<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 33-34494) UNDER
THE SECURITIES ACT OF 1933
POST-EFFECTIVE AMENDMENT NO. 8
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 9
VANGUARD INSTITUTIONAL
INDEX FUND
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
100 VANGUARD BOULEVARD, P.O. BOX 2600,
MALVERN, PA 19355-0741
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE
on March 28, 1997 pursuant to paragraph (b) of Rule 485.
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after this Registration Statement becomes effective.
WE HAVE ELECTED TO REGISTER AN INDEFINITE NUMBER OF SHARES PURSUANT TO RULE
24f-2 UNDER THE INVESTMENT COMPANY ACT OF 1940. WE FILED OUR RULE 24f-2 NOTICE
FOR THE YEAR ENDED DECEMBER 31, 1996 ON FEBRUARY 27, 1997.
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<PAGE> 2
VANGUARD INSTITUTIONAL INDEX FUND
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <S> <C>
Item 1. Cover Page.................................... Cover Page
Item 2. Synopsis...................................... Not Applicable
Item 3. Condensed Financial Information............... Fund Expenses, Financial Highlights
Item 4. General Description of Registrant............. Investment Objective; Investment
Limitations; Investment Policies;
General Information
Item 5. Management of the Fund........................ Management and Investment Advisory
Services
Item 6. Capital Stock and Other Securities............ Opening an Account and Purchasing
Shares; Selling Shares; The Share
Price of the Fund; Dividends, Capital
Gains and Taxes; General Information
Item 7. Purchase of Securities Being Offered.......... Cover Page; Opening an Account and
Purchasing Shares
Item 8. Redemption or Repurchase...................... Selling Shares
Item 9. Pending Legal Proceedings..................... Not Applicable
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
<C> <S> <C>
Item 10. Cover Page.................................... Cover Page
Item 11. Table of Contents............................. Cover Page
Item 12. General Information and History............... Investment Objective and Policies
Item 13. Investment Objective and Policies............. Investment Objective and Policies;
Investment Limitations
Item 14. Management of the Fund........................ Management and Investment Advisory
Services
Item 15. Control Persons and Principal Holders
of Securities................................. Management and Investment Advisory
Services
Item 16. Investment Advisory and Other Services........ Management and Investment Advisory
Services
Item 17. Brokerage Allocation.......................... Not Applicable
Item 18. Capital Stock and Other Securities............ Financial Statements
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered................................. Purchase of Shares; Redemption of
Shares
Item 20. Tax Status.................................... Appendix
Item 21. Underwriters.................................. Not Applicable
Item 22. Calculations of Yield Quotations of Money
Market Fund................................... Not Applicable
Item 23. Financial Statements.......................... Financial Statements
</TABLE>
<PAGE> 3
<TABLE>
<S> <C> <C>
Flag LOGO
Vanguard InstitutionalIndex Fund LOGO
P R O S P E C T U S
MARCH 28, 1997
Vanguard LOGO
</TABLE>
<PAGE> 4
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Vanguard Institutional Index Fund
LOGO A Member of The Vanguard Group
================================================================================
PROSPECTUS -- MARCH 28, 1997
- --------------------------------------------------------------------------------
NEW ACCOUNT INFORMATION: 1-800-523-8066
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE AND
POLICIES
Vanguard Institutional Index Fund (the "Fund") is an
open-end diversified investment company designed as an
"index" fund. Designed primarily for institutional
investors, the Fund's objective is to match the investment
performance of the Standard & Poor's 500 Composite Stock
Price Index (the "S&P 500 Index"), an index emphasizing
large-capitalization common stocks. There is no assurance
that the Fund will achieve its stated objective. Shares of
the Fund are neither insured nor guaranteed by any agency
of the U.S. Government, including the FDIC.
- --------------------------------------------------------------------------------
OPENING AN
ACCOUNT Shares of the Fund may be purchased by Federal Funds wire.
The minimum initial investment is $10 million.
- --------------------------------------------------------------------------------
ABOUT THIS
PROSPECTUS This Prospectus is designed to set forth concisely the
information that a prospective investor should know about
the Fund before investing. It should be retained for
future reference. A "Statement of Additional Information"
containing additional information about the Fund has been
filed with the Securities and Exchange Commission. This
Statement is dated March 28, 1997, and has been
incorporated by reference into this Prospectus. A copy may
be obtained without charge by writing to the Fund or by
calling 1-800-523-8066.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page Page Page
<S> <C> <C> <C>
Fund Expenses .......................2 Implementation of Policies ..........6 SHAREHOLDER GUIDE
Financial Highlights ................2 Investment Limitations ..............8 Opening an Account and
Yield and Total Return ..............3 Management and Investment Purchasing Shares ................13
FUND INFORMATION Advisory Services ...................9 Trade Date Policy ..................14
Investment Objective ................4 Dividends, Capital Gains Selling Shares .....................15
Investment Policies .................4 and Taxes ........................10 Exchanging Shares ..................15
Investment Risks ....................5 The Share Price of The Fund ........11 Exchange Privilege Limitation ......15
Investor Suitability ................5 General Information ................11 Important Information About
Telephone Transactions ...........16
Other Account Information ..........16
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
- --------------------------------------------------------------------------------
<PAGE> 5
FUND
EXPENSES The following table illustrates all expenses and fees that
a shareholder of the Fund will incur. The expenses and
fees set forth in the table are for the 1996 fiscal year.
<TABLE>
<CAPTION>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
------------------------------------------------------------------------------------
Sales Load Imposed on Purchases...................................... None
Sales Load Imposed on Reinvested Dividends........................... None
Redemption Fees...................................................... None
Exchange Fees........................................................ None
ANNUAL FUND OPERATING EXPENSES
------------------------------------------------------------------------------------
Management & Administrative Expenses................................. 0.06%
Investment Advisory Fees............................................. None
12b-1 Fees........................................................... None
Distribution Costs................................................... None
Other Expenses....................................................... None
-------
TOTAL OPERATING EXPENSES.................................... 0.06%
=======
</TABLE>
The purpose of this table is to assist you in
understanding the various costs and expenses that you
would bear directly or indirectly as an investor in the
Fund.
The Fund reserves the right to deduct a portfolio
transaction fee, ranging from 0.08% to 0.20%, from
purchases of shares of the Fund, if such purchase or
cumulative purchases are of a size that is reasonably
deemed to be disruptive to efficient portfolio management.
The fee will be paid to the Fund to offset transaction
costs of buying securities. The fee is not paid to
Vanguard and is not a sales charge. A prospective investor
may determine whether a fee will be charged by calling
Vanguard's Institutional Investor Services Department
before purchasing shares.
The following example illustrates the expenses that an
investor would incur on a $1,000 investment over various
periods, assuming (1) a 5% annual rate of return and (2)
redemption at the end of each period. As noted in the
table above, the Fund charges no redemption fees of any
kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C>
$ 1 $ 2 $ 3 $ 8
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR PERFORMANCE. ACTUAL EXPENSES
MAY BE HIGHER OR LOWER THAN THOSE SHOWN.
- --------------------------------------------------------------------------------
FINANCIAL
HIGHLIGHTS The following financial highlights for a share outstanding
throughout each period, have been audited by Price
Waterhouse LLP, independent accountants, whose report
thereon was unqualified. This information should be read
in conjunction with the Fund's financial statements and
notes thereto, which, together with the remaining portions
of the Fund's 1996 Annual Report to Shareholders, are
incorporated by reference in the Statement of Additional
Information and in this Prospectus, and which appear,
along with the report of Price Waterhouse LLP, in the
Fund's 1996 Annual Report to the Shareholders. For a more
complete discussion of the Fund's performance, please see
the Fund's 1996 Annual Report to Shareholders which may be
obtained without charge by writing to the Fund or by
calling Participant Services at 1-800-523-8066.
2
<PAGE> 6
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------------------------------------------- JULY 31, 1990*
1996 1995 1994 1993 1992 1991 TO DEC. 31, 1990
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD... $57.93 $43.22 $44.20 $41.45 $39.91 $31.62 $34.10
------- ------ ------ ------ ------ ------ ------------
INVESTMENT OPERATIONS
Net Investment Income................ 1.38 1.28 1.23 1.20 1.17 1.16 .52
Net Realized and Unrealized Gain
(Loss) on Investments.............. 11.90 14.86 (.66) 2.92 1.79 8.35 (2.48)
------- ------ ------ ------ ------ ------ -----------
TOTAL FROM INVESTMENT OPERATIONS... 13.28 16.14 .57 4.12 2.96 9.51 (1.96)
- ------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment
Income............................. (1.36) (1.27) (1.21) (1.19) (1.17) (1.16) (.52)
Distributions from Realized Capital
Gains.............................. (.99) (.16) (.34) (.18) (.25) (.06) --
------- ------ ------ ------ ------ ------ -----------
TOTAL DISTRIBUTIONS................ (2.35) (1.43) (1.55) (1.37) (1.42) (1.22) (.52)
- ------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD......... $68.86 $57.93 $43.22 $44.20 $41.45 $39.91 $31.62
========================================================================================================================
TOTAL RETURN........................... 23.06% 37.60% 1.31% 10.02% 7.54% 30.34% (5.74)%
========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions)... $11,426 $6,674 $3,265 $3,103 $1,525 $1,069 $512
Ratio of Expenses to Average Net
Assets............................... 0.06% 0.06% 0.07% 0.07% 0.07% 0.08% 0.09%**
Ratio of Net Investment Income to
Average Net Assets................... 2.18% 2.49% 2.80% 2.72% 2.94% 3.15% 3.98%**
Portfolio Turnover Rate................ 9% 4%+ 23%+ 4%+ 9%+ 4% 2%
Average Commission Rate Paid........... $.0167 N/A N/A N/A N/A N/A N/A
</TABLE>
*Commencement of operations.
