracts are
customarily purchased and sold on margins that may range upward
from less than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
PAGE 46
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
These subsequent payments, called "variation margin," to and
from the futures broker, are made on a daily basis as the price
of the underlying assets fluctuate making the long and short
positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require
actual future delivery of and payment for the underlying
instruments, in practice most futures contracts are usually
closed out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the
underlying instrument is not delivered, the contractual
obligations arising from the sale of one contract of September
Treasury Bills on an exchange may be fulfilled at any time before
delivery of the contract is required (i.e., on a specified date
in September, the "delivery month") by the purchase of one
contract of September Treasury Bills on the same exchange. In
such instance, the difference between the price at which the
futures contract was sold and the price paid for the offsetting
purchase, after allowance for transaction costs, represents the
profit or loss to the Fund.
A futures contract on the Standard & Poor's 500 Stock Index,
composed of 500 selected common stocks, most of which are listed
on the New York Stock Exchange, provides an example of how
futures contracts operate. The S&P 500 Index assigns relative
weightings to the common stocks included in the Index, and the
Index fluctuates with changes in the market values of those
common stocks. In the case of futures contracts on the S&P 500
Index, the contracts are to buy or sell 500 units. Thus, if the
value of the S&P 500 Index were $150, one contract would be worth
$75,000 (500 units x $150). The contract specifies that no
PAGE 47
delivery of the actual stocks making up the index will take
place. Instead, settlement in cash occurs. Over the life of the
contract, the gain or loss realized by the Fund will equal the
difference between the purchase (or sale) price of the contract
and the price at which the contract is terminated. For example,
if the Fund enters into the example contract above and the S&P
500 Index is at $154 on the termination date, the Fund will gain
$2,000 (500 units x gain of $4). If, however, the S&P 500 Index
is at $148 on that future date, the Fund will lose $1,000 (500
units x loss of $2).
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts
are volatile and are influenced, among other things, by actual
and anticipated changes in the market and interest rates, which
in turn are affected by fiscal and monetary policies and national
and international political and economic events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of a trading
session. Once the daily limit has been reached in a particular
type of futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price
movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a
relatively small price movement in a futures contract may result
in immediate and substantial loss, as well as gain, to the
investor. For example, if at the time of purchase, 10% of the
value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient
PAGE 48
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of its
futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or short futures positions. The Fund may close its
positions by taking opposite positions which would operate to
terminate the Fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional
cash would be required to be paid by or released to the Fund, and
the Fund would realize a loss or a gain.
Futures contracts may be closed out only on the exchange or
board of trade where the contracts were initially traded.
Although the Fund intends to purchase or sell futures contracts
only on exchanges or boards of trade where there appears to be an
active market, there is no assurance that a liquid market on an
exchange or board of trade will exist for any particular contract
at any particular time. In such event, it might not be possible
to close a futures contract, and in the event of adverse price
movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures
contracts have been used to hedge the underlying instruments, the
Fund would continue to hold the underlying instruments subject to
the hedge until the futures contracts could be terminated. In
such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses
on the futures contract. However, as described below, there is
no guarantee that the price of the underlying instruments will,
in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures
contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of unexpected market
behavior, market or interest rate trends. There are several
risks in connection with the use by the Fund of futures contracts
as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying
instruments which are the subject of the hedge. T. Rowe Price
will, however, attempt to reduce this risk by entering into
futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the
Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly
PAGE 49
predict movements in the direction of the market. It is possible
that, when the Fund has sold futures to hedge its portfolio
against a decline in the market, the index, indices, or
instruments underlying futures might advance and the value of the
underlying instruments held in the Fund's portfolio might
decline. If this were to occur, the Fund would lose money on the
futures and also would experience a decline in value in its
underlying instruments. However, while this might occur to a
certain degree, T. Rowe Price believes that over time the value
of the Fund's portfolio will tend to move in the same direction
as the market indices used to hedge the portfolio. It is also
possible that if the Fund were to hedge against the possibility
of a decline in the market (adversely affecting the underlying
instruments held in its portfolio) and prices instead increased,
the Fund would lose part or all of the benefit of increased value
of those underlying instruments that it has hedged, because it
would have offsetting losses in its futures positions. In
addition, in such situations, if the Fund had insufficient cash,
it might have to sell underlying instruments to meet daily
variation margin requirements. Such sales of underlying
instruments might be, but would not necessarily be, at increased
prices (which would reflect the rising market). The Fund might
have to sell underlying instruments at a time when it would be
disadvantageous to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions, which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by T.
Rowe Price might not result in a successful hedging transaction
over a very short time period.
Options on Futures Contracts
The Fund may purchase and sell options on the same types of
futures in which it may invest.
PAGE 50
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the
option to the holder of the option will be accompanied by the
delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market
price of the futures contract, at exercise, exceeds (in the case
of a call) or is less than (in the case of a put) the exercise
price of the option on the futures contract. Purchasers of
options who fail to exercise their options prior to the exercise
date suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put
options on interest rate futures, the Fund may write or purchase
call and put options on financial indices. Such options would be
used in a manner similar to the use of options on futures
contracts. From time to time, a single order to purchase or sell
futures contracts (or options thereon) may be made on behalf of
the Fund and other T. Rowe Price Funds. Such aggregated orders
would be allocated among the Funds and the other T. Rowe Price
Funds in a fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of Transactions on
Futures Contracts" are substantially the same as the risks of
using options on futures. In addition, where the Fund seeks to
close out an option position by writing or buying an offsetting
option covering the same index, underlying instrument or contract
and having the same exercise price and expiration date, its
ability to establish and close out positions on such options will
be subject to the maintenance of a liquid secondary market.
Reasons for the absence of a liquid secondary market on an
exchange include the following: (i) there may be insufficient
trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or
series of options, or underlying instruments; (iv) unusual or
unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic
or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that
exchange (or in the class or series of options) would cease to
PAGE 51
exist, although outstanding options on the exchange that had been
issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with
their terms. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times,
render certain of the facilities of any of the clearing
corporations inadequate, and thereby result in the institution by
an exchange of special procedures which may interfere with the
timely execution of customers' orders.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in
futures or options transactions other than those described above,
it reserves the right to do so. Such futures and options trading
might involve risks which differ from those involved in the
futures and options described above.
Foreign Futures and Options
Participation in foreign futures and foreign options
transactions involves the execution and clearing of trades on or
subject to the rules of a foreign board of trade. Neither the
National Futures Association nor any domestic exchange regulates
activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the
power to compel enforcement of the rules of a foreign board of
trade or any applicable foreign law. This is true even if the
exchange is formally linked to a domestic market so that a
position taken on the market may be liquidated by a transaction
on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or
foreign options transaction occurs. For these reasons, when the
Fund trades foreign futures or foreign options contracts, it may
not be afforded certain of the protective measures provided by
the Commodity Exchange Act, the CFTC's regulations and the rules
of the National Futures Association and any domestic exchange,
including the right to use reparations proceedings before the
Commission and arbitration proceedings provided by the National
Futures Association or any domestic futures exchange. In
particular, funds received from the Fund for foreign futures or
foreign options transactions may not be provided the same
protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any
foreign futures or foreign options contract and, therefore, the
potential profit and loss thereon may be affected by any variance
in the foreign exchange rate between the time the Fund's order is
placed and the time it is liquidated, offset or exercised.
PAGE 52
U.S. Treasury Intermediate and Long-Term Funds
Limitations on Futures and Options for
Intermediate and Long-Term Funds
The Funds will not purchase a futures contract or option
thereon if, with respect to positions in futures or options on
futures which do not represent bona fide hedging, the aggregate
initial margin and premiums on such positions would exceed 5% of
the Fund's net asset value. In addition, neither of the Funds
will enter into a futures transaction if it would be obligated to
purchase or deliver under outstanding open futures contracts
amounts which would exceed 15% of the Fund's total assets.
A Fund will not write a covered call option if, as a result,
the aggregate market value of all portfolio securities covering
call options or subject to delivery under put options exceeds 15%
of the market value of the Fund's total assets.
A Fund will not write a covered put option if, as a result,
the aggregate market value of all portfolio securities subject to
such put options or covering call options exceeds 15% of the
market value of the Fund's total assets.
In order to comply with the laws of certain states, a Fund
will not invest more than 5% of its total assets in premiums on
put options. Should these state laws change or should a Fund
obtain a waiver of their applications, the Fund may invest up to
15% of its total assets in premiums on put options.
In order to comply with the laws of certain states, a Fund
will not invest more than 5% of its total assets in premiums on
call options. Should these state laws change or should a Fund
obtain a waiver of their applications, the Fund may invest up to
15% of its total assets in premiums on call options.
In order to comply with the laws of certain states, a Fund
will not purchase puts, calls, straddles, spreads and any
combination thereof if by reason thereof the value of its
aggregate investment in such classes of securities will exceed 5%
of its total assets. Should these state laws change or should a
Fund obtain a waiver of their application, the Fund may invest a
higher percentage of its total assets in puts, calls, straddles,
or spreads.
The total amount of a Fund's total assets invested in
futures and options under any combination of the limitations
described above will not exceed 15% of the Fund's total assets.
PAGE 53
Short Term Bond, New Income and High Yield Funds
Foreign Currency Transactions
A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future
date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are principally traded in the
interbank market conducted directly between currency traders
(usually large, commercial banks) and their customers. A forward
contract generally has no deposit requirement, and no commissions
are charged at any stage for trades.
The Fund may enter into forward contracts for a variety of
purposes in connection with the management of the foreign
securities portion of its portfolio. The Fund's use of such
contracts would include, but not be limited to, the following:
First, when the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, it may
desire to "lock in" the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale, for a
fixed amount of dollars, of the amount of foreign currency
involved in the underlying security transactions, the Fund will
be able to protect itself against a possible loss resulting from
an adverse change in the relationship between the U.S. dollar and
the subject foreign currency during the period between the date
the security is purchased or sold and the date on which payment
is made or received.
Second, when T. Rowe Price believes that one currency may
experience a substantial movement against another currency,
including the U.S. dollar, it may enter into a forward contract
to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign
currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an
effective proxy for other currencies. In such a case, the Fund
may enter into a forward contract where the amount of the foreign
currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging
technique may be more efficient and economical than entering into
separate forward contracts for each currency held in the Fund.
The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible
since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered
into and the date it matures. The projection of short-term
currency market movement is extremely difficult, and the
PAGE 54
successful execution of a short-term hedging strategy is highly
uncertain. Under normal circumstances, consideration of the
prospect for currency parities will be incorporated into the
longer term investment decisions made with regard to overall
diversification strategies. However, T. Rowe Price believes that
it is important to have the flexibility to enter into such
forward contracts when it determines that the best interests of
the Fund will be served.
Third, the Fund may use forward contracts when the Fund
wishes to hedge out of the dollar into a foreign currency in
order to create a synthetic bond or money market instrument--the
security would be issued in U.S. dollars but the dollar component
would be transformed into a foreign currency through a forward
contract.
The Fund may enter into forward contacts for any other
purpose consistent with the Fund's investment objective and
program. However, the Fund will not enter into a forward
contract, or maintain exposure to any such contract(s), if the
amount of foreign currency required to be delivered thereunder
would exceed the Fund's holdings of liquid, high-grade debt
securities and currency available for cover of the forward
contract(s). In determining the amount to be delivered under a
contract, the Fund may net offsetting positions.
At the maturity of a forward contract, the Fund may sell the
portfolio security and make delivery of the foreign currency, or
it may retain the security and either extend the maturity of the
forward contract (by "rolling" that contract forward) or may
initiate a new forward contract.
If the Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss (as
described below) to the extent that there has been movement in
forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward
contract to sell the foreign currency. Should forward prices
decline during the period between the Fund's entering into a
forward contract for the sale of a foreign currency and the date
it enters into an offsetting contract for the purchase of the
foreign currency, the Fund will realize a gain to the extent the
price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward prices
increase, the Fund will suffer a loss to the extent of the price
of the currency it has agreed to purchase exceeds the price of
the currency it has agreed to sell.
The Fund's dealing in forward foreign currency exchange
contracts will generally be limited to the transactions described
above. However, the Fund reserves the right to enter into
forward foreign currency contracts for different purposes and
under different circumstances. Of course, the Fund is not
PAGE 55
required to enter into forward contracts with regard to its
foreign currency-denominated securities and will not do so unless
deemed appropriate by T. Rowe Price. It also should be realized
that this method of hedging against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices
of the securities. It simply establishes a rate of exchange at a
future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the
hedged currency, at the same time, they tend to limit any
potential gain which might result from an increase in the value
of that currency.
