============================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-1A
REGISTRATION STATEMENT (NO. 33-34261) UNDER
THE SECURITIES ACT OF 1933
Pre-Effective Amendment No.
Post-Effective Amendment No. 8
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
Amendment No. 9
VANGUARD OHIO
TAX-FREE FUND
(Exact Name of Registrant as Specified in Charter)
P.O. Box 2600
Valley Forge, PA 19482
(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 hereby requested that this filing become effective
on March 27, 1998, 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 November 30, 1997 on February 27, 1998.
==============================================================================
<PAGE>
VANGUARD OHIO TAX-FREE FUND
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<S> <C>
Item 1. Cover Page ....................................................Cover Page
Item 2. Synopsis ......................................................Portfolio Expenses
Item 3. Condensed Financial Information ...............................Financial Highlights
Item 4. General Description of Registrant .............................Portfolio Profile; The Portfolios'
Objectives; Who Should Invest; Investment
Strategy; Investment Limitations; Investment
Policies; Investment Performance; General
Information
Item 5. Management of the Fund ........................................The Portfolios and Vanguard; Investment
Adviser
Item 5A. Management's Discussion of Fund Performance ..................Herein incorporated by reference to
Registrant's Annual Report to Shareholders
dated November 30, 1997 filed with the
Securities & Exchange Commission's EDGAR
system on January 23, 1998
Item 6. Capital Stock and Other Securities ............................Investing with Vanguard; Buying Shares;
Redeeming Shares; Share Price; Dividends,
Capital Gains and Taxes; Distribution
Options; General Information
Item 7. Purchase of Securities Being Offered ..........................Cover Page; Investing with Vanguard; Buying
Shares
Item 8. Redemption or Repurchase ......................................Redeeming Shares
Item 9. Pending Legal Proceedings .....................................Not Applicable
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
Item 10. Cover Page ...................................................Cover Page
Item 11. Table of Contents ............................................Cover Page
Item 12. General Information and History ..............................Investment Limitations; Investment Policies
Item 13. Investment Objective and Policies ............................Investment Limitations; Investment Policies
Item 14. Management of the Registrant .................................Management of the Fund
Item 15. Control Persons and Principal Holders of
Securities ...................................................Management of the Fund
Item 16. Investment Advisory and Other Services .......................Management of the Fund; Investment
Management
Item 17. Brokerage Allocation .........................................Portfolio Transactions
Item 18. Capital Stock and Other Securities ...........................Description of Shares and Voting Rights
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered ................................................Purchase of Shares; Redemption of
Shares; Share Price
Item 20. Tax Status ...................................................Not Applicable
Item 21. Underwriters .................................................Not Applicable
Item 22. Calculations of Performance Data .............................Yield and Total Return; Calculation of Yield
Item 23. Financial Statements .........................................Financial Statements
</TABLE>
<PAGE>
VANGUARD
OHIO TAX-FREE
FUND
Prospectus
[VANGUARD LOGO]
March 27, 1998
MONEY MARKET
PORTFOLIO
INSURED LONG-TERM
PORTFOLIO
This prospectus contains financial data for the Fund through the fiscal year
ended November 30, 1997.
<PAGE>
A Federal and Ohio State Tax-Exempt
Income Mutual Fund
VANGUARD OHIO TAX-FREE FUND
CONTENTS
Portfolio Profile 1
Portfolio Expenses 3
Financial Highlights 4
A Word About Risk 5
The Portfolios'
Objectives 6
Who Should Invest 6
Investment Strategy 7
Investment Policies 10
Investment Limitations 12
Investment
Performance 12
Share Price 13
Dividends, Capital
Gains, and Taxes 13
The Portfolios and
Vanguard 14
Investment Adviser 15
General Information 15
Investing with
Vanguard 16
Services and
Account Features 16
Types of Accounts 17
Distribution Options 17
Buying Shares 18
Redeeming Shares 20
Transferring
Registration 23
Portfolio and Account
Updates 23
Glossary Inside Back Cover
INVESTMENT OBJECTIVES AND POLICIES
Vanguard Ohio Tax-Free Fund (the "Fund") is a nondiversified, open-end
investment company that includes two separate mutual fund portfolios: the Money
Market Portfolio and the Insured Long-Term Portfolio (the "Portfolios").
Each Portfolio, intended for Ohio residents only, seeks to provide income
that is exempt from both federal and Ohio personal income taxes. The Money
Market Portfolio also seeks to maintain a constant net asset value of $1 per
share. The Money Market Portfolio emphasizes stability; the Insured Long-Term
Portfolio emphasizes income over stability.
IT IS IMPORTANT TO NOTE THAT ALTHOUGH THE MONEY MARKET PORTFOLIO SEEKS TO
MAINTAIN A STABLE NET ASSET VALUE OF $1 PER SHARE, THIS VALUE IS NOT GUARANTEED.
IN ADDITION, THE PORTFOLIOS' SHARES ARE NOT GUARANTEED OR INSURED BY THE FDIC OR
ANY OTHER AGENCY OF THE U.S. GOVERNMENT OR THE STATE OF OHIO. ALTHOUGH THE
INTEREST AND PRINCIPAL PAYMENTS FOR AT LEAST 80% OF THE BONDS IN THE INSURED
LONG-TERM PORTFOLIO ARE GUARANTEED, THE VALUE OF THE BONDS THEMSELVES IS NOT
GUARANTEED. AS WITH ANY INVESTMENT IN BONDS, WHICH ARE SENSITIVE TO CHANGES IN
INTEREST RATES, YOU COULD LOSE MONEY BY INVESTING IN EITHER OF THE PORTFOLIOS.
FEES AND EXPENSES
The Portfolios are offered on a no-load basis, which means that you pay no sales
commissions or 12b-1 marketing fees. You will, however, incur expenses for
investment advisory, management, administrative, and distribution services,
which are included in each Portfolio's expense ratio.
ADDITIONAL INFORMATION ABOUT THE PORTFOLIOS
A Statement of Additional Information (dated March 27, 1998) containing more
information about the Portfolios is, by reference, part of this prospectus and
may be obtained without charge by writing to Vanguard, calling our Investor
Information Department at 1-800-662-7447, or visiting the Securities and
Exchange Commission's website (www.sec.gov).
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objectives, risks, and strategy of each Portfolio
of Vanguard Ohio Tax-Free Fund. To highlight terms and concepts important to
mutual fund investors, we have provided "Plain Talk" explanations along the way.
Reading the prospectus will help you to decide which Portfolio, if any, is the
right investment for you. We suggest that you keep it for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<PAGE>
PORTFOLIO PROFILE
WHO SHOULD INVEST (page 6)
o Ohio residents seeking a municipal bond mutual fund as part of a balanced and
diversified investment program.
o Income-oriented Ohio residents in a high tax bracket.
WHO SHOULD NOT INVEST
o Investors primarily seeking growth of their investment over time.
o Investors unwilling to accept significant fluctuations in share price (this
applies only to the Insured Long-Term Portfolio).
o Investors in a retirement account.
RISKS OF THE PORTFOLIOS (pages 5-11)
Both Portfolios are subject to income risk (the chance that falling interest
rates will cause a Portfolio's income to decline) and objective risk (the chance
that a particular segment of the municipal bond market--such as long-term or
Ohio-issued bonds--will trail returns from the overall municipal bond market).
The Insured Long-Term Portfolio is also subject to interest rate risk (the
chance that bond prices will decline because of rising interest rates).
The Money Market Portfolio seeks to maintain, but does not guarantee, a
constant net asset value of $1 per share. The Money Market Portfolio may invest
a significant portion of its assets in a single issuer. As a result, the
Portfolio is riskier than other types of money market funds that require greater
diversification among issuers. The Insured Long-Term Portfolio's total return
will fluctuate within a wide range, so an investor could lose money over short
or even extended periods. More detailed information about risk--including risks
specific to each Portfolio--is provided beginning on page 5.
DIVIDENDS AND CAPITAL GAINS (page 13)
Dividends are declared daily and paid on the first business day of each month.
Capital gains, if any, are paid annually in December.
INVESTMENT ADVISER (page 15)
Vanguard Fixed Income Group, Valley Forge, Pa., manages both Portfolios.
MINIMUM INITIAL INVESTMENT: $3,000; $1,000 for custodial accounts for minors.
ACCOUNT FEATURES (page 16)
o Telephone Redemption
o Checkwriting
o Vanguard Direct Deposit Service(TM)
o Vanguard Automatic Exchange Service(sm)
o Vanguard Fund Express(sm)
o Vanguard Dividend Express(sm)
AVERAGE ANNUAL TOTAL RETURNS--
PERIODS ENDED NOVEMBER 30, 1997
<TABLE>
<CAPTION>
SINCE
1 YEAR 5 YEARS INCEPTION*
----------------------------
<S> <C> <C> <C>
Ohio Money Market Portfolio 3.5% 3.1% 3.5%
Lipper Ohio Tax-Exempt
Money Market Average 3.2 2.9 3.3
Ohio Insured Long-Term
Portfolio 6.3% 7.1% 8.3%
Lipper Ohio Tax-Exempt
Municipal Bond Average 6.2 6.6 7.5
- ----------------------------------------------------------------------
*June 18, 1990.
