<PAGE> 1
PROSPECTUS
DECEMBER 23, 1998
MERRILL LYNCH SENIOR FLOATING RATE FUND, INC.
COMMON STOCK
------------------------
Merrill Lynch Senior Floating Rate Fund, Inc. (the "Fund") is a
continuously offered, non-diversified, closed-end fund. The Fund seeks as high a
level of current income and such preservation of capital as is consistent with
investment in senior collateralized corporate loans (primarily in the form of
participation interests) made by banks and other financial institutions. There
can be no assurance that the investment objective of the Fund will be realized.
Currently, there is no secondary market for the Fund's common stock. To provide
liquidity, the Fund generally makes quarterly tender offers for its shares. In a
tender offer, the Fund repurchases outstanding shares at the Fund's net asset
value on the last day of the offer. If a tender offer is not made, shareholders
may not be able to sell their shares.
Shares of common stock of the Fund are offered on a best efforts basis at a
price equal to the next determined net asset value per share without a front-end
sales charge. As of the date of this Prospectus, net asset value per share is
$9.86. Shares may be purchased directly from Merrill Lynch Funds Distributor, a
division of Princeton Funds Distributor, Inc., or from selected other securities
dealers, including Merrill Lynch, Pierce, Fenner & Smith Incorporated.
------------------------
This Prospectus contains information you should know before investing,
including information about risks. Please read it before you invest and keep it
for future reference. The Securities and Exchange Commission has not approved or
disapproved these securities or determined if this Prospectus is truthful or
complete. Any representation to the contrary is a criminal offense.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC(1) DISCOUNT(2) FUND(3)
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share......................... $9.86 None $9.86
- -------------------------------------------------------------------------------------------------------------
Total(3).......................... $1,760,288,683 None $1,760,288,683
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Net asset value ranged from $9.81 to $10.02 per share between November 3,
1989 (commencement of operations) to the date of this Prospectus.
(2) The Distributor pays all offering expenses (other than registration fees)
and sales commissions to selected dealers (primarily Merrill Lynch) from its
own assets. Therefore, all of the proceeds of this offering will be
available to the Fund for investment in portfolio securities. See "Purchase
of Shares."
(3) These amounts (a) do not take into account prepaid registration fees
(approximately $151,516), which are being charged to income as the related
shares are issued, and (b) assume all shares currently registered are sold
in the continuous offering.
------------------------
MERRILL LYNCH FUNDS DISTRIBUTOR -- DISTRIBUTOR
MERRILL LYNCH ASSET MANAGEMENT -- INVESTMENT ADVISER
<PAGE> 2
PROSPECTUS SUMMARY
This summary is qualified in its entirety by reference to the detailed
information included in this Prospectus.
THE FUND Merrill Lynch Senior Floating Rate Fund, Inc.
is a continuously offered, non-diversified,
closed-end fund.
THE OFFERING Shares of common stock of the Fund are offered
by the Distributor and other securities
dealers, including Merrill Lynch, Pierce,
Fenner & Smith Incorporated. Investors also may
mail a purchase order directly to Financial
Data Services, Inc., the Fund's Transfer Agent.
The Fund offers its common stock on a best
efforts basis at a price equal to the next
determined net asset value per share without a
front-end sales charge. Shares are sold subject
to certain minimum purchase requirements:
<TABLE>
<CAPTION>
THE THE
MINIMUM MINIMUM
INITIAL SUBSEQUENT
FOR INVESTMENTS PURCHASE PURCHASE
IN THE FUND MADE AMOUNT IS AMOUNT IS
---------------- --------- ----------
<S> <C> <C>
Directly through the Fund's
Distributor or Transfer Agent.... $1,000 $50
Via a Merrill Lynch-maintained
401(k) or 403(b) plan............ None None
Via another retirement plan........ $ 250 $ 1
</TABLE>
INVESTMENT OBJECTIVE AND
POLICIES The Fund seeks to provide shareholders with as
high a level of current income and such
preservation of capital as is consistent with
investment in senior collateralized corporate
loans made to U.S. or non-U.S. borrowers. An
investment in the Fund entails certain risks.
Corporate Loans. The Fund invests primarily in
corporate loans that are direct obligations of
a borrower undertaken to finance the growth of
the borrower's business or a capital
restructuring. A significant portion of such
corporate loans are highly leveraged loans such
as leveraged buy-out loans, leveraged
recapitalization loans and other types of
acquisition loans. The Fund also may invest in
privately placed notes with credit and pricing
terms that are, in the opinion of the
Investment Adviser, consistent with investment
in senior collateralized corporate loans.
Floating or Variable Rate Corporate
Loans. Under normal market conditions, the
Fund will invest at least 65% of its assets in
corporate loans that have floating or variable
interest rates. Floating rate corporate loan
interest rates adjust periodically at a margin
above a generally-recognized base lending rate
such as the prime rate of a designated U.S.
bank, the Certificate of Deposit rate or the
London InterBank Offered Rate.
2
<PAGE> 3
Credit Quality. The Fund will invest in a
corporate loan only if, in the Investment
Adviser's judgment, the borrower can meet debt
service on such loan. The Investment Adviser
performs its own credit analysis of each
borrower. Since the minimum debt rating of a
borrower may not have a meaningful relationship
to the quality of such borrower's senior
collateralized debt, the Fund does not impose
any minimum standard regarding the rating of
other debt instruments of the borrower. The
Fund may invest without limitation in corporate
loans rated below investment grade (i.e., below
BBB or Baa) or which are unrated but of similar
credit quality.
Unsecured Loans and Short-Term
Investments. Generally the Fund invests at
least 80% of its assets in senior
collateralized corporate loans. The remainder
of the Fund's assets may be invested in
unsecured senior loans. The Fund also may
invest in cash or in secured or unsecured
short-term debt obligations. Short-term debt
obligations in which the Fund invests are rated
investment grade (i.e., within the four highest
rating categories assigned by a nationally
recognized rating service) or, if not rated,
are determined to be of comparable quality by
the Investment Adviser. Obligations rated in
the fourth highest rating category may include
obligations considered to have certain
speculative characteristics.
Portfolio Maturity. The Fund has no
restrictions on portfolio maturity, but it is
anticipated that a majority of the corporate
loans in which it invests will have stated
maturities ranging from three to ten years. As
a result of prepayments, however, the average
life of the corporate loans is expected to be
in the two to three year range.
Foreign and Domestic Borrowers. The Fund may
invest in corporate loans made to U.S. or
non-U.S. borrowers, provided that the loans are
U.S. dollar-denominated or otherwise provide
for payment to the Fund in U.S. dollars.
Hedging Techniques. The Fund may engage in
certain interest rate hedging transactions,
such as "swaps", "caps" or "floors," to reduce
the Fund's exposure to interest rate movements.
The Fund also may invest in corporate loans
that pay interest and principal in a currency
other than U.S. dollars if the loan arrangement
also includes a foreign currency swap that
entitles the Fund to receive payments in U.S.
dollars, or if the Fund hedges the foreign
currency exposure itself utilizing forward
contracts or other methods.
BORROWINGS BY THE FUND The Fund may borrow money in amounts up to
33 1/3% of the value of its total assets.
Typically the Fund borrows to satisfy tender
offers, but it also is authorized to borrow to
finance additional investments. The Fund will
borrow to finance additional investments only
when the Investment Adviser believes that the
potential return on such additional investments
will exceed the costs incurred in connection
with the borrowing.
3
<PAGE> 4
INVESTMENT ADVISER AND
ADMINISTRATOR Merrill Lynch Asset Management, L.P., the
investment adviser, provides investment
advisory and administrative services to the
Fund. For advisory services, the Fund pays the
Investment Adviser a fee at the annual rate of
0.95% of the Fund's average daily net assets.
For its administrative services, the Fund pays
the Investment Adviser a fee at the annual rate
of 0.25% of the Fund's average daily net
assets. While the combined advisory and
administrative fees are higher than that paid
by most funds, they are similar to those paid
by other closed-end funds investing primarily
in corporate loans.
DISTRIBUTIONS The Fund intends to declare dividends daily,
pay dividends monthly and distribute all of its
net investment income. Net capital gains, if
any, will be distributed at least annually.
TENDER OFFERS Currently, there is no secondary market for the
Fund's common stock, and it is not expected
that a secondary market will develop. To
provide liquidity, the Board of Directors
considers, on a quarterly basis, whether the
Fund should make a tender offer for its shares.
In a tender offer, the Fund repurchases
outstanding shares at the Fund's net asset
value on the last day of the offer. If a tender
offer is not made, shareholders may not be able
to sell their shares.
EARLY WITHDRAWAL CHARGE Tendered shares of common stock held for less
than three years at the date of tender are
subject to an early withdrawal charge in most
cases. The charge varies with the amount of
time the shares have been held. It is based on
the lesser of cost or net asset value of the
tendered shares.
4
<PAGE> 5
RISK FACTORS AND SPECIAL CONSIDERATIONS
Liquidity of Shares. The Fund is designed primarily for long-term
investors and should not be considered a vehicle for trading purposes.
Currently, there is no secondary market for the Fund's common stock, and a
secondary market is not expected to develop. To provide liquidity to
shareholders, the Board of Directors of the Fund intends to continue to consider
the making of quarterly tender offers to repurchase the Fund's shares at net
asset value. However, the Fund's shares are less liquid than shares of funds
traded on a stock exchange, and shareholders who tender Fund shares held for
less than three years will pay an early withdrawal charge. The Board of
Directors is not obligated to authorize any tender offer, and there may be
quarters in which no tender offer is made. If the Board of Directors does not
authorize a tender offer, shareholders may be unable to sell their shares.
Merrill Lynch and other selected dealers are prohibited from making a market in
the Fund's common stock while the Fund either is offering its shares or is
making a tender offer to repurchase its shares.
Closed-end funds that do trade in a secondary market are subject to the
risk that the net asset value of the shares may be higher than the market price,
commonly referred to as "trading at a discount." As long as there is no
secondary market for the Fund's shares, the Fund is not subject to this risk.
Non-payment. The debt instruments in which the Fund invests are subject to
the risk of non-payment of interest and principal. When a borrower fails to make
scheduled interest or principal payments on a debt instrument, the value of the
instrument, and hence the value of the Fund's shares, may go down. While
collateral may provide some protection against devaluation due to a default on a
collateralized loan, losses may not be completely covered by the liquidation or
sale of collateral.
The Fund may invest without limitation in corporate loans rated below
investment grade (i.e., below BBB or Baa) or which are unrated but of similar
credit quality. These investments have a higher risk of non-payment than
investment grade investments.
Corporate loans made in connection with highly leveraged transactions are
subject to greater risks than other corporate loans. For example, the risks of
default or bankruptcy of the borrower or the risks that other creditors of the
borrower may seek to nullify or subordinate the Fund's claims on the collateral
securing the loan are greater in highly leveraged transactions.
Intermediary. The Fund may invest in corporate loans either by
participating as a co-lender at the time the loan is originated or by buying an
interest in the loan from an institution acting as agent, co-lender or
participant. The financial status of the institutions interposed between the
Fund and a borrower may affect the ability of the Fund to receive principal and
interest payments. For this reason, the Fund will invest in corporate loans only
if, at the time of investment, the outstanding debt obligations of these
intermediary institutions are rated investment grade or are of comparable
quality in the judgment of the Investment Adviser.
The success of the Fund depends, to a great degree, on the skill with which
an agent bank administers the terms of the corporate loan agreements, monitors
borrower compliance with covenants, collects principal, interest and fee
payments from borrowers and, where necessary, enforces creditor remedies against
borrowers. Agent banks typically have broad discretion in enforcing corporate
loan agreements.
Net Asset Value; Interest Rate Sensitivity. Generally, when interest rates
go up, the value of debt securities goes down. Therefore, the net asset value of
a fund that invests primarily in fixed-income debt securities changes as
interest rates fluctuate. Because the Fund invests primarily in floating or
variable rate debt obligations, the Investment Adviser expects that it will be
insulated to a significant degree from net asset value fluctuations caused by
movements in interest rates. However, because floating and variable rate debt
obligations only reset periodically, the Fund's net asset value may fluctuate
from time to time when there is an
5
<PAGE> 6
imperfect correlation between the interest rates on the variable rate loans in
the Fund's portfolio and prevailing interest rates. Changes in the
creditworthiness of borrowers or of co-lenders or participants interposed
between the Fund and the borrowers also may affect the Fund's net asset value.
Furthermore, volatility in the capital markets may affect the Fund's net asset
value given that the Fund uses market prices to value many of its corporate loan
investments.
Borrowings by the Fund. If the Fund chooses to borrow money, rather than
liquidate investments, to satisfy a tender offer, it is subject to the risk that
investment return on Fund shares will be reduced to the extent the cost of the
borrowings exceeds income on the retained investments.
Hedging. Hedging transactions subject the Fund to the risk that, if the
Investment Adviser incorrectly forecasts market values, interest rates or other
applicable factors, the Fund's performance could suffer. In addition, if the
counterparty to an interest rate hedging transaction defaults, the Fund's risk
of loss consists of the net amount of interest payments that the Fund
contractually is entitled to receive. If the counterparty to a foreign currency
swap defaults, the Fund will seek a replacement swap, which may result in
additional costs to the Fund, and will be subject to fluctuations in the
applicable exchange rate until a replacement swap is obtained.
Concentration. The Fund's investments may be concentrated in obligations
issued by financial institutions and their holding companies, including
commercial banks, thrift institutions, insurance companies and finance
companies. As a result, the Fund is subject to certain risks associated with
such institutions, including, among other things, changes in government
regulation, interest rate levels and general economic conditions.
Foreign Investment. Loans to non-U.S. borrowers may involve risks not
typically involved in domestic investment, including fluctuation in foreign
interest rates, future foreign political and economic developments and the
possible imposition of exchange controls or other governmental laws or
restrictions.
Non-diversification. The Fund is classified as a non-diversified
investment company, meaning that the Fund may invest a greater percentage of its
assets in the obligations of a single issuer than a diversified investment
company. Even as a non-diversified fund, the Fund is still subject to the
diversification requirements of the U.S. tax laws. However, since the Fund may
invest a higher percentage of its assets in obligations of a single issuer than
a diversified fund, it is more susceptible than a diversified fund to any
economic, political or regulatory occurrence that affects an individual issuer.
Liquidity of Investments. Certain corporate loans in which the Fund
invests may be deemed to be illiquid. Illiquid investments may impair the Fund's
ability to realize the full value of those investments in the event the Fund
must dispose of them quickly. The Fund's Board of Directors will consider the
liquidity of the Fund's portfolio in determining whether a tender offer should
be made.
6
<PAGE> 7
FEE TABLE
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Load (as a percentage of offering price).... None
Dividend Reinvestment and Cash Purchase Plan Fees......... None
Early Withdrawal Charge (as a percentage of the lesser of
the original purchase price or net asset value at the
time of repurchase)(a)................................. 3.0% during the first year,
decreasing 1.0% annually
thereafter to 0.0% after the
third year
ANNUAL EXPENSES (AS A PERCENTAGE OF NET ASSETS ATTRIBUTABLE
TO COMMON SHARES)
Investment Advisory Fees(b)............................... 0.95%
Interest Payments on Borrowed Funds (c)................... 0.05
Other Expenses(d)......................................... 0.40
----
Total Annual Expenses............................. 1.40%
----
----
</TABLE>
- ---------------
(a) See "Early Withdrawal Charge" -- page 25.