Although the Fund values its assets daily in terms of U.S.
dollars, it does not intend to convert its holdings of foreign
currencies into U.S. dollars on a daily basis. It will do so
from time to time, and investors should be aware of the costs of
currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on
the difference (the "spread") between the prices at which they
are buying and selling various currencies. Thus, a dealer may
offer to sell a foreign currency to the Fund at one rate, while
offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
Federal Tax Treatment of Options, Futures Contracts and Forward
Foreign Exchange Contracts
The Fund may enter into certain option, futures, and forward
foreign exchange contracts, including options and futures on
currencies, which will be treated as Section 1256 contracts or
straddles.
Transactions which are considered Section 1256 contracts
will be considered to have been closed at the end of the Fund's
fiscal year and any gains or losses will be recognized for tax
purposes at that time. Such gains or losses from the normal
closing or settlement of such transactions will be characterized
as 60% long-term capital gain or loss and 40% short-term capital
gain or loss regardless of the holding period of the instrument.
The Fund will be required to distribute net gains on such
transactions to shareholders even though it may not have closed
the transaction and received cash to pay such distributions.
Options, futures and forward foreign exchange contracts,
including options and futures on currencies, which offset a
foreign dollar denominated bond or currency position may be
considered straddles for tax purposes, in which case a loss on
any position in a straddle will be subject to deferral to the
extent of unrealized gain in an offsetting position. The holding
period of the securities or currencies comprising the straddle
will be deemed not to begin until the straddle is terminated.
For securities offsetting a purchased put, this adjustment of the
holding period may increase the gain from sales of securities
PAGE 56
held less than three months. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an
equity security will not include the period of time the option is
outstanding.
Losses on written covered calls and purchased puts on
securities, excluding certain "qualified covered call" options on
equity securities, may be long-term capital loss, if the security
covering the option was held for more than twelve months prior to
the writing of the option.
In order for the Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income derived from
loans of securities, and gains from the sale of securities or
currencies. Pending tax regulations could limit the extent that
net gain realized from option, futures or foreign forward
exchange contracts on currencies is qualifying income for
purposes of the 90% requirement. In addition, gains realized on
the sale or other disposition of securities, including option,
futures or foreign forward exchange contracts on securities or
securities indexes and, in some cases, currencies, held for less
than three months, must be limited to less than 30% of the Fund's
annual gross income. In order to avoid realizing excessive gains
on securities or currencies held less than three months, the Fund
may be required to defer the closing out of option, futures or
foreign forward exchange contracts) beyond the time when it would
otherwise be advantageous to do so. It is anticipated that
unrealized gains on Section 1256 option, futures and foreign
forward exchange contracts, which have been open for less than
three months as of the end of the Fund's fiscal year and which
are recognized for tax purposes, will not be considered gains on
securities or currencies held less than three months for purposes
of the 30% test.
INVESTMENT RESTRICTIONS
Fundamental policies may not be changed without the approval
of the lesser of (1) 67% of the Fund's shares present at a
meeting of shareholders if the holders of more than 50% of the
outstanding shares are present in person or by proxy or (2) more
than 50% of the Fund's outstanding shares. Other restrictions in
the form of operating policies are subject to change by the
Fund's Board of Directors/Trustees without shareholder approval.
Any investment restriction which involves a maximum percentage of
securities or assets shall not be considered to be violated
unless an excess over the percentage occurs immediately after,
and is caused by, an acquisition of securities or assets of, or
borrowings by, the Fund.
PAGE 57
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money except that the Fund may
(i) borrow for non-leveraging, temporary or
emergency purposes and (ii) engage in reverse
repurchase agreements and make other investments
or engage in other transactions, which may involve
a borrowing, in a manner consistent with the
Fund's investment objective and program, provided
that the combination of (i) and (ii) shall not
exceed 33 1/3% of the value of the Fund's total
assets (including the amount borrowed) less
liabilities (other than borrowings) or such other
percentage permitted by law. Any borrowings which
come to exceed this amount will be reduced in
accordance with applicable law. The Fund may
borrow from banks, other Price Funds or other
persons to the extent permitted by applicable law.
(2) Commodities. Purchase or sell physical
commodities; except that the Fund (other than the
Prime Reserve and Treasury Money Funds) may enter
into futures contracts and options thereon;
(3) (a) Industry Concentration (All Funds, except High
Yield, New Income, Prime Reserve and Short-Term
Bond Funds). Purchase the securities of any
issuer if, as a result, more than 25% of the value
of the Fund's total assets would be invested in
the securities of issuers having their principal
business activities in the same industry;
(b) Industry Concentration (High Yield Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
activities in the same industry; provided,
however, that the Fund will normally invest more
than 25% of its total assets in the securities of
the banking industry including, but not limited
to, bank certificates of deposit and bankers'
acceptances, when the Fund's position in issues
maturing in one year or less equals 35% or more of
the Fund's total assets;
(c) Industry Concentration (New Income Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
PAGE 58
activities in the same industry; provided,
however, that the Fund will invest more than 25%
of its total assets, but not more than 50%, in any
one of the gas utility, gas transmission utility,
electric utility, telephone utility, and petroleum
industries under certain circumstances, and
further provided that this limitation does not
apply to securities of the banking industry
including, but not limited to, certificates of
deposit and bankers' acceptances;
(d) Industry Concentration (Prime Reserve Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
activities in the same industry; provided,
however, that this limitation does not apply to
securities of the banking industry including, but
not limited to, certificates of deposit and
bankers' acceptances; and
(e) Industry Concentration (Short-Term Bond Fund).
Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's
total assets would be invested in the securities
of issuers having their principal business
activities in the same industry; provided,
however, that the Fund will normally invest more
than 25% of its total assets in the securities of
the banking industry including, but not limited
to, bank certificates of deposit and bankers'
acceptances when the Fund's position in issues
maturing in one year or less equals 35% or more of
the Fund's total assets; provided, further, that
the Fund will invest more than 25% of its total
assets, but not more than 50%, in any one of the
gas utility, gas transmission utility, electric
utility, telephone utility, and petroleum
industries under certain circumstances;
(4) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an
interfund lending program with other Price Funds
provided that no such loan may be made if, as a
result, the aggregate of such loans would exceed
33 1/3% of the value of the Fund's total assets;
(ii) purchase money market securities and enter
into repurchase agreements; and (iii) acquire
publicly-distributed or privately-placed debt
securities and purchase debt;
PAGE 59
(5) Percent Limit on Assets Invested in Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of its total assets,
more than 5% of the value of the Fund's total
assets would be invested in the securities of a
single issuer, except securities issued or
guaranteed by the U.S. Government or any of its
agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One
Issuer. Purchase a security if, as a result, with
respect to 75% of the value of the Fund's total
assets, more than 10% of the outstanding voting
securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by
the U.S. Government, its agencies or
instrumentalities);
(7) Real Estate. Purchase or sell real estate unless
acquired as a result of ownership of securities or
other instruments (but this shall not prevent the
Fund from investing in securities or other
instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities. Issue senior securities except
in compliance with the Investment Company Act of
1940; or
(9) Underwriting. Underwrite securities issued by
other persons, except to the extent that the Fund
may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in
connection with the purchase and sale of its
portfolio securities in the ordinary course of
pursuing its investment program.
NOTES
The following Notes should be read in connection
with the above-described fundamental policies.
The Notes are not fundamental policies.
With respect to investment restrictions (1) and
(4) the Fund will not borrow from or lend to any
other T. Rowe Price Fund unless each Fund applies
for and receives an exemptive order from the SEC
or the SEC issues rules permitting such
transactions. The Fund has no current intention
of engaging in any such activity and there is no
assurance the SEC would grant any order requested
by the Fund or promulgate any rules allowing the
transactions.
PAGE 60
With respect to investment restriction (1), the
Prime Reserve and Treasury Money Funds have no
current intention of engaging in any borrowing
transactions.
With respect to investment restriction (2), the
Fund does not consider currency contracts or
hybrid instruments to be commodities.
For purposes of investment restriction (3), U.S.,
state or local governments, or related agencies or
instrumentalities, are not considered an industry.
Industries are determined by reference to the
classifications of industries set forth in the
Fund's Semi-annual and Annual Reports.
For purposes of investment restriction (4), the
Fund will consider the acquisition of a debt
security to include the execution of a note or
other evidence of an extension of credit with a
term of more than nine months.
For purposes of investment restriction (5), the
Fund will consider a repurchase agreement fully
collateralized with U.S. government securities to
be U.S. government securities.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional
securities when money borrowed exceeds 5% of its
total assets.
(2) Control of Portfolio Companies. Invest in
companies for the purpose of exercising management
or control;
(3) (a) Equity Securities (All Funds, except High
Yield and New Income Funds). Purchase any common
stocks or other equity securities, or securities
convertible into equity securities except as set
forth in its operating policy on investment
companies;
(b) Equity Securities (High Yield Fund). Invest
more than 20% of the Fund's total assets in equity
securities (including up to 5% in warrants);
PAGE 61
(c) Equity Securities (New Income Fund). Invest
more than 25% of its total assets in equity
securities;
(4) Futures Contracts. Purchase a futures contract or
an option thereon if, with respect to positions in
futures or options on futures which do not
represent bona fide hedging, the aggregate initial
margin and premiums on such positions would exceed
5% of the Fund's net asset value.
(5) Illiquid Securities. Purchase illiquid
securities if, as a result, more than 15% (10% for
the Prime Reserve and Treasury Money Funds) of its
net assets would be invested in such
securities;
(6) Investment Companies. Purchase securities of
open-end or closed-end investment companies except
in compliance with the Investment Company Act of
1940 and applicable state law, and in the case of
the Prime Reserve and U.S. Treasury Money Funds,
only securities of other money market funds.
Duplicate fees may result from such purchases;
(7) Margin. Purchase securities on margin, except (i)
for use of short-term credit necessary for
clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection
with futures contracts or other permissible
investments;
(8) Mortgaging. Mortgage, pledge, hypothecate or, in
any manner, transfer any security owned by the
Fund as security for indebtedness except as may be
necessary in connection with permissible
borrowings or investments and then such
mortgaging, pledging or hypothecating may not
exceed 33 1/3% of the Fund's total assets at the
time of borrowing or investment;
(9) Oil and Gas Programs. Purchase participations or
other direct interests or enter into leases with
respect to, oil, gas, or other mineral exploration
or development programs;
(10) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement
of Additional Information;
PAGE 62
(11) Ownership of Portfolio Securities by Officers and
Directors. Purchase or retain the securities of
any issuer if, to the knowledge of the Fund's
management, those officers and directors of the
Fund, and of its investment manager, who each own
beneficially more than .5% of the outstanding
securities of such issuer, together own
beneficially more than 5% of such securities.
(12) (a) Short Sales (All Funds except High Yield
Fund). Effect short sales of securities;
(b) Short Sales (High Yield Fund). Effect short
sales of securities, other than as set forth in
its prospectus and Statement of Additional
Information;
(13) Unseasoned Issuers. Purchase a security (other
than obligations issued or guaranteed by the U.S.,
any foreign, state or local government, their
agencies or instrumentalities) if, as a result,
more than 5% of the value of the Fund's total
assets would be invested in the securities issuers
which at the time of purchase had been in
operation for less than three years (for this
purpose, the period of operation of any issuer
shall include the period of operation of any
predecessor or unconditional guarantor of such
issuer). This restriction does not apply to
securities of pooled investment vehicles or
mortgage or asset-backed securities; or
(14) Warrants. Invest in warrants if, as a result
thereof, more than 2% of the value of the total
assets of the Fund would be invested in warrants
which are not listed on the New York Stock
Exchange, the American Stock Exchange, or a
recognized foreign exchange, or more than 5% of
the value of the total assets of the Fund would be
invested in warrants whether or not so listed.
For purposes of these percentage limitations, the
warrants will be valued at the lower of cost or
market and warrants acquired by the Fund in units
or attached to securities may be deemed to be
without value.
MANAGEMENT OF FUND
The officers and directors/trustees of the Fund are
listed below. Unless otherwise noted, the address of each is 100
East Pratt Street, Baltimore, Maryland 21202. Except as
PAGE 63
indicated, each has been an employee of T. Rowe Price for more
than five years. In the list below, the Fund's
directors/trustees who are considered "interested persons" of T.
Rowe Price as defined under Section 2(a)(19) of the Investment
Company Act of 1940 are noted with an asterisk (*). These
directors/trustees are referred to as inside directors by virtue
of their officership, directorship, and/or employment with T.
Rowe Price.