**Annualized.
+The portfolio turnover rates excluding in-kind redemptions were 4%, 19%, 3%,
and 6%, respectively.
- --------------------------------------------------------------------------------
YIELD AND TOTAL
RETURN From time to time the Fund may advertise its yield and
total return. Both yield and total return figures are
based on historical earnings and are not intended to
indicate future performance. The "total return" of a fund
refers to the average annual compounded rates of return
over one-, five- and ten-year periods or for the life of
the fund (as stated in the advertisement) that would
equate an initial amount invested at the beginning of a
stated period to the ending redeemable value of the
investment, assuming the reinvestment of all dividend and
capital gains distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day
yield" of the Fund is calculated by dividing the net
investment income per share earned during a 30-day period
by the net asset value per share on the last day of the
period. Net investment income includes interest and
dividend income earned on the Fund's securities; it is net
of all expenses and all recurring and nonrecurring charges
that have been applied to all shareholder accounts. The
yield calculation assumes that net investment income
earned over 30 days is compounded monthly for six months
and then annualized. Methods used to calculate advertised
yields are standardized for all stock and bond mutual
funds. However, these methods differ from the accounting
methods used by the Fund to maintain its books and
records, and so the advertised 30-day yield may
3
<PAGE> 7
not fully reflect the income paid to an investor's account
or the yield reported in the Fund's reports to
shareholders.
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE
THE FUND SEEKS TO
MATCH THE INVESTMENT
PERFORMANCE OF THE
S&P 500 INDEX The Fund is an open-end diversified investment company
designed as an "index" fund. The Fund seeks to replicate
the aggregate price and yield performance, before Fund
expenses, of the Standard & Poor's 500 Composite Stock
Price Index (the "S&P 500 Index"), an unmanaged index that
emphasizes large-capitalization companies. The correlation
between the performance of the Fund and the Index is
expected to be 0.95 or higher. A correlation of 1.00 would
indicate perfect correlation. There is no assurance that
the Fund will achieve its stated objective.
The Fund is neither sponsored by or affiliated with
Standard & Poor's Corporation.
The investment objective is fundamental and so cannot be
changed without the approval of a majority of the Fund's
shareholders.
- --------------------------------------------------------------------------------
INVESTMENT
POLICIES
THE FUND USES A
"PASSIVE" APPROACH
TO INVEST IN COMMON
STOCKS
The Fund is not managed according to traditional methods
of "active" investment management, which involve the
buying and selling of securities based upon economic,
financial and market analysis, and investment judgment.
Instead, the Fund, utilizing a "passive" or "indexing"
investment approach, attempts to duplicate the investment
performance of the S&P 500 Index by investing in all 500
stocks in the S&P 500 Index in approximately the same
proportions as they are represented in the Index. The Fund
is managed without regard to tax ramifications.
The Fund attempts to remain fully invested in common
stocks. Under normal circumstances the Fund will invest at
least 95% of its assets in the common stocks in the S & P
500 Index and futures contracts and options. The Fund may
invest in certain short-term fixed-income securities as
cash reserves, although cash or cash equivalents are
normally expected to represent less than 1% of its assets.
The Fund may also invest up to 20% of its assets in stock
futures contracts and options in order to invest
uncommitted cash balances, to maintain liquidity to meet
shareholder redemptions, or to minimize trading costs. The
Fund will not invest in cash reserves, futures contracts
or options as part of a temporary defensive strategy, such
as lowering its investment in common stocks to protect
against potential stock market declines. Nor may the Fund
use futures contracts or options to leverage its net
assets in an attempt to speculate on potential stock
market gains. See "Implementation of Policies" for a
description of these and other investment practices of the
Fund.
The Fund is responsible for voting the shares of all
securities it holds.
These investment policies are not fundamental and so may
be changed by the Board of Trustees without shareholder
approval.
- --------------------------------------------------------------------------------
4
<PAGE> 8
INVESTMENT
RISKS
THE FUND IS SUBJECT
TO MARKET RISK
As a mutual fund investing in common stocks, the Fund is
subject to MARKET RISK -- i.e., the possibility that
common stock prices will decline over short, or even
extended, periods. The U.S. stock market tends to be
cyclical, with periods when stock prices generally rise
and periods when prices generally decline.
To illustrate the volatility of stock prices, the
following table sets forth the extremes for stock market
returns as well as the average return for the period from
1926 to 1996, as measured by the Standard & Poor's 500
Composite Stock Price Index:
<TABLE>
<CAPTION>
U.S. STOCK MARKET RETURNS (1926-1996)
OVER VARIOUS TIME HORIZONS
1 YEAR 5 YEARS 10 YEARS 20 YEARS
------ ------- -------- --------
<S> <C> <C> <C> <C>
Best +53.9 % +23.9% +20.1% +16.9%
Worst -43.3 -12.5 - 0.9 - 3.1
Average +12.7 +10.4 +10.8 +10.8
</TABLE>
As shown, common stocks have provided annual total returns
(capital appreciation plus dividend income) averaging
+10.8% for all 10-year periods from 1926 to 1995. Average
return may not be useful for forecasting future returns in
any particular period, as stock returns are quite volatile
from year to year.
- --------------------------------------------------------------------------------
INVESTOR
SUITABILITY
THE FUND IS INTENDED
FOR LONG-TERM "INDEX"
INVESTORS
The Fund is designed for investors who seek a low-cost,
"passive" or indexing approach for investing in a broadly
diversified portfolio of common stocks by seeking to
replicate the approximate total return of the S&P 500
Index, an index emphasizing large-capitalization stocks.
Unlike other equity mutual funds, which generally seek to
"beat" such market averages, with often unpredictable
results, the Fund seeks to "match" the index and thus is
expected to provide a highly predictable return relative
to its benchmark index. The Fund is a broadly diversified
equity investment.
The share price of the Fund is expected to be as volatile
as the index it replicates, and investors should be able
to tolerate sudden, sometimes substantial, fluctuations in
the value of their investment. No assurance can be given
that the Fund will achieve its stated objective or that
shareholders will be protected from the risks inherent in
equity investing.
The Fund is intended to be a long-term investment vehicle
and is not designed to provide investors with a means of
speculating on short-term stock market movements.
Investors who engage in excessive account activity
generate additional costs which are borne by all of the
Fund's shareholders. In order to minimize such costs, the
Fund has adopted the following policies. The Fund reserves
the right to reject any purchase request (including
exchange purchases from other Vanguard portfolios) that is
reasonably deemed to be disruptive to efficient portfolio
management, either because of the timing of the investment
or previous excessive trading by the investor.
Additionally, the Fund has adopted exchange privilege
limitations as described in the section "Exchange
Privilege Limitations." Finally, the Fund reserves the
right to suspend the offering of its shares.
5
<PAGE> 9
Investors should not consider the Fund a complete
investment program, but should maintain holdings of
securities with different risk characteristics --
including common stocks, bonds and money market
instruments.
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IMPLEMENTATION
OF POLICIES
THE FUND
INVESTS IN ALL 500
S&P STOCKS Vanguard Institutional Index Fund attempts to duplicate
the investment results of the S&P 500 Index by holding all
500 stocks in approximately the same proportions as they
are represented in the S&P 500 Index. This indexing
technique is known as "complete replication."
The S&P 500 Index is composed of 500 common stocks that
are chosen by Standard & Poor's Corporation on a
statistical basis. The inclusion of a stock in the S&P 500
Index in no way implies that Standard & Poor's Corporation
believes the stock to be an attractive investment. The 500
securities, most of which trade on the New York Stock
Exchange, represented, as of December 31, 1996,
approximately 70% of the market value of all regularly
traded U.S. common stocks. Each stock in the S&P 500 Index
is weighted by its market value.
Because of the market-value weighting, the 50 largest
companies in the S&P 500 Index currently account for
approximately 47% of the Index. Typically, companies
included in the S&P 500 Index are the largest and most
dominant firms in their respective industries. As of
December 31, 1996, the five largest companies in the Index
were: General Electric (2.9%), Coca Cola (2.3%), Exxon
Corporation (2.2%), Intel Corporation (1.9%), Microsoft
Corporation (1.7%), the largest industry categories were:
banks (7.7%), telephone companies (6.6%), pharmaceutical
companies (6.4%), international oil companies (5.8%), and
computer companies (4.6%).