(b) See "Investment Advisory and Administrative Arrangements" -- page 28.
(c) This amount represents interest on borrowed funds paid during the fiscal
year ended August 31, 1998. Typically the Fund will borrow only when
sufficient cash is otherwise unavailable to satisfy tender offers. The
interest paid on borrowed funds in the past does not necessarily indicate
the interest the Fund will pay in connection with borrowings in the future.
(d) Includes administrative fees, which are payable to the Investment Adviser by
the Fund at the rate of 0.25% of net assets attributable to common shares.
See "Investment Advisory and Administrative Arrangements" -- page 28.
<TABLE>
<CAPTION>
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------- ------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000
investment assuming (1) total annual expenses of 1.40%,
(2) a 5% annual return throughout the periods and (3)
tender at the end of the period........................ $44* $54* $77 $168
An investor would pay the following expenses on a $1,000
investment assuming no tender at the end of the
period................................................. $14 $44 $77 $168
</TABLE>
- ---------------
* Reflects the early withdrawal charge.
The Fee Table is intended to assist investors in understanding the costs
and expenses that a shareholder in the Fund will bear directly or indirectly.
The expenses set forth under "Other Expenses" are based on estimated amounts
through the end of the Fund's current fiscal year. The Example set forth above
assumes reinvestment of all dividends and distributions and utilizes a 5% annual
rate of return as mandated by Securities and Exchange Commission regulations.
THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES
OR ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR ANNUAL RATES OF RETURN MAY BE
MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE. Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill Lynch") may charge its customers a
processing fee (presently $5.35) for confirming purchases and repurchases.
Purchases and repurchases made directly through the Transfer Agent are not
subject to the processing fee.
7
<PAGE> 8
FINANCIAL HIGHLIGHTS
The financial information in the table below was audited in conjunction
with the annual audits of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements for the fiscal year ended
August 31, 1998 and the independent auditors' report thereon appear in the
annual report of the Fund for the fiscal year ended August 31, 1998, which is
incorporated by reference herein. Further information about the performance of
the Fund is contained in the annual report, which may be obtained, without
charge, by writing the Fund at the address on the inside back cover of this
Prospectus or by calling (609) 282-2800.
The following per share data and ratios are derived from information
provided in the Fund's audited financial statements.
<TABLE>
<CAPTION>
FOR THE
PERIOD
NOVEMBER 3,
FOR THE YEAR ENDED AUGUST 31, 1989+ TO
---------------------------------------------------------------------- AUGUST 31,
1998 1997 1996 1995 1994 1993 1992 1991 1990
------- ------ ------ ------ ------ ------ ------ ------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period........................... $ 10.02 $ 9.99 $10.02 $10.02 $10.02 $ 9.99 $ 9.99 $10.00 $10.00
------- ------ ------ ------ ------ ------ ------ ------ ------
Investment income -- net......... .68 .68 .66 .75 .59 .53 .64 .85 .76
Realized and unrealized gain
(loss) on investments -- net... (.05) .03 (.03) --++ --++ .03 -- (.01) --
------- ------ ------ ------ ------ ------ ------ ------ ------
Total from investment operations... .63 .71 .63 .75 .59 .56 .64 .84 .76
------- ------ ------ ------ ------ ------ ------ ------ ------
Less dividends from investment
income -- net.................... (.68) (.68) (.66) (.75) (.59) (.53) (.64) (.85) (.76)
------- ------ ------ ------ ------ ------ ------ ------ ------
Net asset value, end of period..... $ 9.97 $10.02 $ 9.99 $10.02 $10.02 $10.02 $ 9.99 $ 9.99 $10.00
======= ====== ====== ====== ====== ====== ====== ====== ======
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share.......................... 6.47% 7.23% 6.53% 7.68% 5.94% 5.74% 6.58% 8.79% 7.63%#
======= ====== ====== ====== ====== ====== ====== ====== ======
RATIOS TO AVERAGE NET ASSETS:
Expenses, excluding interest
expense........................ 1.35% 1.32% -- -- -- -- -- -- --
======= ====== ====== ====== ====== ====== ====== ====== ======
Expenses, net of reimbursement... 1.40% 1.33% 1.34% 1.34% 1.43% 1.47% 1.39% 1.27% .79%*
======= ====== ====== ====== ====== ====== ====== ====== ======
Expenses......................... 1.40% 1.33% 1.34% 1.34% 1.43% 1.47% 1.41% 1.33% 1.35%*
======= ====== ====== ====== ====== ====== ====== ====== ======
Investment income -- net......... 6.79% 6.72% 6.54% 7.45% 5.75% 5.27% 6.58% 8.44% 9.06%*
======= ====== ====== ====== ====== ====== ====== ====== ======
LEVERAGE:
Average amount of borrowings
outstanding during the period
(in thousands)................. $24,299 $4,409 -- -- -- -- -- -- --
======= ====== ====== ====== ====== ====== ====== ====== ======
Average amount of borrowings
outstanding per share during
the period..................... $ .08 $ .02 -- -- -- -- -- -- --
======= ====== ====== ====== ====== ====== ====== ====== ======
SUPPLEMENTAL DATA:
Net assets, end of period (in
millions)...................... $ 3,365 $2,992 $2,946 $2,163 $ 934 $ 713 $ 834 $1,705 $1,728
======= ====== ====== ====== ====== ====== ====== ====== ======
Portfolio turnover............... 69.59% 74.00% 80.20% 55.23% 61.31% 90.36% 46.48% 58.22% 29.61%
======= ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
- ---------------
* Annualized.
** Total investment returns exclude the effects of the early withdrawal
charge, if any. The Fund is a continuously offered closed-end fund, the
shares of which are offered at net asset value. Therefore, no separate
market exists.
+ Commencement of operations.
++ Amount is less than $.01 per share.
# Aggregate total investment return.
8
<PAGE> 9
THE FUND
Merrill Lynch Senior Floating Rate Fund, Inc. is a continuously offered,
non-diversified, closed-end management investment company. The Fund was
incorporated under the name "Merrill Lynch Prime Fund, Inc." under the laws of
the State of Maryland on July 27, 1989 and has registered under the Investment
Company Act of 1940, as amended (the "1940 Act"). The Fund's principal office is
located at 800 Scudders Mill Road, Plainsboro, New Jersey 08536 and its
telephone number is (609) 282-2800.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide as high a level of current
income and such preservation of capital as is consistent with investment in
senior collateralized corporate loans ("Corporate Loans") primarily in the form
of Participation Interests, as defined below, in Corporate Loans made by banks
or other financial institutions. It is anticipated that the Corporate Loans will
pay interest at rates that float at a margin above a generally recognized base
lending rate such as the prime rate of a designated U.S. bank, or which adjust
periodically at a margin above the Certificate of Deposit ("CD") rate or the
London InterBank Offered Rate ("LIBOR"). This is a fundamental policy of the
Fund and may not be changed without a vote of a majority of the outstanding
shares of the Fund. There can be no assurance that the investment objective of
the Fund will be realized.
Under normal market conditions the Fund will invest at least 80% of its
total assets in interests in Corporate Loans that have floating or variable
interest rates. Under normal market conditions, at least 65% of the total assets
of the Fund will be invested in floating or variable rate loans made to
corporations. The Fund may invest up to 20% of its total assets in cash or in
short-term debt obligations including, but not limited to, U.S. Government and
Government agency securities (some of which may not be backed by the full faith
and credit of the United States), bank money instruments (such as certificates
of deposit and bankers' acceptances), corporate and commercial obligations (such
as commercial paper and medium-term notes) and repurchase agreements. Such
short-term debt obligations, which need not be secured, will all be investment
grade (rated Baa, P-3 or higher by Moody's Investors Service, Inc. ("Moody's")
or BBB, A-3 or higher by Standard & Poor's ("S&P") or, if unrated, determined to
be of comparable quality in the judgment of the Investment Adviser). Securities
rated Baa, BBB, P-3 or A-3 are considered to have adequate capacity for payment
of principal and interest, but are more susceptible to adverse economic
conditions and, in the case of securities rated BBB or Baa (or comparable
unrated securities), have speculative characteristics. Such securities or cash
will not exceed 20% of the Fund's total assets except during interim periods
pending investment of the net proceeds of public offerings of the Fund's
securities and during temporary defensive periods when, in the opinion of the
Investment Adviser, suitable Corporate Loans are not available for investment by
the Fund or prevailing market or economic conditions warrant. The Fund also may
invest up to 20% of its total assets in senior loans made on an unsecured basis
("Unsecured Corporate Loans"). Investments in Unsecured Corporate Loans will be
made on the same basis as investments in Corporate Loans as described herein,
except with respect to collateral requirements. To a limited extent, incidental
to and in connection with its lending activities, the Fund also may acquire
warrants and other debt and equity securities.
The Fund has no restrictions on portfolio maturity, but it is anticipated
that a majority of the Corporate Loans in which it will invest will have stated
maturities ranging from three to ten years. As a result of prepayments, however,
it is expected that the average life of the Corporate Loans will be in the two
to three year range. See "Description of Corporate Loans."
Investment in shares of common stock of the Fund offers several benefits.
The Fund offers investors the opportunity to receive a high level of current
income by investing in a professionally managed portfolio comprised primarily of
Corporate Loans, a type of investment typically not available to individual
investors. In managing such portfolio, the Investment Adviser provides the Fund
and its shareholders with professional
9
<PAGE> 10
credit analysis and portfolio diversification. The Fund also relieves the
investor of the burdensome administrative details involved in managing a
portfolio of such investments, if available to individual investors. The
benefits are at least partially offset by the expenses involved in operating an
investment company. Such expenses primarily consist of the investment advisory
and administrative fees and operational costs.
The net asset value of the shares of common stock of an investment company
that invests primarily in fixed-income securities changes as the general levels
of interest rates fluctuate. When interest rates decline, the value of a
fixed-income portfolio can be expected to rise. Conversely, when interest rates
rise, the value of a fixed-income portfolio can be expected to decline. The
Investment Adviser expects the Fund's net asset value to be relatively stable
during normal market conditions, because the Fund's portfolio will consist
primarily of floating and variable rate Corporate Loans, of fixed-rate Corporate
Loans hedged by interest rate swap transactions and of short-term instruments.
For these reasons, the Investment Adviser expects the value of the Fund's
portfolio to fluctuate significantly less as a result of interest rate changes
than would a portfolio of fixed-rate obligations. However, because variable
interest rates only reset periodically, the Fund's net asset value may fluctuate
from time to time in the event of an imperfect correlation between either the
interest rates on variable rate loans in the Fund's portfolio or the variable
interest rates on notional amounts in the Fund's interest rate swap
transactions, and prevailing interest rates. Also, a default on a Corporate Loan
in which the Fund has invested or a sudden and extreme increase in prevailing
interest rates may cause a decline in the Fund's net asset value. Conversely, a
sudden and extreme decline in interest rates could result in an increase in the
Fund's net asset value. Furthermore, volatility in the capital markets may
affect the Fund's net asset value given that the Fund uses market prices to
value many of its corporate loan investments.
The Fund is classified as non-diversified within the meaning of the 1940
Act, which means that the Fund is not limited by such Act in the proportion of
its assets that it may invest in securities of a single issuer. However, the
Fund's investments will be limited so as to qualify the Fund as a "regulated
investment company" for purposes of the Federal tax laws. See "Taxes." To
qualify, among other requirements, the Fund will limit its investments so that,
at the close of each quarter of the taxable year, (i) not more than 25% of the
market value of the Fund's total assets will be invested in the securities
(other than U.S. Government securities) of a single issuer and (ii) with respect
to 50% of the market value of its total assets, not more than 5% of the market
value of its total assets will be invested in the securities (other than U.S.
Government securities) of a single issuer. A fund that elects to be classified
as "diversified" under the 1940 Act must satisfy the foregoing 5% requirement
with respect to 75% of its total assets. To the extent that the Fund assumes
large positions in the securities of a small number of issuers, the Fund's net
asset value may fluctuate to a greater extent than that of a diversified company
as a result of changes in the financial condition or in the market's assessment
of the issuers.
DESCRIPTION OF CORPORATE LOANS
The Corporate Loans in which the Fund invests primarily consist of direct
obligations of a borrower undertaken to finance the growth of the borrower's
business, internally or externally, or to finance a capital restructuring.
Corporate Loans may also include debtor in possession financings pursuant to
Chapter 11 of the U.S. Bankruptcy Code and obligations of a borrower issued in
connection with a restructuring pursuant to Chapter 11 of the U.S. Bankruptcy
Code. A significant portion of such Corporate Loans are highly leveraged loans
such as leveraged buy-out loans, leveraged recapitalization loans and other
types of acquisition loans. Such Corporate Loans may be structured to include
both term loans, which are generally fully funded at the time of the Fund's
investment, and revolving credit facilities, which would require the Fund to
make additional investments in the Corporate Loans as required under the terms
of the credit facility. Such Corporate Loans may also include receivables
purchase facilities, which are similar to revolving credit facilities secured by
a borrower's receivables. Corporate Loans generally are issued in the form of
senior syndicated loans, but the
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Fund also may invest from time to time in privately placed notes with credit and
pricing terms which are, in the opinion of the Investment Adviser, consistent
with investments in senior collateralized loan obligations. The Fund may invest
without limitation in highly leveraged Corporate Loans that are rated below
investment grade or are unrated. See "Risk Factors and Special Considerations."
The Fund may invest in Corporate Loans that are made to non-U.S. borrowers,
provided that the loans are U.S. dollar-denominated or otherwise provide for
payment in U.S. dollars, and any such borrower meets the credit standards
established by the Investment Adviser for U.S. borrowers. The Fund similarly may
invest in Corporate Loans made to U.S. borrowers with significant non-dollar
denominated revenues, provided that the loans are U.S. dollar-denominated or
otherwise provide for payment to the Fund in U.S. dollars. In all cases where
the Corporate Loans are not denominated in U.S. dollars, the Corporate Loan
facility will provide for payments to the lenders, including the Fund, in U.S.
dollars pursuant to foreign currency swap arrangements. Loans to such non-U.S.
borrowers or U.S. borrowers may involve risks not typically involved in domestic
investment, including fluctuation in foreign exchange rates, future foreign
political and economic developments, and the possible imposition of exchange
controls or other foreign or U.S. governmental laws or restrictions applicable
to such loans. With respect to certain foreign countries, there is the
possibility of expropriation or confiscatory taxation, political or social
instability, or diplomatic developments which could affect the Fund's
investments in those countries. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payment position. In addition, information with
respect to non-U.S. borrowers may differ from that available with respect to
U.S. borrowers, since foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards, practices and
requirements comparable to those applicable to U.S. borrowers.
The Corporate Loans in which the Fund invests, in many instances, hold the
most senior position in the capitalization structure of the borrower, and, in
any case, in the judgment of the Investment Adviser, are in the category of
senior debt of the borrower. Each Corporate Loan is secured by collateral that
the Investment Adviser believes to have a market value, at the time of the
Fund's investment in the Corporate Loan, which equals or exceeds the principal
amount of the Corporate Loan. The value of such collateral generally is
determined by an independent appraisal or by obtaining the market value of such
collateral (e.g., cash or securities) if it is readily ascertainable. In the
event of a default, however, the ability of the lender to have access to the
collateral may be limited by bankruptcy and other insolvency laws. The value of
the collateral may decline below the amount of the Corporate Loan subsequent to
the Fund's investment in the loan. Under certain circumstances, the collateral
is released with the consent of the Agent Bank and Co-Lenders or pursuant to the
terms of the underlying credit agreement with the borrower. There is no
assurance that the liquidation of the collateral will satisfy the borrower's
obligation in the event of nonpayment of scheduled interest or principal, or
that the collateral could be readily liquidated. As a result, the Fund might not
receive payments to which it is entitled and thereby may experience a decline in
the value of the investment and, possibly, its net asset value.