All Funds
Independent Directors/Trustees
ROBERT P. BLACK, Retired; formerly President, Federal Reserve
Bank of Richmond; Address: 10 Dahlgren Road, Richmond, Virginia
23233
CALVIN W. BURNETT, PH.D., President, Coppin State College;
Director, Maryland Chamber of Commerce and Provident Bank of
Maryland; President, Baltimore Area Council Boy Scouts of
America; Vice President, Board of Directors, The Walters Art
Gallery; Address: 2500 West North Avenue, Baltimore, Maryland
21216
ANTHONY W. DEERING, Director, President and Chief Operating
Officer, The Rouse Company, real estate developers, Columbia,
Maryland; Advisory Director, Kleinwort, Benson (North America)
Corporation, a registered broker-dealer; Address: 10275 Little
Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, President, F. Pierce Linaweaver &
Associates, Inc.; formerly (1987-1991) Executive Vice President,
EA Engineering, Science, and Technology, Inc., and (1987-1990)
President, EA Engineering, Inc., Baltimore, Maryland; Address:
The Legg Mason Tower, 111 South Calvert Street, Suite 2700,
Baltimore, Maryland 21202
JOHN G. SCHREIBER, President, Schreiber Investments, a real
estate investment company; Director and formerly (1/80-12/90)
Executive Vice President, JMB Realty Corporation, a national real
estate investment manager and developer; Address: 1115 East
Illinois Road, Lake Forest, Illinois 60045
ANNE MARIE WHITTEMORE, Partner, law firm of McGuire, Woods,
Battle & Boothe, Richmond, Virginia; formerly, Chairman (1991-
1993) and Director (1989-1993), Federal Reserve Bank of Richmond;
Director, Owens & Minor, Inc., USF&G Corporation, Old Dominion
University, and James River Corporation; Member, Richmond Bar
Association and American Bar Association; Address: One James
Center, 901 East Cary Street, Richmond, Virginia 23219-4030
Officers
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment
Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price
Trust Company; Vice President, Rowe Price-Fleming International,
Inc. and T. Rowe Price Retirement Plan Services, Inc.
PAGE 64
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T.
Rowe Price Services, Inc., and T. Rowe Price Trust Company
ROGER L. FIERY, III, Assistant Vice President--Vice President,
Rowe Price-Fleming International, Inc.
EDWARD T. SCHNEIDER, Assistant Vice President--Assistant Vice
President, T. Rowe Price and T. Rowe Price Services, Inc.
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T.
Rowe Price
Adjustable Rate Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Trust
Company and T. Rowe Price Retirement Plan Services, Inc.,
Chartered Investment Counselor
*PETER VAN DYKE, President and Director--Managing Director, T.
Rowe Price; Vice President of Rowe Price-Fleming International,
Inc. and T. Rowe Price Trust Company
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., and T. Rowe Price Retirement Plan Services, Inc.; President
and Director, T. Rowe Price Investment Services, Inc; President
and Trust Officer, T. Rowe Price Trust Company; Director, Rowe
Price-Fleming International, Inc. and Rhone-Poulenc Rorer, Inc.
HEATHER R. LANDON, Executive Vice President--Vice President, T.
Rowe Price and T. Rowe Price Trust Company
VEENA A. KUTLER, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International, Inc.
JAMES M. MCDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly, (1972-1989) charter
member of the U.S. Senior Executive Services and Director,
Analysis and Evaluation Division in the Office of Water
Regulations and Standards of the U.S. Environmental Protection
Agency
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Rowe Price-Fleming International, Inc.
GWENDOLYN G. WAGNER, Vice President--Assistant Vice President, T.
Rowe Price
DONNA M. ENNIS-DAVIS, Assistant Vice President--Employee, T. Rowe
Price
GNMA Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director and Chief Executive Officer, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Trust
Company and T. Rowe Price Retirement Plan Services, Inc.;
Chartered Investment Counselor
PAGE 65
*JAMES S. RIEPE, Vice President and Trustee--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., and T. Rowe Price Retirement Plan Services, Inc.; President
and Director, T. Rowe Price Investment Services, Inc.; President
and Trust Officer, T. Rowe Price Trust Company; Director, Rowe
Price-Fleming International, Inc. and Rhone-Poulenc Rorer, Inc.
PETER VAN DYKE, President--Managing Director, T. Rowe Price; Vice
President, Rowe Price-Fleming International, Inc. and T. Rowe
Price Trust Company
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International, Inc.; formerly (4/80-5/90)
Vice President and Director, Private Finance, New York Life
Insurance Company, New York, New York
VEENA A. KUTLER, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International, Inc.
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly (1972-1989) charter
member of the U.S. Senior Executive Service and Director,
Analysis and Evaluation Division in the Office of Water
Regulations and Standards of the U.S. Environmental Protection
Agency
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Rowe Price-Fleming International, Inc.
High Yield Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Trust
Company and T. Rowe Price Retirement Plan Services, Inc.,
Chartered Investment Counselor
*RICHARD S. SWINGLE, President and Director--Managing Director,
T. Rowe Price
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., and T. Rowe Price Retirement Plan Services, Inc.; President
and Director, T. Rowe Price Investment Services, Inc; President
and Trust Officer, T. Rowe Price Trust Company; Director, Rowe
Price-Fleming International, Inc. and Rhone-Poulenc Rorer, Inc.
CATHERINE B. BRAY, Vice President--Vice President, T. Rowe Price
ANDREW M. BROOKS, Vice President--Vice President, T. Rowe Price
MICHAEL J. CONELIUS, Vice President--Assistant Vice President, T.
Rowe Price
HUBERT M. STILES, JR., Vice President--Vice President, T. Rowe
Price
JAY W. VAN ERT, Vice President--Vice President, T. Rowe Price
MARK J. VASELKIV, Vice President--Vice President, T. Rowe Price
THEA N. WILLIAMS, Vice President--Vice President, T. Rowe Price
JAMES M. McDONALD, Assistant Vice President--Vice President, T.
Rowe Price
PAGE 66
New Income Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Trust
Company and T. Rowe Price Retirement Plan Services, Inc.,
Chartered Investment Counselor
*CARTER O. HOFFMAN, Vice President and Director--Managing
Director, T. Rowe Price; Chartered Investment Counselor
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., and T. Rowe Price Retirement Plan Services, Inc.; President
and Director, T. Rowe Price Investment Services, Inc; President
and Trust Officer, T. Rowe Price Trust Company; Director, Rowe
Price-Fleming International, Inc. and Rhone-Poulenc Rorer, Inc.
*CHARLES P. SMITH, President and Director--Managing Director, T.
Rowe Price; Vice President, Rowe Price-Fleming International,
Inc.
SHAWN P. BURKE, Vice President--Vice President, T. Rowe Price;
formerly (1985-1990) Assistant Vice President/Corporate Finance,
Standard & Poor's Corporation; (1990-1993) Vice President/Senior
Credit Officer, Merrill Lynch & Co., New York, New York
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Rowe Price Fleming International, Inc.; formerly (4/80-5/90)
Vice President and Director, Private Finance, New York Life
Insurance Company, New York, New York
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company; formerly (1972-1989) charter
member of the U.S. Senior Executive Service and Director,
Analysis and Evaluation Division in the Office of Water
Regulations and Standards of the U.S. Environmental Protection
Agency
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe
Price; formerly (1/89-12/93) senior bond trader, Scudder, Stevens
& Clark, Boston, Massachusetts
PETER VAN DYKE, Vice President--Managing Director, T. Rowe Price;
Vice President, Rowe Price-Fleming International, Inc. and T.
Rowe Price Trust Company
Prime Reserve Fund
*GEORGE J. COLLINS, Vice President and Director--President,
Managing Director, and Chief Executive Officer, T. Rowe Price;
Director, Rowe Price-Fleming International, Inc., T. Rowe Price
Trust Company and T. Rowe Price Retirement Plan Services, Inc.,
Chartered Investment Counselor
PAGE 67
*CARTER O. HOFFMAN, Chairman of the Board--Managing Director, T.
Rowe Price; Chartered Investment Counselor
EDWARD A. WIESE, President--Vice President, T. Rowe Price, Rowe
Price-Fleming International, Inc. and T. Rowe Price Trust Company
ROBERT P. CAMPBELL, Executive Vice President--Vice President, T.
Rowe Price and Rowe Price-Fleming International Inc.; formerly
(4/80-5/90) Vice President and Director, Private Finance, New
York Life Insurance Company, New York, New York
JAMES M. MCDONALD, Executive Vice President--Vice President, T.
Rowe Price
PATRICE L. BERCHTENBREITER, Vice President--Vice President, T.
Rowe Price
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist of T. Rowe Price
MICHAEL J. CONELIUS, Vice President--Assistant Vice President, T.
Rowe Price
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., and T. Rowe Price Retirement Plan Services, Inc.; President
and Director, T. Rowe Price Investment Services, Inc; President
and Trust Officer, T. Rowe Price Trust Company; Director, Rowe
Price-Fleming International, Inc. and Rhone-Poulenc Rorer, Inc.
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
Short-Term Bond Fund
*GEORGE J. COLLINS, Chairman of the Board--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Trust
Company and T. Rowe Price Retirement Plan Services, Inc.,
Chartered Investment Counselor
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., and T. Rowe Price Retirement Plan Services, Inc.; President
and Director, T. Rowe Price Investment Services, Inc; President
and Trust Officer, T. Rowe Price Trust Company; Director, Rowe
Price-Fleming International, Inc. and Rhone-Poulenc Rorer, Inc.
VEENA A. KUTLER, President--Vice President, T. Rowe Price and
Rowe Price-Fleming International, Inc.
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International, Inc.; formerly (4/80-5/90)
Vice President and Director, Private Finance, New York Life
Insurance Company, New York, New York
CHRISTY M. DIPIETRO, Vice President--Vice President, T. Rowe
Price and T. Rowe Price Trust Company
JAMES M. MCDONALD, Vice President--Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President--Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President--Managing Director, T. Rowe
Price; Vice President, Rowe Price-Fleming International, Inc.
EDWARD A. WIESE, Vice President--Vice President, T. Rowe Price,
Rowe Price-Fleming International, Inc. and T. Rowe Price Trust
Company
PAGE 68
Intermediate, Long-Term and Money Funds
*GEORGE J. COLLINS, President and Director--President, Managing
Director, and Chief Executive Officer, T. Rowe Price; Director,
Rowe Price-Fleming International, Inc., T. Rowe Price Trust
Company and T. Rowe Price Retirement Plan Services, Inc.,
Chartered Investment Counselor
*JAMES S. RIEPE, Vice President and Director--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., and T. Rowe Price Retirement Plan Services, Inc.; President
and Director, T. Rowe Price Investment Services, Inc; President
and Trust Officer, T. Rowe Price Trust Company, Director, Rowe
Price-Fleming International, Inc. and Rhone-Poulenc Rorer, Inc.
*CHARLES P. SMITH, Executive Vice President and Director--
Managing Director, T. Rowe Price; Vice President, Rowe Price-
Fleming International, Inc.
*PETER VAN DYKE, Executive Vice President and Director--Managing
Director, T. Rowe Price; Vice President, Rowe Price-Fleming
International, Inc. and T. Rowe Price Trust Company
EDWARD A. WIESE, Executive Vice President--Vice President, T.
Rowe Price, Rowe Price-Fleming International, Inc. and T. Rowe
Price Trust Company
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist of T. Rowe Price
ROBERT P. CAMPBELL, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International Inc.; formerly (4/80-5/90)
Vice President and Director, Private Finance, New York Life
Insurance Company, New York, New York
VEENA A. KUTLER, Vice President--Vice President, T. Rowe Price
and Rowe Price-Fleming International, Inc.
HEATHER R. LANDON, Vice President--Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. McDONALD, Vice President--Vice President, T. Rowe Price
JOAN R. POTEE, Vice President--Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President--Vice President, T. Rowe
Price; formerly (1/89-12/93) senior bond trader, Scudder, Stevens
& Clark, Boston, Massachusetts
Each Fund's Executive Committee, consisting of the Fund's
interested directors/trustees, has been authorized by its
respective Board of Directors/Trustees to exercise all powers of
the Board to manage the Fund in the intervals between meetings of
the Board, except the powers prohibited by statute from being
delegated.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and directors
of the Fund, as a group, owned less than 1% of the outstanding
shares of the Fund.
PAGE 69
As of February 28, 1994, Yachtcrew & Co., FBO Spectrum
Income Account, State Street Bank and Trust Co., 1776 Heritage
Drive-4W, North Quincy, MA 02171-2010 beneficially owned more
than 5% of the outstanding shares of the GNMA, High Yield, New
Income and Short-Term Bonds Funds, and T. Rowe Price Trust Co.
Inc., Attn: Installation Team for Conversion Assets, New England
Electric Plan, 25 Research Drive, Westborough, MA 01582
beneficially owned more than 5% of then outstanding shares of the
Money Fund.
INVESTMENT MANAGEMENT SERVICES
Services
Under the Management Agreement, T. Rowe Price provides the
Fund with discretionary investment services. Specifically, T.
Rowe Price is responsible for supervising and directing the
investments of the Fund in accordance with the Fund's investment
objectives, program, and restrictions as provided in its
prospectus and this Statement of Additional Information. T. Rowe
Price is also responsible for effecting all security transactions
on behalf of the Fund, including the negotiation of commissions
and the allocation of principal business and portfolio brokerage.