</TABLE>
IN EVALUATING PAST PERFORMANCE, REMEMBER THAT IT IS NOT INDICATIVE OF FUTURE
PERFORMANCE. PERFORMANCE FIGURES INCLUDE THE REINVESTMENT OF ANY DIVIDEND AND
CAPITAL GAINS DISTRIBUTIONS. THE RETURNS SHOWN ARE NET OF EXPENSES. NOTE, TOO,
THAT BOTH THE RETURN AND (EXCEPT FOR THE MONEY MARKET PORTFOLIO) PRINCIPAL VALUE
OF AN INVESTMENT WILL FLUCTUATE, SO INVESTORS' SHARES, WHEN REDEEMED, MAY BE
WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
1
<PAGE>
PORTFOLIO PROFILE (continued)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
INSURED
MONEY MARKET LONG-TERM
- ------------------------------------------------------------------------------
<S> <C> <C>
INCEPTION DATE: 6/18/1990 6/18/1990
NET ASSETS AS OF 11/30/1997: $298 million $253 million
PORTFOLIO EXPENSE RATIO FOR THE
YEAR ENDED 11/30/1997: 0.19% 0.17%
LOADS, 12B-1 MARKETING FEE: None None
SUITABLE FOR IRAS: NO NO
NEWSPAPER ABBREVIATION: VangOH* OHInsLT
CUSIP NUMBER: 921929105 921929204
QUOTRON SYMBOL: VOHXX.Q VOHIX.Q
VANGUARD FUND NUMBER: 096 097
- ------------------------------------------------------------------------------
*Money market funds are listed separately from the daily mutual fund listings.
</TABLE>
2
<PAGE>
PLAIN TALK ABOUT
THE COSTS OF INVESTING
Costs are an important consideration in choosing a mutual
fund. That's because you, as a shareholder, pay the costs of
operating a fund plus any transaction costs associated with
buying, selling, or exchanging shares. These costs can erode
a substantial portion of the gross income or capital
appreciation a fund achieves. Even seemingly small
differences in fund expenses can, over time, have a dramatic
impact on a fund's performance.
PORTFOLIO EXPENSES
The examples below are designed to help you understand the various costs you
would bear, directly or indirectly, as an investor in one or both of the
Portfolios.
As noted in this table, you do not pay fees of any kind when you buy, sell,
or exchange shares of the Portfolios:
SHAREHOLDER TRANSACTION EXPENSES
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
The next table illustrates the operating expenses that you would incur as a
shareholder of either Portfolio. These expenses are deducted from the
Portfolio's income before it is paid to you. Expenses include investment
advisory fees as well as the costs of maintaining accounts, administering a
Portfolio, providing shareholder services, and other activities. The expenses
shown in the table are based upon those incurred in the fiscal year ended
November 30, 1997.
ANNUAL PORTFOLIO OPERATING EXPENSES
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
MONEY INSURED
MARKET LONG-TERM
- ------------------------------------------------------------------------------
<S> <C> <C>
Management and Administrative Expenses: 0.14% 0.13%
Investment Advisory Expenses: 0.01% 0.01%
12b-1 Marketing Fees: None None
Other Expenses
Marketing and Distribution Costs: 0.03% 0.02%
Fund Insurance: None None
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.01% 0.01%
---- ----
Total Other Expenses: 0.04% 0.03%
---- ----
TOTAL OPERATING EXPENSES (EXPENSE RATIO): 0.19% 0.17%
==== ====
</TABLE>
PLAIN TALK ABOUT
FUND EXPENSES
All mutual funds have operating expenses.
These expenses, which are deducted from a
fund's gross income, are expressed as a
percentage of the net assets of the fund. For
example, the Insured Long-Term Portfolio's
expense ratio in fiscal year 1997 was 0.17%,
or $1.70 per $1,000 of average net assets.
The average tax-exempt bond mutual fund
(excluding money market funds) had expenses
in 1997 of 1.03%, or $10.30 per $1,000 of
average net assets, according to Lipper
Analytical Services, which reports on the
mutual fund industry.
3
<PAGE>
The following example is intended to help you compare the cost of investing
in a Portfolio with the cost of investing in other mutual funds, by illustrating
the hypothetical expenses that you would incur on a $1,000 investment over
various periods. The example assumes that (1) the Portfolio provides a return of
5% a year and (2) you redeem your investment at the end of each period.
<TABLE>
<CAPTION>
- ------------------------------------------------------------
PORTFOLIO 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------------------------------------------------------------
<S> <C> <C> <C> <C>
Money Market $2 $6 $11 $24
Insured Long-Term $2 $5 $10 $22
- ------------------------------------------------------------
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE, WHICH MAY BE HIGHER OR LOWER THAN
THOSE SHOWN.
FINANCIAL HIGHLIGHTS
The following financial highlights tables show the results for a share
outstanding of each Portfolio for each period since the Portfolio's inception on
June 18, 1990. The financial statements that include these finanCial highlights
were audited by Price Waterhouse LLP, independent accountants. You should read
this information in conjunction with each Portfolio's financial statements and
accompanying notes, which appear, along with the audit report from Price
Waterhouse, in the Fund's most recent annual report to shareholders. The annual
report is incorporated by reference in the Statement of Additional Information
and in this prospectus, and contains a more complete discussion of each
Portfolio's performance. You may have the report sent to you without charge by
writing to Vanguard or by calling our Investor Information Department.
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
This explanation uses the Money Market Portfolio as an
example. The Portfolio began fiscal 1997 with a net asset
value (price) of $1 per share. During the year, the
Portfolio earned $0.034 per share from investment income
(interest and dividends). All of these earnings were
returned to shareholders in the form of dividend
distributions. The earnings ($0.034 per share) less
distributions ($0.034 per share) resulted in a share price
of $1 at the end of the fiscal year. Assuming that the
shareholder had reinvested the distributions in the purchase
of more shares, total return from the Portfolio was 3.49%
for the year.
As of November 30, 1997, the Portfolio had $298 million
in net assets; an expense ratio of 0.19% ($1.90 per $1,000
of net assets); and net investment income amounting to 3.43%
of its average net assets.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
MONEY MARKET PORTFOLIO
---------------------------------------------------------
YEAR ENDED NOVEMBER 30, JUNE 18,*
1997 1996 1995 1994 1993 1992 1991 NOV. 30, 1990
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .034 .034 .037 .026 .023 .030 .045 .027
Net Realized and Unrealized Gain (Loss) on Investments - - - - - - - -
------------------------------------------------------------------------
TOTAL FROM INVESTMENT OPERATIONS .034 .034 .037 .026 .023 .030 .045 .027
- ------------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.034) (.034) (.037) (.026) (.023) (.030) (.045) (.027)
Distributions from Realized Capital Gains - - - - - - - -
------------------------------------------------------------------------
TOTAL DISTRIBUTIONS (.034) (.034) (.037) (.026) (.023) (.030) (.045) (.027)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
====================================================================================================================================
TOTAL RETURN 3.49% 3.42% 3.78% 2.58% 2.37% 3.01% 4.64% 2.59%
====================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $298 $254 $178 $147 $132 $92 $79 $37
Ratio of Total Expenses to Average Net Assets 0.19% 0.20% 0.21% 0.23% 0.21% 0.31% 0.26% 0.23**
Ratio of Net Investment Income to Average Net Assets 3.43% 3.36% 3.71% 2.56% 2.34% 2.95% 4.45% 5.65%**
Portfolio Turnover Rate N/A N/A N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
*Inception date.
**Annualized.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
INSURED LONG-TERM PORTFOLIO
--------------------------------------------------------------------------
YEAR ENDED NOVEMBER 30, JUNE 18,*
------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 NOV. 30, 1990
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $11.67 $11.63 $10.28 $11.61 $11.07 $10.60 $10.30 $10.00
INVESTMENT OPERATIONS
Net Investment Income .598 .603 .610 .599 .608 .630 .650 .295
Net Realized and Unrealized Gain (Loss) on Investments .110 .040 1.350 (1.298) .685 .474 .300 .300
--------------------------------------------------------------------------
TOTAL FROM INVESTMENT OPERATIONS .708 .643 1.960 (.699) 1.293 1.104 .950 .595
- ------------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.598) (.603) (.610) (.599) (.608) (.630) (.650) (.295)
Distributions from Realized Capital Gains (.060) - - (.032) (.145) (.004) - -
--------------------------------------------------------------------------
Total Distributions (.658) (.603) (.610) (.631) (.753) (.634) (.650) (.295)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $11.72 $11.67 $11.63 $10.28 $11.61 $11.07 $10.60 $10.30
====================================================================================================================================
TOTAL RETURN 6.30% 5.75% 19.45% -6.29% 12.03% 10.69% 9.50% 6.04%
====================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $253 $216 $197 $149 $166 $101 $61 $17
Ratio of Total Expenses to Average Net Assets 0.17% 0.20% 0.21% 0.23% 0.21% 0.31% 0.27% 0.22%**
Ratio of Net Investment Income to Average Net Assets 5.17% 5.26% 5.45% 5.38% 5.29% 5.77% 6.20% 6.55%**
Portfolio Turnover Rate 14% 17% 7% 16% 10% 27% 20% 2%
- ------------------------------------------------------------------------------------------------------------------------------------
*Inception date.