In the case of highly leveraged loans, a borrower generally is required to
pledge collateral that may include (i) working capital assets, such as accounts
receivable and inventory, (ii) tangible fixed assets, such as real property,
buildings and equipment, (iii) intangible assets, such as trademarks, copyrights
and patent rights and (iv) security interests in securities of subsidiaries or
affiliates. In the case of Corporate Loans to privately held companies, the
companies' owners may provide additional credit support in the form of
guarantees and/or pledges of other securities that they own. There may be
temporary periods in the course of financing a borrower's tender offer where the
collateral for the loan consists of common stock having a value not less than
200% of the value of the loan on the date the loan is made. Under such
circumstances, the borrower generally proceeds with a subsequent transaction
that will permit it to pledge assets of a company as
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collateral for the loan, although there can be no assurance that the borrower
will be able to effect such transaction.
In the case of project finance loans, the borrower is generally a special
purpose entity that pledges undeveloped land and other non-income producing
assets as collateral and obtains construction completion guaranties from third
parties, such as the project sponsor. Project finance credit facilities
typically provide for payment of interest from escrowed funds during a scheduled
construction period, and for the pledge of current and fixed assets after the
project is constructed and becomes operational. During the construction period,
however, the lenders bear the risk that the project will not be constructed in a
timely manner, or will exhaust project funds prior to completion. In such an
event, the lenders may need to take legal action to enforce the completion
guaranties, or may need to lend more money to the project on less favorable
financing terms, or may need to liquidate the undeveloped project assets. There
can be no assurance in any of such cases that the lenders will recover all of
their invested capital.
The rate of interest payable on floating or variable rate Corporate Loans
is established as the sum of a base lending rate plus a specified margin. These
base lending rates generally are the Prime Rate of a designated U.S. bank,
LIBOR, the CD rate or another base lending rate used by commercial lenders. The
interest rate on Prime Rate-based Corporate Loans floats daily as the Prime Rate
changes, while the interest rate on LIBOR-based and CD-based Corporate Loans is
reset periodically, typically every 30 days to one year. Certain of the floating
or variable rate Corporate Loans in which the Fund invests permit the borrower
to select an interest rate reset period of up to one year. A portion of the
Fund's portfolio may be invested in Corporate Loans with interest rates that are
fixed for the term of the loan. Investment in Corporate Loans with longer
interest rate reset periods or fixed interest rates may increase fluctuations in
the Fund's net asset value as a result of changes in interest rates. However,
the Fund attempts to hedge all of its fixed rate Corporate Loans against
fluctuations in interest rates by entering into interest rate swap transactions.
The Fund also attempts to maintain a portfolio of Corporate Loans that have a
dollar weighted average period to the next interest rate adjustment of no more
than 90 days.
The Fund may receive and/or pay certain fees in connection with its lending
activities. These fees are in addition to interest payments received and may
include facility fees, commitment fees, amendment fees, commissions and
prepayment fees. When the Fund buys a Corporate Loan it may receive a facility
fee, and when it sells a Corporate Loan may pay a facility fee. In certain
circumstances, the Fund may receive a prepayment fee on the prepayment of a
Corporate Loan by a borrower. In connection with the acquisition of Corporate
Loans, the Fund also may acquire warrants and other debt and equity securities
of the borrower or its affiliates. The acquisition of such debt and equity
securities will only be incidental to the Fund's purchase of an interest in a
Corporate Loan.
The Fund invests in a Corporate Loan only if, in the Investment Adviser's
judgment, the borrower can meet debt service on such loan. In addition, the
Investment Adviser will consider other factors deemed by it to be appropriate to
the analysis of the borrower and the Corporate Loan. Such factors include
financial ratios of the borrower such as pre-tax interest coverage, leverage
ratios, the ratio of cash flows to total debt and the ratio of tangible assets
to debt. In its analysis of these factors, the Investment Adviser also will be
influenced by the nature of the industry in which the borrower is engaged, the
nature of the borrower's assets and the Investment Adviser's assessments of the
general quality of the borrower.
The primary consideration in selecting such Corporate Loans for investment
by the Fund is the creditworthiness of the borrower. The Investment Adviser
performs its own independent credit analysis of the borrower in addition to
utilizing information prepared and supplied by the Agent Bank, Co-Lender or
Participant (each defined below) from whom the Fund purchases its Participation
Interest in a Corporate Loan. The Investment Adviser's analysis continues on an
ongoing basis for any Corporate Loans in which the
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Fund has invested. Although the Investment Adviser uses due care in making such
analysis, there can be no assurance that such analysis will disclose factors
that may impair the value of the Corporate Loan.
Corporate Loans made in connection with highly leveraged transactions are
subject to greater credit risks than other Corporate Loans in which the Fund may
invest. These credit risks include a greater possibility of default or
bankruptcy of the borrower and the assertion that the pledging of collateral to
secure the loan constituted a fraudulent conveyance or preferential transfer
which can be nullified or subordinated to the rights of other creditors of the
borrower under applicable law.
The Fund does not have a policy with regard to minimum ratings for
Corporate Loans in which it may invest. Investments in Corporate Loans are based
primarily on the Investment Adviser's independent credit analyses of a
particular borrower. Moreover, the Investment Adviser does not regard the
ratings of other publicly held securities of a borrower to be relevant to its
investment considerations. See "Appendix--Ratings of Securities."
A borrower also must comply with various restrictive covenants contained in
any Corporate Loan agreement between the borrower and the lending syndicate.
Such covenants, in addition to requiring the scheduled payment of interest and
principal, may include restrictions on dividend payments and other distributions
to stockholders, provisions requiring the borrower to maintain specific
financial ratios or relationships and limits on total debt. In addition, the
Corporate Loan agreement may contain a covenant requiring the borrower to prepay
the Corporate Loan with any excess cash flow. Excess cash flow generally
includes net cash flow after scheduled debt service payments and permitted
capital expenditures, among other things, as well as the proceeds from asset
dispositions or sales of securities. A breach of a covenant (after giving effect
to any cure period) which is not waived by the Agent Bank and the lending
syndicate normally is an event of acceleration (i.e., the Agent Bank has the
right to call the outstanding Corporate Loan).
It is expected that a majority of the Corporate Loans will have stated
maturities ranging from three to ten years. However, such Corporate Loans
usually require, in addition to scheduled payments of interest and principal,
the prepayment of the Corporate Loan from excess cash flow, as discussed above,
and may permit the borrower to prepay at its election. The degree to which
borrowers prepay Corporate Loans, whether as a contractual requirement or at
their election, may be affected by general business conditions, the financial
condition of the borrower and competitive conditions among lenders, among other
factors. Accordingly, prepayments cannot be predicted with accuracy. Upon a
prepayment, the Fund may receive both a prepayment fee from the prepaying
borrower and a facility fee on the purchase of a new Corporate Loan with the
proceeds from the prepayment of the former. Such fees may mitigate any adverse
impact on the yield on the Fund's portfolio which may arise as a result of
prepayments and the reinvestment of such proceeds in Corporate Loans bearing
lower interest rates.
Loans to non-U.S. borrowers or to U.S. borrowers with significant non-U.S.
dollar-denominated revenues may provide for conversion of all or part of the
loan from a U.S. dollar-denominated obligation into a foreign currency
obligation at the option of the borrower. The Fund may invest in Corporate Loans
that were converted into non-U.S. dollar-denominated obligations only when the
Corporate Loan facility provides for payments to the lenders in U.S. dollars
pursuant to foreign currency swap arrangements. Foreign currency swaps involve
the exchange by the lenders, including the Fund, with another party (the
"counterparty") of the right to receive the currency in which the loan is
denominated for the right to receive U.S. dollars. The Fund will enter into a
transaction subject to a foreign currency swap only if, at the time of entering
into such swap,
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the outstanding debt obligations of the counterparty are investment grade (i.e.,
rated BBB or A-3 or higher by S&P or Baa or P-3 or higher by Moody's, or
determined to be of comparable quality in the judgment of the Investment
Adviser). The amounts of U.S. dollar payments to be received by the lenders and
the foreign currency payments to be received by the counterparty are fixed at
the time the swap arrangement is entered into. Accordingly, the swap protects
the Fund from fluctuations in exchange rates and locks in the right to receive
payments under the loan in a predetermined amount of U.S. dollars. If there is a
default by the counterparty, the Fund will have contractual remedies pursuant to
the swap arrangements; however, the U.S. dollar value of the Fund's right to
foreign currency payments under the loan will be subject to fluctuations in the
applicable exchange rate to the extent that a replacement swap arrangement is
unavailable or the Fund is unable to recover damages from the defaulting
counterparty. If the borrower defaults on or prepays the underlying Corporate
Loan, the Fund may be required pursuant to the swap arrangements to compensate
the counterparty to the extent of fluctuations in exchange rates adverse to the
counterparty. In the event of such a default or prepayment, an amount of cash or
liquid securities having an aggregate net asset value at least equal to the
amount of compensation that must be paid to the counterparty pursuant to the
swap arrangements will be maintained in a segregated account by the Fund's
custodian.
DESCRIPTION OF PARTICIPATION INTERESTS
A Corporate Loan in which the Fund may invest typically is originated,
negotiated and structured by a syndicate of lenders ("Co-Lenders") consisting of
commercial banks, thrift institutions, insurance companies, finance companies or
other financial institutions one or more of which administers the Loan on behalf
of the syndicate (the "Agent Bank"). Co-Lenders may sell Corporate Loans to
third parties called "Participants." The Fund invests in a Corporate Loan either
by participating as a Co-Lender at the time the loan is originated or by buying
an interest in the Corporate Loan from a Co-Lender or a Participant. Co-Lenders
and Participants interposed between the Fund and a borrower, together with Agent
Banks, are referred to herein as "Intermediate Participants."
The Fund may invest in a Corporate Loan at origination as a Co-Lender or by
acquiring participations in, assignments of or novations of a Corporate Loan
(collectively, "Participation Interests"). In a novation, the Fund accepts all
of the rights of the Intermediate Participants in a Corporate Loan, including
the right to receive payments of principal and interest and other amounts
directly from the borrower and to enforce its rights as a lender directly
against the borrower and assumes all of the obligations of the Intermediate
Participants, including any obligations to make future advances to the borrower.
As a result, therefore, the Fund has the status of a Co-Lender. As an
alternative, the Fund may purchase an assignment of all or a portion of an
Intermediate Participant's interest in a Corporate Loan, in which case the Fund
is required generally to rely on the assigning lender to demand payment and
enforce its rights against the borrower but would otherwise be entitled to all
of such lender's rights in the Corporate Loan. The Fund also may purchase a
participation in a portion of the rights of an Intermediate Participant in a
Corporate Loan by means of a participation agreement with such Intermediate
Participant. A participation in the rights of an Intermediate Participant is
similar to an assignment in that the Intermediate Participant transfers to the
Fund all or a portion of an interest in a Corporate Loan. Unlike an assignment,
however, a participation does not establish any direct relationship between the
Fund and the borrower. In such a case, the Fund is required to rely on the
Intermediate Participant that sold the participation not only for the
enforcement of the Fund's rights against the borrower but also for the receipt
and processing of payments due to the Fund under the Corporate Loans. The Fund
will not act as an Agent Bank, guarantor, sole negotiator or sole structuror
with respect to a Corporate Loan.
Because it may be necessary to assert through an Intermediate Participant
such rights as may exist against the borrower, in the event the borrower fails
to pay principal and interest when due, the Fund may be subject to delays,
expenses and risks that are greater than those that would be involved if the
Fund could
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enforce its rights directly against the borrower. Moreover, under the terms of a
participation, the Fund may be regarded as a creditor of the Intermediate
Participant (rather than of the borrower), so that the Fund may also be subject
to the risk that the Intermediate Participant may become insolvent. Similar
risks may arise with respect to the Agent Bank, as described below. Further, in
the event of the bankruptcy or insolvency of the borrower, the obligation of the
borrower to repay the Corporate Loan may be subject to certain defenses that can
be asserted by such borrower as a result of improper conduct by the Agent Bank
or Intermediate Participant. The Fund invests in Corporate Loans only if, at the
time of investment, the outstanding debt obligations of the Agent Bank and
Intermediate Participants are investment grade (i.e., rated BBB or A-3 or higher
by S&P or Baa or P-3 or higher by Moody's, or determined to be of comparable
quality in the judgment of the Investment Adviser).
Because the Fund regards the issuer of a Corporate Loan as including the
borrower under a Corporate Loan Agreement, the Agent Bank and any Intermediate
Participant, the Fund may be deemed to be concentrated in securities of issuers
in the industry group consisting of financial institutions and their holding
companies, including commercial banks, thrift institutions, insurance companies
and finance companies. As a result, the Fund is subject to certain risks
associated with such institutions. Banking and thrift institutions are subject
to extensive governmental regulations which may limit both the amounts and types
of loans and other financial commitments that such institutions may make and the
interest rates and fees that such institutions may charge. The profitability of
these institutions is largely dependent on the availability and cost of capital
funds, and has shown significant recent fluctuation as a result of volatile
interest rate levels. In addition, general economic conditions are important to
the operations of these institutions, with exposure to credit losses resulting
from possible financial difficulties of borrowers potentially having an adverse
effect. Insurance companies also are affected by economic and financial
conditions and are subject to extensive government regulation, including rate
regulation. The property and casualty industry is cyclical, being subject to
dramatic swings in profitability which can be affected by natural catastrophes
and other disasters. Individual companies may be exposed to material risks,
including reserve inadequacy, latent health exposure and inability to collect
from their reinsurance carriers. The financial services area is currently
undergoing relatively rapid change as existing distinctions between financial
service segments become less clear. In this regard, recent business combinations
have included insurance, finance and securities brokerage under single
ownership. Moreover, the Federal laws generally separating commercial and
investment banking are currently being studied by Congress.
In a typical Corporate Loan, the Agent Bank administers the terms of the
Corporate Loan Agreement and is responsible for the collection of principal and
interest and fee payments from the borrower and the apportionment of these
payments to the credit of all lenders which are parties to the Corporate Loan
Agreement. The Fund generally relies on the Agent Bank or an Intermediate
Participant to collect its portion of the payments on the Corporate Loan.
Furthermore, the Fund generally relies on the Agent Bank to use appropriate
creditor remedies against the borrower. Typically, under Corporate Loan
Agreements, the Agent Bank is given broad discretion in enforcing the Corporate
Loan Agreement, and is obligated to use only the same care it would use in the
management of its own property. The borrower compensates the Agent Bank for
these services. Such compensation may include special fees paid on structuring
and funding the Corporate Loan and other fees paid on a continuing basis.