In addition to these services, T. Rowe Price provides the Fund
with certain corporate administrative services, including:
maintaining the Fund's corporate existence and corporate records;
registering and qualifying Fund shares under federal and state
laws; monitoring the financial, accounting, and administrative
functions of the Fund; maintaining liaison with the agents
employed by the Fund such as the Fund's custodian and transfer
agent; assisting the Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as
officers, directors, and committee members of the Fund without
cost to the Fund.
The Management Agreement also provides that T. Rowe Price,
its directors, officers, employees, and certain other persons
performing specific functions for the Fund will only be liable to
the Fund for losses resulting from willful misfeasance, bad
faith, gross negligence, or reckless disregard of duty.
Management Fee
The Fund pays T. Rowe Price a fee ("Fee") which consists of
two components: a Group Management Fee ("Group Fee") and an
Individual Fund Fee ("Fund Fee"). The Fee is paid monthly to T.
Rowe Price on the first business day of the next succeeding
calendar month and is calculated as described below.
The monthly Group Fee ("Monthly Group Fee") is the sum of
the daily Group Fee accruals ("Daily Group Fee Accruals") for
each month. The Daily Group Fee Accrual for any particular day
PAGE 70
is computed by multiplying the Price Funds' group fee accrual as
determined below ("Daily Price Funds' Group Fee Accrual") by the
ratio of the Fund's net assets for that day to the sum of the
aggregate net assets of the Price Funds for that day. The Daily
Price Funds' Group Fee Accrual for any particular day is
calculated by multiplying the fraction of one (1) over the number
of calendar days in the year by the annualized Daily Price Funds'
Group Fee Accrual for that day as determined in accordance with
the following schedule:
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
0.480% First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Thereafter
For the purpose of calculating the Group Fee, the Price
Funds include all the mutual funds distributed by T. Rowe Price
Investment Services, Inc., (excluding T. Rowe Price Spectrum
Fund, Inc. and any institutional or private label mutual funds).
For the purpose of calculating the Daily Price Funds' Group Fee
Accrual for any particular day, the net assets of each Price Fund
are determined in accordance with the Fund's prospectus as of the
close of business on the previous business day on which the Fund
was open for business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the
daily Fund Fee accruals ("Daily Fund Fee Accruals") for each
month. The Daily Fund Fee Accrual for any particular day is
computed by multiplying the fraction of one (1) over the number
of calendar days in the year by the individual Fund Fee Rate and
multiplying this product by the net assets of the Fund for that
day, as determined in accordance with the Fund's prospectus as of
the close of business on the previous business day on which the
Fund was open for business. The individual fund fees for each
Fund are listed in the chart below:
PAGE 71
Individual Fund Fees
Adjustable Rate Fund 0.10%
GNMA Fund 0.15%
High Yield Fund 0.30%
New Income Fund 0.15%
Prime Reserve Fund 0.05%
Short-Term Bond Fund 0.10%
Intermediate Fund 0.05%
Long-Term Fund 0.05%
Money Fund 0.00%
The following chart sets forth the total management fees, if
any, paid to T. Rowe Price by each Fund, during the last three
years:
Fund 1994 1993 1992
Adjustable Rate $ 526,000 $ 627,000 *
GNMA 4,626,000 4,102,000 $ 3,069,000
High Yield 10,554,000 8,014,000 5,701,000
New Income 7,750,000 7,113,000 6,348,000
Prime Reserve 13,617,000 15,620,000 18,486,000
Short-Term Bond 2,873,000 2,136,000 1,398,000
Intermediate 755,000 571,000 309,000
Long-Term 180,000 125,000 4,000
Money 2,084,000 165,000 2,140,000
* Due to the Fund's expense limitation in effect at that time,
no management fee was paid by the Fund to T. Rowe Price.
Limitation on Fund Expenses
The Management Agreement between the Fund and T. Rowe Price
provides that the Fund will bear all expenses of its operations
not specifically assumed by T. Rowe Price. However, in
compliance with certain state regulations, T. Rowe Price will
reimburse the Fund for certain expenses which in any year exceed
the limits prescribed by any state in which the Fund's shares are
qualified for sale. Presently, the most restrictive expense
ratio limitation imposed by any state is 2.5% of the first $30
million of the Fund's average daily net assets, 2% of the next
$70 million of the Fund's assets, and 1.5% of net assets in
excess of $100 million. Reimbursement by the Fund to T. Rowe
Price of any expenses paid or assumed under a state expense
limitation may not be made more than two years after the end of
the fiscal year in which the expenses were paid or assumed.
The following chart sets forth expense ratio limitations and
the periods for which they are effective. For each, T. Rowe
Price has agreed to bear any Fund expenses which would cause the
Fund's ratio of expenses to average net assets to exceed the
indicated percentage limitations. The expenses borne by T. Rowe
PAGE 72
Price are subject to reimbursement by the Fund through the
indicated reimbursement date, provided no reimbursement will be
made if it would result in the Fund's expense ratio exceeding its
applicable limitation.
Expense
Limitation Ratio Reimbursement
Fund Period Limitation Date
Adjustable Rate+ January 1, 1994- 0.70% May 31, 1998
May 31, 1996
Intermediate++ March 1, 1993- 0.80% February 28, 1997
February 28, 1995
Long-Term++ March 1, 1993- 0.80% February 28, 1997
February 28, 1995
+ The Adjustable Rate Fund previously operated under a 0.40%
limitation that expired December 31, 1993. The reimbursement
period for this limitation extends through June 30, 1995.
++ The Intermediate and Long-Term Funds' operated under a 0.80%
limitation that expired February 29, 1993. The reimbursement
period for this limitation extends through February 28, 1995.
Each of the above-referenced Fund's Management Agreement also
provides that one or more additional expense limitation periods
(of the same or different time periods) may be implemented after
the expiration of the current expense limitation, and that with
respect to any such additional limitation period, the Fund may
reimburse T. Rowe Price, provided the reimbursement does not
result in the Fund's aggregate expenses exceeding the additional
expense limitation.
Pursuant to the Adjustable Rate Fund's current expense
limitation, $938,000 of management fees were not accrued by the
Fund for the year ended February 28, 1994.
Pursuant to the Intermediate Fund's current expense
limitation, $77,000 of unaccrued 1993 fees for the Fund,
representing the entire unaccrued balance, were reimbursed to T.
Rowe Price during the year ended February 28, 1994.
Pursuant to the Long-Term Fund's current expense limitation,
$61,000 of management fees were not accrued by the Fund for the
year ended February 28, 1994. Additionally, $303,000 of
unaccrued fees from the prior period for the Fund was subject to
reimbursement through February 28, 1995.
PAGE 73
GNMA, High Yield, New Income, Prime Reserve and Short-Term Bond
Funds
T. Rowe Price Spectrum Fund, Inc.
The Fund is a party to a Special Servicing Agreement
("Agreement") between and among T. Rowe Price Spectrum Fund, Inc.
("Spectrum Fund"), T. Rowe Price, T. Rowe Price Services, Inc.
and various other T. Rowe Price funds which, along with the Fund,
are funds in which Spectrum Fund invests (collectively all such
funds "Underlying Price Funds").
The Agreement provides that, if the Board of
Directors/Trustees of any Underlying Price Fund determines that
such Underlying Fund's share of the aggregate expenses of
Spectrum Fund is less than the estimated savings to the
Underlying Price Fund from the operation of Spectrum Fund, the
Underlying Price Fund will bear those expenses in proportion to
the average daily value of its shares owned by Spectrum Fund,
provided further that no Underlying Price Fund will bear such
expenses in excess of the estimated savings to it. Such savings
are expected to result primarily from the elimination of numerous
separate shareholder accounts which are or would have been
invested directly in the Underlying Price Funds and the resulting
reduction in shareholder servicing costs. Although such cost
savings are not certain, the estimated savings to the Underlying
Price Funds generated by the operation of Spectrum Fund are
expected to be sufficient to offset most, if not all, of the
expenses incurred by Spectrum Fund.
All Funds
DISTRIBUTOR FOR FUND
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, serves as the Fund's
distributor. Investment Services is registered as a broker-
dealer under the Securities Exchange Act of 1934 and is a member
of the National Association of Securities Dealers, Inc. The
offering of the Fund's shares is continuous.
Investment Services is located at the same address as the
Fund and T. Rowe Price -- 100 East Pratt Street, Baltimore,
Maryland 21202.
Investment Services serves as distributor to the Fund
pursuant to an Underwriting Agreement ("Underwriting Agreement"),
which provides that the Fund will pay all fees and expenses in
connection with: registering and qualifying its shares under the
various state "blue sky" laws; preparing, setting in type,
printing, and mailing its prospectuses and reports to
PAGE 74
shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services
will pay all fees and expenses in connection with: printing and
distributing prospectuses and reports for use in offering and
selling Fund shares; preparing, setting in type, printing, and
mailing all sales literature and advertising; Investment
Services' federal and state registrations as a broker-dealer; and
offering and selling Fund shares, except for those fees and
expenses specifically assumed by the Fund. Investment Services'
expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the Fund in
connection with the sale of its shares in all states in which the
shares are qualified and in which Investment Services is
qualified as a broker-dealer. Under the Underwriting Agreement,
Investment Services accepts orders for Fund shares at net asset
value. No sales charges are paid by investors or the Fund.
CUSTODIAN
State Street Bank and Trust Company is the custodian for the
Fund's domestic securities and cash, but it does not participate
in the Fund's investment decisions. Portfolio securities
purchased in the U.S. are maintained in the custody of the Bank
and may be entered into the Federal Reserve Book Entry System, or
the security depository system of the Depository Trust
Corporation. The Fund (other than the GNMA, Prime Reserve and
U.S. Treasury Intermediate, Long-Term and Money Funds) has
entered into a Custodian Agreement with The Chase Manhattan Bank,
N.A., London, pursuant to which portfolio securities which are
purchased outside the United States are maintained in the custody
of various foreign branches of The Chase Manhattan Bank and such
other custodians, including foreign banks and foreign securities
depositories as are approved by the Fund's Board of
Directors/Trustees in accordance with regulations under the
Investment Company Act of 1940. The Bank's main office is at 225
Franklin Street, Boston, Massachusetts 02110. The address for
The Chase Manhattan Bank, N.A., London is Woolgate House, Coleman
Street, London, EC2P 2HD, England.
CODE OF ETHICS
The Fund's investment adviser (T. Rowe
Price) has a written Code of Ethics which requires all employees
to obtain prior clearance before engaging in any personal
securities transactions. In addition, all employees must report
their personal securities transactions within ten days of their
execution. Employees will not be permitted to effect
PAGE 75
transactions in a security: If there are pending client orders in
the security; the security has been purchased or sold by a client
within seven calendar days; the security is being considered for
purchase for a client; a change has occurred in T. Rowe Price's
rating of the security within five days; or the security is
subject to internal trading restrictions. Any material violation
of the Code of Ethics is reported to the Board of the Fund. The
Board also reviews the administration of the Code of Ethics on an
annual basis.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T.
Rowe Price is also responsible for implementing these decisions,
including the negotiation of commissions and the allocation of
portfolio brokerage and principal business. The Fund's purchases
and sales of fixed-income portfolio securities are normally done
on a principal basis and do not involve the payment of a
commission although they may involve the designation of selling
concessions. That part of the discussion below relating solely
to brokerage commissions would not normally apply to the Fund
(except to the extent it purchases equity securities (New Income
and High Yield Funds only)). However, it is included because T.
Rowe Price does manage a significant number of common stock
portfolios which do engage in agency transactions and pay
commissions and because some research and services resulting from
the payment of such commissions may benefit the Fund.
How Brokers and Dealers are Selected
Equity Securities
In purchasing and selling the Fund's portfolio securities, it
is T. Rowe Price's policy to obtain quality execution at the most
favorable prices through responsible brokers and dealers and, in
the case of agency transactions, at competitive commission rates.
However, under certain conditions, the Fund may pay higher
brokerage commissions in return for brokerage and research
services. As a general practice, over-the-counter orders are
executed with market-makers. In selecting among market-makers,
T. Rowe Price generally seeks to select those it believes to be
actively and effectively trading the security being purchased or
sold. In selecting broker-dealers to execute the Fund's
portfolio transactions, consideration is given to such factors as
the price of the security, the rate of the commission, the size
and difficulty of the order, the reliability, integrity,
financial condition, general execution and operational
capabilities of competing brokers and dealers, and brokerage and
research services provided by them. It is not the policy of T.
PAGE 76
Rowe Price to seek the lowest available commission rate where it
is believed that a broker or dealer charging a higher commission
rate would offer greater reliability or provide better price or
execution.