The Fund is not sponsored, endorsed, sold or promoted by
Standard & Poor's Corporation ("S&P"). S&P makes no
representation or warranty, implied or express, to the
purchasers of the Fund or any member of the public
regarding the advisability of investing in index funds or
the ability of the S&P 500 Index to track general stock
market performance. S&P does not guarantee the accuracy
and/or the completeness of the S&P 500 Index or any data
included therein.
S&P makes no warranty, express or implied, as to the
results to be obtained by the Fund, owners of the Fund,
any person or any entity from the use of the S&P 500 or
any data included therein. S&P makes no express or implied
warranties and hereby expressly disclaims all such
warranties of merchantability or fitness for a particular
purpose for use with respect to the S&P 500 or any data
included therein.
S&P's only relationship to the Fund is the licensing of
the S&P marks and the S&P 500 Index, which is determined,
composed and calculated by S&P without regard to the Fund.
THE FUND MAY
INVEST IN SHORT-TERM
FIXED-INCOME
SECURITIES
Although it normally seeks to remain fully invested in
common stocks, the Fund may invest temporarily in certain
short-term fixed-income securities. Such securities may be
used to invest uncommitted cash balances or to maintain
liquidity to meet shareholder redemptions. These
securities include: obligations of the United States
Government and its agencies or instrumentalities;
commercial paper, bank
6
<PAGE> 10
certificates of deposit, and bankers' acceptances; and
repurchase agreements collateralized by these securities.
DERIVATIVE INVESTING Derivatives are instruments whose values are linked to or
derived from an underlying security or index. The most
common and conventional types of derivative securities are
futures and options.
THE FUND MAY USE
FUTURES CONTRACTS,
OPTIONS AND WARRANTS,
CONVERTIBLE SECURITIES
AND SWAP AGREEMENTS The Fund may utilize stock futures contracts, options, and
warrants to a limited extent. Specifically, the Fund may
enter into futures contracts and options provided that not
more than 5% of its assets are required as a margin
deposit for futures contracts or options. Additionally,
the Fund's investment in warrants will not exceed more
than 5% of its assets (2% with respect to warrants not
listed on the New York or American Stock Exchanges).
Futures contracts, options, warrants, convertible
securities and swap agreements may be used for several
reasons: to simulate full investment in the underlying
index while retaining a cash balance for fund management
purposes; to facilitate trading; to reduce transaction
costs; or to seek higher investment returns when a futures
contract, option, warrant, convertible security or swap
agreement is priced more attractively than the underlying
equity security or index. While each of these securities
can be used as leveraged investments, the Fund may not use
them to leverage its net assets.
FUTURES CONTRACTS,
OPTIONS, WARRANTS,
CONVERTIBLE SECURITIES
AND SWAP AGREEMENTS
POSE CERTAIN RISKS
The risk of loss associated with futures contracts in some
strategies can be substantial due both to the low margin
deposits required and the extremely high degree of
leverage involved in futures pricing. As a result, a
relatively small price movement in a futures contract may
result in an immediate and substantial loss or gain.
However, the Fund will not use futures contracts, options,
warrants, convertible securities or swap agreements for
speculative purposes or to leverage its net assets.
Accordingly, the primary risks associated with the use of
futures contracts, options, warrants, convertible
securities or swap agreements by the Fund are: (i)
imperfect correlation between the change in market value
of the stocks held by a fund and the prices of futures
contracts and options; and (ii) possible lack of a liquid
secondary market for a futures contract and the resulting
inability to close a futures position prior to its
maturity date. The risk of imperfect correlation will be
minimized by investing only in those contracts whose
behavior is expected to resemble that of the Fund's
underlying securities. The risk that the Fund will be
unable to close out a futures position will be minimized
by entering into such transactions on a national exchange
with an active and liquid secondary market. However,
options, warrants, convertible securities and swap
agreements purchased or sold over-the-counter may be less
liquid than exchange traded securities. Illiquid
securities, in general, may not represent more than 15% of
the net assets of the Fund.
Swap agreements are contracts between parties in which one
party agrees to make payments to the other party based on
the change in market value of a specified index or asset.
In return, the other party agrees to make payments to the
first party based on the return of a different specified
index or asset. Although swap agreements entail the risk
that a party will default on its payment obligations
thereunder, the Fund will minimize this risk by entering
into agreements that mark
7
<PAGE> 11
to market no less frequently than quarterly. Swap
agreements also bear the risk that the Fund will not be
able to meet its obligation to the counterparty. This risk
will be mitigated by investing the Fund in the specific
asset for which it is obligated to pay a return.
THE FUND MAY LEND
ITS SECURITIES
The Fund may lend its investment securities on a
short-term or long-term basis to qualified institutional
investors for the purpose of realizing additional income.
Loans of securities by the Fund will be collateralized by
cash, letters of credit, or securities issued or
guaranteed by the U.S. Government or its agencies. The
collateral will equal at least 100% of the current market
value of the loaned securities.
PORTFOLIO TURNOVER
RATE IS EXPECTED
TO BE LOW
Although the Fund generally seeks to invest for the long
term, it retains the right to sell securities irrespective
of how long they have been held. However, because of the
"passive" investment management approach of the Fund, the
portfolio turnover rate for the Fund is expected to be
under 50%, a generally lower turnover rate than for most
other investment companies. A portfolio turnover rate of
50% would occur if one half of the Fund's securities were
sold within one year. Ordinarily, securities will be sold
only to reflect certain administrative changes in the S&P
500 Index (including mergers or changes in the composition
of the index) or to accommodate cash flows into and out of
the Fund while maintaining its similarity to the S&P 500
Index.
THE FUND MAY
BORROW MONEY The Fund may borrow money, subject to the limits set forth
below, for temporary or emergency purposes including the
meeting of redemption requests which might otherwise
require the untimely disposition of securities.
- --------------------------------------------------------------------------------
INVESTMENT
LIMITATIONS
THE FUND HAS ADOPTED
CERTAIN FUNDAMENTAL
LIMITATIONS
The Fund has adopted certain limitations on its investment
practices. Specifically, the Fund will not:
(a) with respect to 75% of its assets, purchase
securities of any issuer (except obligations of the
U.S. Government and its instrumentalities) if, as a
result, more than 5% of the value of the Fund's
assets would be invested in the securities of such
issuer or purchase more than 10% of the voting
securities of any issuer;
(b) invest more than 25% of its assets in any one
industry; and
(c) borrow money, except that the Fund may borrow from
banks (or through reverse repurchase agreements), for
temporary or emergency (not leveraging) purposes, in
an amount not exceeding 15% of the value of the
Fund's net assets (including the amount borrowed and
the value of any outstanding reverse repurchase
agreements) at the time the borrowing is made.
Whenever borrowings exceed 5% of the value of the
Fund's net assets, the Fund will not make any
additional investments.
These investment limitations are considered at the time
investment securities are purchased. The limitations
described here and in the Statement of Additional
8
<PAGE> 12
Information may be changed only with the approval of a
majority of the Fund's shareholders.
- --------------------------------------------------------------------------------
MANAGEMENT AND
INVESTMENT
ADVISORY SERVICES
VANGUARD
ADMINISTERS,
DISTRIBUTES, AND
PROVIDES ADVISORY
SERVICES TO THE FUND The Fund currently employs The Vanguard Group, Inc.
("Vanguard") to provide management, administrative and
investment advisory services. Vanguard provides virtually
all of the corporate management, administrative, and
distribution services to The Vanguard Group of Investment
Companies, a family of more than 30 investment companies
with more than 90 distinct investment portfolios and total
assets in excess of $250 billion. Vanguard also provides
investment advisory services to certain Vanguard Funds.
The Officers of the Fund manage its day-to-day operations
and are responsible to the Fund's Board of Trustees. The
Trustees set broad policies for the Fund and choose its
Officers. A list of Trustees and Officers of the Fund and
a statement of their present positions and principal
occupations during the past five years can be found in the
Statement of Additional Information.
Vanguard employs a supporting staff of management and
administrative personnel to provide the requisite services
to the Fund and also furnishes the Fund with the necessary
office space, furnishings and equipment.
Vanguard also provides distribution and marketing services
to the Fund. The Fund is available on a no-load basis
(i.e., there are no sales commissions or 12b-1 fees).
The Fund receives all investment advisory services on an
at-cost basis from Vanguard's Core Management Group. The
Core Management Group manages the investment and
reinvestment of the Fund's assets and continuously
reviews, supervises, and administers the Fund's investment
program with respect to those assets. The Core Management
Group discharges its responsibilities subject to the
control of the Officers and Directors of the Fund.
The Core Management Group also provides investment
advisory services to several Vanguard Funds, including
Vanguard Index Trust, Vanguard Balanced Index Fund,
Vanguard International Equity Index Fund, Vanguard REIT
Index, the Equity Index Portfolio of the Vanguard Variable
Insurance Fund, the Growth and Income and Capital
Appreciation Portfolios and the equity portion of the
Balanced Portfolio of Vanguard Tax-Managed Fund, the
Aggressive Growth Portfolio of Vanguard Horizon Fund, a
portion of Vanguard/Morgan Growth Fund and a portion of
the assets of Vanguard/Windsor II, as well as to several
indexed separate accounts. Total assets under management
by the Core Management Group were approximately $57
billion as of December 31, 1996. The Fund is not actively
managed, but is instead administered by the Core
Management Group, using computerized, quantitative
techniques.