**Annualized.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
From time to time, the Vanguard funds advertise yield and total return
figures. Yield is a historical measure of dividend income, and total return is a
measure of past dividend income (assuming that it has been reinvested) plus
realized and unrealized capital appreciation (or depreciation). Neither yield
nor total return should be used to predict the future performance of a fund.
A WORD ABOUT RISK
This prospectus describes the risks you would face as an investor in the
Portfolios of Vanguard Ohio Tax-Free Fund. It is important to keep in mind one
of the main axioms of investing: The higher the risk of losing money, the higher
the potential reward. The reverse, also, is generally true: The lower the risk,
the lower the potential reward. As you consider an investment in one or both of
the Portfolios, you should take into account your need to protect your
investment, as well as your desire for current income.
Look for this "warning flag" symbol [FLAG] throughout the prospectus. It is
used to mark detailed information about each type of risk that you, as a
shareholder of either of the Portfolios, would confront.
5
<PAGE>
PLAIN TALK ABOUT
TAXABLE VERSUS
TAX-EXEMPT INVESTMENTS
You may not always profit from a state tax-exempt
investment; sometimes a taxable investment can serve you
better. To determine which is more suitable for you, figure
out the state tax-exempt portfolio's taxable equivalent
yield. You do this by:
o First figuring out your effective state bracket. Simply
subtract your federal tax bracket from 100%; then
multiply that number by your state bracket. For
example, if you are in a 7.0% state tax bracket and a
36% federal tax bracket, your effective state tax
bracket would be 4.5% ([100% - 36%] x 7.0%).
o Then add your federal tax bracket and effective state
tax bracket together foryour combined tax bracket. In
this example, your combined tax bracket would be 40.5%
(36% + 4.5%).
o Finally, divide the portfolio's tax-exempt yield by the
difference between 100% and your combined tax bracket.
Continuing with this example and assuming that you are
considering a state tax-exempt portfolio with a 5%
yield, your taxable equivalent yield would be 8.4% (5%
divided by [100% - 40.5%] ).
In this example, you would choose the state tax-exempt
portfolio if its taxable equivalent yield of 8.4% were
greater than the yield of a similar, though taxable,
investment.
Remember that we have used assumed tax brackets in this
example. Please verify your actual tax brackets--federal,
state, and local (if any)--before calculating taxable
equivalent yields of your own.
THE PORTFOLIOS' OBJECTIVES
Both Portfolios seek to provide varying amounts of income that is exempt from
federal and Ohio personal income taxes. The Money Market Portfolio also seeks to
maintain, but does not guarantee, a constant net asset value of $1 per share.
These objectives are fundamental, which means that they cannot be changed unless
a majority of Portfolio shareholders vote to do so.
[FLAG] BECAUSE OF THE SEVERAL TYPES OF RISKS DESCRIBED ON THE FOLLOWING PAGES,
YOUR INVESTMENT IN ONE OR BOTH OF THE PORTFOLIOS, AS WITH ANY INVESTMENT
IN BONDS, COULD LOSE MONEY.
[FLAG] BECAUSE THEY INVEST PRIMARILY IN SECURITIES ISSUED BY OHIO AND ITS
MUNICIPALITIES, THE PORTFOLIOS ARE MORE VULNERABLE TO UNFAVORABLE
DEVELOPMENTS IN OHIO THAN FUNDS THAT INVEST IN MUNICIPAL BONDS OF MANY
STATES.
WHO SHOULD INVEST
Either of the Portfolios may be a suitable investment for you if you are an Ohio
resident and:
o You wish to add a municipal bond income fund to your existing holdings, which
could include other tax-exempt--as well as stock, money market, and taxable
bond--investments.
o You seek income that is exempt from federal and Ohio personal income taxes.
However, one Portfolio may more closely meet your personal investment
objectives than the other. For instance, the Money Market Portfolio may be
suitable for you if:
o You do not want fluctuation in the share price of your investment.
o You are seeking a short-term investment vehicle.
The Insured Long-Term Portfolio may be suitable for you if:
o You are seeking a potentially greater amount of tax-exempt income and are
willing to accept significant fluctuations in share price.
Neither Portfolio is an appropriate investment if you are a market-timer.
Investors who engage in excessive in-and-out trading activity generate
additional costs that are borne by all of the shareholders in a Portfolio. To
minimize such costs, which reduce the ultimate returns achieved by you and other
shareholders, the Portfolios have adopted the following policies:
o Each Portfolio reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it regards as disruptive to the
efficient management of the Portfolio. This could be because of the timing of
the investment or because of a history of excessive trading by the investor.
o There is a limit on the number of times you can exchange into or out of a
Portfolio (see "Redeeming Shares" in the INVESTING WITH VANGUARD section).
6
<PAGE>
o The Portfolios reserve the right to stop offering shares at any time.
PLAIN TALK ABOUT
MUNICIPAL BONDS
Municipal bonds are securities issued by state and local
governments and regional government authorities as a way of
raising money for public construction projects (for example,
highways, airports, housing); for operating expenses; or for
loans to public institutions and facilities.
INVESTMENT STRATEGY
This section explains how the Portfolios' investment adviser seeks to provide
income that is exempt from federal and Ohio personal income taxes. It also
explains important risks--income risk, interest rate risk, call risk, objective
risk, credit risk, and manager risk--faced by the Portfolios' shareholders.
Unlike the Portfolios' investment objectives, the adviser's investment strategy
is not fundamental and can be changed by the Fund's Board of Trustees without
shareholder approval. However, before making any important change in its
strategy, a Portfolio will give shareholders 30 days' notice, in writing.
PLAIN TALK ABOUT
BONDS AND INTEREST RATES
When interest rates rise, bond prices fall. The opposite is also
true: Bond prices go up when interest rates fall. Why do bond
prices and interest rates move in opposite directions? Let's
assume that you hold a bond offering a 5% yield. A year later,
interest rates are on the rise and bonds are offered with a 6%
yield. With higher-yielding bonds available, you would have
trouble selling your 5% bond for the price you paid--causing you
to lower your asking price. On the other hand, if interest rates
were falling and 4% bonds were being offered, you would be able
to sell your 5% bond for more than you paid.
MARKET EXPOSURE
Both Portfolios invest primarily in tax-exempt Ohio State and local municipal
bonds that, depending on their maturity and quality, provide varying amounts of
tax-exempt income.
[FLAG] EACH PORTFOLIO IS SUBJECT TO INCOME RISK, WHICH IS THE POSSIBILITY THAT A
PORTFOLIO'S DIVIDENDS (INCOME) WILL DECLINE DUE TO FALLING INTEREST
RATES. INCOME RISK IS GENERALLY GREATEST FOR SHORT-TERM BONDS AND LEAST
FOR LONG-TERM BONDS.
Changes in interest rates can affect bond prices as well as bond income.
[FLAG] THE INSURED LONG-TERM PORTFOLIO IS PARTICULARLY SUBJECT TO INTEREST RATE
RISK, WHICH IS THE POSSIBILITY THAT BOND PRICES OVERALL WILL DECLINE OVER
SHORT OR EVEN EXTENDED PERIODS DUE TO RISING INTEREST RATES. INTEREST
RATE RISK SHOULD BE MODEST FOR SHORTER-TERM BONDS, MODERATE FOR
INTERMEDIATE-TERM BONDS, AND HIGH FOR LONGER-TERM BONDS.
In the past, bond investors have seen the value of their investment rise and
fall--sometimes significantly--with changes in interest rates. Between December
1976 and September 1981, for instance, rising interest rates caused long-term
bond prices to fall by almost 48%.
Because the Insured Long-Term Portfolio invests mainly in longer-term bonds,
changes in interest rates will have a significant impact on the value of that
Portfolio's assets. To illustrate how much of an impact, the following table
shows the effect of a 1% change and a 2% change (both up and down) in interest
rates on a bond with a face value of $1,000, similar to those bonds held by the
Insured Long-Term Portfolio on November 30, 1997.
PLAIN TALK ABOUT
BOND MATURITIES
A bond is issued with a specific maturity date--the date when the
bond's issuer must pay back the bond's initial value (known as
its "face value"). Bond maturities generally range from less than
one year (short term) to 30 years (long term). The longer a
bond's maturity, the more risk you, as a bond investor, face as
interest rates rise--but also the more interest you could
receive. Long-term bonds are more suitable for investors willing
to take greater risks in hope of higher yields; short-term bond
investors should be willing to accept lower yields in return for
less fluctuation in the value of their investment.