Fixed Income Securities
Fixed income securities are generally purchased from the
issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
With respect to equity and fixed income securities, T. Rowe
Price may effect principal transactions on behalf of the Fund
with a broker or dealer who furnishes brokerage and/or research
services, designate any such broker or dealer to receive selling
concessions, discounts or other allowances, or otherwise deal
with any such broker or dealer in connection with the acquisition
of securities in underwritings. T. Rowe Price may receive
research services in connection with brokerage transactions,
including designations in fixed price offerings.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for
transactions executed on behalf of the Fund. In evaluating the
reasonableness of commission rates, T. Rowe Price considers: (a)
historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research services from
brokers and dealers. These services include information on the
economy, industries, groups of securities, individual companies,
statistical information, accounting and tax law interpretations,
political developments, legal developments affecting portfolio
securities, technical market action, pricing and appraisal
PAGE 77
services, credit analysis, risk measurement analysis, performance
analysis and analysis of corporate responsibility issues. These
services provide both domestic and international perspective.
Research services are received primarily in the form of written
reports, computer generated services, telephone contacts and
personal meetings with security analysts. In addition, such
services may be provided in the form of meetings arranged with
corporate and industry spokespersons, economists, academicians
and government representatives. In some cases, research services
are generated by third parties but are provided to T. Rowe Price
by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information
presently provided by brokers and dealers. T. Rowe Price pays
cash for certain research services received from external
sources. T. Rowe Price also allocates brokerage for research
services which are available for cash. While receipt of research
services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could
be materially increased if it attempted to generate such
additional information through its own staff. To the extent that
research services of value are provided by brokers or dealers, T.
Rowe Price may be relieved of expenses which it might otherwise
bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
Commissions to Brokers who Furnish Research Services
Certain brokers and dealers who provide quality brokerage and
execution services also furnish research services to T. Rowe
Price. With regard to the payment of brokerage commissions, T.
Rowe Price has adopted a brokerage allocation policy embodying
the concepts of Section 28(e) of the Securities Exchange Act of
1934, which permits an investment adviser to cause an account to
pay commission rates in excess of those another broker or dealer
would have charged for effecting the same transaction, if the
adviser determines in good faith that the commission paid is
reasonable in relation to the value of the brokerage and research
services provided. The determination may be viewed in terms of
PAGE 78
either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over
which it exercises investment discretion. Accordingly, while T.
Rowe Price cannot readily determine the extent to which
commission rates or net prices charged by broker-dealers reflect
the value of their research services, T. Rowe Price would expect
to assess the reasonableness of commissions in light of the total
brokerage and research services provided by each particular
broker. T. Rowe Price may receive research, as defined in
Section 28(e), in connection with selling concessions and
designations in fixed price offerings in which the Funds
participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific
amount of business to any broker or dealer over any specific time
period. Historically, the majority of brokerage placement has
been determined by the needs of a specific transaction such as
market-making, availability of a buyer or seller of a particular
security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for
that portion of its discretionary client brokerage business where
special needs do not exist, or where the business may be
allocated among several brokers or dealers which are able to meet
the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers or dealers,
and attempts to allocate a portion of its brokerage business in
response to these assessments. Research analysts, counselors,
various investment committees, and the Trading Department each
seek to evaluate the brokerage and research services they receive
from brokers or dealers and make judgments as to the level of
business which would recognize such services. In addition,
brokers or dealers sometimes suggest a level of business they
would like to receive in return for the various brokerage and
research services they provide. Actual brokerage received by any
firm may be less than the suggested allocations but can, and
often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above.
In no case is a broker or dealer excluded from receiving business
from T. Rowe Price because it has not been identified as
providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent
a substantial majority of all assets under management. Research
services furnished by brokers or dealers through which T. Rowe
Price effects securities transactions may be used in servicing
all accounts (including non-Fund accounts) managed by T. Rowe
PAGE 79
Price. Conversely, research services received from brokers or
dealers which execute transactions for the Fund are not
necessarily used by T. Rowe Price exclusively in connection with
the management of the Fund.
From time to time, orders for clients may be placed through a
computerized transaction network.
The Fund does not allocate business to any broker-dealer on
the basis of its sales of the Fund's shares. However, this does
not mean that broker-dealers who purchase Fund shares for their
clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Fund. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if,
as a result of such purchases, 10% or more of the outstanding
common stock of such company would be held by its clients in the
aggregate.
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through
T. Rowe Price Investment Services, Inc., the Fund's distributor.
At the present time, T. Rowe Price does not recapture commissions
or underwriting discounts or selling group concessions in
connection with taxable securities acquired in underwritten
offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession
or underwriting discount when purchasing tax-exempt municipal
securities on behalf of its clients in underwritten offerings.
PAGE 80
Adjustable Rate, High Yield, New Income and Short-Term Bond Funds
Transactions with Related Brokers and Dealers
As provided in the Investment Management Agreement between
the Fund and T. Rowe Price, T. Rowe Price is responsible not only
for making decisions with respect to the purchase and sale of the
Fund's portfolio securities, but also for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. It is
expected that T. Rowe Price may place orders for the Fund's
portfolio transactions with broker-dealers through the same
trading desk T. Rowe Price uses for portfolio transactions in
domestic securities. The trading desk accesses brokers and
dealers in various markets in which the Fund's foreign securities
are located. These brokers and dealers may include certain
affiliates of Robert Fleming Holdings Limited ("Robert Fleming
Holdings") and Jardine Fleming Group Limited ("JFG"), persons
indirectly related to T. Rowe Price. Robert Fleming Holdings,
through Copthall Overseas Limited, a wholly-owned subsidiary,
owns 25% of the common stock of Rowe Price-Fleming International,
Inc. ("RPFI"), an investment adviser registered under the
Investment Advisers Act of 1940. Fifty percent of the common
stock of RPFI is owned by TRP Finance, Inc., a wholly-owned
subsidiary of T. Rowe Price, and the remaining 25% is owned by
Jardine Fleming Holdings Limited, a subsidiary of JFG. JFG is
50% owned by Robert Fleming Holdings and 50% owned by Jardine
Matheson Holdings Limited. Orders for the Fund's portfolio
transactions placed with affiliates of Robert Fleming Holdings
and JFG will result in commissions being received by such
affiliates.
The Board of Directors/Trustees of the Fund has authorized T.
Rowe Price to utilize certain affiliates of Robert Fleming and
JFG in the capacity of broker in connection with the execution of
the Fund's portfolio transactions. These affiliates include, but
are not limited to, Jardine Fleming Securities Limited ("JFS"), a
wholly-owned subsidiary of JFG, Robert Fleming & Co. Limited
("RF&Co."), Jardine Fleming Australia Securities Limited, and
Robert Fleming, Inc. (a New York brokerage firm). Other
affiliates of Robert Fleming Holding and JFG also may be used.
Although it does not believe that the Fund's use of these brokers
would be subject to Section 17(e) of the Investment Company Act
of 1940, the Board of Directors/Trustees of the Fund has agreed
that the procedures set forth in Rule 17e-1 under that Act will
be followed when using such brokers.
Other
The Funds engaged in portfolio transactions involving broker-
dealers in the following amounts for the fiscal years ended
February 28, 1994, February 28, 1993 and February 29, 1992:
PAGE 81
Fund 1994 1993 1992
______ ____ ____ ____
Adjustable Rate$ 793,565,000 $ 1,876,498,000 $ 427,475,000
GNMA 2,306,951,000 1,528,454,000 1,438,762,000
High Yield 18,554,222,000 16,168,606,000 6,702,967,000
New Income 20,265,475,000 15,193,999,000 6,648,064,000
Prime Reserve 29,024,172,000 36,478,989,000 29,975,769,000
Short-Term Bond 4,266,837,000 5,805,958,000 5,534,535,000
Intermediate 81,970,000 91,923,000 218,317,000
Long-Term 142,513,000 192,941,000 192,774,000
Money 3,449,951,000 2,804,196,000 23,290,378,000
The entire amount for each of these years represented
principal transactions as to which the Adjustable Rate, GNMA,
Prime Reserve, U.S. Treasury Intermediate, Long-Term and Money
Funds have no knowledge of the profits or losses realized by the
respective broker-dealers for the fiscal years ended February 28,
1994, February 28, 1993 and February 29, 1992. With respect to
the High Yield, New Income and Short-Term Bond Funds, the
following amounts consisted of principal transactions as to which
the Funds have no knowledge of the profits or losses realized by
the respective broker-dealers for the fiscal years ended February
28, 1994, February 28, 1993 and February 29, 1992:
Fund 1994 1993 1992
______ ____ ____ ____
High Yield $17,956,306,000 $15,737,460,000 $6,682,140,000
New Income 20,206,382,000 15,189,019,000 6,518,595,000
Short-Term Bond 0 0 5,034,535,000
The following amounts involved trades with brokers acting as
agents or underwriters for the fiscal years ended February 28,
1994, February 28, 1993, and February 29, 1992:
Fund 1994 1993 1992
______ ____ ____ ____
High Yield $597,916,000 $431,147,000 $ 20,827,000
New Income 59,093,000 4,980,000 129,469,000
Short-Term Bond 0 0 5,000,000
The amounts shown below involved trades with brokers acting
as agents or underwriters, in which such brokers received total
commissions, including discounts received in connection with
underwritings for the fiscal years ended February 28, 1994,
February 28, 1993 and February 29, 1992:
PAGE 82
Fund 1994 1993 1992
______ ____ ____ ____
High Yield $16,730,000 $3,661,000 $1,201,000
New Income 169,000 20,000 402,000
Short-Term Bond 0 0 15,000
The percentage of total portfolio transactions, placed with
firms which provided research, statistical, or other services to
T. Rowe Price in connection with the management of the Funds, or
in some cases, to the Funds for the fiscal years ended February
28, 1994, February 28, 1993 and February 29, 1992, are shown
below:
Fund 1994 1993 1992
______ ____ ____ ____
Adjustable Rate 100% 94% 100%
GNMA 91% 91% 99%
High Yield 70% 70% 59%
New Income 61% 61% 87%
Prime Reserve 87% 81% 76%
Short-Term Bond 61% 84% 79%
Intermediate 85% 98% 100%
Long-Term 98% 99% 100%
Money 66% 75% 60%
The portfolio turnover rates for the following Funds for the
fiscal years ended February 28, 1994, February 28, 1993 and
February 29, 1992 are as follows:
Fund 1994 1993 1992
______ ____ ____ ____
Adjustable Rate 70.4% 110.8% 98.4%
GNMA 92.5% 94.2% 66.0%
High Yield 107.0% 104.4% 58.9%
New Income 58.3% 85.8% 49.7%
Short-Term Bond 90.8% 68.4% 380.7%
Intermediate 20.2% 22.8% 91.4%
Long-Term 59.4% 165.4% 162.4%
Prime Reserve Fund
The Fund, in pursuing its objectives, may engage in short-term
trading to take advantage of market variations. The Fund will
seek to protect principal, improve liquidity of its securities,
or enhance yield by purchasing and selling securities based upon
existing or anticipated market discrepancies.
PAGE 83
Money Fund
The Fund, in pursuing its objectives, may engage in short-term
trading to take advantage of market variations. The Fund will
seek to protect principal, improve liquidity of its securities,
or enhance yield by purchasing and selling securities based upon
existing or anticipated market discrepancies.
PRICING OF SECURITIES
Adjustable Rate, GNMA, High Yield, New Income, Short-Term Bond,
U.S. Treasury Intermediate and Long-Term Funds
Fixed income securities are generally traded in the over-the-
counter market. Investments in domestic securities with
remaining maturities of one year or more and foreign securities
are stated at fair value using a bid-side valuation as furnished
by dealers who make markets in such securities or by an
independent pricing service, which considers yield or price of
bonds of comparable quality, coupon, maturity, and type, as well
as prices quoted by dealers who make markets in such securities.
Domestic securities with remaining maturities less than one year
are stated at fair value which is determined by using a matrix
system that establishes a value for each security based on bid-
side money market yields.
There are a number of pricing services available, and the
Board of Directors, on the basis of ongoing evaluation of these
services, may use or may discontinue the use of any pricing
service in whole or in part.
High Yield and New Income Funds
Equity securities listed or regularly traded on a securities
exchange (including NASDAQ) are valued at the last quoted sales
price on the day the valuations are made. A security which is
listed or traded on more than one exchange is valued at the
quotation on the exchange determined to be the primary market for
such security. Other equity securities and those listed
securities that are not traded on a particular day are valued at
a price within the limits of the latest bid and asked prices
deemed by the Board of Directors/Trustees, or by persons
delegated by the Board, best to reflect fair value.
Debt securities are generally traded in the over-the-counter
market and are valued at a price deemed best to reflect fair
value as quoted by dealers who make markets in these securities
or by an independent pricing service. Short-term debt securities
are valued at their cost in local currency which, when combined
with accrued interest, approximates fair value.