In the event that an Agent Bank becomes insolvent, or has a receiver,
conservator, or similar official appointed for it by the appropriate bank
regulatory authority or becomes a debtor in a bankruptcy proceeding, assets held
by the Agent Bank under the Corporate Loan Agreement should remain available to
holders of Corporate Loans. If, however, assets held by the Agent Bank for the
benefit of the Fund were determined by an appropriate regulatory authority or
court to be subject to the claims of the Agent Bank's general or secured
creditors, the Fund might incur certain costs and delays in realizing payment on
a Corporate Loan or suffer a
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loss of principal and/or interest. In situations involving Intermediate
Participants similar risks may arise, as described above.
The Fund may have certain obligations pursuant to a Corporate Loan
agreement, which may include the obligation to make future advances to the
borrower in connection with revolving credit facilities in certain
circumstances. The Fund currently intends to reserve against such contingent
obligations by segregating sufficient investments in high quality, short-term,
liquid instruments. The Fund will not invest in Corporate Loans that would
require the Fund to make any additional investments in connection with such
future advances if such commitments would exceed 20% of the Fund's total assets
or would cause the Fund to fail to meet the diversification requirements
described under "Investment Objective and Policies."
ILLIQUID SECURITIES
Certain Corporate Loans are, at present, not readily marketable and may be
subject to restrictions on resale. Although the market for Corporate Loans has
developed significantly during recent years, certain of the Corporate Loans in
which the Fund invests do not have the liquidity of conventional debt securities
traded in the secondary market and may be considered illiquid. The Fund has no
limitation on the amount of its investments which are not readily marketable or
are subject to restrictions on resale. Such investments, which may be considered
illiquid, may affect the Fund's ability to realize the net asset value in the
event of a voluntary or involuntary liquidation of its assets. To the extent
that such investments are illiquid, the Fund may have difficulty disposing of
portfolio securities in order to purchase shares of its common stock pursuant to
tender offers, if any. The Board of Directors of the Fund will consider the
liquidity of the Fund's portfolio securities in determining whether a tender
offer should be made by the Fund. See "Net Asset Value" for information with
respect to valuation of illiquid Corporate Loans.
OTHER INVESTMENT POLICIES
The Fund has adopted certain other policies as set forth below:
Borrowing. The Fund is authorized to borrow money in amounts of up to
33 1/3% of the value of its total assets at the time of such borrowings.
Borrowings by the Fund (commonly known as "leveraging") create an opportunity
for greater total return but, at the same time, increase exposure to capital
risk. In addition, borrowed funds are subject to interest costs that may offset
or exceed the return earned on the borrowed funds. See "Borrowings by the Fund."
Repurchase Agreements. The Fund may enter into repurchase agreements with
respect to its permitted investments but currently intends to do so only with
member banks of the Federal Reserve System or with primary dealers in U.S.
Government securities. Under a repurchase agreement the Fund buys a security at
one price and simultaneously promises to sell that same security back to the
seller at a higher price. The Fund's repurchase agreements will provide that the
value of the collateral underlying the repurchase agreement will always be at
least equal to the repurchase price, including any accrued interest earned on
the repurchase agreement, and will be marked to market daily. The repurchase
date usually is within seven days of the original purchase date. Repurchase
agreements are deemed to be loans under the 1940 Act. In all cases, the
Investment Adviser must be satisfied with the creditworthiness of the other
party to the agreement before entering into a repurchase agreement. In the event
of the bankruptcy (or other insolvency proceeding) of the other party to a
repurchase agreement, the Fund might experience delays in recovering its cash.
To the extent that, in the meantime, the value of the securities the Fund
purchases may have declined, the Fund could experience a loss.
Lending of Portfolio Securities. The Fund may from time to time lend
securities from its portfolio with a value not exceeding 33 1/3% of its total
assets to banks, brokers and other financial institutions and receive collateral
in cash or securities issued or guaranteed by the United States Government. Such
collateral will be
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maintained at all times in an amount equal to at least 100% of the current
market value of the loaned securities. This limitation is a fundamental policy,
and it may not be changed without the approval of the holders of a majority of
the Fund's outstanding voting securities, as defined in the 1940 Act. The
purpose of such loans is to permit the borrower to use such securities for
delivery to purchasers when such borrower has sold short. If cash collateral is
received by the Fund, it is invested in short-term money market securities, and
a portion of the yield received in respect of such investment is retained by the
Fund. Alternatively, if securities are delivered to the Fund as collateral, the
Fund and the borrower negotiate a rate for the loan premium to be received by
the Fund for lending its portfolio securities. In either event, the total yield
on the Fund's portfolio is increased by loans of its portfolio securities. The
Fund will have the right to regain record ownership of loaned securities to
exercise beneficial rights such as voting rights, subscription rights and rights
to dividends, interest or other distributions. Such loans are terminable at any
time. The Fund may pay reasonable finder's, administrative and custodial fees in
connection with such loans. In the event that the borrower defaults on its
obligation to return borrowed securities, because of insolvency or otherwise,
the Fund could experience delays and costs in gaining access to the collateral
and could suffer a loss to the extent that the value of the collateral falls
below the market value of the borrowed securities.
"WHEN ISSUED" AND "DELAYED DELIVERY" TRANSACTIONS
The Fund also may purchase and sell interests in Corporate Loans and other
portfolio securities on a "when issued" and "delayed delivery" basis. No income
accrues to the Fund on such interests or securities in connection with such
transactions prior to the date the Fund actually takes delivery of such
interests or securities. These transactions are subject to market fluctuation;
the value of the interests in Corporate Loans and other portfolio debt
securities at delivery may be more or less than their purchase price, and yields
generally available on such interests or securities when delivery occurs may be
higher than yields on the interests or securities obtained pursuant to such
transactions. Because the Fund relies on the buyer or seller, as the case may
be, to consummate the transaction, failure by the other party to complete the
transaction may result in the Fund missing the opportunity of obtaining a price
or yield considered to be advantageous. When the Fund is the buyer in such a
transaction, however, it will maintain, in a segregated account with its
custodian, cash or liquid securities having an aggregate value equal to the
amount of such purchase commitments until payment is made. The Fund will make
commitments to purchase such interest or securities on such basis only with the
intention of actually acquiring these interests or securities, but the Fund may
sell such interests or securities prior to the settlement date if such sale is
considered to be advisable. To the extent the Fund engages in "when issued" and
"delayed delivery" transactions, it will do so for the purpose of acquiring
interests or securities for the Fund's portfolio consistent with the Fund's
investment objective and policies and not for the purpose of investment
leverage. No specific limitation exists as to the percentage of the Fund's
assets which may be used to acquire securities on a "when issued" or "delayed
delivery" basis.
INTEREST RATE HEDGING TRANSACTIONS
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates by entering into interest rate hedging
transactions. While the Fund's use of hedging strategies is intended to further
the Fund's investment objective, there can be no assurance that the Fund's
interest rate hedging transactions will be effective.
Certain Federal income tax requirements may limit the Fund's ability to
engage in interest rate hedging transactions. Gains from transactions in
interest rate hedges distributed to shareholders are taxable as ordinary income
or, in certain circumstances, as long-term capital gains to shareholders. See
"Taxes."
The Fund expects to enter into interest rate hedging transactions primarily
to preserve a return or spread on a particular investment or portion of its
portfolio or to protect against any increase in the price of securities the Fund
anticipates purchasing at a later date. The Fund also attempts to enter into
interest rate hedging
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transactions to hedge all of its fixed rate Corporate Loans against fluctuations
in interest rates. The Fund may enter into interest rate hedges on either an
asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities. Typically, the parties with which the Fund enters
into interest rate hedging transactions are broker-dealers and other financial
institutions.
The interest rate hedging transactions in which the Fund may engage include
interest rate swaps involving the exchange by the Fund with another party of
their respective commitments to pay or receive interest, such as an exchange of
fixed rate payments for floating rate payments. For example, if the Fund holds a
Corporate Loan with an interest rate that is reset only once each year, it may
swap the right to receive interest at this fixed rate for the right to receive
interest at a rate that is reset every week. This enables the Fund to offset a
decline in the value of the Corporate Loan due to rising interest rates, but
would also limit its ability to benefit from falling interest rates. Conversely,
if the Fund holds a Corporate Loan with an interest rate that is reset every
week and it would like to lock in what it believes to be a high interest rate
for one year, it may swap the right to receive interest at this variable weekly
rate for the right to receive interest at a rate that is fixed for one year.
Such a swap would protect the Fund from a reduction in yield due to falling
interest rates, but would preclude it from taking full advantage of rising
interest rates.
The Fund also may engage in interest rate hedging transactions in the form
of purchasing or selling interest rate caps or floors. The Fund will not sell
interest rate caps or floors that it does not own. The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest equal to the
difference of the index and the predetermined rate on a notional principal
amount (the reference amount with respect to which interest obligations are
determined although no actual exchange of principal occurs) from the party
selling such interest rate cap. The purchase of an interest rate floor entitles
the purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest at the difference of the index
and the predetermined rate on a notional principal amount from the party selling
such interest rate floor. The Fund will not enter into caps or floors if, on a
net basis, the aggregate notional principal amount with respect to such
agreements exceeds the net assets of the Fund.
Inasmuch as these interest rate hedging transactions are entered into for
good faith hedging purposes, the Investment Adviser believes that such
obligations do not constitute senior securities and, accordingly, will not treat
them as being subject to its borrowing restrictions. The Fund usually enters
into interest rate swaps on a net basis, i.e., the two payment streams are
netted out, with the Fund receiving or paying, as the case may be, only the net
amount of the two payments. The net amount of the excess, if any, of the Fund's
obligations over its entitlements with respect to each interest rate swap will
be accrued on a daily basis, and an amount of cash or high grade liquid debt
securities having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian. If
the interest rate swap transaction is entered into on other than a net basis,
the full amount of the Fund's obligations will be accrued on a daily basis, and
the full amount of the Fund's obligations will be maintained in a segregated
account by the Fund's custodian. The Fund will not enter into any interest rate
hedging transaction unless the Investment Adviser considers the credit quality
of the unsecured senior debt or the claims-paying ability of the other party
thereto to be investment grade. If there is a default by the other party to such
a transaction, the Fund will have contractual remedies pursuant to the
agreements related to the transaction but such remedies may be subject to
bankruptcy and insolvency laws which could affect the Fund's rights as a
creditor. The swap market has grown substantially in recent years with a large
number of banks and investment banking firms acting both as principals and as
agents utilizing standardized swap documentation. As a result, the swap market
has become relatively liquid in comparison with other similar instruments traded
in the interbank market. Interest rate caps and floors are more recent
innovations and they are less liquid than swaps. There can be no assurance,
however, that the Fund will be able to enter into interest rate swaps or to
purchase interest rate caps or floors at prices or on terms the Investment
Adviser believes are advantageous to the Fund. In addition, although the
18
<PAGE> 19
terms of interest rate swaps, caps and floors may provide for termination, there
can be no assurance the Fund will be able to terminate an interest rate swap or
to sell or offset interest rate caps or floors that it has purchased.
The use of interest rate hedges is a highly specialized activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If the Investment Adviser is
incorrect in its forecasts of market values, interest rates and other applicable
factors, the investment performance of the Fund would diminish compared with
what it would have been if these investment techniques were not used.
There is no limit on the amount of interest rate hedging transactions that
may be entered into by the Fund. These transactions do not involve the delivery
of securities or other underlying assets or principal. Accordingly, the risk of
loss with respect to interest rate hedges is limited to the net amount of
interest payments that the Fund is contractually obligated to make. If the
Corporate Loan underlying an interest rate swap is prepaid and the Fund
continues to be obligated to make payments to the other party to the swap, the
Fund would have to make such payments from another source. If the other party to
an interest rate swap defaults, the Fund's risk of loss consists of the net
amount of interest payments that the Fund contractually is entitled to receive.
Since interest rate transactions are individually negotiated, the Investment
Adviser expects to achieve an acceptable degree of correlation between the
Fund's rights to receive interest on Participation Interests and its rights and
obligations to receive and pay interest pursuant to interest rate swaps.
BORROWINGS BY THE FUND
The Fund may borrow money representing up to approximately 33 1/3%, or
issue shares of preferred stock representing up to approximately 50%, of the
Fund's total assets immediately after such borrowing or issuance. There can be
no assurance, however, that money will actually be borrowed or that preferred
stock representing such percentage of the Fund's capital will actually be
issued. Borrowings by the Fund or the issuance of the preferred stock will
result in leveraging of the common stock. The Fund at times may borrow from
affiliates of the Investment Adviser, provided that the terms of such borrowings
are no less favorable than those available from comparable sources of funds in
the marketplace.
BORROWINGS TO FINANCE TENDER OFFERS
The Fund may borrow money to finance the purchase of shares of its common
stock pursuant to tender offers. On June 22, 1998, the Fund entered into an
agreement with The Bank of New York ("BONY") providing for an unsecured 364-day
revolving credit facility (the "Facility"). The proceeds of the Facility may be
used to finance the purchase of shares tendered in a tender offer by the Fund
and to pay fees and expenses incurred in connection with the Facility. The
Facility enables the Fund to borrow up to $100,000,000 at an interest rate equal
to, at the Fund's option, the sum of the Federal funds rate (i.e., the rate at
which BONY is offered overnight Federal funds by a Federal funds broker selected
by BONY) plus the Applicable Margin (defined below) or the sum of the Eurodollar
rate (based on the rates quoted by BONY to leading banks in the London interbank
eurodollar market as the rate at which BONY is offering dollar deposits) plus
the Applicable Margin (defined below). The Applicable Margin means, as to each
loan, (i) 0.25% during the first 30 days that such loan is outstanding, (ii)
0.30% during the next 30 days that such loan is outstanding and (iii) 0.40%
during the next 30 days that such loan is outstanding. Interest on borrowings is
computed on the basis of a year of 360 days for the actual number of days
elapsed and is payable in arrears on the last day of each month in the case of
borrowings that bear interest at the Federal funds rate, and at the end of the
interest period selected by the Fund in the case of borrowings that bear
interest at the Eurodollar rate. Each loan must be repaid at the earlier of (i)
90 days from the borrowing date of such loan and (ii) one business day prior to
19
<PAGE> 20
the date on which the Fund's next tender offer expires. Borrowings under the
Facility, if any, may be repaid with the proceeds of portfolio investments sold
by the Fund subsequent to the expiration date of a tender offer.
The terms of the Facility may be modified by written agreement of the
parties thereto. The Facility requires the Fund to maintain a Borrowing Base
(defined as the sum of the value of all securities held by the Fund (less
liabilities) plus the debt outstanding under the Facility, less non-performing
assets) of not less than 300% of the outstanding principal balance of borrowings
under the Facility and accrued interest. During the term of the Facility, the
Fund may not incur indebtedness except for indebtedness incurred under the
Facility, in hedging transactions, for purchases of securities on short-term
credit as may be necessary for the clearance of sales or purchases of portfolio
securities and for overdrafts extended by the custodian. Additionally, during
the term of the Facility, the Fund is restricted with respect to the declaration
or payment of dividends and the repurchase of shares pursuant to tender offers.
Pursuant to such agreement, as long as certain defaults have not occurred and
are not continuing under the Facility, the Fund may (i) make its periodic
dividend payments to shareholders in an amount not in excess of its net
investment income (and net realized capital gains not previously distributed to
shareholders) for such period, (ii) distribute each year all of its net
investment income (including net realized capital gains) so that it will not be
subject to tax under the Federal tax laws and (iii) repurchase its shares
pursuant to tender offers.