7
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
HOW INTEREST RATE CHANGES AFFECT INVESTMENT
- --------------------------------------------------------------------------------
VALUE OF A $1,000 INVESTMENT
------------------------------------------------------------
YIELD/ AFTER A 1% AFTER A 1% AFTER A 2% AFTER A 2%
AVERAGE MATURITY INCREASE DECREASE INCREASE DECREASE
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
4.70%/8.5 years $933 $1,072 $872 $1,151
- --------------------------------------------------------------------------------
</TABLE>
These figures are for illustration only and should not be regarded as an
indication of future returns from the municipal bond market as a whole, or
ANY Portfolio in particular.
Falling interest rates can cause other problems for bond portfolio
shareholders.
PLAIN TALK ABOUT
CALLABLE BONDS
Although bonds are issued with clearly defined maturities, a bond
issuer may be able to redeem, or call, a bond earlier than its
maturity date. The bondholder must now replace the called bond with
a bond that may have a lower yield than the original. One way for
bond investors to protect themselves against call risk is to
purchase a bond early in its lifetime, when it is less likely to be
called. Another way is to buy bonds with call protection--that is,
assurance that a bond will not be called for a specific time
period, such as ten years.
[FLAG] THE INSURED LONG-TERM PORTFOLIO, AND TO A MUCH LESSER EXTENT THE MONEY
MARKET PORTFOLIO, IS SUBJECT TO CALL RISK, WHICH IS THE POSSIBILITY THAT
DURING PERIODS OF FALLING INTEREST RATES, A BOND ISSUER WILL "CALL"--OR
REPAY--ITS HIGH-YIELDING BOND BEFORE ITS MATURITY DATE. FORCED TO INVEST
THE UNANTICIPATED PROCEEDS AT LOWER INTEREST RATES, THE PORTFOLIO WOULD
EXPERIENCE A DECLINE IN INCOME--AND THE POTENTIAL FOR TAXABLE CAPITAL
GAINS.
Longer-term bonds, like those held by the Insured Long-Term Portfolio,
generally have "call protection"--that is, assurance that a bond will not be
called for a specific period, such as ten years.
SECURITY SELECTION
Vanguard Fixed Income Group, adviser to the Portfolios, selects bonds issued
by Ohio state and local governments and regional governmental authorities. The
municipal bonds held by the two Portfolios, though, differ significantly in
terms of maturity and quality. Up to 20% of each Portfolios assets may be
invested in securities that are subject to the Alternative Minimum Tax (AMT).
[FLAG] THE PORTFOLIOS ARE SUBJECT TO OBJECTIVE RISK, WHICH IS THE POSSIBILITY
THAT RETURNS FROM A PARTICULAR BOND MARKET SEGMENT (FOR EXAMPLE,
LONGER-TERM BONDS OR BONDS ISSUED BY THE STATE OF OHIO) WILL TRAIL
RETURNS FROM THE OVERALL BOND MARKET.
PLAIN TALK ABOUT
ALTERNATIVE MINIMUM TAX
Certain tax-exempt bonds whose proceeds are used to fund
private, for-profit organizations are subject to the
Alternative Minimum Tax (AMT)--a special tax system that
ensures that individuals pay at least some federal taxes.
Although AMT bond income is exempt from federal regular
income tax, a very limited number of taxpayers who have many
tax deductions may have to pay Alternative Minimum Tax on
the income from bonds considered "tax-preference items."
The MONEY MARKET PORTFOLIO invests at least 80% of its assets in a variety of
high-quality, short-term Ohio municipal securities. The Portfolio seeks to
provide a stable net asset value of $1 per share by investing in securities with
an effective maturity of 13 months or less and by maintaining an average
weighted maturity of 90 days or less. An investment in a money market fund is
neither insured nor guaranteed by the U.S. government, and there can be no
assurance that the Portfolio will be able to maintain a stable net asset value
of $1 per share.
The INSURED LONG-TERM PORTFOLIO buys longer-term municipal bonds issued by
the state of Ohio, its local governments, and public financing authorities (and,
possibly, by certain U.S. territories). The Portfolio may also buy industrial
revenue bonds and bonds issued by hospitals and universities.
8
<PAGE>
Normally, a fund that concentrates its assets in one state would be exposed
to considerable credit risk. (Details of the risks of investing in Ohio can be
found in the Statement of Additional Information.) To provide a level of credit
protection, at least 80% of the Insured Long-Term Portfolio's assets are
invested in municipal bonds whose principal and interest payments are guaranteed
by top-rated insurance companies at the time of purchase. This insurance
coverage may take one of several forms:
o A new-issue insurance policy, which is purchased by a bond issuer at the time
the security is issued. This insurance is likely to increase the credit
rating of the security, as well as its purchase price and resale value.
o A mutual fund insurance policy, which is used to guarantee specific bonds
only while held by a mutual fund. For the Insured Long-Term Portfolio (which
has obtained a policy from Financial Guaranty Insurance Company), the annual
premiums for the policy may reduce the Portfolio's current yield.
o A secondary market insurance policy, which is purchased by an investor (such
as the Insured Long-Term Portfolio) after a bond has been issued and insures
the bond until its maturity date.
PLAIN TALK ABOUT
CREDIT QUALITY
A bond's credit quality depends on the issuer's ability to
pay interest on the bond and, ultimately, to repay the debt.
The lower the rating by one of the independent bond-rating
agencies (for example, Moody's or Standard & Poor's), the
greater the chance (in the rating agency's opinion) the bond
issuer will default, or fail to meet its payment
obligations. Most bond-rating agencies use a descending
alphabet scale to rate bonds (for example, Aaa is the
highest rating, C among the poorest quality). All things
being equal, the lower a bond's credit quality, the higher
the yield the bond seeks to pay (as compensation for the
risks an investor must take).
Typically, an insured municipal bond in the Portfolio will be covered by only
one of the three policies. For instance, if a bond is covered by a new-issue
insurance policy or a secondary market insurance policy, the security will
probably not be insured under the Portfolio's mutual fund insurance policy.
Normally, the Insured Long-Term Portfolio seeks to invest substantially all
of its assets in insured Ohio municipal obligations. However, up to 20% of the
Portfolio's assets may be invested in either:
o Uninsured Ohio municipal securities with the equivalent of a minimum-quality
rating of AA by a Nationally Recognized Statistical Rating Organization
(NRSRO), or
o Uninsured, high-quality, short-term Ohio municipal securities.
The Insured Long-Term Portfolio has no limitations as to the maturities of
the securities in which it invests. However, the Portfolio is expected to
maintain a dollar-weighted average maturity of between 15 and 25 years.
In unusual circumstances, such as a national financial emergency or a
temporary decline in the availability of Ohio obligations, up to 20% of the
Fund's assets may be invested in securities, such as short-term municipal
securities issued outside of Ohio or certain taxable fixed-income securities,
that generate income subject to Ohio state or federal personal income taxes.
As tax-advantaged investments, the Portfolios are particularly vulnerable to
federal and Ohio state tax law changes (for instance, if the Internal Revenue
Service ruled that the income from certain types of state-issued bonds could no
longer be considered tax-exempt).
PLAIN TALK ABOUT
CONVERSION PERIOD FOR MONEY MARKET FUNDS
Before it can begin earning dividends, your investment in a
money market fund must be converted to federal funds, which
are Federal Reserve deposits that banks and other financial
institutions "borrow" from one another to meet short-term
cash needs--and which fund advisers must use to pay for the
securities they buy. Conversion of your money market
investment to federal funds is done by the fund management
and usually takes one business day. Because of this
conversion period, your money market account will be
credited on the business day following the day your
investment is received. You will begin earning dividends on
your investment on the next calendar day. For example, if
your check is received on a Thursday before the close of
trading on the New York Stock Exchange, your account will be
credited the next business day (Friday) and you will begin
earning dividends on Saturday.
9
<PAGE>
[FLAG] THE PORTFOLIOS ARE SUBJECT TO CREDIT RISK, WHICH IS THE POSSIBILITY THAT
A BOND ISSUER WILL FAIL TO REPAY INTEREST AND PRINCIPAL IN A TIMELY
MANNER.
The Money Market Portfolio invests primarily in high-quality, short-term Ohio
municipal securities, and the Insured Long-Term Portfolio invests primarily in
bonds insured by top-rated insurance companies against the possible default of
an issuer. Therefore, credit risk should be low for the Money Market Portfolio
and very low for the Insured Long-Term Portfolio. The average qualities of the
Money Market Portfolio and the Insured Long-Term Portfolio, as rated by Moody's
on November 30, 1997, were MIG 1 and Aaa, respectively.
The Portfolios try to minimize credit risk by purchasing a wide selection of
Ohio municipal securities. As a result, there is less chance that a Portfolio
will be hurt significantly by a particular bond issuer's failure to repay either
principal or interest.