PAGE 84
Prime Reserve and U.S. Treasury Money Funds
Securities with more than 60 days remaining to maturity are
stated at fair value which is determined by using a matrix system
that establishes a value for each security based on money market
yields. Securities originally purchased with remaining
maturities of 60 days or less are valued at amortized cost. In
addition, securities purchased with maturities in excess of 60
days, but which currently have maturities of 60 days or less, are
valued at their amortized cost for the 60 days prior to maturity-
- -such amortization being based on the fair value of the
securities on the 61st day prior to maturity.
All Funds
For the purposes of determining the Fund's net asset value
per share, all assets and liabilities initially expressed in
foreign currencies are converted into U.S. dollars at the mean of
the bid and offer prices of such currencies against U.S. dollars
quoted by any major bank.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value, as determined in good faith by or
under the supervision of officers of the Funds, as authorized by
the Board of Directors.
Prime Reserve and Money Funds
Maintenance of Net Asset Value Per Share
It is the policy of the Fund to attempt to maintain a net
asset value of $1.00 per share by rounding to the nearest one
cent. This method of valuation is commonly referred to as "penny
rounding" and is permitted by Rule 2a-7 under the Investment
Company Act of 1940. Under Rule 2a-7:
(a) the Board of Directors of the Fund must undertake to
assure, to the extent reasonably practical taking into
account current market conditions affecting the Fund's
investment objectives, that the Fund's net asset value will
not deviate from $1.00 per share;
Prime Reserve Fund
(b) the Fund must (i) maintain a dollar-weighted average
portfolio maturity appropriate to its objective of
maintaining a stable price per share, (ii) not purchase any
instrument with a remaining maturity greater than 397 days
(or in the case of U.S. government securities greater than
762 days), and (iii) maintain a dollar-weighted average
portfolio maturity of 90 days or less;
PAGE 85
Money Fund
(b) The Fund must (i) maintain a dollar-weighted average
portfolio maturity appropriate to its objective of
maintaining a stable price per share, (ii) not purchase any
instrument with a remaining maturity greater than 762 days,
and (iii) maintain a dollar-weighted average portfolio
maturity of 90 days or less;
Prime Reserve and Money Funds
(c) the Fund must limit its purchase of portfolio
instruments, including repurchase agreements, to those U.S.
dollar-denominated instruments which the Fund's Board of
Directors determines present minimal credit risks, and which
are eligible securities as defined by Rule 2a-7; and
(d) the Board of Directors must determine that (i) it is in
the best interest of the Fund and its shareholders to
maintain a stable price per share under the penny rounding
method; and (ii) the Fund will continue to use the penny
rounding method only so long as the Board of Directors
believes that it fairly reflects the market based net asset
value per share.
Although the Fund believes that it will be able to maintain
its net asset value at $1.00 per share under most conditions,
there can be no absolute assurance that it will be able to do so
on a continuous basis. If the Fund's net asset value per share
declined, or was expected to decline, below $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
temporarily reduce or suspend dividend payments in an effort to
maintain the net asset value at $1.00 per share. As a result of
such reduction or suspension of dividends, an investor would
receive less income during a given period than if such a
reduction or suspension had not taken place. Such action could
result in an investor receiving no dividend for the period during
which he holds his shares and in his receiving, upon redemption,
a price per share lower than that which he paid. On the other
hand, if the Fund's net asset value per share were to increase,
or were anticipated to increase above $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
supplement dividends in an effort to maintain the net asset value
at $1.00 per share.
Prime Reserve Fund
Prime Money Market Securities Defined. Prime money market
securities are those which are described as First Tier Securities
under Rule 2a-7 of the Investment Company Act of 1940. These
include any security with a remaining maturity of 397 days or
less that is rated (or that has been issued by an issuer that is
PAGE 86
rated with respect to a class of short-term debt obligations, or
any security within that class that is comparable in priority and
security with the security) by any two nationally recognized
statistical rating organizations (NRSROs) (or if only one NRSRO
has issued a rating, that NRSRO) in the highest rating category
for short-term debt obligations (within which there may be sub-
categories). First Tier Securities also include unrated
securities comparable in quality to rated securities, as
determined by T. Rowe Price under the supervision of the Fund's
Board of Directors.
All Funds
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Fund's shares is
equal to the Fund's net asset value per share or share price.
The Fund determines its net asset value per share by subtracting
the Fund's liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of the Fund is normally calculated as of the close of
trading on the New York Stock Exchange ("NYSE") every day the
NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Washington's Birthday, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
Determination of net asset value (and the offering, sale
redemption and repurchase of shares) for the Fund may be
suspended at times (a) during which the NYSE is closed, other
than customary weekend and holiday closings, (b) during which
trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the Fund of securities
owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net
assets, or (d) during which a governmental body having
jurisdiction over the Fund may by order permit such a suspension
for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) shall
govern as to whether the conditions prescribed in (b), (c), or
(d) exist.
DIVIDENDS AND DISTRIBUTIONS
Unless you elect otherwise, the Fund's annual capital gain
distribution, if any, will be reinvested on the reinvestment date
using the NAV per share of that date. The reinvestment date
PAGE 87
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
The Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
A portion of the dividends paid by the Fund may be eligible
for the dividends-received deduction for corporate shareholders.
For tax purposes, it does not make any difference whether
dividends and capital gain distributions are paid in cash or in
additional shares. The Fund must declare dividends equal to at
least 98% of ordinary income (as of December 31) and capital
gains (as of October 31) in order to avoid a federal excise tax
and distribute 100% of ordinary income and capital gains as of
its tax year-end to avoid federal income tax.
At the time of your purchase, the Fund's net asset value may
reflect undistributed capital gains or net unrealized
appreciation of securities held by the Fund. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains. On May 31, 1994, the books of each Fund
indicated that each Fund's aggregate net assets included
undistributed net income, net realized capital gains, and
unrealized appreciation which are listed below.
Net Realized Unrealized
Undistributed Capital Appreciation/
Fund Net Income Gains/(Losses) (Depreciation)
Adjustable Rate $(1,938,550) $(953,447) $(3,465,529)
GNMA (5,493,399) (15,464,402) (26,398,092)
High Yield 3,993,026 (5,944,499) (119,580,285)
New Income 21,962 1,014,811 (65,070,648)
Prime Reserve 2,078,604 1,900 203,760
Short-Term Bond (1,326,250) (4,542,864) (15,924,117)
Intermediate (108,298) 55,985 (6,124,061)
Long-Term (38,345) (577,048) (2,954,108)
Money 0 2,371 174,801
If, in any taxable year, the Fund should not qualify as a
regulated investment company under the Code: (i) the Fund would
be taxed at normal corporate rates on the entire amount of its
taxable income, if any, without deduction for dividends or other
distributions to shareholders; and (ii) the Fund's distributions
PAGE 88
to the extent made out of the Fund's current or accumulated
earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been
considered capital gain dividends).
Taxation of Foreign Shareholders
The Code provides that dividends from net income will be
subject to U.S. tax. For shareholders who are not engaged in a
business in the U.S., this tax would be imposed at the rate of
30% upon the gross amount of the dividends in the absence of a
Tax Treaty providing for a reduced rate or exemption from U.S.
taxation. Distributions of net long-term capital gains realized
by the Fund are not subject to tax unless the foreign shareholder
is a nonresident alien individual who was physically present in
the U.S. during the tax year for more than 182 days.
Foreign Currency Gains and Losses
Foreign currency gains and losses, including the portion of
gain or loss on the sale of debt securities attributable to
foreign exchange rate fluctuations, are taxable as ordinary
income. If the net effect of these transactions is a gain, the
dividend paid by the Fund will be increased; if the result is a
loss, the income dividend paid by the Fund will be decreased.
Adjustments to reflect these gains and losses will be made at the
end of the Fund's taxable year.
YIELD INFORMATION
From time to time, the Fund may advertise a yield figure
calculated in the following manner:
Adjustable Rate and GNMA Funds
In conformity with regulations of the Securities and
Exchange Commission, an income factor is calculated for each
security in the portfolio based upon the security's coupon rate.
The income factors are then adjusted for any gains or losses
which have resulted from prepayments of principal during the
period. The income factors are then totalled for all securities
in the portfolio. Next, expenses of the Fund for the period net
of expected reimbursements, are deducted from the income to
arrive at net income, which is then converted to a per-share
amount by dividing net income by the average number of shares
outstanding during the period. The net income per share is
divided by the net asset value on the last day of the period to
produce a monthly yield which is then annualized. Quoted yield
factors are for comparison purposes only, and are not intended to
indicate future performance or forecast the dividend per share of
the Fund.
PAGE 89
The yields of the Adjustable Rate and GNMA Funds calculated
under the above-described method for the month ended May 31, 1994
were 4.10% and 5.40%, respectively.
High Yield, New Income, Short-Term Bond, Intermediate and Long-
Term Funds
An income factor is calculated for each security in the
portfolio based upon the security's market value at the beginning
of the period and yield as determined in conformity with
regulations of the Securities and Exchange Commission. The
income factors are then totalled for all securities in the
portfolio. Next, expenses of the Fund for the period net of
expected reimbursements are deducted from the income to arrive at
net income, which is then converted to a per-share amount by
dividing net income by the average number of shares outstanding
during the period. The net income per share is divided by the
net asset value on the last day of the period to produce a
monthly yield which is then annualized. Quoted yield factors are
for comparison purposes only, and are not intended to indicate
future performance or forecast the dividend per share of the
Fund.
The yields of the High Yield, New Income, Short-Term Bond,
Intermediate and Long-Term Funds calculated under the above-
described method for the month ended May 31, 1994, were 8.87%,
6.12%, 5.55%, 5.75% and 6.47%, respectively.
Prime Reserve and Money Funds
The Fund's current and historical yield for a period is
calculated by dividing the net change in value of an account
(including all dividends accrued and dividends reinvested in
additional shares) by the account value at the beginning of the
period to obtain the base period return. This base period return
is divided by the number of days in the period then multiplied by
365 to arrive at the annualized yield for that period. The
Fund's annualized compound yield for such period is compounded by
dividing the base period return by the number of days in the
period, and compounding that figure over 365 days.
The seven-day yields ending May 31, 1994 for the Prime
Reserve and Money Funds were 3.33% and 3.18%, respectively, and
the Funds' compound yield for the same period were 3.38% and
3.23%, respectively.
PAGE 90
All Funds
INVESTMENT PERFORMANCE
Total Return Performance
The Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in the Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of the Fund.
Each average annual compound rate of return is derived from the
cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over
any other period of time will vary from the average.
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
2/28/94 2/28/94 2/28/94 2/28/94
Adjustable Rate U.S. Government Fund
T. Rowe Price Adjustable
Rate U.S. Government
Fund, Inc. 3.11% 9.30%
(9/30/91)
Lipper Average of
Adjustable Rate Mortgage
Funds 3.17 10.27
Merrill Lynch 1-3 Year
Govt. Index 3.48 16.22
Salomon Brothers 1-Year
Treasury Index 2.61 11.17
Salomon Brothers 2-Year
Treasury Index 3.46 16.51
GNMA Fund
T. Rowe Price GNMA Fund 3.71 61.78% 96.72
(11/26/85)
Salomon Brothers 30-Year
GNMA Index 4.67 69.52 124.78
Lehman Brothers GNMA
Bond Index 4.49 68.70 123.75
Lipper GNMA Funds Average 3.78 60.10 100.59
PAGE 91
High Yield Fund
High Yield Fund 16.59 58.38 176.57
(12/31/84)
Merrill Lynch High
Yield Index 14.16 84.90 225.33
Merrill Lynch Medium
Quality Long Corporate
Index 8.89 85.02 223.61
Lipper's Average of High
Current Yield Funds 16.66 71.26 174.45
New Income Fund
New Income Fund 5.36 61.39 162.15% 514.54
(8/31/73)
Salomon Bros. Broad
Investment Grade Index 5.58 69.34 202.62 N/A
Salomon Bros. High Grade
Corporate Bond Index 6.73 81.35 264.06 605.12
Lehman Bros. Govt./Corp.