In placing portfolio transactions, the Core Management
Group uses its best judgment to choose the broker most
capable of providing the brokerage services necessary to
obtain the best available price and most favorable
execution at the lowest commission rate. The full range
and quality of brokerage services available are considered
when making these determinations. In those instances where
more than one brokerage firm can offer the services needed
to obtain the best available price and the most favorable
execution,
9
<PAGE> 13
consideration may be given to those brokers that supply
statistical information and provide other services in
addition to execution services to the Fund. However, the
Core Management Group will not pay higher commissions
specifically for the purpose of obtaining research
services.
Under the terms of the Service and Advisory agreement with
Vanguard, Vanguard pays all of the Fund's expenses, except
for taxes and brokerage commissions. In turn, the Fund
will pay Vanguard a fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on the
following annual percentage rates, to the average daily
net assets for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
------------------- ----
<S> <C>
First $500 million .09%
Next $500 million .07%
Over $1 billion .06%
</TABLE>
During the 1996 fiscal year the Fund paid Vanguard a
management, investment advisory, distribution and
marketing fee which represented an effective annual rate
of .06 of 1% of average (daily) net assets.
- --------------------------------------------------------------------------------
DIVIDENDS,
CAPITAL GAINS
AND TAXES
THE FUND PAYS
DIVIDENDS EACH
QUARTER
The Fund distributes substantially all of its ordinary
income in the form of quarterly dividends. Capital gains
distributions, if any, are made annually. The Fund's
dividend and capital gains distributions may be reinvested
in additional shares or received in cash. See
"Distribution Options."
In order to satisfy certain requirements of the Tax Reform
Act of 1986, the Fund may declare year-end dividend and
capital gains distributions during December. Such
distributions, if received by shareholders by January 31,
are deemed to have been paid by the Fund and received by
shareholders on December 31 of the prior year.
The Fund intends to continue to qualify for taxation as a
"regulated investment company" under the Internal Revenue
Code so that it will not be subject to federal income tax
to the extent its income is distributed to shareholders.
Dividends paid by the Fund from net investment income and
net short-term capital gains, whether received in cash or
reinvested in additional shares, will be taxable to
shareholders as ordinary income. For corporate investors,
dividends from net investment income will generally
qualify in part for the intercorporate dividends-received
deduction. However, the portion of the dividends so
qualified depends on the aggregate taxable qualifying
dividend income received by a Fund from domestic (U.S.)
sources.
Distributions paid by the Fund from long-term capital
gains, whether received in cash or reinvested in
additional shares, are taxable as long-term capital gains,
regardless of the length of time the shares have been
owned. Capital gains distributions are made when the Fund
realizes net capital gains on sales of portfolio
securities during the year. The Fund does not seek to
realize any particular amount of capital gains during a
year; rather, realized gains are a by-product of Fund
management activities. Consequently, capital gains
distributions may be expected to vary considerably from
year to year; there will be no capital gains distributions
in years when the Fund realizes net capital losses.
10
<PAGE> 14
Note that if capital gains distributions are received in
cash instead of reinvested in additional shares, a
shareholder's capital in the Fund will, in effect, be
reduced. Also, keep in mind that if shares of the Fund are
purchased shortly before the record date for a dividend or
capital gains distribution, a portion of the investment
will be returned as a taxable distribution, regardless of
whether distributions are being reinvested or received in
cash.
The Fund will notify shareholders annually as to the tax
status of dividend and capital gains distributions paid by
the Fund.
A CAPITAL GAIN OR LOSS
MAY BE REALIZED UPON
EXCHANGE OR
REDEMPTION A sale of shares of the Fund is a taxable event and may
result in a capital gain or loss. A capital gain or loss
may be realized from an ordinary redemption of shares or
an exchange of shares between two mutual funds.
Dividend distributions, capital gains distributions, and
capital gains or losses from redemptions or exchanges may
be subject to state and local taxes.
The Fund is required to withhold 31% of taxable dividends,
capital gains distributions, and redemptions paid to
shareholders who have not complied with IRS taxpayer
identification regulations. This withholding requirement
may be avoided by certifying on the Account Registration
Form a proper Social Security or Employer Identification
number and by certifying that backup withholding does not
apply.
The tax discussion set forth above is included for general
information only. Prospective investors should consult
their own tax advisers concerning the tax consequences of
an investment in the Fund.
- --------------------------------------------------------------------------------
THE SHARE PRICE OF
THE FUND The share price or "net asset value" per share of the Fund
is determined by dividing the total market value of the
Fund's investments and other assets, less any liabilities,
by the number of outstanding shares of the Fund. Net asset
value per share is determined as of the regular close of
the New York Stock Exchange (generally 4:00 p.m. Eastern
time), each day the Exchange is open for trading.
Fund securities that are listed on a securities exchange
are valued at the last quoted sales price on the day the
valuation is made. Price information on listed securities
is taken from the exchange where the security is primarily
traded. Securities that are listed on an exchange and that
are not traded on the valuation date are valued at the
mean of the bid and asked prices. Unlisted securities for
which market quotations are readily available are valued
at the latest quoted bid price. Securities may be valued
on the basis of prices provided by a pricing service when
such prices are believed to reflect fair market value of
such securities. Other assets and securities for which no
current quotations are readily available are valued at
fair value as determined in good faith by the Trustees.
- --------------------------------------------------------------------------------
GENERAL
INFORMATION The Fund is a Pennsylvania business trust. The Declaration
of Trust permits the Trustees to issue an unlimited number
of shares of beneficial interest with no par value. The
Board of Trustees has the power to designate one or more
classes ("series") of shares of beneficial interest and to
classify or reclassify any unissued shares with respect to
such series. Currently the Fund is offering shares of one
series.
11
<PAGE> 15
The shares are fully paid and non-assessable; have no
preference as to conversion, exchange, dividends,
retirement or other features; and have no pre-emptive
rights. Such shares have non-cumulative voting rights,
meaning that the holders of more than 50% of the shares
voting for the election of Trustees can elect 100% of the
Trustees if they so choose.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other
applicable law. An annual meeting will be held to vote on
the removal of a Trustee or Trustees of the Fund if
requested in writing by the holders of not less than 10%
of the outstanding shares of the Fund.
All securities and cash are held by CoreStates Bank,
Philadelphia, PA. The Vanguard Group, Inc., Valley Forge,
PA, serves as the Fund's Transfer and Dividend Disbursing
Agent. Price Waterhouse LLP, serves as independent
accountants for the Fund and will audit its financial
statements annually. The Fund is not involved in any
litigation.
- --------------------------------------------------------------------------------
12
<PAGE> 16
SHAREHOLDER GUIDE
OPENING AN
ACCOUNT AND
PURCHASING
SHARES To open a new account, complete an Account Registration
Form and mail it to:
VANGUARD FINANCIAL CENTER
VANGUARD INSTITUTIONAL INDEX FUND
ATTN: INSTITUTIONAL INVESTOR SERVICES
P.O. BOX 1472
VALLEY FORGE, PA 19482
For express or registered mail, send your registration
form to: Vanguard Financial Center, Vanguard Institutional
Index Fund, Attn: Institutional Investor Services, 100
Vanguard Boulevard, Malvern, PA 19355.
Once the account has been opened, Vanguard will assign a
Service Representative for future account transactions.
Because of the risks associated with common stock
investments, the Fund is intended to be a long-term
investment vehicle and is not designed to provide
investors with a means of speculating on short-term stock
market movements. Consequently, the Fund reserves the
right to reject any specific purchase (or exchange
purchase) request. The Fund also reserves the right to
suspend the offering of shares for a period of time.
Shares of the Fund generally may be purchased by Federal
Funds wire. The minimum initial investment for the Fund is
$10 million. Please contact your Institutional Investor
Services Representative or call Participant Services
(1-800-523-8066) to notify the Fund of the intended
investment and to receive an account number. Wiring
instructions are provided below.
Subsequent investments of $5 million or more will be
credited to an account on the date of purchase if Vanguard
is notified one business day in advance of the intended
purchase and a Federal Funds wire is received by 4:00 p.m.
(Eastern time) on the date of purchase. See "Trade Date
Policy."
IMPORTANT NOTE
ON FEES
The Fund reserves the right to deduct a portfolio
transaction fee, ranging from 0.08% to 0.20%, from
purchases of shares of the Fund, if such purchase or
cumulative purchases are of a size that is reasonably
deemed to be disruptive to efficient portfolio management.
The fee will be paid to the Fund to offset transaction
costs of buying securities. The fee is not paid to
Vanguard and is not a sales charge. Please call Vanguard's
Institutional Investor Services Department before
investing to determine whether a fee will be charged for
your share purchase.
ADDITIONAL
INVESTMENTS
Please contact your
Service Representative
Additional investments may be made at any time by wiring
monies to Vanguard. As noted above, investments of $5
million or more require prior-day notification to qualify
for credit on the date of purchase. To ensure prompt
investment, please notify your Institutional Investor
Services Representative in advance of the wire.