[FLAG] THE PORTFOLIOS ARE SUBJECT TO MANAGER RISK, WHICH IS THE POSSIBILITY THAT
VANGUARD FIXED INCOME GROUP WILL DO A POOR JOB OF SELECTING SECURITIES.
To help you distinguish between the two Portfolios and their various risks, a
summary table is presented below.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
RISKS OF THE PORTFOLIO
- --------------------------------------------------------------------------------
INCOME INTEREST CALL CREDIT
PORTFOLIO RISK RATE RISK RISK RISK
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Portfolio Risk Rate Risk Risk Risk
Money Market High Low Negligible Low
Insured Long-Term Low High High Very Low
- --------------------------------------------------------------------------------
</TABLE>
PORTFOLIO TURNOVER
Although the Insured Long-Term Portfolio generally seeks to invest for the long
term, it retains the right to sell securities regardless of how long they have
been held. Shorter-term bonds will mature--and need to be replaced--more
frequently than longer-term bonds. As a result, shorter-term bond portfolios may
tend to have higher portfolio turnover rates than longer-term bond portfolios.
PLAIN TALK ABOUT
PORTFOLIO TURNOVER
Before investing in a mutual fund, you should review its
portfolio turnover rate for an indication of the potential
effect of transaction costs on the fund's future returns. In
general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and
other transaction costs will have on its return. Also, funds
with high portfolio turnover rates may be more likely than
low-turnover funds to generate capital gains that must be
distributed to shareholders as taxable income. The average
turnover rate for actively managed tax-exempt bond funds
(excluding money market funds) is 44%.
INVESTMENT POLICIES
Besides investing in high-quality municipal bonds, each Portfolio may follow a
number of other investment policies to achieve its objectives.
[FLAG] EACH OF THE FUND'S PORTFOLIOS MAY INVEST, TO A LIMITED EXTENT, IN
DERIVATIVES.
10
<PAGE>
The Money Market Portfolio may invest in partnership and grantor trust-type
derivatives. Ownership of derivative securities allows the purchaser to receive
principal and interest payments on underlying municipal bonds or municipal
notes. There are many types of derivatives, including derivatives in which the
tax-exempt interest rate is determined by an index, a swap agreement, or some
other formula.
The Money Market Portfolio intends to use derivatives to increase the
diversification of, as well as maintain the quality of, securities held by the
Portfolio. Derivative securities are subject to certain structural risks that,
in unexpected circumstances, could cause the Portfolio's shareholders to lose
money or receive taxable income. However, the Portfolio will invest in
derivatives only when these securities are judged consistent with the
Portfolio's objective of maintaining a stable $1 share price and producing
tax-exempt income.
The Insured Long-Term Portfolio may invest in bond (interest rate) futures
and options contracts and other types of derivatives. Losses (or gains)
involving futures can sometimes be substantial--in part because a relatively
small price movement in a futures contract may result in an immediate and
substantial loss (or gain) for a portfolio. The Portfolio will keep separate
cash reserves or other liquid portfolio securities in the amount of the
obligation underlying the futures contract. Only a limited percentage of the
Portfolio's assets--5%--may be applied toward the deposits required on futures
contracts, and the value of all futures contracts in which the Portfolio
acquires an interest cannot exceed 20% of the Portfolio's total assets.
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on
(or "derived" from) a traditional security (such as a stock
or a bond), an asset (such as a commodity like gold), or a
market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated
exchanges for more than two decades. These "traditional"
derivatives are standardized contracts that can easily be
bought and sold, and whose market values are determined and
published daily. It is these characteristics that
differentiate futures and options from the relatively new
types of derivatives such as swap agreements and
partnerships or grantor trust-type derivatives. If used for
speculation or as leveraged investments, derivatives can
carry considerable risks).
The reasons for which the Insured Long-Term Portfolio will invest in futures
and options are:
o To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in bonds.
o To reduce the Portfolio's transaction costs by buying futures instead of
actual bonds.
o To add value to the Portfolio by buying futures instead of actual bonds when
futures are cheaper.
The Insured Long-Term Portfolio will not use futures and options for
speculative purposes or as leveraged investments that magnify the gains or
losses of an investment.
The Statement of Additional Information offers a detailed explanation of the
other types of derivatives in which the Portfolios may invest.
The Insured Long-Term Portfolio will usually hold only a small percentage of
its assets in cash reserves, although if the investment adviser believes that
market conditions warrant a temporary defensive measure, the Portfolio may hold
cash reserves without limit.
In addition, either Portfolio may purchase tax-exempt securities on a
"when-issued" basis. With "when-issued" securities, a portfolio agrees to buy
securities at a certain price, even if the market price of the securities at the
time of delivery is higher or lower than the agreed-upon purchase price.
11
<PAGE>
INVESTMENT LIMITATIONS
The Portfolios have adopted limitations on some of their investment policies.
Some of these limitations are that each Portfolio will not:
o Invest more than 25% of its assets in the securities of a single issuer,
except the U.S. government and cash reserves.
o Invest more than 50% of its assets in bonds that make up more than 5% of the
Portfolio's total assets.
o Borrow money, except for temporary or emergency purposes in an amount not
exceeding 10% of its net assets. Whenever the Portfolio's outstanding
borrowing is more than 5% of its net assets, it will stop making investments
A complete list of the Portfolios' investment limitations can be found in the
Statement of Additional Information. These limitations are fundamental and may
be changed only by approval of a majority of a Portfolio's shareholders.
INVESTMENT PERFORMANCE
The Portfolios of Vanguard Ohio Tax-Free Fund invest in bonds with a variety of
maturities from a variety of issuers in Ohio, so their performance will differ
depending on the performance of specific bond market segments. Historically,
changes in interest rates have been--and remain--the strongest influence on bond
market performance.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
FOR PERIODS ENDED NOVEMBER 30, 1997
- --------------------------------------------------------------------------------
SINCE
1 YEAR 5 YEARS INCEPTION*
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Ohio Money Market Portfolio 3.5% 3.1% 3.5%
Lipper Ohio Tax-Exempt Money
Market Average 3.2 2.9 3.3
- --------------------------------------------------------------------------------
Ohio Insured Long-Term Portfolio 6.3% 7.1% 8.3%
Lipper Ohio Tax-Exempt Municipal
Bond Average 6.2 6.6 7.5
- --------------------------------------------------------------------------------
*June 18, 1990.
- --------------------------------------------------------------------------------
</TABLE>
PLAIN TALK ABOUT
PAST PERFORMANCE
Whenever you see information on a fund's performance, do not
consider the figures to be an indication of the performance
you could expect by making an investment in the fund today.
The past is an imperfect guide to the future; history does
not repeat itself in neat, predictable patterns.
The results shown above represent the Portfolios' "average annual total
return" performance, which assumes that any distributions of capital gains and
dividends were reinvested for the indicated periods. Also included is
comparative information for each Portfolio's unmanaged benchmark index.
12
<PAGE>
SHARE PRICE
Each Portfolio's share price, called its net asset value, or NAV, is calculated
each business day after the close of trading (generally 4 p.m. Eastern time) of
the New York Stock Exchange. The net asset value per share is calculated by
adding up the total assets of the Portfolio, subtracting all of its liabilities,
or debts, and then dividing by the total number of Portfolio shares outstanding:
TOTAL ASSETS -- LIABILITIES
NET ASSET VALUE = ------------------------------
NUMBER OF SHARES OUTSTANDING
The daily net asset value is useful to you as a shareholder because the NAV,
multiplied by the number of Portfolio shares you own, gives you the dollar
amount you would have received had you sold all of your shares back to the
Portfolio that day.
The Insured Long-Term Portfolio's share price can be found daily in the
mutual fund listings of most major newspapers under the heading "Vanguard
Funds." Different newspapers use different abbreviations of the Portfolio's
name, but the most common is OHINSLT. The Money Market Portfolio is listed,
along with other money market funds, separately from other mutual funds; its
abbreviation is VANGOH. The Money Market Portfolio's share price is
expected--although not guaranteed--to remain at a constant $1.
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your share of a
portfolio's income from interest and dividends, and gains
from the sale of investments. You receive such earnings as
either income dividends or capital gains distributions.
Income dividends come from interest the portfolio earns from
its money market and bond investments. Capital gains are
realized whenever the portfolio sells securities for higher
prices than it paid for them. These capital gains are either
short-term or long-term depending on whether the portfolio
held the securities for less than or more than one year.
DIVIDENDS, CAPITAL GAINS, AND TAXES
The Portfolios' dividends accrue daily. On the first business day of every
month, the Portfolios distribute to shareholders virtually all of their income
from interest and dividends as dividend distributions. These dividend
distributions are expected to be free from federal, Ohio personal, and (to the
extent relevant) municipal income taxes. Any capital gains realized from the
sale of securities are distributed annually in December. You can choose to
receive your distributions of income and capital gains (or of income alone) in
cash, or you can have them automatically invested in more shares of the
Portfolio. In either case, distributions of capital gains (but not dividends)
are taxable to you. It is important to note that distributions of capital gains
(but not dividends) that are declared in December--if paid to you by the end of
January--are taxed as if they had been paid to you in December. Vanguard will
send you a statement each year showing the tax status of all your distributions.
o The short-term capital gains that you receive are taxable to you as ordinary
dividend income for federal income tax purposes. Any distributions of net
long-term capital gains by a Portfolio are taxable to you as long-term
capital gains, no matter how long you've owned shares in the Portfolio.