Bond Index 5.71 69.42 198.31 574.11
Lipper Corporate Bond
Fund's -A Rated Average 5.64 64.93 188.36 523.68
Short-Term Bond Fund
T. Rowe Price Short-Term
Bond Fund 4.36 47.78 122.71
(3/2/84)
T. Rowe Price Prime
Reserve Fund 2.60 30.24 88.03
Donoghue Average of all
Taxable Money Funds 2.70 30.32 86.25
Lehman Bros. 1-3 Year
Govt./Corp. Bond Index 3.62 50.11 139.27
Lipper Short Investment
Grade Debt Funds Average 3.95 49.71 136.46
U.S. Treasury Intermediate Fund
Intermediate Fund 3.80 47.81
(9/29/89)
Lehman Brothers
Intermediate Treasury
Index 4.23 48.86
PAGE 92
U.S. Treasury Long-Term Fund
Long-Term Fund 5.89 52.29
(9/29/89)
Lehman Brothers
Government/Corporate
Bond Index 5.71 54.53
Lehman Brothers Long
Treasury Index 8.32 64.05
Merrill Lynch 10-15 Year
Treasury Index 6.54 61.96
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception-
2/28/94 2/28/94 2/28/94 2/28/94
Adjustable Rate U.S. Government Fund
T. Rowe Price Adjustable
Rate U.S. Government
Fund, Inc. 3.11% 3.75%
(9/30/91)
Lipper Average of
Adjustable Rate
Mortgage Funds 3.17 4.13
Merrill Lynch 1-3 Year
Govt. Index 3.48 6.42
Salomon Brothers 1-Year
Treasury Index 2.61 4.48
Salomon Brothers 2-Year
Treasury Index 3.46 6.53
GNMA Fund
T. Rowe Price GNMA Fund 3.71 10.10% 8.54
(11/26/85)
Salomon Brothers 30-Year
GNMA Index 4.67 11.13 10.31
Lehman Brothers GNMA
Bond Index 4.49 11.03 10.25
Lipper GNMA Funds Average 3.78 9.87 8.80
PAGE 93
High Yield Fund
High Yield Fund 16.59 9.63 11.74
(12/31/84)
Merrill Lynch High
Yield Index 14.16 13.08 13.74
Merrill Lynch Medium
Quality Long Corporate
Index 8.89 13.09 13.67
Lipper's Average of High
Current Yield Funds 16.66 11.28 11.55
New Income Fund
New Income Fund 5.36 10.05 10.12% 9.26
(8/31/73)
Salomon Bros. Broad
Investment Grade Index 5.58 11.11 11.71 N/A
Salomon Bros. High Grade
Corporate Bond Index 6.73 12.64 13.79 9.99
Lehman Bros. Govt./Corp.
Bond Index 5.71 11.12 11.55 9.75
Lipper Corporate Bond
Fund's -A Rated Average 5.64 10.52 11.17 9.34
Short-Term Bond Fund
T. Rowe Price Short-Term
Bond Fund 4.36 8.12 8.34
(3/2/84)
T. Rowe Price Prime
Reserve Fund 2.60 5.42 6.52
Donoghue Average of all
Taxable Money Funds 2.70 5.44 6.42
Lehman Bros. 1-3 Year
Govt./Corp. Bond Index 3.62 8.46 9.12
Lipper Short Investment
Grade Debt Funds Average 3.95 8.40 8.99
U.S. Treasury Intermediate Fund
Intermediate Fund 3.80 9.25
(9/29/89)
Lehman Brothers
Intermediate Treasury
Index 4.23 9.43
PAGE 94
U.S. Treasury Long-Term Fund
Long-Term Fund 5.89 9.99
(9/29/89)
Lehman Brothers
Government/Corporate
Bond Index 5.71 10.36
Lehman Brothers Long
Treasury Index 8.32 11.86
Merrill Lynch 10-15 Year
Treasury Index 6.54 11.54
Outside Sources of Information
From time to time, in reports and promotional literature, one
or more of the T. Rowe Price funds, including this Fund, may
compare its performance to Overnight Government Repurchase
Agreements, Treasury bills, notes, and bonds, certificates of
deposit, and six-month money market certificates. Performance
may also be compared to (1) indices of broad groups of managed or
unmanaged securities considered to be representative of or
similar to Fund portfolio holdings; (2) other mutual funds; or
(3) other measures of performance set forth in publications such
as:
Advertising News Service, Inc., "Bank Rate Monitor+ - The
Weekly Financial Rate Reporter" is a weekly publication which
lists the yields on various money market instruments offered to
the public by 100 leading banks and thrift institutions in the
U.S., including loan rates offered by these banks. Bank
certificates of deposit differ from mutual funds in several
ways: the interest rate established by the sponsoring bank is
fixed for the term of a CD; there are penalties for early
withdrawal from CDs; and the principal on a CD is insured.
Donoghue Organization, Inc., "Donoghue's Money Fund Report" is
a weekly publication which tracks net assets, yield, maturity
and portfolio holdings on approximately 380 money market mutual
funds offered in the U.S. These funds are broken down into
various categories such as U.S. Treasury, Domestic Prime and
Euros, Domestic Prime and Euros and Yankees, and Aggressive.
First Boston High Yield Index. It shows statistics on the
Composite Index and analytical data on new issues in the
marketplace and low-grade issuers.
Lipper Analytical Services, Inc., "Lipper-Fixed Income Fund
Performance Analysis" is a monthly publication which tracks net
assets, total return, principal return and yield on
approximately 950 fixed income mutual funds offered in the
United States.
PAGE 95
Merrill Lynch, Pierce, Fenner & Smith, Inc., "Taxable Bond
Indices" is a monthly publication which lists principal, coupon
and total return on over 100 different taxable bond indices
tracked by Merrill Lynch, together with the par weighted
characteristics of each Index. The index used as a benchmark
for the High Yield Fund is the High Yield Index. The two
indices used as benchmarks for the Short-Term Bond Fund are the
91-Day Treasury Bill Index and the 1-2.99 Year Treasury Note
Index.
Morningstar, Inc., is a widely used independent research firm
which rates mutual funds by overall performance, investment
objectives and assets.
Salomon Brothers Inc., "Analytical Record of Yields and Yield
Spreads" is a publication which tracks historical yields and
yield spreads on short-term market rates, public obligations of
the U.S. Treasury and agencies of the U.S. government, public
corporate debt obligations, municipal debt obligations and
preferred stocks.
Salomon Brothers Inc., "Bond Market Round-up" is a weekly
publication which tracks the yields and yield spreads on a
large, but select, group of money market instruments, public
corporate debt obligations, and public obligations of the U.S.
Treasury and agencies of the U.S. Government.
Salomon Brothers Inc., "High Yield Composite Index" is an index
which provides performance and statistics for the high yield
market place.
Salomon Brothers Inc., "Market Performance" is a monthly
publication which tracks principal return, total return and
yield on the Salomon Brothers Broad investment - Grade Bond
Index and the components of the Index.
Shearson Lehman Brothers, Inc., "The Bond Market Report" is a
monthly publication which tracks principal, coupon and total
return on the Shearson Lehman Govt./Corp. Index and Shearson
Lehman Aggregate Bond Index, as well as all the components of
these Indices.
Telerate Systems, Inc., is a market data distribution network
which tracks a broad range of financial markets including, the
daily rates on money market instruments, public corporate debt
obligations and public obligations of the U.S. Treasury and
agencies of the U.S. Government.
Wall Street Journal, is a national daily financial news
publication which lists the yields and current market values on
money market instruments, public corporate debt obligations,
public obligations of the U.S. Treasury and agencies of the
U.S. government as well as common stocks, preferred stocks,
PAGE 96
convertible preferred stocks, options and commodities; in
addition to indices prepared by the research departments of
such financial organizations as Shearson Lehman/American
Express Inc., and Merrill Lynch, Pierce, Fenner and Smith,
Inc., including information provided by the Federal Reserve
Board.
Performance rankings and ratings reported periodically in
national financial publications such as MONEY, FORBES, BUSINESS
WEEK, BARRON'S, etc. will also be used.
All Funds, Except Prime Reserve Fund
Benefits of Investing in High-Quality Bond Funds
o Higher Income
Bonds have generally provided a higher income than money
market securities because yield usually increased with longer
maturities. For instance, the yield on the 30-year Treasury
bond usually exceeds the yield on the 1-year Treasury bill or
5-year Treasury note. However, securities with longer
maturities fluctuate more in price than those with shorter
maturities. Therefore, the investor must weigh the
advantages of higher yields against the possibility of
greater fluctuation in the principal value of your
investment.
o Income Compounding
Investing in bond mutual funds allows investors to benefit
from easy and convenient compounding, because you can
automatically reinvest monthly dividends in additional fund
shares. Each month investors earn interest on a larger
number of shares. Also, reinvesting dividends removes the
temptation to spend the income.
o Broad Diversification
Each share of a mutual fund represents an interest in a large
pool of securities, so even a small investment is broadly
diversified by maturity. Since most bonds trade efficiently
only in very large blocks,mutual funds provide a degree of
diversification that may be difficult for individual
investors to achieve on their own.
o Lower Portfolio Volatility
Investing a portion of one's assets in longer term, high-
quality bonds can help smooth out the fluctuations in your
overall investment results, because bond prices do not
necessarily move with stock prices. Also, bonds usually have
higher income yields than stocks, thus increasing the total
PAGE 97
income component of your portfolio. This strategy should
also add stability to overall results, as income is always a
positive component of total return.
o Liquidity
A bond fund can supplement a money market fund or bank
account as a source of capital for unexpected contingencies.
T. Rowe Price fixed-income funds offer you easy access to
money through free checkwriting and convenient redemption or
exchange features. Of course, the value of a bond fund's
shares redeemed through checkwriting may be worth more or
less than their value at the time of their original purchase.
o Suitability
High-quality bond funds are most suitable for the following
objectives: obtaining a higher current income with minimal
credit risk; compounding of income over time; or diversifying
overall investments to reduce volatility.
All Funds
IRAs
An IRA is a long-term investment whose objective is to
accumulate personal savings for retirement. Due to the long-term
nature of the investment, even slight differences in performance
will result in significantly different assets at retirement.
Mutual funds, with their diversity of choice, can be used for IRA
investments. Generally, individuals may need to adjust their
underlying IRA investments as their time to retirement and
tolerance for risk changes.
Other Features and Benefits
The Fund is a member of the T. Rowe Price Family of Funds
and may help investors achieve various long-term investment
goals, such as investing money for retirement, saving for a down
payment on a home, or paying college costs. To explain how the
Fund could be used to assist investors in planning for these
goals and to illustrate basic principles of investing, various
worksheets and guides prepared by T. Rowe Price Associates, Inc.
and/or T. Rowe Price Investment Services, Inc. may be made
available. These currently include: the Asset Mix Worksheet
which is designed to show shareholders how to reduce their
investment risk by developing a diversified investment plan; the
College Planning Guide which discusses various aspects of
financial planning to meet college expenses and assists parents
in projecting the costs of a college education for their
children; the Retirement Planning Kit (also available in a PC
version) includes a detailed workbook to determine how much money
you may need for retirement and suggests how you might invest to
PAGE 98
achieve your objectives; and the Retirees Financial Guide which
includes a detailed workbook to determine how much money you can
afford to spend and still preserve your purchasing power and
suggests how you might invest to reach your goal. From time to
time, other worksheets and guides may be made available as well.
Of course, an investment in the Fund cannot guarantee that such
goals will be met.
To assist investors in understanding the different returns
and risk characteristics of various investments, the
aforementioned guides will include presentation of historical
returns of various investments using published indices. An
example of this is shown below.
Historical Returns for Different Investments
Annualized returns for periods ended 12/31/93
50 years 20 years 10 years 5 years
Small-Company Stocks 15.3% 18.8% 10.0% 13.3%
Large-Company Stocks 12.3 12.8 14.9 14.5
Foreign Stocks N/A 14.4 17.9 2.3
Long-Term Corporate Bonds 5.6 10.2 14.0 13.0
Intermediate-Term U.S.
Gov't. Bonds 5.7 9.8 11.4 11.3
Treasury Bills 4.6 7.5 6.4 5.6
U.S. Inflation 4.3 5.9 3.7 3.9
Sources: Ibbotson Associates, Morgan Stanley. Foreign stocks
reflect performance of The Morgan Stanley Capital International
EAFE Index, which includes some 1,000 companies representing the
stock markets of Europe, Australia, New Zealand, and the Far
East. This chart is for illustrative purposes only and should
not be considered as performance for, or the annualized return
of, any T. Rowe Price Fund. Past performance does not guarantee
future results.
Also included will be various portfolios demonstrating how
these historical indices would have performed in various
combinations over a specified time period in terms of return. An
example of this is shown below.
PAGE 99
Performance of Retirement Portfolios*
Asset Mix Average Annualized Value
Returns 20 Years of
Ended 12/31/93 $10,000
Investment
After Period
___________________________________________ ____________
Nominal Real Best Worst
PortfolioGrowthIncome Safety Return Return** Year Year
I. Low
Risk 40% 40% 20% 11.3% 5.4% 24.9%-9.3%$ 79,775
II. Moderate
Risk 60% 30% 10% 12.1% 6.2% 29.1%-15.6%$ 90,248
III. High
Risk 80% 20% 0% 12.9% 7.0% 33.4%-21.9%$100,031
Source: T. Rowe Price Associates; data supplied by Lehman
Brothers, Wilshire Associates, and Ibbotson Associates.