- --------------------------------------------------------------------------------
13
<PAGE> 17
PURCHASING BY WIRE
BEFORE WIRING
Please contact your
Service Representative
Monies should be wired to:
CORESTATES BANK, N.A.
ABA 031000011
CORESTATES NO 0101-9897
ATTN VANGUARD
VANGUARD INSTITUTIONAL INDEX FUND
ACCOUNT NUMBER
ACCOUNT REGISTRATION
To ensure proper receipt, please be sure to include in the
wiring instructions the complete Fund name, the account
number Vanguard has assigned you and the eight-digit
CoreStates number. Note: Federal Funds wire purchase
orders will be accepted only when the Portfolio and
Custodian Bank are open for business.
- --------------------------------------------------------------------------------
PURCHASING BY
EXCHANGE (from a
Vanguard account) Purchases may also be made by exchange from an existing
Vanguard Fund account. However, the Fund reserves the
right to refuse any exchange purchase request. Please call
your Service Representative or call Participant Services
(1-800-523-8066.)
- --------------------------------------------------------------------------------
DISTRIBUTION OPTIONS Dividend and capital gains distributions paid by the Fund
will be automatically reinvested in additional Fund
shares. A cash dividend option is also available from the
Fund. Please contact your Service Representative for
further information.
CERTIFICATES
Share certificates will not be issued for the Fund.
ELECTRONIC
PROSPECTUS
DELIVERY
If you would prefer to receive a prospectus for the Fund
or any of the Vanguard Funds in an electronic format,
please call 1-800-231-7870 for additional information. If
you elect to do so, you may also receive a paper copy of
the prospectus, by calling 1-800-523-8066.
- --------------------------------------------------------------------------------
TRADE DATE
POLICY
Investments will be credited on the date of purchase under
the following conditions:
- FOR INVESTMENTS OF $5 MILLION OR MORE: The Fund must be
notified of the intended purchase by the close of the
New York Stock Exchange, (generally 4:00 p.m. Eastern
time) on the prior business day and the Federal Funds
wire must be received by Vanguard by the close of the
Exchange on the date of purchase.
- FOR INVESTMENTS OF LESS THAN $5 MILLION: The Fund must
be notified of the intended purchase by 10:45 a.m.
(Eastern time) on the day of purchase and the Federal
Funds wire must be received by the close of the
Exchange.
Generally, if these requirements are not met, an
investment will be credited to the account on the business
day following receipt of a Federal Funds wire.
The trade date, the day on which an account is credited,
is generally the day on which the Fund receives an
investment in the form of Federal Funds. For purchases by
Federal Funds wire or by exchange, the Fund is credited
immediately with Federal Funds. If a purchase by Federal
Funds wire or exchange is received by the close of the New
York Stock Exchange, (generally 4:00 p.m. Eastern time),
the trade date is the day of receipt assuming proper
notification has been given, as described above.
14
<PAGE> 18
If a purchase is received after the close of the Exchange,
the trade date is the business day following the receipt
of the wire or exchange.
- --------------------------------------------------------------------------------
SELLING SHARES
WIRE PROCEEDS Any portion of an account may be withdrawn by contacting
your Service Representative. The redemption proceeds will
be wired to the bank account indicated on the Account
Registration Form within five business days following
receipt of a request.
Wire redemptions of less than $5,000 are subject to a $5
charge deducted from the principal in your account. There
is no charge for wire redemptions of $5,000 or more, or
for subsequent dividend wires.
For our mutual protection, wiring instructions must be on
file at Vanguard prior to executing any redemption
request. A request to change the bank account associated
with the wire redemption feature or a request to wire
funds to a bank other than that on file must be received
in writing. A signature guarantee of an authorized officer
is required if the bank registration is not identical to
the Fund account registration.
- --------------------------------------------------------------------------------
OTHER REDEMPTION
INFORMATION The Fund may suspend the redemption rights or postpone
payment at times when the New York Stock Exchange is
closed or under any emergency circumstances as determined
by the United States Securities and Exchange Commission.
If the Board of Trustees determines that it would be
detrimental to the best interests of the Fund's remaining
shareholders to make payment in cash, the Fund may pay
redemption proceeds in whole or in part by a distribution
in kind of readily marketable securities.
The Fund reserves the right to redeem shares of any
account with a balance of less than $10 million. This
action will be taken when the balance of the account falls
below $10 million due to account redemptions. Reductions
in account balances due to market depreciation will not be
considered until the account balance declines to less than
$5 million. Investors will be provided with 60 days'
notice before any such action is taken.
- --------------------------------------------------------------------------------
EXCHANGING
SHARES Shares of the Fund may be exchanged for those of other
available Vanguard Funds, but only upon prior approval by
Vanguard. Exchanges without prior Vanguard authorization
are not permitted for the Fund. Contact your Service
Representative for further information.
Exchange requests may be made in writing or by telephone.
The Fund reserves the right to revise or terminate the
exchange privilege and its provisions, limit the amount of
or reject any exchange, as deemed necessary, at any time,
without prior notice.
- --------------------------------------------------------------------------------
EXCHANGE
PRIVILEGE
LIMITATION The Fund's Exchange Privilege is not intended to afford
investors a way to speculate on short-term movements in
the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive
exchange activity. Exchange activity will not be deemed
excessive if limited to one substantive exchange
redemption per calendar year, taken from
15
<PAGE> 19
assets that have been invested in the Fund for periods of
one year or longer. The Fund is designed for long-term
investors.
- --------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ABOUT TELEPHONE
TRANSACTIONS The ability to initiate exchanges by telephone is
automatically established on your account unless you
request in writing that telephone transactions on your
account not be permitted. The ability to initiate wire
redemptions by telephone will be established on your
account only if you specifically elect this option in
writing.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions,
Vanguard generally adheres to the following security
procedures:
1. SECURITY CHECK. To request a transaction by telephone,
the caller must identify (i) the fund name; and (ii)
the 10-digit account number.
2. PAYMENT POLICY. The proceeds of any telephone
redemption by wire will be made only in accordance with
the shareowner's prior written instructions.
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by
telephone, provided that reasonable security procedures
have been followed. Vanguard believes that the security
procedures described above are reasonable, and that if
such procedures are followed, you will bear the risk of
any losses resulting from unauthorized or fraudulent
telephone transactions on your account.
- --------------------------------------------------------------------------------
OTHER ACCOUNT
INFORMATION A current corporate resolution must be maintained on file
at Vanguard at all times. Any revisions to a corporate
resolution must be submitted to your Service
Representative at Vanguard.
To change the registration of an account, a request must
be submitted in writing to Vanguard and include the
following information: the account number and Fund name,
authorized signatures, any applicable signature
guarantees, and other supporting legal documents as
necessary.
All requests should be mailed to the following address:
VANGUARD FINANCIAL CENTER
ATTN: INSTITUTIONAL INVESTOR SERVICES
P.O. BOX 1472
VALLEY FORGE, PA 19482-1472
- --------------------------------------------------------------------------------
16
<PAGE> 20
[THIS PAGE INTENTIONALLY LEFT BLANK.]
<PAGE> 21
Vanguard Institutional Index Fund
LOGO
- ---------------------------
THE VANGUARD GROUP
INSTITUTIONAL INVESTOR SERVICES
Vanguard Financial Center
P.O. Box 2900
Valley Forge, PA 19482
PARTICIPANT SERVICES
1-800-523-8066
TRANSFER AGENT:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
I094
- --------------------------------------------------------------------------------
<PAGE> 22
PART B
VANGUARD INSTITUTIONAL INDEX FUND
STATEMENT OF ADDITIONAL INFORMATION
MARCH 28, 1997
This Statement is not a prospectus but should be read in conjunction with the
Fund's Prospectus dated March 28, 1997. To obtain the Prospectus, please call:
INSTITUTIONAL INVESTOR SERVICES DEPARTMENT
1-800-523-8066
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................................... B-1
Investment Limitations.................................................................... B-4
Purchase of Shares........................................................................ B-5
Redemption of Shares...................................................................... B-6
Management and Advisory Services.......................................................... B-7
Portfolio Transactions.................................................................... B-9
Description of Shares and Voting Rights................................................... B-9
Financial Statements...................................................................... B-10
Yield and Total Return.................................................................... B-10
Performance Measures...................................................................... B-10
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
REPURCHASE AGREEMENTS The Fund may invest in repurchase agreements with
commercial banks, brokers or dealers to generate income from its excess cash
balances. A repurchase agreement is an agreement under which the Fund acquires a
money market instrument (generally a security issued by the U.S. Government or
an agency thereof, a banker's acceptance or a certificate of deposit) from a
commercial bank, broker or dealer, subject to resale to the seller at an agreed
upon price and date (normally, the next business day). A repurchase agreement
may be considered a loan collateralized by securities. The resale price reflects
an agreed upon interest rate effective for the period the instrument is held by
the Fund and is unrelated to the interest rate on the underlying instrument. In
these transactions, the securities acquired by the Fund (including accrued
interest earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by the Fund's custodial bank until
repurchased. In addition, the Board of Trustees will monitor the Fund's
repurchase agreement transactions generally and will establish guidelines and
standards for review of the creditworthiness of any bank, broker or dealer party
to a repurchase agreement with the Fund. No more than an aggregate of 15% of the
Fund's assets, at the time of investment, will be invested in repurchase
agreements having maturities longer than seven days and securities subject to
legal or contractual restrictions on resale for which there are no readily
available market quotations. From time to time, the Fund's Board of Directors
may determine that certain restricted securities known as Rule 144A securities
are liquid and not subject to the 15% limitation described above.