Long-term capital gains may be taxed at different rates depending on how long
the Portfolio held the securities. Although the Portfolios do not seek to
realize any particular amount of capital gains during a year, such gains are
realized from time to time as by-products of the ordinary investment
activities of the Portfolios.
PLAIN TALK ABOUT
"BUYING A CAPITAL GAIN"
It is not to your advantage to buy shares of a portfolio
shortly before it makes a capital gains distribution,
because part of your investment will come back to you as a
taxable distribution. This is known as "buying a capital
gain." For example: on December 15, you invest $5,000,
buying 250 shares for $20 each. If the portfolio pays a
capital gains distribution of $1 per share on December 16,
its share price would drop to $19 (not counting market
change). You would still have only $5,000 (250 shares x $19
= $4,750 in share value, plus 250 shares x $1 = $250 in
capital gains distributions), but you would owe tax on the
$250 capital gain you received, even if you had reinvested
it in more shares. To avoid "buying a capital gain" check
the portfolio's distribution schedule before you invest.
13
<PAGE>
o If you sell or exchange shares of a Portfolio, any gain or loss you have is a
taxable event, which means that you may have a capital gain to report as
income, or a capital loss to report as a deduction, when you complete your
federal income tax return.
o Distributions of capital gains, and capital gains or losses from your sale or
exchange of Portfolio shares, may be subject to state and local income taxes
as well.
The tax information in this prospectus is provided as general information.
You should consult your tax adviser about the tax consequences of an investment
in either of the Portfolios.
THE PORTFOLIOS AND VANGUARD
The Portfolios of Vanguard Ohio Tax-Free Fund are members of The Vanguard Group,
a family of more than 30 investment companies with more than 95 distinct
investment portfolios and total net assets of more than $350 billion. All of the
Vanguard funds share in the expenses associated with business operations, such
as personnel, office space, equipment, and advertising.
Vanguard also provides marketing services to the funds. Although shareholders
do not pay sales commissions or 12b-1 marketing fees, each fund pays its
allocated share of The Vanguard Group's costs.
A list of the Fund's Trustees and officers, and their present positions and
principal occupations during the past five years, can be found in the Statement
of Additional Information.
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group, Inc., is the only MUTUAL mutual fund
company. It is owned jointly by the funds it oversees and
by the shareholders in those funds. Other mutual funds are
operated by for-profit management companies that may be
owned by one person, by a group of individuals, or by
investors who bought the management company's publicly
traded stock. Because of its structure, Vanguard operates
its funds at cost. Instead of distributing profits from
operations to a separate management company, Vanguard
returns profits to fund shareholders in the form of lower
operating expenses.
14
<PAGE>
INVESTMENT ADVISER
Vanguard Fixed Income Group, P.O. Box 2600, Valley Forge, PA 19482, provides
investment advisory services to the Portfolios of Vanguard Ohio Tax-Free Fund on
an at-cost basis, subject to the control of the Trustees and officers of the
Fund.
The Fixed Income Group chooses brokers or dealers to handle the purchase and
sale of the Portfolios' securities, and is responsible for getting the best
available price and most favorable execution for all transactions. When the
Portfolios purchase a newly issued security at a fixed price, the Group may
designate certain members of the underwriting syndicate to receive compensation
associated with that transaction. Certain dealers have agreed to rebate a
portion of such compensation directly to the Portfolios to offset their
management expenses.
PLAIN TALK ABOUT
THE FUND'S ADVISER
Vanguard Fixed Income Group currently manages more than $100
billion in assets and provides investment advisory services
on an at-cost basis to more than 40 Vanguard Portfolios. The
managers responsible for the Fund are:
IAN A. MACKINNON, Managing Director of Vanguard; has worked
in investment management since 1974; primary responsibility
for Vanguard's internal fixed-income policy and strategy
since 1981; B.A., Lafayette College, M.B.A., Pennsylvania
State University.
JOHN M. CARBONE, Principal of Vanguard and, since 1996,
Portfolio Manager of the Money Market Portfolio; has worked
in investment management since 1986; B.S., Babson College,
M.B.A., Southern Methodist University.
DANINE MUELLER, Principal of Vanguard and, since 1996,
Portfolio Manager of the Insured Long-Term Portfolio; has
worked in investment management since 1985; B.S., Villanova
University.
GENERAL INFORMATION
Vanguard Ohio Tax-Free Fund is a Pennsylvania business trust. Shareholders of
the Fund's Portfolios have rights and privileges similar to those enjoyed by
other corporate and trust shareholders. If any matters are to be voted on by
shareholders (such as a change in a fundamental investment objective or the
election of Trustees), each share outstanding at that point would be entitled to
one vote. Annual meetings will not be held by the Portfolios except as required
by the Investment Company Act of 1940. A meeting will be scheduled to vote on
the removal of a Trustee if the holders of at least 10% of a Portfolio's shares
request a meeting in writing.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc.
15
<PAGE>
INVESTING WITH VANGUARD
Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information? Establish an account for a
minor child?
Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.
The following sections of the prospectus briefly explain the many services we
offer you as a shareholder of one of the Portfolios of Vanguard Ohio Tax-Free
Fund. Booklets providing detailed information are available on the services
marked with a [BOOK]. Please call us to request copies.
SERVICES AND ACCOUNT FEATURES
Vanguard offers many services that make it convenient to buy, sell, or
exchange shares.
TELEPHONE REDEMPTIONS Automatically set up for each
(SALES AND EXCHANGES) Portfolio unless you notify us otherwise.
CHECKWRITING Method for drawing money from your
account by writing a checkwriting draft for
$250 or more.
VANGUARD DIRECT DEPOSIT Automatic method for depositing your paycheck
SERVICE (TM) or U.S. government payment (including Social
[BOOK] Security and government pension checks) into
your account.
VANGUARD AUTOMATIC Automatic method for moving a fixed amount of
EXCHANGE SERVICE (SM) money from one Vanguard fund account to
another.*
VANGUARD FUND EXPRESS (R) Electronic method for buying or selling
[BOOK] shares. You can transfer money between your
Vanguard fund account and an account at your
bank, savings and loan, or credit union on a
systematic schedule or whenever you wish.*
VANGUARD DIVIDEND EXPRESS (SM) Electronic method for transferring dividend
[BOOK] and/or capital gains distributions directly
from your Vanguard fund account to your bank,
savings and loan, or credit union account.
VANGUARD BROKERAGE SERVICES (VBS) A cost-effective way to trade stocks, bonds,
[BOOK] and options on major exchanges, Nasdaq, and
other domestic over-the-counter markets at
reduced rates, and to buy and sell shares of
non-Vanguard mutual funds. Call VBS
(1-800-992-8327) for additional information
and the appropriate forms.
*Can be used to "dollar-cost average" [BOOK].
16
<PAGE>
TYPES OF ACCOUNTS
INDIVIDUAL OR OTHER ENTITY
Vanguard's account registration form can be used to establish a variety of
accounts.
FOR ONE OR MORE PEOPLE To open an account in the name of one
(individual) or more (joint tenants) people.
$3,000 minimum initial investment.
FOR A MINOR CHILD To open an account as an UGMA/UTMA (Uniform
[BOOK] Gifts/Transfers to Minors Act). Age of
majority and other requirements are set by
state law. $1,000 minimum initial investment.
FOR HOLDING TRUST ASSETS To invest assets held in an existing trust.
[BOOK] $3,000 minimum initial investment.
FOR AN ORGANIZATION To open an account as a corporation,
partnership, or other entity. These accounts
may require a corporate resolution or other
documents to name the individuals authorized
to act. $3,000 minimum initial investment.
DISTRIBUTION OPTIONS
You can receive distributions of dividends and/or capital gains in a number of
ways:
REINVESTMENT Dividends and capital gains are automatically
reinvested in additional shares of the
Portfolio, unless you request a different
distribution method.
DIVIDENDS IN CASH Dividends are paid by check and mailed to
your account's address of record, and
capital gains are reinvested in additional
shares of the Portfolio.
CAPITAL GAINS IN CASH Capital gains distributions are paid by
check and mailed to your account's address
of record, and dividends are reinvested in
additional shares of the Portfolio.
DIVIDENDS AND CAPITAL GAINS Both dividends and capital gains
IN CASH distributions are paid by check and mailed
to your account's address of record.
To electronically transfer cash dividends and/or capital gains to your bank,
savings and loan, or credit union account, see Vanguard Dividend Express under
"Services and Account Features."
If you have elected to receive dividend and/or capital gains distributions in
cash, but the Postal Service is unable to make delivery to your address of
record, your distribution option will be changed to reinvestment. No interest
will accrue on amounts represented by uncashed distribution checks.