OTHER BORROWINGS
The Fund also may incur borrowings and/or issue preferred shares for the
purpose of acquiring additional income-producing investments when the Investment
Adviser believes that the interest or dividend payments and other costs with
respect to such borrowings and/or preferred shares will be exceeded by the
anticipated return on such investments. The amount of any such borrowing or
issuance will depend on market or economic conditions existing at that time.
Although the Fund is authorized to borrow money to finance the purchase of
investments, it has not and does not currently anticipate doing so.
Capital raised through leverage will be subject to interest costs or
dividend payments which may or may not exceed the interest on the assets
purchased. The Fund also may be required to maintain minimum average balances in
connection with borrowings or to pay a commitment or other fee to maintain a
line of credit; either of these requirements will increase the cost of borrowing
over the stated interest rate. The issuance of additional classes of preferred
shares involves offering expenses and other costs and may limit the Fund's
freedom to pay dividends on shares of common stock or to engage in other
activities. Borrowings and the issuance of a class of preferred stock having
priority over the Fund's common stock create an opportunity for greater income
per share of common stock, but at the same time such borrowing or issuance is a
speculative technique in that it will increase the Fund's exposure to capital
risk. Such risks may be reduced through the use of borrowings and preferred
stock that have floating rates of interest. Unless the income and appreciation,
if any, on assets acquired with borrowed funds or offering proceeds exceeds the
cost of borrowing or issuing additional classes of securities, the use of
leverage will diminish the investment performance of the Fund compared with what
it would have been without leverage.
The Fund's willingness to borrow money and issue new securities for
investment purposes, and the amount it will borrow, will depend on many factors,
the most important of which are investment outlook, market conditions and
interest rates. Successful use of a leveraging strategy depends on the
Investment Adviser's ability to predict correctly interest rates and market
movements, and there is no assurance that a leveraging strategy will be
successful during any period in which it is employed.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and,
prior to issuance of any preferred stock, may not be changed without the
approval of the holders of a majority of the Fund's outstanding shares
20
<PAGE> 21
of common stock (which for this purpose and under the 1940 Act means the lesser
of (i) 67% of the shares of common stock represented at a meeting at which more
than 50% of the outstanding shares of common stock are represented or (ii) more
than 50% of the outstanding shares). Subsequent to the issuance of a class of
preferred stock, the following investment restrictions may not be changed
without the approval of a majority of the outstanding shares of common stock and
of the preferred stock, voting together as a class, and the approval of a
majority of the outstanding shares of preferred stock, voting separately by
class. The Fund may not:
1. Borrow money or issue senior securities, except as permitted by
Section 18 of the 1940 Act.
2. Make investments for the purpose of exercising control or
management.
3. Purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization, or
by purchase in the open market of securities of closed-end investment
companies where no underwriter's or dealer's commission or profit, other
than customary broker's commission, is involved and only if immediately
thereafter not more than 10% of the Fund's total assets would be invested
in such securities.
4. Purchase or sell real estate; provided that the Fund may invest in
securities secured by real estate or interests therein or issued by
companies which invest in real estate or interests therein.
5. Underwriter securities of other issuers except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933 in selling
portfolio securities.
6. Make loans to other persons, except (i) to the extent that the
Fund may be deemed to be making loans by purchasing Corporate Loans, as a
Co-Lender or otherwise, and other debt securities and entering into
repurchase agreements in accordance with its investment objective, policies
and limitations and (ii) the Fund may lend its portfolio securities in an
amount not in excess of 33 1/3% of its total assets, taken at market value,
provided that such loans shall be made in accordance with the guidelines
set forth in this Prospectus.
7. Invest more than 25% of its total assets in the securities of
issuers in any one industry; provided that this limitation shall not apply
with respect to obligations issued or guaranteed by the U.S. Government or
by its agencies or instrumentalities; and provided further that the Fund
may invest more than 25% and may invest up to 100% of its assets in
securities of issuers in the industry group consisting of financial
institutions and their holding companies, including commercial banks,
thrift institutions, insurance companies and finance companies. For
purposes of this restriction, the term "issuer" includes the Borrower, the
Agent Bank and any Intermediate Participant (as defined under "Investment
Objective and Policies -- Description of Participation Interests").
8. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities.
9. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options.
An additional investment restriction adopted by the Fund, which may be
changed by the Board of Directors, provides that the Fund may not mortgage,
pledge, hypothecate or in any manner transfer, as security for indebtedness, any
securities owned or held by the Fund except as may be necessary in connection
with hedging techniques involving interest rate transactions, foreign currency
swap transactions relating to non-U.S. dollar-denominated loans and permitted
borrowings by the Fund.
If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentage resulting from changing values will not be
considered a violation.
21
<PAGE> 22
Because of the affiliation of Merrill Lynch with the Investment Adviser,
the Fund is prohibited from engaging in certain transactions involving Merrill
Lynch except pursuant to an exemptive order or otherwise in compliance with the
provisions of the 1940 Act and the rules and regulations thereunder. Included
among such restricted transactions will be purchases from or sales to Merrill
Lynch of securities in transactions in which it acts as principal. See
"Portfolio Transactions."
The Fund has established procedures for blocking the use of inside
information in securities transactions (commonly referred to as "Chinese Wall
procedures"). As a result, in relation to other funds managed by the same
portfolio manager as the Fund, if one fund buys a security that is publicly
traded or privately placed, respectively, the other fund may be deprived of the
opportunity to buy a security of the same issuer that is privately placed or
publicly traded, respectively.
PURCHASE OF SHARES
The Distributor, an affiliate of the Investment Adviser, acts as the
distributor of shares of common stock of the Fund. The Fund is engaged in a
continuous offering of its shares of common stock through the Distributor and
other securities dealers that have entered into selected dealer agreements with
the Distributor, including Merrill Lynch. The Fund may, from time to time,
suspend the sale of its shares of common stock. During any continuous offering
of the Fund's common stock, shares of the Fund may be purchased from the
Distributor or selected dealers, including Merrill Lynch, or by mailing a
purchase order directly to the Fund's Transfer Agent. Minimum initial purchase
requirements are:
<TABLE>
<CAPTION>
THE THE
MINIMUM MINIMUM
INITIAL SUBSEQUENT
PURCHASE PURCHASE
FOR INVESTMENTS IN THE FUND MADE AMOUNT IS AMOUNT IS
-------------------------------- ----------- -----------
<S> <C> <C>
Directly through the Fund's Distributor or Transfer
Agent................................................... $1,000 $50
Via 401(k) or 403(b) plans maintained through Merrill
Lynch................................................... None None
Via other individual retirement accounts or other
retirement plans that are not maintained through Merrill
Lynch................................................... $ 250 $ 1
</TABLE>
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share without a front-end sales charge. The
applicable offering price for purchase orders is based on the net asset value of
the Fund next determined after receipt of the purchase order by the Distributor.
As to purchase orders received by securities dealers prior to the close of
business on the New York Stock Exchange (generally, the NYSE closes at 4:00
p.m., Eastern time), which includes orders received after the close of business
on the previous day, the applicable offering price is based on the net asset
value determined as of 15 minutes after the close of business on the NYSE on
that day, provided the Distributor in turn receives the order from the
securities dealer prior to 30 minutes after the close of business on the NYSE on
that day. If the purchase orders are not received by the Distributor prior to 30
minutes after the close of business on the NYSE on that day, such orders are
deemed received on the next business day. Any order may be rejected by the
Distributor or the Fund. The Fund or the Distributor may suspend the continuous
offering of the Fund's shares at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Neither the Distributor nor the dealers are permitted to withhold
placing orders to benefit themselves by a price change. The Distributor is
required to advise the Fund promptly of all purchase orders and cause payments
for shares of common stock to be delivered promptly to the Fund. Merrill Lynch
charges its customers a processing fee (presently $5.35) to confirm a purchase
of shares by such customers. Purchases made directly through the Fund's Transfer
Agent are not subject to the processing fee.
Due to the administrative complexities associated with a continuous
offering, administrative errors may result in the Distributor or an affiliate
inadvertently acquiring nominal numbers (in no event in excess of 5% of
22
<PAGE> 23
the shares of common stock) of shares of common stock that it may wish to
resell. Such shares of common stock will not be subject to any investment
restriction and may be resold pursuant to this Prospectus.
The Distributor compensates Merrill Lynch or other selected dealers at a
rate of 3.0% of amounts purchased. In addition, the Distributor compensates
Merrill Lynch or such dealers quarterly at an annual rate equal to 0.25% of the
value of Fund shares that remain outstanding after one year from the date of
their original purchase sold by Merrill Lynch or such dealers. The foregoing
payments made by the Distributor will be made from its own assets and will not
be an expense borne by the Fund. Total compensation paid to Merrill Lynch,
selected dealers and the Distributor, including the compensation paid at the
time of purchase, the quarterly payments mentioned above and the early
withdrawal charge, if any, will not exceed the applicable limit (presently, 8%),
as determined from time to time by the National Association of Securities
Dealers, Inc. For the fiscal years ended August 31, 1996, 1997 and 1998 the
Distributor paid $29,197,327, $12,542,788 and $25,888,426 respectively, to
Merrill Lynch in connection with the sale of shares of common stock of the Fund.
Upon the transfer of shares out of a Merrill Lynch brokerage account, an
investment account in the transferring shareholder's name may be opened at the
Transfer Agent. Shareholders should be aware that it will not be possible to
transfer their shares from Merrill Lynch to another brokerage firm or financial
institution. Shareholders interested in transferring their brokerage accounts
from Merrill Lynch and who do not wish to have an account maintained for such
shares at the Fund's transfer agent must tender the shares for repurchase by the
Fund as described under "Tender Offers" so that the cash proceeds can be
transferred to the account at the new firm.
TENDER OFFERS
In recognition of the possibility that a secondary market for the Fund's
shares will not exist, the Fund takes certain actions that provide liquidity to
shareholders. Since the Fund's inception, it has made tender offers to purchase
its shares of common stock from all beneficial holders at a price per share
equal to the net asset value per share determined at the close of business on
the day an offer terminates. Commencing with the second quarter of Fund
operations, the Board of Directors has considered making tender offers on a
quarterly basis, and the Board of Directors intends to continue this practice.
There can be no assurance, however, that the Board of Directors will undertake
the making of any tender offer. Subject to the Fund's investment restriction
with respect to borrowings, the Fund may borrow money to finance the repurchase
of shares pursuant to any tender offers. See "Borrowings by the Fund" and
"Investment Restrictions."
The Fund expects that ordinarily there will be no secondary market for the
Fund's common stock and that periodic tenders will be the only source of
liquidity for Fund shareholders. Nevertheless, if a secondary market develops
for the common stock of the Fund, the market price of the shares may vary from
net asset value from time to time. Such variance may be affected by, among other
factors, relative demand and supply of shares and the performance of the Fund,
especially as it affects the yield on and net asset value of the common stock of
the Fund. A tender offer for shares of common stock of the Fund at net asset
value is expected to reduce any spread between net asset value and market price
that may otherwise develop. However, there can be no assurance that such action
would result in the Fund's common stock trading at a price which equals or
approximates net asset value.
Although the Board of Directors believes that the tender offers generally
are beneficial to shareholders, the acquisition of shares of common stock by the
Fund will decrease the total assets of the Fund. Tender offers are therefore
likely to increase the Fund's expense ratio (assuming such acquisition is not
offset by the issuance of additional shares of common stock). Furthermore, to
the extent the Fund borrows to finance the making of tender offers, interest on
such borrowings reduce the Fund's net investment income.
23
<PAGE> 24
It is the Board's announced policy, which may be changed by the Board, not
to purchase shares pursuant to a tender offer if (1) such purchases would impair
the Fund's status as a regulated investment company under the Federal tax laws
(which would make the Fund a taxable entity, causing the Fund's income to be
taxed at the corporate level in addition to the taxation of shareholders who
receive dividends from the Fund); (2) the Fund would not be able to liquidate
portfolio securities in a manner which is orderly and consistent with the Fund's
investment objective and policies in order to purchase common stock tendered
pursuant to the tender offer; or (3) there is, in the Board's judgment, any (a)
legal action or proceeding instituted or threatened challenging the tender offer
or otherwise materially adversely affecting the Fund, (b) declaration of a
banking moratorium by Federal or state authorities or any suspension of payment
by banks in the United States or New York State, which is material to the Fund,
(c) limitation imposed by Federal or state authorities on the extension of
credit by lending institutions, (d) commencement of war, armed hostilities or
other international or national calamity directly or indirectly involving the
United States which is material to the Fund, or (e) other event or condition
which would have a material adverse effect on the Fund or its shareholders if
shares of common stock tendered pursuant to the tender offer were purchased.
Thus, there can be no assurance that the Board will proceed with any tender
offer. The Board of Directors may modify these conditions in light of
circumstances existing at the time. If the Board of Directors determines to
purchase the Fund's shares of common stock pursuant to a tender offer, such
purchases could reduce significantly the asset coverage of any borrowing or
outstanding senior securities. The Fund may not purchase shares of common stock
to the extent such purchases would result in the asset coverage with respect to
such borrowing or senior securities being reduced below the asset coverage
requirement set forth in the 1940 Act. Accordingly, in order to purchase all
shares of common stock tendered, the Fund may have to repay all or part of any
then outstanding borrowing or redeem all or part of any then outstanding senior
securities to maintain the required asset coverage. See "Borrowings by the
Fund." In addition, the amount of shares of common stock for which the Fund
makes any particular tender offer may be limited for the reasons set forth above
or in respect of other concerns related to liquidity of the Fund's portfolio.
In the event that circumstances arise under which the Fund does not conduct
the tender offers regularly, the Board of Directors will consider alternative
means of providing liquidity for holders of common stock. Such action would
include evaluating any secondary market that then exists and determining whether
such market provides liquidity for shareholders. If the Board of Directors
determines that such market, if any, fails to provide liquidity for the holders
of common stock, the Board plans to consider alternatives to providing such
liquidity. Among the alternatives that the Board of Directors may consider is
the listing of the Fund's common shares on a major domestic stock exchange or on
the Nasdaq National Market. The Board of Directors also may consider causing the
Fund to repurchase its shares from time to time in open-market or private
transactions when it can do so on terms that represent a favorable investment
opportunity. In any event, the Board of Directors cause the Fund to take
whatever action it deems necessary or appropriate to provide liquidity for the
shareholders in light of the facts and circumstances existing at such time.
Consummating a tender offer may require the Fund to liquidate portfolio
securities, and realize gains or losses, at a time when the Investment Adviser
would otherwise consider it disadvantageous to do so.
Each tender offer is made and shareholders are notified in accordance with
the requirements of the Securities Exchange Act of 1934 and the 1940 Act, either
by publication or mailing or both. The offering documents contain information
prescribed by such laws and the rules and regulations promulgated thereunder.
The repurchase of tendered shares by the Fund is a taxable event. See "Taxes."
The Fund pays all costs and expenses associated with the making of any tender
offer. An early withdrawal charge is imposed on most shares accepted for tender
that have been held for less than three years. See "Early Withdrawal Charge." In
addition, Merrill Lynch charges its customers a processing fee (presently $5.35)
to confirm a repurchase of shares from such customers pursuant to a tender
offer. Tenders made directly through the Fund's Transfer Agent are not subject
to the processing fee.