The use of repurchase agreements involves certain risks. For example, if the
other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Fund may incur a loss upon disposition of the security. If the other party to
the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Fund not within the control
of the Fund and therefore the Fund may not be able to substantiate its interest
in the underlying security and may be deemed an unsecured creditor of the other
party to the agreement. While the Fund's management acknowledges these risks, it
is expected that they can be controlled through careful monitoring procedures.
B-1
<PAGE> 23
LENDING OF SECURITIES The Fund may lend its securities on a short-term or
long-term basis to qualified institutional investors who need to borrow
securities in order to complete certain transactions, such as covering short
sales, avoiding failures to deliver securities, or completing arbitrage
operations. By lending its portfolio securities, the Fund attempts to increase
its net investment income through the receipt of interest on the loan. Any gain
or loss in the market price of the securities loaned that might occur during the
term of the loan would be for the account of the Fund. The Fund may lend its
portfolio securities to qualified brokers, dealers, banks or other financial
institutions, so long as the terms, the structure and the aggregate amount of
such loans are not inconsistent with the Investment Company Act of 1940, or the
Rules and Regulations or interpretations of the Securities and Exchange
Commission (the "Commission") thereunder, which currently require that (a) the
borrower pledge and maintain with the Fund collateral consisting of cash, a
letter of credit issued by a domestic U.S. bank, or securities issued or
guaranteed by the United States Government having at all times not less than
100% of the value of the securities loaned, (b) the borrower add to such
collateral whenever the price of the securities loaned rises (i.e., the borrower
"marks to the market" on a daily basis), (c) the loan be made subject to
termination by the Fund at any time and (d) the Fund receive reasonable interest
on the loan (which may include the Fund's investing any cash collateral in
interest-bearing short-term investments), any distribution on the loaned
securities and any increase in their market value. Loan arrangements made by the
Fund will comply with all other applicable regulatory requirements, including
the rules of the New York Stock Exchange, which rules presently require the
borrower, after notice, to redeliver the securities within the normal settlement
time of three business days. All relevant facts and circumstances, including the
creditworthiness of the broker, dealer or institution, will be considered in
making decisions with respect to the lending of securities, subject to review by
the Board of Trustees.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's trustees. In addition, voting rights pass
with the loaned securities, but if a material event will occur affecting an
investment on loan, the loan must be called and the securities voted.
FUTURES CONTRACTS The Fund may enter into futures contracts, options, and
options on futures contracts for the purpose of remaining fully invested and
reducing transactions costs. Futures contracts provide for the future sale by
one party and purchase by another party of a specified amount of a specific
security at a specified future time and at a specified price. Futures contracts
that are standardized as to maturity date and underlying financial instrument
are traded on national futures exchanges. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC"), a U.S. Government Agency. Assets committed to futures
contracts will be segregated at the Fund's custodian bank to the extent required
by law.
Although futures contracts by their terms call for actual delivery or acceptance
of the underlying securities, in most cases the contracts are closed out before
the settlement date without the making or taking of delivery. Closing out an
open futures position is done by taking an opposite position ("buying" a
contract that has previously been "sold," or "selling" a contract previously
purchased) in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements that are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on deposits which
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is marked
to market daily. If the futures contract price changes to the extent that the
margin on deposit does not satisfy margin requirements, payment of additional
"variation" margin will be required. Conversely, change in the contract value
may reduce the required margin, resulting in a repayment of excess margin to the
contract holder. Variation margin payments
B-2
<PAGE> 24
are made to and from the futures broker for as long as the contract remains
open. The Fund expects to earn interest income on its margin deposits.
The Fund will only use futures contracts and options to simulate full investment
in the underlying index while retaining a cash balance for Fund management
purposes.
Regulations of the CFTC applicable to the Fund require that all of its futures
transactions constitute bona fide hedging transactions. The Fund will only sell
futures contracts to protect securities it owns against price declines or
purchase contracts to protect against an increase in the price of securities it
intends to purchase. As evidence of this hedging interest, the Fund expects that
approximately 75% of its futures contract purchases will be "completed"; that
is, equivalent amounts of related securities will have been purchased or are
being purchased by the Fund upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts could
be used to control the Fund's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
the Fund will incur commission expenses in both opening and closing out futures
positions, these costs are lower than transaction costs incurred in the purchase
and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS The Fund will not enter into
futures contract transactions to the extent that, immediately thereafter, the
sum of its initial margin deposits on open contracts exceeds 5% of the market
value of its total assets.
RISK FACTORS IN FUTURES TRANSACTIONS Positions in futures contracts may be
closed out only on an Exchange that provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, the Fund would continue to be required to make daily cash payments to
maintain its required margin. In such situations, if the Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, the Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions could also have an
adverse impact on the ability to effectively hedge it.
The Fund will minimize the risk that it will be unable to close out a futures
contract by only entering into futures that are traded on national futures
exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required and the extremely high
degree of leverage involved in futures pricing. As a result, a relatively small
price movement in a futures contract may result in immediate and substantial
loss (as well as gain) to the investor. For example, if at the time of purchase,
10% of the value of the futures contract is deposited as margin, a subsequent
10% decrease in the value of the futures contract would result in a total loss
of the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
150% of the original margin deposit if the contract were closed out. Thus, a
purchase or sale of a futures contract may result in losses in excess of the
amount invested in the contract. However, because the futures strategy of the
Fund is engaged in only for hedging purposes, the Fund's officers do not believe
that the Fund is subject to the risks of loss frequently associated with futures
transactions. The Fund would presumably have sustained comparable losses if,
instead of the futures contract, it had invested in the underlying financial
instrument and sold it after the decline.
Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that the Fund could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a futures contract or related
option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit
B-3
<PAGE> 25
has been reached in a particular type of contract, no trades may be made on that
day at a price beyond that limit. The daily limit governs only price movement
during a particular trading day and therefore does not limit potential losses,
because the limit may prevent the liquidation of unfavorable positions. Futures
contract prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of future positions and subjecting some futures traders to
substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS The Fund is required for federal
income tax purposes to recognize as income for each taxable year its net
unrealized gains and losses on certain futures contracts as of the end of the
year as well as those actually realized during the year. In most cases, any gain
or loss recognized with respect to a futures contract is considered to be 60%
long-term capital gain or loss and 40% short-term capital gain or loss, without
regard to the holding period of the contract. Furthermore, sales of futures
contracts which are intended to hedge against a change in the value of
securities held by the Fund may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. The Fund may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Fund.
In order for the Fund to continue to qualify for federal income tax treatment as
a regulated investment company, at least 90% of its gross income for a taxable
year must be derived from qualifying income; i.e., dividends, interest, income
derived from loans of securities, gains from the sale of securities or of
foreign currencies or other income derived with respect to the Fund's business
of investing in securities. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of the Fund's annual gross income. It is anticipated that any net
gain realized from the closing out of futures contracts will be considered gain
from the sale of securities and therefore be qualifying income for purposes of
the 90% requirement. In order to avoid realizing excessive gains on securities
held less than three months, the Fund may be required to defer the closing out
of futures contracts beyond the time when it would otherwise be advantageous to
do so. It is anticipated that unrealized gains on futures contracts, which have
been open for less than three months as of the end of the Fund's fiscal year and
which are recognized for tax purposes, will not be considered gains on sales of
securities held less than three months for the purpose of the 30% test.
The Fund will distribute to shareholders annually any net capital gains which
have been recognized for federal income tax purposes (including unrealized gains
at the end of the Fund's fiscal year) on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Fund's other investments and shareholders will be advised on the nature of
the distributions.