17
<PAGE>
BUYING SHARES
If we receive your check (or electronic transfer) by the close of trading on the
New York Stock Exchange (generally 4 p.m. Eastern time) on a regular business
day, your investment in the Insured Long-Term Portfolio will be converted to
federal funds and credited to your account at that day's closing price, the
next-determined net asset value. You will begin earning dividends on your
investment the following calendar day. (Federal funds are Federal Reserve
deposits that banks and other financial institutions "borrow" from one another
to meet short-term cash needs; portfolio advisers must use federal funds to pay
for the securities they buy.)
Your investment in the Money Market Portfolio will also be converted to
federal funds and credited to your account; however, the conversion to federal
funds for Money Market Portfolio investments takes one business day. Because of
this conversion period, your Money Market Portfolio account will be credited on
the business day following the day we receive your check. You will begin earning
dividends on your investment on the next calendar day. For example, if we
receive your check before the close of trading on the New York Stock Exchange on
a Thursday, your account will be credited the next business day (Friday) and you
will begin earning dividends on Saturday.
Each of the Fund's Portfolios is offered on a no-load basis, meaning that you
do not pay sales commissions or 12b-1 marketing fees.
<TABLE>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
<S> <C> <C>
MINIMUM INVESTMENT $3,000 (regular account); $100 by mail or exchange;
$1,000 (custodial accounts $1,000 by wire.
BY MAIL Complete and sign the Mail your check with an
[ENVELOPE] application form. Invest-By-Mail form
FIRST-CLASS MAIL TO: detached from your
The Vanguard Group confirmation statement to
P.O. Box 2600 the address listed on the
Valley Forge, PA 19482-2600 form.
EXPRESS or REGISTERED
mail to:
The Vanguard Group Make your check payable Make your check payable
455 Devon Park Drive to: The Vanguard Group-- to: The Vanguard Group--
Wayne, PA 19087-1815 (insert appropriate (insert appropriate
PortfolioNumber, see Portfolio Number, see
below) below)
Money Market 96 Money Market 96
Insured Long-Term 97 Insured Long-Term 97
All purchases must be All purchases must be
made in U.S. dollars, and made in U.S. dollars, and
checks must be drawn on checks must be drawn on
U.S. banks. U.S. banks.
</TABLE>
IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.
18
<PAGE>
BUYING SHARES (continued)
<TABLE>
<CAPTION>
<S> <C> <C>
BY TELEPHONE Call Vanguard Tele- Call Vanguard Tele-
[PHONE] Account* 24 hours a Account* 24 hours a
1-800-662-6273 day--or Client Services day--or Client Services
Vanguard Tele-Account(R) during business hours-- during business hours--
1-800-662-2739 to exchange from another to exchange from another
Client Services Vanguard fund account Vanguard fund account
with the same registration with the same registration
(name, address, taxpayer (name, address, taxpayer
I.D., and account type). I.D., and account type).
Use Vanguard Fund Express
(see "Services and Account
Features") to transfer
assets from your bank
account. Call Client
Services before your first
use to verify that this
option is in place.
*You must obtain a Personal Identification Number
through Tele-Account at least seven days before you
request your first exchange.
</TABLE>
FOR THE MONEY MARKET PORTFOLIO ONLY: If you buy Portfolio shares through an
exchange from another Vanguard fund by the close of trading on the New York
Stock Exchange, your investment does not have to be converted to federal funds;
you begin earning dividends the next calendar day.
IMPORTANT NOTE: Once a telephone transaction has been approved by you and a
confirmation number assigned, it cannot be revoked. We reserve the right to
refuse any purchase.
<TABLE>
<CAPTION>
<S> <C> <C>
BY WIRE Call Client Services to Call Client Services to
[WIRE] arrange your wire arrange your wire
Wire to: transaction. transaction.
CoreStates Bank, N.A.
ABA 031000011
CoreStates No. 0141 1274
[Temporary Account Number]
Vanguard Ohio Tax-Free Fund
[Portfolio Name]
[Account Registration]
Attention: Vanguard
</TABLE>
FOR THE MONEY MARKET PORTFOLIO ONLY: If you buy Portfolio shares through a
federal funds wire, your investment begins earning dividends the next calendar
day. You can begin earning dividends immediately if you notify Vanguard by 10:45
a.m. Eastern time that you intend to make a wire purchase that day.
<TABLE>
<CAPTION>
<S> <C> <C>
AUTOMATICALLY - Vanguard offers a variety
[CIRCLE OF ARROWS] of ways that you can add
to your account
automatically. See
"Services and Account
Features."
</TABLE>
You can redeem (that is, sell or exchange) shares purchased by check or Vanguard
Fund Express at any time. However, while your redemption request will be
processed at the next-determined net asset value after it is received, your
redemption proceeds will not be available until payment for your purchase is
collected, which may take up to ten calendar days.
IMPORTANT NOTE: If you buy Portfolio shares through a registered broker/dealer
or investment adviser, the broker/dealer or adviser may charge you a service
fee.
19
<PAGE>
BUYING SHARES (continued)
It is important that you call Vanguard before you invest a large dollar
amount by wire or check. We must consider the interests of all Portfolio
shareholders and so reserve the right to delay or refuse any purchase that will
disrupt the Portfolio's operation or performance.
REDEEMING SHARES
IMPORTANT TAX NOTE: Any sale or exchange of Portfolio shares could result in a
taxable gain or a loss. However, because the Money Market Portfolio seeks to
maintain a stable net asset value of $1 per share, you will not incur a taxable
gain or loss when you sell or exchange shares of this Portfolio.
The ability to redeem (that is, sell or exchange) Portfolio shares by
telephone is automatically established for your account unless you tell us in
writing that you do not want this option.
To protect your account from unauthorized or fraudulent telephone
instructions, Vanguard follows specific security procedures. When we receive a
call requesting an account transaction, we require the caller to provide:
[X] Portfolio name.
[X] 10-digit account number.
[X] Name and address exactly as registered on that account.
[X] Social Security or employer identification number as registered on that
account.
If you call to sell shares, the sale proceeds will be made payable to you, as
the registered shareholder, and mailed to your account's address of record.
If we follow reasonable security procedures, neither the Portfolios nor
Vanguard will be responsible for the authenticity of transaction instructions
received by telephone. We believe that these procedures are reasonable and that,
if we follow them, you bear the risk of any losses resulting from unauthorized
or fraudulent telephone transactions on your account.
HOW TO SELL SHARES
You may withdraw any part of your account, at any time, by selling shares.
One way to sell shares is the checkwriting option (established when you set
up your account or by completing a Checkwriting Signature Form, which can be
ordered by calling Client Services). Your personalized Vanguard checks work in
much the same way as bank checks, except that Vanguard checks are considered
drafts and cannot be cashed immediately like a bank check. You cannot write a
Vanguard check to redeem shares that you purchased by check within the previous
ten calendar days.
When you sell shares by telephone or mail, sale proceeds are normally mailed
within two business days after Vanguard receives your request. The sale price of
your shares will be the Portfolio's next-determined net asset value after
Vanguard receives your request in good order.
Good order means that the request includes:
[X] Portfolio name and account number.
[X] Amount of the transaction (in dollars or shares).
[X] Signatures of all owners exactly as registered on the account.
[X] Signature guarantees (if required).
[X] Any supporting legal documentation that may be required.
[X] Any certificates you are holding for the account.
20
<PAGE>
REDEEMING SHARES (continued)
Sales or exchange requests received after the close of trading on the New
York Stock Exchange (generally 4 p.m. Eastern time) are processed the next
business day. No interest will accrue on amounts represented by uncashed
redemption checks. The Portfolio will not cancel any trade (e.g., purchase,
redemption, or exchange) believed to be authentic, once the trade request has
been received in writing or by telephone.
The Portfolios reserve the right to close any account whose balance falls
below the minimum initial investment. The Portfolios will deduct a $10 annual
fee in either June or December if your account balance falls below $2,500 or if
your UGMA/UTMA account balance falls below $500. The fee is waived if your total
Vanguard account assets are $50,000 or more.
Some written requests require a signature guarantee from a bank, broker, or
other acceptable financial institution. A notary public cannot provide a
signature guarantee.
HOW TO EXCHANGE SHARES
An exchange is the selling of shares of one Vanguard fund to purchase shares of
another.
Although we make every effort to maintain the exchange privilege, Vanguard
reserves the right to revise or terminate the exchange privilege, limit the
amount of an exchange, or reject any exchange, at any time, without notice.
Because excessive exchanges can potentially disrupt the management of the
Portfolios and increase transaction costs, Vanguard limits exchange activity to
TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (at least 30 days apart) from each
Portfolio (except the Money Market Portfolio) during any 12-month period.
"Substantive" means either a dollar amount or a series of movements between
Vanguard funds that Vanguard determines, in its sole discretion, could have an
adverse impact on the management of the Portfolio.
Before you exchange into a new Vanguard fund, be sure to read its prospectus.