24
<PAGE> 25
Shareholders have an investment option consisting of the right to reinvest
the net proceeds from a sale of shares (the "Original Shares") in a tender offer
by the Fund in Class A initial sales charge shares of certain Merrill
Lynch-sponsored open-end funds ("Eligible Class A Shares") at their net asset
value, without the imposition of the initial sales charge, if the conditions set
forth below are satisfied. First, net proceeds from the sale of the Original
Shares in the tender offer must be immediately reinvested in Eligible Class A
Shares. Second, the investment option is available only with respect to the
proceeds of shares as to which no early withdrawal charge is applicable. Before
taking advantage of this investment option, shareholders should obtain a
currently effective prospectus of the fund in which they intend to invest and
should consult their Merrill Lynch Financial Consultant.
EARLY WITHDRAWAL CHARGE
An early withdrawal charge to recover distribution expenses incurred by the
Distributor is charged against the shareholder's investment account and paid to
the Distributor in connection with most shares of common stock held for less
than three years which are repurchased pursuant to a tender offer. The early
withdrawal charge is imposed on those shares accepted for tender based on an
amount equal to the lesser of the then current net asset value or the cost of
the shares. Accordingly, the early withdrawal charge is not imposed on increases
in the net asset value above the initial purchase price. In addition, the early
withdrawal charge is not imposed on shares acquired by reinvesting dividends or
capital gains distributions. In determining whether an early withdrawal charge
is payable, it is assumed that the acceptance of an offer to repurchase pursuant
to a tender offer would be made from the earliest purchase of shares of common
stock. The early withdrawal charge imposed, if any, varies depending on the
length of time the common stock has been owned since purchase (separate
purchases shall not be aggregated for these purposes), as set forth in the
following table:
<TABLE>
<CAPTION>
EARLY
YEAR OF REPURCHASE WITHDRAWAL
AFTER PURCHASE CHARGE
------------------ ----------
<S> <C>
First....................................................... 3.0%
Second...................................................... 2.0%
Third....................................................... 1.0%
Fourth and following........................................ 0.0%
</TABLE>
In determining whether an early withdrawal charge is applicable to a tender
of shares of common stock, the calculation is determined in the manner that
results in the lowest possible amount being charged. Therefore, it is assumed
that the shareholder first tenders shares held for over three years and shares
acquired by reinvesting dividends or distributions, followed by shares of common
stock held longest during the three-year period. The Fund waives the early
withdrawal charge on shares tendered following the death of all beneficial
owners of such shares, provided the shares are tendered within one year of death
(a death certificate and other applicable documents may be required). At the
time of tender, the record or succeeding beneficial owner must notify the
Transfer Agent either directly or indirectly through the Distributor that the
early withdrawal charge should be waived. Upon confirmation of the owner's
entitlement, the waiver will be granted; otherwise, the waiver will be lost.
EXAMPLE:
Assume an investor purchased 1,000 shares of common stock (at a cost of
$10,000) and two years after purchase, the net asset value per share is $10.15
and, during the two year period, the investor has acquired 100 additional shares
of common stock upon dividend reinvestment. If the investor first tenders 500
shares at this time (proceeds of $5,075), 100 shares will not be subject to the
early withdrawal charge because they were acquired by dividend reinvestment.
With respect to the remaining 400 shares, the early withdrawal charge is applied
only to the original cost of $10 per share (and not to the increase in net asset
value of $0.15 per share).
25
<PAGE> 26
Therefore, $4,000 of the $5,075 redemption proceeds will be charged at a rate of
2.0% (the applicable rate in the second year after purchase).
For the fiscal years ended August 31, 1996, 1997 and 1998 the amount of
early withdrawal charges paid to the Distributor aggregated $3,171,259,
$4,868,307 and $3,175,705 respectively.
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and portfolio manager
of the Fund, including their ages and their principal occupations for at least
the last five years, is set forth below. Unless otherwise noted, the address of
the portfolio manager and each Director and executive officer is P.O. Box 9011,
Princeton, New Jersey 08536-9011.
ARTHUR ZEIKEL (66) -- President and Director(1)(2) -- Chairman of the
Investment Adviser and its affiliate, Fund Asset Management, L.P. ("FAM") (which
terms as used herein include their corporate predecessors), since 1997;
President of the Investment Adviser and FAM from 1977 to 1997; Chairman of
Princeton Services, Inc. ("Princeton Services") since 1997 and Director thereof
since 1993; President of Princeton Services from 1993 to 1997; Executive Vice
President of Merrill Lynch & Co., Inc. ("ML & Co.") since 1990.
RONALD W. FORBES (58) -- Director(2) -- 1400 Washington Avenue, Albany, New
York 12222. Professor of Finance, School of Business, State University of New
York at Albany since 1989; Consultant, Urban Institute, Washington, D.C. since
1995.
CYNTHIA A. MONTGOMERY (46) -- Director(2) -- Harvard Business School,
Soldiers Field Road, Boston, Massachusetts 02163. Professor, Harvard Business
School since 1989; Associate Professor, J.L. Kellogg Graduate School of
Management, Northwestern University from 1985 to 1989; Assistant Professor,
Graduate School of Business Administration, The University of Michigan from 1979
to 1985; Director, UNUM Corporation since 1990 and Director of Newell Co. since
1995.
CHARLES C. REILLY (67) -- Director(2) -- 9 Hampton Harbor Road, Hampton
Bays, New York 11946. Self-employed financial consultant since 1990; President
and Chief Investment Officer of Verus Capital, Inc. from 1979 to 1990; Senior
Vice President of Arnhold and S. Bleichroeder, Inc. from 1973 to 1990; Adjunct
Professor, Columbia University Graduate School of Business from 1990 to 1991;
Adjunct Professor, Wharton School, The University of Pennsylvania from 1989 to
1990; Partner, Small Cities Cable Television from 1986 to 1997.
KEVIN A. RYAN (66) -- Director(2) -- 127 Commonwealth Avenue, Chestnut
Hill, Massachusetts 02167. Founder and current Director of The Boston University
Center for the Advancement of Ethics and Character; Professor of Education at
Boston University since 1982; formerly taught on the faculties of The University
of Chicago, Stanford University and Ohio State University.
RICHARD R. WEST (60) -- Director(2) -- Box 604, Genoa, NV 89411. Professor
of Finance since 1984, and Dean from 1984 to 1993, and currently Dean Emeritus
of New York University, Leonard N. Stern School of Business Administration;
Director of Bowne & Co., Inc., Vornado Realty Trust, Inc., Vornado Operating
Company and Alexander's Inc.
TERRY K. GLENN (58) -- Executive Vice President(1)(2) -- Executive Vice
President of the Investment Adviser and FAM since 1983; President of Princeton
Funds Distributor, Inc. ("PFD") since 1986 and Director thereof since 1991;
Executive Vice President and Director of Princeton Services since 1993;
President of Princeton Administrators, L.P. since 1988.
JOSEPH T. MONAGLE, JR.(50) -- Senior Vice President(1)(2) -- Senior Vice
President of the Investment Adviser and FAM since 1990; Department Head of the
Global Fixed Income Division of the Investment Adviser and FAM since 1997;
Senior Vice President of Princeton Services since 1993.
R. DOUGLAS HENDERSON (41) -- Senior Vice President and Portfolio
Manager(1)(2) -- First Vice President of the Investment Adviser since 1997; Vice
President of the Investment Adviser from 1989 to 1997.
26
<PAGE> 27
DONALD C. BURKE (38) -- Vice President(1)(2) -- First Vice President of the
Investment Adviser since 1997; Vice President of the Investment Adviser from
1990 to 1997; Director of Taxation of the Investment Adviser since 1990.
GERALD M. RICHARD (49) -- Treasurer(1)(2) -- Senior Vice President and
Treasurer of the Investment Adviser and FAM since 1984; Senior Vice President
and Treasurer of Princeton Services since 1993; Vice President of PFD since 1981
and Treasurer thereof since 1984.
PATRICK D. SWEENEY (44) -- Secretary(1)(2) -- First Vice President of the
Investment Adviser since 1997; Vice President of the Investment Adviser from
1990 to 1997.
At October 1, 1998, the Directors and officers of the Fund as a group (12
persons) owned an aggregate of less than 1% of the outstanding common stock of
the Fund. At such date, Mr. Zeikel, an officer and Director of the Fund, and the
other officers of the Fund, owned less than 1% of the outstanding shares of
common stock of ML & Co.
- ---------------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Director or officer is a director, trustee, officer or member of the
advisory board of certain other investment companies for which the
Investment Adviser or FAM acts as investment adviser.
COMPENSATION OF DIRECTORS
Pursuant to its investment advisory agreement with the Fund (the
"Investment Advisory Agreement"), the Investment Adviser pays all compensation
of officers and employees of the Fund as well as the fees of all Directors of
the Fund who are affiliated persons of ML & Co. or its subsidiaries. The Fund
pays each Director not affiliated with the Investment Adviser (each a
"non-affiliated Director") a fee of $3,000 per year plus $300 per meeting
attended and pays all Directors' actual out-of-pocket expenses relating to
attendance at meetings. The Fund also pays members of the Board's Audit and
Nominating Committee (the "Committee"), which consists of all of the
non-affiliated Directors, an annual fee of $900. The Chairman of the Committee
receives an additional annual fee of $1,000. For the fiscal year ended August
31, 1998, fees and expenses paid to the non-affiliated Directors which were
allocated to the Fund aggregated $36,061.
The following table sets forth the compensation earned by the
non-affiliated Directors from the Fund for the fiscal year ended August 31, 1998
and the aggregate compensation paid to non-affiliated Directors from all
registered investment companies advised by the Investment Adviser and its
affiliate FAM ("MLAM/FAM Advised Funds") for the calendar year ended December
31, 1997.
<TABLE>
<CAPTION>
AGGREGATE
FROM FUND AND
PENSION OR RETIREMENT MLAM/FAM ADVISED
COMPENSATION BENEFITS ACCRUED AS PART FUNDS PAID TO
NAME OF TRUSTEE FROM FUND OF FUND EXPENSE DIRECTORS(1)
- --------------- ------------ ------------------------ ----------------
<S> <C> <C> <C>
Ronald W. Forbes....................... $7,400 None $153,500
Cynthia A. Montgomery.................. $7,400 None $153,500
Charles C. Reilly...................... $8,400 None $313,000
Kevin A. Ryan.......................... $7,400 None $153,000
Richard R. West........................ $7,400 None $299,000
</TABLE>
- ---------------
(1) The Directors serve on the Boards of other MLAM/FAM Advised Funds as
follows: Mr. Forbes (35 registered investment companies consisting of 48
portfolios); Ms. Montgomery (35 registered investment companies consisting
of 48 portfolios); Mr. Reilly (54 registered investment companies consisting
of 67 portfolios); Mr. Ryan (35 registered investment companies consisting
of 48 portfolios); and Mr. West (56 registered investment companies
consisting of 81 portfolios).
27
<PAGE> 28
INVESTMENT ADVISORY
AND ADMINISTRATIVE ARRANGEMENTS
The Investment Adviser, which is owned and controlled by ML & Co., a
financial services holding company and the parent of Merrill Lynch, provides the
Fund with investment advisory and administrative services. The Merrill Lynch
Asset Management Group (which includes the Investment Adviser) acts as the
investment adviser to more than 100 registered investment companies. The
Investment Adviser also offers investment advisory services to individuals and
institutions. As of September 1998, the Asset Management Group had a total of
approximately $467.2 billion in investment company and other portfolio assets
under management. This amount includes assets managed for certain affiliates of
the Investment Adviser. The Investment Adviser is a limited partnership, the
partners of which are ML & Co. and Princeton Services, Inc. The principal
business address of the Investment Adviser is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536.
The Investment Advisory Agreement provides that, subject to the direction
of the Board of Directors of the Fund, the Investment Adviser is responsible for
the actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors.
The Investment Adviser provides the portfolio management for the Fund. Such
portfolio management will consider analyses from various sources, make the
necessary investment decisions, and place orders for transactions accordingly.
The Investment Adviser also will be responsible for the performance of certain
management services for the Fund. The Portfolio Manager for the Fund is R.
Douglas Henderson.
For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund pays a monthly fee at an annual rate of 0.95% of
the Fund's average daily net assets (i.e., the average daily value of the total
assets of the Fund, minus the sum of accrued liabilities of the Fund and
accumulated dividends on the shares of preferred stock, if any). For purposes of
this calculation, average daily net assets is determined at the end of each
month on the basis of the average net assets of the Fund for each day during the
month.
Under the terms of an administration agreement with the Fund (the
"Administration Agreement"), the Investment Adviser also performs or arranges
for the performance of the administrative services (i.e., services other than
investment advice and related portfolio activities) necessary for the operation
of the Fund, including paying all compensation of and furnishing office space
for officers and employees performing investment and economic research, trading
and investment management for the Fund, as well as the compensation of all
Directors of the Fund who are affiliated persons of the Investment Adviser or
any of its affiliates.
For administrative services, the Fund pays the Investment Adviser a monthly
fee at an annual rate of 0.25% of the Fund's average daily net assets determined
in the same manner as the fee payable by the Fund under the Investment Advisory
Agreement. The combined advisory and administration fees are greater than the
advisory fees paid by most funds but are similar in amount to the fees paid by
similar funds making similar investments.
For the fiscal years ended August 31, 1996, 1997 and 1998 the fee paid by
the Fund to the Investment Adviser pursuant to the Investment Advisory Agreement
was $25,872,222, $27,674,808 and $29,695,074 respectively, and the fee paid by
the Fund pursuant to the Administration Agreement was $6,808,480, $7,282,844 and
$7,814,493 respectively (based on average daily net assets of approximately $2.7
billion, $2.9 billion and $3.1 billion respectively).
The Investment Adviser has entered into a sub-advisory agreement with
Merrill Lynch Asset Management U.K. Limited ("MLAM U.K."), an indirect,
wholly-owned subsidiary of ML & Co. and an affiliate of
28
<PAGE> 29
the Investment Adviser, pursuant to which the Investment Adviser pays MLAM U.K.
a fee for providing investment advisory services to the Investment Adviser with
respect to the Fund in an amount to be determined from time to time by the
Investment Adviser and MLAM U.K. but in no event in excess of the amount that
the Investment Adviser actually receives for providing services to the Fund
pursuant to the Investment Advisory Agreement. MLAM U.K. has offices at Milton
Gate, 1 Moor Lane, London EC2Y 9HA, England. For the fiscal year ended August
31, 1998, the Investment Adviser paid no fee to MLAM U.K.
The Fund pays all other expenses incurred in its operations, including,
among other things, legal and auditing expenses, taxes, costs of printing
proxies, stock certificates and shareholder reports, charges of the Custodian
and Transfer Agent, expenses of registering the shares under Federal and state
securities laws, fees and expenses with respect to the issuance of preferred
shares or any borrowing, Securities and Exchange Commission fees, fees and
expenses of non-interested Directors, accounting and pricing costs, insurance,
interest, brokerage costs, litigation and other extraordinary or non-recurring
expenses, mailing and other expenses properly payable by the Fund. Accounting
services are provided to the Fund by the Investment Adviser, and the Fund
reimburses the Investment Adviser for its costs in connection with such
services. For the fiscal years ended August 31, 1996, 1997 and 1998, the
reimbursement for such services aggregated $401,728, $373,370 and $403,737
respectively.