INVESTMENT LIMITATIONS
Except as indicated otherwise below, the following restrictions and fundamental
policies cannot be changed without approval of the holders of a majority of the
outstanding shares of the Fund (as defined in the Investment Company Act of 1940
(the "1940 Act")). The Fund may not under any circumstances:
1) change its investment objective, which is to provide investment results that
correspond to the price and yield performance of publicly-traded common
stocks;
2) change its investment policy, which is to attempt to duplicate the
performance of Standard & Poor's 500 Composite Stock Price Index by owning
as many of the 500 stocks contained in the index as is feasible;
3) invest in commodities or purchase real estate, although it may purchase
securities of companies which deal in real estate or interests therein
except that the Fund may invest in stock index futures contracts, stock
options and options on stock index futures contracts to that extent that not
more than 5% of the Fund's assets are required as margin deposit for such
futures contracts;
4) lend money to any person except (i) by purchasing a portion of an issue of
short-term debt securities or similar obligations (including repurchase
agreements) which are publicly distributed or customarily purchased by
institutional investors, and (ii) as provided under "Lending of Securities";
5) purchase securities on margin or sell securities short except as described
in limitation number "3";
B-4
<PAGE> 26
6) with respect to 75% of the Fund's assets, purchase more than 10% of the
outstanding voting securities of any company, or purchase securities of any
issuer (except obligations of the United States Government and its
instrumentalities), if as a result, more than 5% of the value of the
Portfolio's total assets would be invested in the securities of such issuer;
7) borrow money, except that the Fund may borrow from banks (or through reverse
repurchase agreements), for temporary or emergency (not leveraging)
purposes, including the meeting of redemption requests which might otherwise
require the untimely disposition of securities, in an amount not exceeding
15% of the value of the Fund's net assets (including the amount borrowed and
the value of any outstanding reverse repurchase agreements) at the time the
borrowing is made. Whenever borrowings exceed 5% of the value of the Fund's
net assets, the Fund will not make any additional investments;
8) pledge, mortgage or hypothecate the Fund's assets to an extent greater than
5% of its total assets;
9) invest in securities of other investment companies, except as they may be
acquired as a part of a merger, consolidation or acquisition of assets
approved by the Fund's shareholders or otherwise to the extent permitted by
Section 12 of the 1940 Act. The Fund will invest only in investment
companies which have investment objectives and policies consistent with
those of the Fund;
10) invest for the purpose of controlling management of any company;
11) engage in the business of underwriting securities issued by other persons,
except to the extent that the Fund may technically be deemed to be an
underwriter under the Securities Act of 1933, as amended, in disposing of
portfolio securities;
12) invest more than 25% of the value of its total assets in any one industry;
13) invest in put, call, straddle or spread options or in interests in oil, gas
or other mineral exploration or development programs, except as set forth in
limitation number "3" above; and
14) purchase or otherwise acquire any security if, as a result, more than 15% of
its net assets would be invested in securities that are illiquid.
These investment limitations are considered at the time investment securities
are purchased. Notwithstanding these limitations, the Fund may own all or any
portion of the securities of, or make loans to, or contribute to the costs or
other financial requirements of any company which will be wholly owned by the
Fund and one or more other investment companies and is primarily engaged in the
business of providing, at-cost, management, administrative, distribution or
related services to the Fund and other investment companies.
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the offerings
of its shares, (ii) to reject purchase orders when in the judgment of management
such rejection is in the best interest of the Fund, and (iii) to reduce or waive
the minimum investment for or any other restrictions on initial and subsequent
investments for certain fiduciary accounts or under circumstances where certain
economies can be achieved in sales of the Fund's shares.
EXCHANGE OF SECURITIES FOR SHARES OF THE FUND In certain circumstances, shares
of the Fund may be purchased in exchange for common stocks. Such common stocks
must be included in the appropriate Index and have a market value in excess of
$10,000. Securities accepted by the Fund will be valued as set forth under "The
Fund's Share Price" in the Fund's prospectus as of the time of the next
determination of net asset value after such acceptance. Shares of the Fund are
issued at net asset value determined as of the same time. All dividends,
subscription, or other rights which are reflected in the market price of
accepted securities at the time of valuation become the property of the Fund and
must be delivered to the Fund by the investor upon receipt from the issuer. A
gain or loss for Federal income tax purposes would be realized by the investor
upon the exchange depending upon the cost of the securities tendered.
The Fund will not accept securities in exchange for its shares unless: (1) such
securities are, at the time of the exchange, included in the Fund; (2) such an
exchange will not cause the Fund's weightings to become imbalanced with respect
to the weightings of the stocks included in the Index; (3) the investor
represents and
B-5
<PAGE> 27
agrees that all securities offered to the Fund are not subject to any
restrictions upon their sale by the Fund under the Securities Act of 1933, or
otherwise; (4) such securities are traded in an unrelated transaction with a
quoted sales price on the same day the exchange valuation is made; (5) the
quoted sales price used as a basis of valuation is representative (i.e., one
that does not involve a trade of substantial size which artificially influences
the price of the security); and (6) the value of any such security being
exchanged will not exceed 5% of the Fund's net assets immediately prior to the
transaction.
Investors interested in such purchases should contact the Fund.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment (i)
during any period that the New York Stock Exchange is closed, or trading on the
Exchange is restricted as determined by the Securities and Exchange Commission
(the "Commission"), (ii) during any period when an emergency exists as defined
by the rules of the Commission as a result of which it is not reasonably
practicable for the Fund to dispose of securities owned by it, or fairly to
determine the value of its assets, and (iii) for such other periods as the
Commission may permit.
No charge is made by the Fund for redemptions. Any redemption may be more or
less than the shareholder's cost depending on the market value of the securities
held.
The Fund has made an election with the Commission to pay in cash all redemptions
requested by any shareholder of record limited in amount during any 90-day
period to the lesser of $250,000 or 1% of the net assets of the Fund at the
beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part investment securities or in cash as the Fund may deem
appropriate, however, payment will be made wholly in cash unless the Trustees
believe that economic or market conditions exist which would make such a
practice detrimental to the best interests of the Fund. If redemptions are paid
in investment securities, such securities will be valued as set forth in the
Prospectus under "The Fund's Share Price" and a redeeming shareholder would
normally incur brokerage expenses if he converted these securities to cash.
B-6
<PAGE> 28
MANAGEMENT AND ADVISORY SERVICES
TRUSTEES AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are responsible to
the Fund's Trustees. The Trustees set broad policies for the Fund and choose its
Officers. The following is a list of Trustees and Officers of the Fund and a
statement of their present positions and principal occupations during the past
five years. The mailing address of the Fund's Trustees and Officers is Post
Office Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman and Trustee*
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group; Director of The Mead
Corporation, General Accident Insurance, and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive
Officer & Trustee*
President, Chief Executive Officer and Director of The Vanguard Group,
Inc., and of each of the other investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Trustee
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Director of
Sun Company, Inc.; Director of Westinghouse Electric Corporation.
BARBARA BARNES HAUPTFUHRER, Trustee
Director of The Great Atlantic and Pacific Tea Company, Alco Standard
Corp., Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Co. and Trustee Emerita of Wellesly College.
BRUCE K. MACLAURY, Trustee
President Emeritus of The Brookings Institution; Director of American
Express Bank, Ltd., The St. Paul Companies, Inc. and National Steel
Company.
BURTON G. MALKIEL, Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co. and Southern New England Communications
Company.
ALFRED M. RANKIN, JR., Trustee
Chairman, President and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company, and The Standard Products Company.
JOHN C. SAWHILL, Trustee
President and Chief Executive Officer, the Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co.; President, New York
University; Director of Pacific Gas and Electric Company, Procter & Gamble
Company and NACCO Industries.
JAMES O. WELCH, JR., Trustee
Retired Chairman of Nabisco Brands, Inc., retired Vice Chairman and
Director of RJR Nabisco; Director of TECO Energy, Inc.; and Director of
Kmart Corporation.
J. LAWRENCE WILSON, Trustee
Chairman and Chief Executive Officer of Rohm & Hass Company; Director of
Cummins Engine Company; and Trustee of Vanderbilt University.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary
of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc., and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ---------------
*Mr. Bogle and the Officers of the Fund are "interested persons" as defined in
the Investment Company Act of 1940.
B-7
<PAGE> 29
REMUNERATION OF TRUSTEES AND OFFICERS
The Fund's Trustees and Officers receive no direct remuneration from the Fund.
However, the Trustees do receive remuneration for their service as Directors or
Trustees of the Funds comprising the Vanguard Group of Investment Companies. The
following table provides detailed information with respect to the aggregate
amounts paid or accrued for the Trustees by the Vanguard Funds for the fiscal
year ended December 31, 1996.
COMPENSATION TABLE
<TABLE>
<CAPTION>
ESTIMATED TOTAL COMPENSATION
ANNUAL BENEFITS FROM ALL VANGUARD FUNDS
NAME OF TRUSTEES UPON RETIREMENT PAID TO TRUSTEES(2)
- ---------------- --------------- -----------------------
<S> <C> <C>
John C. Bogle(1) -- --
John J. Brennan(1) -- --
Barbara Barnes Hauptfuhrer $15,000 $65,000
Robert E. Cawthorn $13,000 $65,000
Bruce K. MacLaury $12,000 $60,000
Burton G. Malkiel $15,000 $65,000
Alfred M. Rankin, Jr. $15,000 $65,000
John C. Sawhill $15,000 $65,000
James O. Welch, Jr. $15,000 $65,000
J. Lawrence Wilson $15,000 $65,000
</TABLE>
- ---------------
(1) As "Interested Trustees," Messrs. Bogle and Brennan receive no compensation
for their service as Trustees.
(2) The amounts reported in this column reflect the total compensation paid to
each Trustee for their service as Director or Trustee of 34 Vanguard funds
(33 in the case of Mr. Malkiel; 27 in the case of Mr. MacLaury).