* Based on actual performance for the 20 years ended 1993 of
stocks (85% Wilshire 5000 and 15% Europe, Australia, Far East
[EAFE] Index), bonds (Lehman Brothers Aggregate Bond Index
from 1976-93 and Lehman Brothers Government/Corporate Bond
Index from 1974-75), and 30-day Treasury bills from January
1974 through December 1993. Past performance does not
guarantee future results. Figures include changes in
principal value and reinvested dividends and assume the same
asset mix is maintained each year. This exhibit is for
illustrative purposes only and is not representative of the
performance of any T. Rowe Price fund.
** Based on inflation rate of 5.9% for the 20-year period ended
12/31/93.
Insights
From time to time, Insights, a T. Rowe Price publication of
reports on specific investment topics and strategies, may be
included in the Fund's fulfillment kit. Such reports may include
information concerning: calculating taxable gains and losses on
mutual fund transactions, coping with stock market volatility,
benefiting from dollar cost averaging, understanding
international markets, investing in high-yield "junk" bonds,
growth stock investing, conservative stock investing, value
investing, investing in small companies, tax-free investing,
fixed income investing, investing in mortgage-backed securities,
as well as other topics and strategies.
PAGE 100
Other Publications
From time to time, in newsletters and other publications
issued by T. Rowe Price Investment Services, Inc., reference may
be made to economic, financial and political developments in the
U.S. and abroad and their effect on securities prices. Such
discussions may take the form of commentary on these developments
by T. Rowe Price mutual fund portfolio managers and their views
and analysis on how such developments could affect investments in
mutual funds.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in
kind redemption of portfolio securities of the Fund, brokerage
fees could be incurred by the shareholder in a subsequent sale of
such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the Fund; (b) are acquired
for investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
All Funds, Except GNMA Fund
CAPITAL STOCK
The Fund's Charter authorizes the Board of Directors to
classify and reclassify any and all shares which are then
unissued, including unissued shares of capital stock into any
number of classes or series, each class or series consisting of
such number of shares and having such designations, such powers,
preferences, rights, qualifications, limitations, and
restrictions, as shall be determined by the Board subject to the
Investment Company Act and other applicable law. The shares of
any such additional classes or series might therefore differ from
the shares of the present class and series of capital stock and
from each other as to preferences, conversions or other rights,
voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to
applicable law, and might thus be superior or inferior to the
capital stock or to other classes or series in various
characteristics. The Board of Directors may increase or decrease
the aggregate number of shares of stock or the number of shares
of stock of any class or series that the Fund has authorized to
issue without shareholder approval.
PAGE 101
Except to the extent that the Fund's Board of Directors
might provide by resolution that holders of shares of a
particular class are entitled to vote as a class on specified
matters presented for a vote of the holders of all shares
entitled to vote on such matters, there would be no right of
class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no
provision entitling the holders of the present class of capital
stock to a vote as a class on any matter. Accordingly, the
preferences, rights, and other characteristics attaching to any
class of shares, including the present class of capital stock,
might be altered or eliminated, or the class might be combined
with another class or classes, by action approved by the vote of
the holders of a majority of all the shares of all classes
entitled to be voted on the proposal, without any additional
right to vote as a class by the holders of the capital stock or
of another affected class or classes.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of directors (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
will be unable to elect any person as a director. As set forth
in the By-Laws of the Fund, a special meeting of shareholders of
the Fund shall be called by the Secretary of the Fund on the
written request of shareholders entitled to cast at least 10% of
all the votes of the Fund entitled to be cast at such meeting.
Shareholders requesting such a meeting must pay to the Fund the
reasonably estimated costs of preparing and mailing the notice of
the meeting. The Fund, however, will otherwise assist the
shareholders seeking to hold the special meeting in communicating
to the other shareholders of the Fund to the extent required by
Section 16(c) of the Investment Company Act of 1940.
GNMA Fund
DESCRIPTION OF THE FUND
For tax and business reasons, the Fund was organized in 1985
as a Massachusetts Business Trust and is registered with the
Securities and Exchange Commission under the Investment Company
PAGE 102
Act of 1940 as a diversified, open-end investment company,
commonly known as a "mutual fund."
The Declaration of Trust permits the Board of Trustees to
issue an unlimited number of full and fractional shares of a
single class. The Declaration of Trust also provides that the
Board of Trustees may issue additional series or classes of
shares. Each share represents an equal proportionate beneficial
interest in the Fund. In the event of the liquidation of the
Fund, each share is entitled to a pro rata share of the net
assets of the Fund.
Shareholders are entitled to one vote for each full share
held (and fractional votes for fractional shares held) and will
vote in the election of or removal of trustees (to the extent
hereinafter provided) and on other matters submitted to the vote
of shareholders. There will normally be no meetings of
shareholders for the purpose of electing trustees unless and
until such time as less than a majority of the trustees holding
office have been elected by shareholders, at which time the
trustees then in office will call a shareholders' meeting for the
election of trustees. Pursuant to Section 16(c) of the
Investment Company Act of 1940, holders of record of not less
than two-thirds of the outstanding shares of the Fund may remove
a trustee by a vote cast in person or by proxy at a meeting
called for that purpose. Except as set forth above, the trustees
shall continue to hold office and may appoint successor trustees.
Voting rights are not cumulative, so that the holders of more
than 50% of the shares voting in the election of trustees can, if
they choose to do so, elect all the trustees of the Trust, in
which event the holders of the remaining shares will be unable to
elect any person as a trustee. No amendments may be made to the
Declaration of Trust without the affirmative vote of a majority
of the outstanding shares of the Trust.
Shares have no preemptive or conversion rights; the right of
redemption and the privilege of exchange are described in the
prospectus. Shares are fully paid and nonassessable, except as
set forth below. The Trust may be terminated (i) upon the sale
of its assets to another diversified, open-end management
investment company, if approved by the vote of the holders of
two-thirds of the outstanding shares of the Trust, or (ii) upon
liquidation and distribution of the assets of the Trust, if
approved by the vote of the holders of a majority of the
outstanding shares of the Trust. If not so terminated, the Trust
will continue indefinitely.
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of
the Fund. However, the Declaration of Trust disclaims
shareholder liability for acts or obligations of the Fund and
requires that notice of such disclaimer be given in each
agreement, obligation or instrument entered into or executed by
PAGE 103
the Fund or a Trustee. The Declaration of Trust provides for
indemnification from Fund property for all losses and expenses of
any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder incurring financial loss
on account of shareholder liability is limited to circumstances
in which the Fund itself would be unable to meet its obligations,
a possibility which T. Rowe Price believes is remote. Upon
payment of any liability incurred by the Fund, the shareholders
of the Fund paying such liability will be entitled to
reimbursement from the general assets of the Fund. The Trustees
intend to conduct the operations of the Fund in such a way so as
to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of such Fund.
FEDERAL AND STATE REGISTRATION OF SHARES
The Fund's shares are registered for sale under the
Securities Act of 1933, and the Fund or its shares are registered
under the laws of all states which require registration, as well
as the District of Columbia and Puerto Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman, & Goodman, whose address is 919
Third Avenue, New York, New York 10022, is legal counsel to the
Fund.
INDEPENDENT ACCOUNTANTS
GNMA, High Yield, New Income, Prime Reserve, Short-Term Bond and
Money Funds
Price Waterhouse, 7 St. Paul Street, Suite 1700, Baltimore,
Maryland 21202, are independent accountants to the Fund.
Adjustable Rate, Intermediate and Long-Term Funds
Coopers & Lybrand, 217 East Redwood Street, Baltimore,
Maryland 21202, are independent accountants to the Fund.
Financial Statements
The financial statements of the Fund for the year ended
February 28, 1994, and the report of independent accountants are
included in the Fund's Annual Report for the period February 28,
1994. A copy of the Annual Report accompanies this Statement of
Additional Information. The following financial statements and
the report of independent accountants appearing in the Annual
Report for the year ended February 28, 1994 are incorporated into
this Statement of Additional Information by reference:
PAGE 104
NEW PRIME SHORT-
GNMA INCOME RESERVE TERM BOND
____ ______ _______ _________
Report of Independent
Accountants 12 15 11 17
Statement of Net Assets,
February 28, 1994 6-7 6-10 5-8 6-11
Statement of Operations, year
ended February 28, 1994 8 11 8 12
Statement of Changes in Net
Assets, years ended
February 28, 1994 and
February 28, 1993 9 12 9 13
Notes to Financial Statements
February 28, 1994 9-11 12-14 9-10 14-15
Financial Highlights 11 14 11 16
MONEY INTERMEDIATE LONG-TERM
_____ ____________ __________
Report of Independent
Accountants 18 19 19
Statement of Net Assets,
February 28, 1994 7-9 8-9 10-11
Statement of Operations, year
ended February 28, 1994 11 11 11
Statement of Changes in Net
Assets, years ended
February 28, 1994 and
February 28, 1993 12 12 12
Notes to Financial Statements
February 28, 1994 13-14 13-14 13-14
Financial Highlights 15 16 17
PAGE 105
ADJUSTABLE RATE HIGH YIELD
_______________ __________
Report of Independent
Accountants 13 19
Portfolio of Investments,
February 28, 1994 5-7 6-13
Statement of Assets and
Liabilities, February 28, 1994 7 14
Statement of Operations, year
ended February 28, 1994 8 15
Statement of Changes in Net
Assets, years ended
February 28, 1994 and
February 28, 1993 9 16
Notes to Financial Statements
February 28, 1994 10-11 16-18
Financial Highlights 12 18
RATINGS OF COMMERCIAL PAPER
Adjustable Rate, High Yield, Prime Reserve and Short-Term Bond
Funds
Moody's Investors Service, Inc.: The rating of Prime-1 is the
highest commercial paper rating assigned by Moody's. Among the
factors considered by Moody's in assigning ratings are the
following: valuation of the management of the issuer; economic
evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in
certain areas; evaluation of the issuer's products in relation to
competition and customer acceptance; liquidity; amount and
quality of long-term debt; trend of earnings over a period of 10
years; financial strength of the parent company and the
relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a
result of public interest questions and preparations to meet such
obligations. These factors are all considered in determining
whether the commercial paper is rated P1, P2, or P3.
Standard & Poor's Corporation: Commercial paper rated A (highest
quality) by S&P has the following characteristics: liquidity
ratios are adequate to meet cash requirements; long-term senior
debt is rated "A" or better, although in some cases "BBB" credits
may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances.
Typically, the issuer's industry is well established and the
issuer has a strong position within the industry. The
reliability and quality of management are unquestioned. The
relative strength or weakness of the above factors determines
whether the issuer's commercial paper is rated A1, A2, or A3.
PAGE 106
Prime Reserve Fund
Fitch Investors Service, Inc.: Fitch 1 - Highest grade.
Commercial paper assigned this rating is regarded as having the
strongest degree of assurance for timely payment. Fitch 2 - Very
good grade. Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest
issues.
RATINGS OF CORPORATE DEBT SECURITIES
Adjustable Rate, High Yield, New Income and Short-Term Bond Funds
Moody's Investors Services, Inc. (Moody's)
Aaa-Bonds rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are
generally referred to as "gilt edge."
Aa-Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds.
A-Bonds rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations.
Baa-Bonds rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly
secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as
well.
Ba-Bonds rated Ba are judged to have speculative elements:
their futures cannot be considered as well assured. Often the
protection of interest and principal payments may be very
moderate and thereby not well safeguarded during both good and
bad times over the future. Uncertainty of position characterize
bonds in this class.
B-Bonds rated B generally lack the characteristics of a
desirable investment. Assurance of interest and principal
payments or of maintenance of other terms of the contract over
any long period of time may be small.
Caa-Bonds rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with
respect to principal or interest.
PAGE 107
Ca-Bonds rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked short-comings.
Standard & Poor's Corporation (S&P)
AAA-This is the highest rating assigned by Standard & Poor's
to a debt obligation and indicates an extremely strong capacity
to pay principal and interest.
AA-Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is very
strong.
A-Bonds rated A have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
BBB-Bonds rated BBB are regarded as having an adequate
capacity to pay principal and interest. Whereas they normally
exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, C, CCC, CC-Bonds rated BB, B, CCC, and CC are regarded on
balance, as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal. BB
indicates the lowest degree of speculation and CC the highest
degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse
conditions.
Fitch Investors Service, Inc.
AAA-High grade, broadly marketable, suitable for investment by
trustees and fiduciary institutions, and liable to but slight
market fluctuation other than through changes in the money rate.
The prime feature of a "AAA" bond is the showing of earnings
several times or many times interest requirements for such
stability of applicable interest that safety is beyond reasonable
question whenever changes occur in conditions. Other features
may enter, such as a wide margin of protection through
collateral, security or direct lien on specific property.
Sinking funds or voluntary reduction of debt by call or purchase
or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA-Of safety virtually beyond question and readily salable.
Their merits are not greatly unlike those of "AAA" class but a
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bond so rated may be junior though of strong lien, or the margin
of safety is less strikingly broad. The issue may be the
obligation of a small company, strongly secured, but influenced
as to rating by the lesser financial power of the enterprise and
more local type of market.