The Investment Adviser is a limited partnership, the partners of which are
ML & Co. and Princeton Services. ML & Co. and Princeton Services are
"controlling persons" of the Investment Adviser as defined under the 1940 Act
because of their ownership of its voting securities and their power to exercise
a controlling influence over its management or policies. Similarly, the
following entities may be considered "controlling persons" of MLAM U.K.: Merrill
Lynch Europe PLC (MLAM U.K.'s parent), a subsidiary of Merrill Lynch
International Holdings, Inc., a subsidiary of Merrill Lynch International, Inc.,
a subsidiary of ML & Co.
Unless earlier terminated as described below, the Investment Advisory and
Administration Agreements remain in effect from year to year if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the 1940 Act)
of any such party. Such contracts are not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party thereto
or by the vote of the shareholders of the Fund.
Securities held by the Fund, including Corporate Loans, may also be held
by, or be appropriate investments for, other funds or investment advisory
clients for which the Investment Adviser or its affiliates act as an adviser.
Because of different objectives or other factors, a particular security may be
bought for an advisory client when other clients are selling the same security.
If purchases or sales of securities by the Investment Adviser for the Fund or
other funds for which it acts as investment adviser or for advisory clients
arise for consideration at or about the same time, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. Transactions effected by the
Investment Adviser (or its affiliate) on behalf of more than one of its clients
during the same period may increase the demand for securities being purchased or
the supply of securities being sold, causing an adverse effect on price.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Investment
Adviser (together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on Fund
investment personnel.
29
<PAGE> 30
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are designed
to identify any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Investment Adviser include a ban on acquiring any securities in a "hot" initial
public offering and a prohibition from profiting on short-term trading in
securities. In addition, no employee may purchase or sell any security which at
the time is being purchased or sold (as the case may be), or to the knowledge of
the employee is being considered for purchase or sale, by any fund advised by
the Investment Adviser. Furthermore, the Codes provide for trading "blackout
periods" which prohibit trading by investment personnel of the Fund within
periods of trading by the Fund in the same (or equivalent) security (15 or 30
days depending upon the transaction).
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such factors
as price (including the applicable fee, commission or spread), size of order,
difficulty of execution and operational facilities of the firm involved and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonably competitive fee or commission rates, the Fund does
not necessarily pay the lowest commission or spread available.
The Fund purchases Corporate Loans in individually negotiated transactions
with commercial banks, thrifts, insurance companies, finance companies and other
financial institutions. In selecting such financial institutions, the Investment
Adviser may consider, among other factors, the financial strength, professional
ability, level of service and research capability of the institution. See
"Investment Objective and Policies -- Description of Participation Interests."
While such financial institutions generally are not required to repurchase
Participation Interests in Corporate Loans which they have sold, they may act as
principal or on an agency basis in connection with the Fund's disposition of
Corporate Loans.
The Fund has no obligation to deal with any bank, broker or dealer in
execution of transactions in portfolio securities. Subject to providing the best
price and execution, securities firms that provide investment research to the
Investment Adviser, including Merrill Lynch, may receive orders for transactions
by the Fund. Research information provided to the Investment Adviser by
securities firms is supplemental. It does not replace or reduce the level of
services performed by the Investment Adviser and the expenses of the Investment
Adviser will not be reduced.
The Fund invests in securities traded primarily in the over-the-counter
markets, and the Fund intends to deal directly with dealers who make markets in
the securities involved, except in those circumstances where better prices and
execution are available elsewhere. Under the 1940 Act, except as permitted by
exemptive order, persons affiliated with the Fund, including Merrill Lynch, are
prohibited from dealing with the Fund as principal in the purchase and sale of
securities. Since transactions in the over-the-counter market usually involve
transactions with dealers acting as principal for their own account, the Fund
does not deal with Merrill Lynch and its affiliates in connection with such
transactions. See "Investment Restrictions." An affiliated person of the Fund
may serve as its broker in over-the-counter transactions conducted on an agency
basis.
PORTFOLIO TURNOVER
The Fund may dispose of securities without regard to the length of time
they have been held when such actions, for defensive or other reasons, appear
advisable to the Investment Adviser. While it is not possible to predict
turnover rates with any certainty, presently it is anticipated that the Fund's
annual portfolio turnover rate, under normal circumstances, should be less than
100%. (The portfolio turnover rate is calculated by
30
<PAGE> 31
dividing the lesser of purchases or sales of portfolio securities for the
particular fiscal year by the monthly average value of the portfolio securities
owned by the Fund during the particular fiscal year. For purposes of determining
this rate, all securities whose maturities at the time of acquisition are one
year or less are excluded.) A high portfolio turnover rate bears certain tax
consequences and results in greater transaction costs, which are borne directly
by the Fund. For the fiscal years ended August 31, 1997 and 1998, the Fund's
portfolio turnover rate was 74.00% and 69.59%, respectively.
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to continue to distribute all its net investment income.
Dividends from such net investment income are declared daily and paid monthly to
holders of common stock. Monthly distributions to holders of common stock
consist of substantially all net investment income remaining after the payment
of interest on any borrowing or dividends or interest on any senior securities
from and after any borrowing or issuance of senior securities. For Federal tax
purposes, the Fund is required to distribute substantially all of its net
investment income for each calendar year. All net realized capital gains, if
any, are distributed at least annually to holders of common stock. Shares of
common stock accrue dividends as long as they are issued and outstanding. Shares
of common stock are issued and outstanding from the settlement date of a
purchase order to the settlement date of a tender offer. The Fund has entered
into an agreement providing for an unsecured revolving credit facility that
contains restrictions on the payment of dividends by the Fund. For a description
of such restrictions see "Borrowings by the Fund."
Under the 1940 Act, the Fund may not declare any dividend or other
distribution upon any class of its capital stock, or purchase any such capital
stock, unless the aggregate indebtedness of the Fund has at the time of the
declaration of any such dividend or distribution or at the time of any such
purchase an asset coverage of at least 300% after deducting the amount of such
dividend, distribution, or purchase price, as the case may be.
While any shares of preferred stock are outstanding, the Fund may not
declare any cash dividend or other distribution on its common stock, unless at
the time of such declaration, (1) all accumulated preferred stock dividends have
been paid and (2) the net asset value of the Fund's portfolio (determined after
deducting the amount of such dividend or other distribution) is at least 200% of
the liquidation value of the outstanding preferred stock (expected to be equal
to original purchase price per share plus any accumulated and unpaid dividends
thereon). This limitation, and the limitation contained in the preceding
paragraph, on the Fund's ability to make distributions on its common stock could
under certain circumstances impair the ability of the Fund to maintain its
qualification for taxation as a regulated investment company. See "Borrowings by
the Fund" and "Taxes."
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of common stock may be
automatically reinvested in shares of common stock of the Fund. Dividends and
distributions are taxable to shareholders whether they are reinvested in shares
of the Fund or received in cash (provided that, in the event that a payment on
an account maintained at the Transfer Agent would amount to $10 or less, a
shareholder will not receive such payment in cash and such payment will be
automatically invested in additional shares).
TAXES
GENERAL
The Fund intends to continue to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue Code
of 1986, as amended (the "Code"). As long as it so
31
<PAGE> 32
qualifies, in any taxable year in which it distributes at least 90% of its net
income (see below), the Fund will not be subject to Federal income tax to the
extent that it distributes its net investment income and net realized capital
gains. The Fund intends to distribute substantially all of its net investment
income and net capital gains.
Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions, if any, from the excess of net
long-term capital gains over net short-term capital losses derived from the sale
of securities or from certain transactions in interest rate swaps ("capital gain
dividends") are taxable as long-term capital gains, regardless of the length of
time the shareholder has owned Fund shares. Recent legislation created
additional categories of capital gains taxable at different rates. Additional
legislation eliminates the highest 28% category for most sales of capital assets
occurring after December 31, 1997. Generally not later than 60 days after the
close of its taxable year, the Fund will provide its shareholders with a written
notice designating the amounts of any ordinary income dividends or capital gain
dividends as well as the amounts of capital gain dividends in the different
categories of capital gain referred to above. Any loss upon the sale or exchange
of Fund shares held for six months or less is treated as long-term capital loss
to the extent of any capital gain dividends received by the shareholder.
Distributions in excess of the Fund's earnings and profits first reduce the
adjusted tax basis of a holder's common stock and, after such adjusted tax basis
is reduced to zero, constitute capital gains to such holder (assuming such
common stock is held as a capital asset).
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Distributions by the Fund, whether from ordinary
income or capital gains, generally are not eligible for the dividends received
deduction allowed to corporations under the Code. If the Fund pays a dividend in
January which was declared in the previous October, November or December to
shareholders of record on a specified date in one of such months, then such
dividend is treated for tax purposes as being paid and received on December 31
of the year in which the dividend was declared.
The IRS has taken the position in a revenue ruling that if a RIC has two or
more classes of shares, it may designate distributions made to each class in any
year as consisting of no more than such class's proportionate share of
particular types of income, including the different categories of capital gains,
discussed above. A class's proportionate share of a particular type of income is
determined according to the percentage of total dividends paid by the RIC during
the year that was paid to such class. Consequently, if both common stock and
preferred stock are outstanding, the Fund intends to designate distributions
made to the classes as consisting of particular types of income in accordance
with the classes' proportionate shares of such income. Thus, capital gain
dividends, including the different categories of capital gains, as discussed
above, will be allocated among the holders of common stock and any series of
preferred stock in proportion to the total dividends paid to each class during
the taxable year, or otherwise as required by applicable law.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute during each calendar year 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income and
capital gains in the manner necessary to minimize imposition of the 4% excise
tax, there can be no assurance that sufficient amounts of the Fund's taxable
income and capital gains will be distributed to avoid entirely the imposition of
the tax. In such event, the Fund will be liable for the tax only on the amount
by which it does not meet the foregoing distribution requirements.
Under the terms of the revolving credit facility, the Fund may be
restricted with respect to the declaration and payment of dividends in certain
circumstances. See "Borrowings by the Fund." Additionally, if at any time when
shares of preferred stock are outstanding the Fund does not meet the asset
coverage requirements
32
<PAGE> 33
of the 1940 Act, the Fund will be required to suspend distributions to holders
of common stock until the asset coverage is restored. See "Dividends and
Distributions." Limits on the Fund's payment of dividends may prevent the Fund
from distributing at least 90% of its net income and may therefore jeopardize
the Fund's qualification for taxation as a RIC and/or may subject the Fund to
the 4% Federal excise tax described above. Upon any failure to meet the asset
coverage requirement of the 1940 Act, the Fund may, in its sole discretion,
redeem shares of preferred stock in order to maintain or restore the requisite
asset coverage and avoid the adverse consequences to the Fund and its
shareholders of failing to qualify as a RIC. There can be no assurance, however,
that any such action would achieve these objectives. The Fund will endeavor to
avoid restriction of its dividend payments under the facility.
As noted above, the Fund must distribute annually at least 90% of its net
investment income. A distribution will only be counted for this purpose if it
qualifies for the dividends paid deduction under the Code. Some types of
preferred stock that the Fund has the authority to issue may raise a question as
to whether distributions on such preferred stock are "preferential" under the
Code and therefore not eligible for the dividends paid deduction. The Fund
intends to rely on the advice of its counsel and may seek a private letter
ruling from the IRS on questions raised by issuance of these types of preferred
stock. Moreover, the Fund intends to issue preferred stock that counsel advises
or the IRS has ruled will not result in the payment of preferential dividends.
If the Fund ultimately relies solely on a legal opinion on issuance of such
preferred stock, there is no assurance that the IRS would agree that dividends
on the preferred stock are not preferential. If the IRS successfully disallowed
the dividends paid deduction for dividends on the preferred stock, the Fund
could lose the benefit of the special treatment afforded RICs under the Code.
The Federal income tax rules governing the taxation of interest rate swaps
are not entirely clear and may require the Fund to treat payments received under
such arrangements as ordinary income and to amortize payments under certain
circumstances. Additionally, because the treatment of swaps under the RIC
qualification rules is not clear, the Fund will limit its activity in this
regard in order to maintain its qualification as a RIC.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that such investor is
not otherwise subject to backup withholding tax.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own tax advisers concerning the applicability of the United States withholding
tax.
Interest income from non-U.S. securities may be subject to withholding and
other taxes imposed by the country in which the issuer is located. Tax
conventions between certain countries and the United States may reduce or
eliminate such taxes.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
33
<PAGE> 34
OFFERS TO PURCHASE SHARES
Under current law, a shareholder who, pursuant to any tender offer, tenders
all of its shares and who, after such tender offer, is not considered to own any
shares under attribution rules contained in the Code will realize a taxable gain
or loss depending upon such shareholder's basis in the shares. Such gain or loss
will be treated as capital gain or loss if the shares are held as capital
assets. Different tax consequences may apply to tendering and nontendering
shareholders in connection with a tender offer, and these consequences will be
disclosed in the related offering documents. For example, if a shareholder
tenders less than all shares owned by or attributed to such shareholder, and if
the distribution to such shareholder does not otherwise qualify as a sale or
exchange, the proceeds received will be treated as a taxable dividend, a return
of capital or capital gain depending on the Fund's earnings and profits and the
shareholder's basis in the tendered shares. Also, there is a remote risk that
non-tendering shareholders may be considered to have received a deemed
distribution which may be a taxable dividend in whole or in part. Shareholders
may wish to consult their tax advisers prior to tendering. If holders of common
stock whose shares are acquired by the Fund in the open market sell less than
all shares owned by or attributed to them, a risk exists that these shareholders
will be subject to taxable dividend treatment and a remote risk exists that the
remaining shareholders may be considered to have received a deemed distribution.
-------------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative, judicial, or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Shareholders are urged to consult their tax advisors regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors should
consider applicable foreign taxes in their evaluation of an investment in the
Fund.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
All dividends and capital gains distributions are reinvested automatically
in full and fractional shares of the Fund at the net asset value per share next
determined on the payable date of such dividend or distribution. A shareholder
may at any time, by request to his Merrill Lynch financial consultant or by
written notification to Merrill Lynch if the shareholder's account is maintained
with Merrill Lynch or by written notification or by telephone (1-800-MER-FUND)
to the Transfer Agent if the shareholder's account is maintained with the
Transfer Agent, elect to have subsequent dividends or capital gains
distributions, or both, paid in cash, rather than reinvested, in which event
payment will be mailed on or about the payment date (provided that, in the event
that a payment on an account maintained at the Transfer Agent would amount to
$10 or less, a shareholder will not receive such payment in cash and such
payment will be automatically reinvested in additional shares). Cash payments
can also be directly deposited to the shareholder's bank account. No early
withdrawal charge will be imposed upon redemption of shares issued as a result
of the automatic reinvestment of dividends or capital gains distributions. The
Fund is not responsible for any failure of delivery to the shareholder's address
of record and no interest will accrue on amounts represented by uncashed
distribution or redemption checks.
The automatic reinvestment of dividends and distributions does not relieve
participants of any Federal income tax that may be payable (or required to be
withheld) on such dividends or distributions. See "Taxes."
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<PAGE> 35
NET ASSET VALUE
The net asset value per share of common stock is determined Monday through
Friday as of 15 minutes after the close of business on the NYSE (generally, the
NYSE closes at 4:00 p.m., Eastern time), on each business day during which the
NYSE is open. The NYSE is not open on New Year's Day, Martin Luther King, Jr.
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. For purposes of determining the net asset
value of a share of common stock, the value of the securities held by the Fund
plus any cash or other assets (including interest and dividends accumulated but
not yet received) minus all liabilities (including accrued expenses) and the
aggregate liquidation value of the outstanding shares of preferred stock is
divided by the total number of shares of common stock outstanding at such time.