THE VANGUARD GROUP
The Fund currently employs The Vanguard Group, Inc. ("Vanguard") to provide
management, administrative and investment advisory services. Vanguard also
provides virtually all of the corporate management, administrative, and
distribution services for The Vanguard Group of Investment Companies, a family
of more than 30 investment companies with more than 90 distinct investment
portfolios and total assets in excess of $250 billion. Vanguard also provides
investment advisory services to certain Vanguard Funds.
Vanguard employs a supporting staff of management and administrative personnel
needed to provide the requisite services to the Fund and also furnishes the Fund
with the necessary office space, furnishings and equipment.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines substantially similar to
those recommended by the mutual fund industry and approved by the U.S.
Securities and Exchange Commission.
The Fund receives all investment advisory services from Vanguard's Core
Management Group. The Core Management Group manages the investment and
reinvestment of the Fund's assets and continuously reviews, supervises, and
administers the Fund's investment program with respect to those assets. The Core
Management Group discharges its responsibilities subject to the control of the
Officers and Trustees of the Fund.
The Core Management Group also provides investment advisory services to several
Vanguard Funds, including Vanguard Index Trust, Vanguard Balanced Index Fund,
Vanguard International Equity Index Fund, Vanguard REIT Index, Vanguard Treasury
Fund, the Growth and Income and Capital Appreciation Portfolios and the equity
portion of the Balanced Portfolio of Vanguard Tax-Managed Fund, the Aggressive
Growth Portfolio of Vanguard Horizon Fund, Vanguard Variable Insurance
Fund-Equity Index Portfolio, and a portion of Vanguard/Windsor II, a portion of
Vanguard/Morgan Growth Fund as well as to several indexed separate accounts.
Total assets under management by the Core Management Group were approximately
$57 billion as of December 31, 1996. The
B-8
<PAGE> 30
Fund is not actively managed, but is instead administered by the Core Management
Group, using computerized, quantitative techniques.
Under the terms of the service and advisory agreement, Vanguard pays all of the
Fund's expenses, except for taxes and brokerage commissions. In turn, the Fund
pays Vanguard a fee at the end of each fiscal quarter, calculated by applying a
quarterly rate, based on the following annual percentage rates, to the average
daily net assets for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
------------------- ----
<S> <C>
First $500 million .09%
Next $500 million .07%
Over $1 billion .06%
</TABLE>
For the years ended December 31, 1994, 1995, and 1996, the Fund paid
approximately $2,044,000, $3,057,000, and $5,580,669 respectively, to Vanguard
for services rendered under the Agreement.
PORTFOLIO TRANSACTIONS
In placing portfolio transactions, the Core Management Group uses its best
judgment to choose the broker most capable of providing the brokerage services
necessary to obtain best available price and most favorable execution. The full
range and quality of brokerage services available are considered in making these
determinations. In those instances where it is reasonably determined that more
than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration will be given to
those brokers which supply statistical information and provide other services in
addition to execution services to the Fund.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be made through such
firms. However, the Fund may place portfolio orders with qualified
broker-dealers who recommend the Fund to clients, and may, when a number of
brokers and dealers can provide best price and execution on a particular
transaction, consider the sale of Fund shares by a broker or dealer in selecting
among broker dealers. For the years ended December 31, 1994, 1995, and 1996, the
Fund paid $314,246, $496,995, and $862,036 respectively, in brokerage
commissions.
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Declaration of Trust permits the Trustees to issue an unlimited number of
shares of beneficial interest, without par value. The Board of Trustees has the
power to designate one or more classes ("Series") of shares and to classify or
reclassify any unissued shares with respect to such series. Currently the Fund
is offering shares of one series.
The shares of the Fund are fully paid and nonassessable, except as set forth
under "Shareholder and Trustee Liability," and have no preference as to
conversion, exchange, dividends, retirement or other features. The shares of the
Fund have no pre-emptive rights. The shares of the Fund have non-cumulative
voting rights, which means that the holders of more than 50% of the shares
voting for the election of Trustees can elect 100% of the Trustees if they
choose to do so. A shareholder is entitled to one vote for each full share held
(and a fractional vote for each fractional share held), then standing in his
name on the books of the Fund. On any matter submitted to a vote of
shareholders, all shares of the Fund then issued and outstanding and entitled to
vote, irrespective of the class, shall be voted in the aggregate and not by
class; except (i) when required by the 1940 Act, shares shall be voted by
individual class; and (ii) when the matter does not affect any interest of a
particular class, then only shareholders of the affected class or classes shall
be entitled to vote thereon.
B-9
<PAGE> 31
The Fund will continue without limitation of time, provided however that:
(1) Subject to the majority vote of the holders of shares of the Fund
outstanding, the Trustees may sell or convert the assets of the Fund to
another investment company in exchange for shares of such investment
company and distribute such shares ratably among the shareholders of the
Fund;
(2) Subject to the majority vote of shares of the Fund outstanding,
the Trustees may sell and convert into money the assets of the Fund and
distribute such assets ratably among the shareholders of the Fund; and
(3) Without the approval of the shareholders of the Fund, unless
otherwise required by law, the Trustees may combine the assets of any two
or more Portfolios into a single Portfolio so long as such combination will
not have a material adverse effect upon the shareholders of such Portfolio.
Upon completion of the distribution of the remaining proceeds or the remaining
assets of any Portfolio as provided in paragraphs 1), 2), 3) above the Trust
shall terminate as to that Portfolio and the Trustees shall be discharged of any
and all further liabilities and duties hereunder and the right, title and
interest of all parties shall be cancelled and discharged.
SHAREHOLDER AND TRUSTEE LIABILITY Under Pennsylvania law, shareholders of such
a Trust may, under certain circumstances, be held personally liable as partners
for the obligations of the Trust. Therefore, the Declaration of Trust contains
an express disclaimer of shareholder liability for acts or obligations of the
Trust and requires that notice of such disclaimer be given in each agreement,
obligation, or instrument entered into or executed by the Trust or the Trustees.
The Declaration of Trust provides for indemnification out of the Trust property
of any shareholder held personally liable for the obligations of the Trust. The
Declaration of Trust also provides that the Trust shall, upon request, assume
the defense of any claim against any shareholder for any act or obligation of
the Trust and satisfy any judgment thereon. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Trust itself would be unable to meet
its obligations.
The Declaration of Trust further provides that the Trustees will not be liable
for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of his
office.
FINANCIAL STATEMENTS
The Fund's financial statements for the year ended December 31, 1996, including
the financial highlights for each of the periods, appearing in the Vanguard
Institutional Index Fund 1996 Annual Report to Shareholders, and the report
thereon of Price Waterhouse LLP, independent accountants, also appearing
therein, are incorporated by reference in this Statement of Additional
Information. The Fund's 1996 Annual Report to Shareholders is enclosed with this
Statement of Additional Information.
YIELD AND TOTAL RETURN
The average annual total return of the Fund for one year, three years and five
years and since inception on July 31, 1990 was +23.06%, +19.71%, +15.21% and
+15.30%, respectively. The annualized yield for the thirty days ended December
31, 1996 was +1.97%.
PERFORMANCE MEASURES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or any
of the member funds of The Vanguard Group of Investment Companies.
The Fund may from time to time use one or more of the following unmanaged
indices for comparative performance purposes.
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX -- is a well diversified list
of 500 companies representing the U.S. Stock Market.
B-10
<PAGE> 32
WILSHIRE 5000 EQUITY INDEX -- consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
WILSHIRE 4500 EQUITY INDEX -- consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard & Poor's 500 Index.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX -- is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX -- currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
SALOMON BROTHERS GNMA INDEX -- includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National Mortgage
Association.
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX -- consists of publicly issued,
non-convertible corporate bonds rated Aa or Aaa. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
LEHMAN LONG-TERM TREASURY BOND -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND -- consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
LEHMAN CORPORATE (Baa) BOND INDEX -- all publicly offered fixed-rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
BOND BUYER MUNICIPAL BOND INDEX (20 YEAR) -- is a yield index on current coupon
high-grade general obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX -- is a yield index based upon the average
yield of four high-grade, non-callable preferred stock issues.
NASDAQ INDUSTRIAL INDEX -- is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX -- 70% Standard & Poor's 500 Index, 30% NASDAQ Industrial Index.
COMPOSITE INDEX -- 65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
COMPOSITE INDEX -- 65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index and 12.5% Standard & Poor's Utilities Index and 12.5% Standard and Poor's
Telephone Index).
LEHMAN LONG-TERM CORPORATE AA OR BETTER BOND INDEX -- consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
LEHMAN BROTHERS AGGREGATE BOND INDEX -- is a market weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass-through
securities corporate rated BBB- or better. The Index has a market value of over
$4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX -- is a
market weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities
between 1 and 5 years. The index has a market value of over $1.6 trillion.
B-11
<PAGE> 33
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX -- is
a market weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities between 5 and 10
years. The index has a market value of over $700 billion.
LEHMAN BROTHERS MUTUAL FUND LONG (10+) GOVERNMENT/CORPORATE INDEX -- is a market
weighted index that contains individually priced U.S. Treasury, agency, and
corporate securities rated BBB- or better with maturities greater than 10 years.
The index has a market value of over $900 billion.
B-12