Expenses, including the fees payable to the Investment Adviser, are accrued
daily.
Corporate Loans will be valued in accordance with guidelines established by
the Board of Directors. Under the Fund's current guidelines, Corporate Loans for
which the Investment Adviser can obtain at least two quotations from banks or
dealers in Corporate Loans will be valued by the Investment Adviser by
calculating the mean of the last available bid and asked prices in the market
for such Corporate Loans, and then using the mean of those two means. If only
one quote for a particular Corporate Loan is available, and the Investment
Adviser believes that such quote is a reliable indicator of value, such
Corporate Loan will be valued on the basis of the mean of the last available bid
and asked prices in the market. For Corporate Loans for which no reliable quotes
are available, such Corporate Loans will be valued by the Investment Adviser at
fair value, which is intended to approximate market value. In valuing a
Corporate Loan at fair value, the Investment Adviser will consider, among other
factors, (i) the creditworthiness of the borrower and any Intermediate
Participants, (ii) the current interest rate period until next interest rate
reset and maturity of the Corporate Loan, (iii) recent prices in the market for
similar Corporate Loans, if any, and (iv) recent prices in the market for
instruments of similar quality, rate, period until next interest rate reset and
maturity.
Other portfolio securities (other than short-term obligations but including
listed issues) may be valued on the basis of prices furnished by one or more
pricing services which determine prices for normal, institutional-size trading
units of such securities using market information, transactions for comparable
securities and various relationships between securities which are generally
recognized by institutional traders. In certain circumstances, such other
portfolio securities are valued at the last sale price on the exchange that is
the primary market for such securities, or the last quoted bid price for those
securities for which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The value of
interest rate swaps, caps and floors is determined in accordance with a formula
and then confirmed periodically by obtaining a bank quotation. Positions in
options are valued at the last sale price on the market where any such option is
principally traded. Obligations with remaining maturities of 60 days or less are
valued at amortized cost unless this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. Rights or
warrants to acquire stock, or stock acquired pursuant to the exercise of a right
or warrant, may be valued taking into account various factors such as original
cost to the Fund, earnings and net worth of the issuer, market prices for
securities of similar issuers, assessment of the issuer's future prosperity,
liquidation value or third party transactions involving the issuer's securities.
Securities for which there exist no price quotations or valuations and all other
assets are valued at fair value as determined in good faith by or on behalf of
the Board of Directors of the Fund.
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 1,000,000,000 shares of capital stock, par
value $.10 per share, all of which shares are initially classified as common
stock. The Board of Directors is authorized, however, to classify and reclassify
any unissued shares of capital stock by setting or changing in any one or more
respects
35
<PAGE> 36
the designation and number of shares of any such class or series, and the
nature, rates, amounts and times at which and the conditions under which
dividends shall be payable on, and the voting, conversion, redemption and
liquidation rights of, such class or series and any other preferences, rights,
restrictions and qualifications applicable thereto.
Shares of common stock, when issued and outstanding, are fully paid and
non-assessable. Shareholders are entitled to share pro rata in the net assets of
the Fund available for distribution to shareholders upon liquidation of the
Fund. Shareholders are entitled to one vote for each share held.
The Fund has not and does not currently anticipate issuing preferred stock.
However, in the event the Fund issues preferred stock and so long as any shares
of the Fund's preferred stock are outstanding, holders of common stock are not
entitled to receive any net income of or other distributions from the Fund
unless all accumulated dividends on preferred stock have been paid, and unless
asset coverage (as defined in the 1940 Act) with respect to preferred stock
would be at least 200% after giving effect to such distributions. During the
term of the Fund's revolving credit facility, the Fund may not issue any
additional capital stock other than common stock. See "Borrowings by the Fund."
The Fund sends unaudited reports at least semi-annually and audited annual
financial statements to all of its shareholders of record.
The following table sets forth the authorized shares of the Fund, the
number of shares held by the Fund for its own account and the total number of
shares outstanding as of August 31, 1998, exclusive of that held by the Fund.
<TABLE>
<CAPTION>
AMOUNT OUTSTANDING
AUGUST 31, 1998,
(EXCLUSIVE OF
AMOUNT HELD BY AMOUNT HELD BY
AMOUNT FUND FOR OWN FUND FOR OWN
CLASS OF SHARES AUTHORIZED ACCOUNT ACCOUNT)
- --------------- ------------- -------------- ------------------
<S> <C> <C> <C>
Common Stock................................ 1,000,000,000 -- 337,417,538
</TABLE>
CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION
In February 1994, the shareholders of the Fund approved the change of the
name of the Fund from "Merrill Lynch Prime Fund, Inc." to "Merrill Lynch Senior
Floating Rate Fund, Inc."
The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A Director elected by all holders of
capital stock or by the holders of preferred stock may be removed from office
only for cause by vote of the holders of at least 66 2/3% of the shares of
capital stock or preferred stock, as the case may be, of the Fund entitled to be
voted on the matter.
In addition, the Articles of Incorporation require the favorable vote of
the holders of at least 66 2/3% of the Fund's shares of capital stock, then
entitled to be voted, voting as a single class, to approve, adopt or authorize
the following:
(i) a merger or consolidation or statutory share exchange of the Fund
with other corporations;
(ii) a sale of all or substantially all of the Fund's assets (other
than in the regular course of the Fund's investment activities); or
(iii) a liquidation or dissolution of the Fund,
36
<PAGE> 37
unless such action has been approved, adopted or authorized by the affirmative
vote of two-thirds of the total number of Directors fixed in accordance with the
by-laws, in which case the affirmative vote of a majority of the Fund's shares
of capital stock is required. Following any issuance of preferred stock, it is
anticipated that the approval, adoption or authorization of the foregoing would
also require the favorable vote of a majority of the Fund's shares of preferred
stock then entitled to be voted, voting as a separate class.
The Board of Directors has determined that the 66 2/3% voting requirements
described in the foregoing paragraph and under "Certain Provisions of the
Articles of Incorporation," which are greater than the minimum requirements
under Maryland law or the 1940 Act, are in the best interests of shareholders
generally. Reference should be made to the Articles of Incorporation on file
with the Securities and Exchange Commission for the full text of these
provisions.
PERFORMANCE DATA
From time to time the Fund may include its yield and/or total return for
various specified time periods in advertisements or information furnished to
present or prospective shareholders.
The yield of the Fund refers to the income generated by an investment in
the Fund over a stated period. Yield is calculated by annualizing the most
recent monthly distribution and dividing the product by the average maximum
offering price. For the fiscal year ended August 31, 1998, the Fund earned
$0.678 per share income dividends, representing a net annualized yield of 6.82%,
based on a month-end per share net asset value of $9.97.
The Fund also may quote annual total return and aggregate total return
performance data. Total return quotations for the specified periods will be
computed by finding the rate of return (based on net investment income and any
capital gains or losses on portfolio investments over such periods) that would
equate the initial amount invested to the redeemable value of such investment at
the end of the period. For the fiscal year ended August 31, 1998, the annual
total return of the Fund was 6.47%, based on the change in per share net asset
value from $10.02 to $9.97, and assuming reinvestment of $0.679 per share income
dividends. For the period November 3, 1989 (commencement of operations) to
August 31, 1998, the aggregate total return of the Fund was 83.07%, based on the
change in per share net asset value from $10.00 to $9.97, and assuming
reinvestment of $6.083 per share income dividends.
The calculation of yield and total return does not reflect the imposition
of any early withdrawal charges.
Yield and total return figures are based on the Fund's historical
performance and are not intended to indicate future performance. The Fund's
yield is expected to fluctuate, and its total return varies depending on market
conditions, the Corporate Loans and other securities comprising the Fund's
portfolio, the Fund's operating expenses and the amount of net realized and
unrealized capital gains or losses during the period.
On occasion, the Fund may compare its yield to (1) the Prime Rate, quoted
daily in The Wall Street Journal as the base rate on corporate loans at large
U.S. money center commercial banks, (2) the CD rate, quoted daily in The Wall
Street Journal as the average of top rates paid by major New York banks on
primary new issues of negotiable CDs, usually on amounts of $1 million and more,
(3) one or more averages compiled by Donoghue's Money Fund Report, a widely
recognized independent publication that monitors the performance of money market
mutual funds, (4) the average yield reported by the Bank Rate Monitor National
Index(TM) for money market deposit accounts offered by the 100 leading banks and
thrift institutions in the ten largest standard metropolitan statistical areas,
(5) yield data published by Lipper Analytical Services, Inc., or (6) the yield
on an investment in 90-day Treasury bills on a rolling basis, assuming quarterly
compounding. In addition, the Fund may compare the Prime Rate, the CD rate, the
Donoghue's averages and the other yield data described above to each other. As
with yield quotations, yield comparisons should not be considered indicative of
the Fund's yield or relative performance for any future period.
37
<PAGE> 38
CUSTODIAN
The Fund's securities and cash are held under a custodial agreement with
The Bank of New York, 90 Washington Street, New York, New York 10286.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT
AND SHAREHOLDER SERVICING AGENT; SHAREHOLDER REPORTS
The Transfer Agent for the shares of the Fund is Financial Data Services,
Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484, a subsidiary
of ML & Co.
The Transfer Agent, which is a subsidiary of ML & Co., acts as the Fund's
transfer agent pursuant to a Transfer Agency, Dividend Disbursing Agency and
Shareholder Servicing Agency Agreement (the "Transfer Agency Agreement").
Pursuant to the Transfer Agency Agreement, the Transfer Agent is responsible for
the issuance, transfer and tender of shares and the opening and maintenance of
shareholder accounts. Pursuant to the Transfer Agency Agreement, the Transfer
Agent receives an annual fee of up to $14.00 per shareholder account, and is
entitled to reimbursement for certain transaction charges and out-of-pocket
expenses incurred by it under the Agreement. Additionally, a $.20 monthly closed
account charge is assessed on all accounts that close during the calendar year.
Application of this fee commences the month following the month the account is
closed and terminates at the end of the calendar year. For purposes of the
Transfer Agency Agreement, the term "account" includes a shareholder account
maintained directly by the Transfer Agent and any other account representing the
beneficial interest of a person in the relevant share class on a recordkeeping
system, provided the recordkeeping system is maintained by a subsidiary of ML &
Co. For the fiscal year ended August 31, 1998, the total fee paid by the Fund to
the Transfer Agent was $1,763,950.
Shareholder Reports. Only one copy of each shareholder report and certain
shareholder communications will be mailed to each identified shareholder
regardless of the number of accounts such shareholder has. If a shareholder
wishes to receive separate copies of each report and communication for each of
the shareholder's related accounts the shareholder should notify in writing:
Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
The written notification should include the shareholder's name, address,
tax identification number and Merrill Lynch and/or mutual fund account numbers.
If you have any questions regarding this please call your Merrill Lynch
financial consultant or Financial Data Services, Inc. at (800) 637-3863.
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate
years. These systems may not be able to distinguish the Year 2000 from the Year
1900 (commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by the Investment Adviser or other Fund
service providers do not properly address this problem prior to January 1, 2000.
The Investment Adviser expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told the Investment Adviser that they
also expect to resolve the Year 2000 Problem, and the Investment Adviser will
continue to monitor the situation as the Year 2000 approaches. However, if the
problem has not been fully addressed, the Fund could be negatively affected. The
Year 2000 Problem could also have a negative impact on the issuers of securities
in which the Fund invest, and this could hurt the Fund's investment returns.
38
<PAGE> 39
LEGAL OPINIONS
Certain legal matters in connection with the common stock offered hereby
are passed on for the Fund by Brown & Wood LLP, One World Trade Center, New
York, New York 10048-0557.
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this Prospectus
by reference to its 1998 annual report to Shareholders. You may request a copy
of the annual report at no charge by calling 1-800-456-4587 ext. 789 between
8:00 a.m. and 8:00 p.m. on any business day.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, have
been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to ratification by the shareholders of the Fund.
The independent auditors are responsible for auditing the financial statements
of the Fund.
39
<PAGE> 40
APPENDIX
RATINGS OF SECURITIES
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ("MOODY'S") SECURITY RATINGS
AAA Securities which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such
issues.
AA Securities which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade securities. They are rated lower than the best
securities because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude
or there may be other elements present which make the long-term risks appear
somewhat larger than in Aaa securities.
A Securities which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may
be present which suggest a susceptibility to impairment sometime in the
future.
BAA Securities which are rated Baa are considered as medium grade obligations;
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such securities lack outstanding investment
characteristics and in fact have speculative characteristics as well.
BA Securities which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes securities in this class.
B Securities which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payment or of maintenance of
other terms of the contract over any long period of time may be small.
CAA Securities which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest.
CA Securities which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C Securities which are rated C are the lowest rated class of securities, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
NOTE: Those securities in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa1, A1, Baa1, Ba1 and B1.
SHORT-TERM NOTES: The three ratings of Moody's for short-term notes are MIG
1/VMIG 1, MIG 2/VMIG 2 and MIG 3/VMIG 3; MIG 1/VMIG 1 denotes "best quality,
enjoying strong protection from established cash flows;" MIG 2/VMIG 2 denotes
"high quality" with ample margins of protection; MIG 3/VMIG 3 notes are of
"favorable quality . . . but lacking the undeniable strength of the preceding
grades."
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41
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[Graph]
MERRILL LYNCH SENIOR FLOATING RATE FUND, INC.
<PAGE> 43
- ------
INFORMATION ABOUT THE FUND CAN BE REVIEWED AND COPIED AT THE SEC'S PUBLIC
REFERENCE ROOM IN WASHINGTON, D.C. CALL 1-800-SEC-0330 FOR INFORMATION ON THE
OPERATION OF THE PUBLIC REFERENCE ROOM. THIS INFORMATION IS ALSO AVAILABLE ON
THE SEC'S INTERNET SITE AT HTTP://WWW.SEC.GOV AND COPIES MAY BE OBTAINED UPON
PAYMENT OF A DUPLICATING FEE BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC,
WASHINGTON, D.C. 20549-6009.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE
IS AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT.
-------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................. 2
Risk Factors and Special
Considerations.................... 5
Fee Table........................... 7
Financial Highlights................ 8
The Fund............................ 9
Investment Objective and Policies... 9
Borrowings by the Fund.............. 19
Investment Restrictions............. 20
Purchase of Shares.................. 22
Tender Offers....................... 23
Early Withdrawal Charge............. 25
Directors and Officers.............. 26
Investment Advisory and
Administrative Arrangements....... 28
Portfolio Transactions.............. 30
Dividends and Distributions......... 31
Taxes............................... 31
Automatic Dividend Reinvestment
Plan.............................. 34
Net Asset Value..................... 35
Description of Capital Stock........ 35
Performance Data.................... 37
Custodian........................... 38
Transfer Agent, Dividend Disbursing
Agent and Shareholder Servicing
Agent; Shareholder Reports........ 38
Year 2000 Issues.................... 38
Legal Opinions...................... 39
Financial Statements................ 39
Independent Auditors................ 39
Appendix -- Ratings of Securities... 40
</TABLE>
Code # 10938--1298
[MERRILL LYNCH LOGO]
MERRILL LYNCH
SENIOR FLOATING
RATE FUND, INC.
PROSPECTUS [MLYNCH COMPASS]
December 23, 1998
Distributor:
Merrill Lynch
Funds Distributor,
a division of
Princeton Funds
Distributor, Inc.
This prospectus should be
retained for future reference.