For a copy and for answers to questions you might have, call Investor
Information.
21
<PAGE>
REDEEMING SHARES (continued)
<TABLE>
<CAPTION>
SELLING OR EXCHANGING SHARES INSTRUCTIONS
<S> <C>
By Telephone Call Vanguard Tele-Account* 24 hours a day--
[PHONE] or Client Services during business hours--to
1-800-662-6273 sell or exchange shares. You can exchange
Vanguard Tele-Account shares from either Portfolio to open an
1-800-662-2739 account in another Vanguard fund or to add
Client Services to an existing Vanguard fund account with an
identical registration.
*You must obtain a Personal Identification
Number through Tele-Account at least seven
days before you request your first
redemption.
BY MAIL Send a letter of instruction signed by all
[ENVELOPE] registered account holders. Include the
FIRST-CLASS mail to: portfolio name and account number and
The Vanguard Group (if you are selling) a dollar amount or
Vanguard Ohio number of shares OR (if you are exchanging)
Tax-Free Fund the name of the fund you want to exchange
P.O. Box 1120 into and a dollar amount or number of shares.
Valley Forge, PA 19482-1120 To exchange into an account with a different
EXPRESS or REGISTERED mail to: registration (including a different name,
The Vanguard Group address, or taxpayer identification number),
Vanguard Ohio you must provide Vanguard with written
Tax-Free Fund instructions that include the guaranteed
455 Devon Park Drive signatures of all current account owners.
Wayne, PA 19087-1815
Exchanging Shares Online You may use your personal computer to
[COMPUTER] exchange shares of most Vanguard funds by
accessing our website (www.vanguard.com).
To establish this service for your account,
you must first register through the website.
We will then send to you, by mail, an account
access password that will enable you to make
online exchanges.
The Vanguard funds that you cannot purchase
or sell through online exchange are VANGUARD
INDEX TRUST, VANGUARD BALANCED INDEX FUND,
VANGUARD INTERNATIONAL EQUITY INDEX FUND,
VANGUARD REIT INDEX PORTFOLIO, VANGUARD TOTAL
INTERNATIONAL PORTFOLIO, AND VANGUARD GROWTH
AND INCOME PORTFOLIO (formerly known as
Vanguard Quantitative Portfolios). These
funds do permit online exchanges within IRAs
and other retirement accounts.
BY CHECK You can sell shares by writing a
[CHECK] checkwriting draft for $250 or more.
AUTOMATICALLY Vanguard offers several ways to sell or
[CIRCLE OF ARROWS] exchange shares automatically (see "Services
and Account Features"). Call Investor
Information for the appropriate booklet and
application if you did not elect this feature
when you opened your account.
</TABLE>
It is important that you call Vanguard before you redeem a large dollar amount.
We must consider the interests of all Portfolio shareholders and so reserve the
right to delay delivery of your redemption proceeds--up to seven days--if the
amount will disrupt the Portfolio's operation or performance.
22
<PAGE>
A NOTE ON UNUSUAL CIRCUMSTANCES
Vanguard reserves the right to revise or terminate the telephone redemption
privilege at any time, without notice. In addition, Vanguard can stop selling
shares or postpone payment at times when the New York Stock Exchange is closed
or under any emergency circumstances as determined by the U.S. Securities and
Exchange Commission. If you experience difficulty making a telephone redemption
during periods of drastic economic or market change, you can send us your
request by regular or express mail. Follow the instructions on selling or
exchanging shares by mail in the "Redeeming Shares" section.
TRANSFERRING REGISTRATION
HOW TO TRANSFER SHARES
You may transfer the registration of any of your Portfolio shares to another
owner by completing a transfer form and sending it to: The Vanguard Group,
Attention: Transfer Department, P.O. Box 1110, Valley Forge, PA
19482-1110.
PORTFOLIO AND ACCOUNT UPDATES
STATEMENTS AND REPORTS
We will send you clear, concise account and tax statements to help you keep
track of your Portfolio account throughout the year as well as when you are
preparing your income tax returns.
In addition, you will receive financial reports about each Portfolio twice a
year. These comprehensive reports include an assessment of each Portfolio's
performance (and a comparison with its industry benchmark), an overview of the
markets, a report from the adviser, a listing of the Portfolio's holdings, and
other financial statements.
23
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
CONFIRMATION STATEMENT Sent each time you buy, sell, or exchange
shares; confirms the trade date and the
amount of your transaction.
PORTFOLIO SUMMARY Mailed quarterly; shows the market value of
[BOOK] your account at the close of the statement
period, as well as distributions, purchases,
sales, and exchanges for the current calendar
year.
FUND FINANCIAL REPORTS Mailed in January and July for each
Portfolio.
TAX STATEMENTS Generally mailed in January; report previous
year's taxable distributions and proceeds
from the sale of Portfolio shares.
AVERAGE COST STATEMENT Issued quarterly for most taxable accounts
[BOOK] (accompanies your Portfolio Summary); shows
the average cost of shares that you redeemed
during the calendar year, using the average-
cost single-category method.
CHECKWRITING STATEMENT Sent monthly to shareholders using Vanguard's
checkwriting option. Our clear, easy-to-use
statement provides images of the front and
back of each checkwriting draft paid in the
previous month. This consolidated statement
is sent instead of the original canceled
drafts, which will not be returned.
AUTOMATED TELEPHONE ACCESS
VANGUARD TELE-ACCOUNT Toll-free access to Vanguard fund and account
1-800-662-6273 information--as well as some transactions--
Any time, seven days a week, through any Touch-Tone (TM) telephone. Tele-
from anywhere in the continental Account provides total return, share price,
United States and Canada. price change, and yield quotations for all
[BOOK] Vanguard funds; gives your account balances
and history (e.g., last transaction, latest
dividend distribution, redemptions by check
during the last three months); and allows
you to sell fund shares.
COMPUTER ACCESS
VANGUARD ONLINE(R) Use your personal computer to learn more
www.vanguard.com about Vanguard's funds and services; keep in
touch with your Vanguard accounts; map out a
long-term investment strategy; initiate
certain transactions; and ask questions, make
suggestions, and send messages to Vanguard.
Our education-oriented website provides
timely news and information about Vanguard's
funds and services; an online "university"
that offers a variety of mutual fund classes;
and easy-to-use, interactive tools to help
you create your own investment and retirement
strategies.
</TABLE>
24
<PAGE>
GLOSSARY OF INVESTMENT TERMS
ALTERNATIVE MINIMUM TAX (AMT)
A separate tax system designed to ensure that individuals pay at least a minimum
amount of federal income taxes. Certain securities used to fund private,
for-profit activities are subject to AMT.
BOND
A debt security (IOU) issued by a corporation, government, or government agency
in exchange for the money you lend it. In most instances, the issuer agrees to
pay back the loan by a specific date and to make regular interest payments until
that date.
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized during the year on
securities that the fund has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits as well as short-term bank deposits, money market instruments,
U.S. Treasury bills, bank certificates of deposit (CDs), repurchase agreements,
commercial paper,and banker's acceptances.
DIVIDEND INCOME
Payment to shareholders of net income from interest or dividends generated by a
fund's investments.
DURATION
A measure of the sensitivity of bond--and bond fund--prices to interest rate
movements. For example, if a bond has a duration of two years, its price would
fall by about 2% when interest rates rose 1 percentage point. On the other hand,
the bond's price would rise by about 2% when interest rates fell by 1 percentage
point.
EXPENSE RATIO
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
marketing fees.
FACE VALUE
The amount to be paid at maturity of a bond; the par value or principal.
FIXED-INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
INSURED BONDS
Bonds whose payments of both principal and interest are guaranteed. The
insurance does not guarantee the value of the bonds, only that bond payments
will be made in a timely fashion.
INVESTMENT GRADE
Bonds whose credit quality is considered by independent bond-rating agencies to
be among the highest.
MATURITY
The date when a bond issuer agrees to return the bond's principal, or face
value, to the bond's buyer.
MUNICIPAL BOND
A bond issued by a state or local government. Dividend income from municipal
bonds is generally free from federal income taxes, as well as taxes in the state
in which it was issued.
NET ASSET VALUE (NAV)
The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
VOLATILITY
The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Current income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE>
[VANGUARD LOGO]
Post Office Box 2600
Valley Forge, PA 19482
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTOR VANGUARD BROKERAGE ELECTRONIC ACCESS TO THE
INFORMATION SERVICES VANGUARD MUTUAL FUND
DEPARTMENT 1-800-992-8327 EDUCATION AND INFORMATION
1-800-662-7447 (SHIP) For information on CENTER
Text Telephone: trading stocks, bonds, World Wide Web
1-800-952-3335 and options at www.vanguard.com
For information on our reduced commissions
funds, fund services, E-mail
and retirement accounts; VANGUARD TELE-ACCOUNT(R) [email protected]
requests for literature 1-800-662-6273 (ON-BOARD)
For 24-hour automated
CLIENT SERVICES access to price and
DEPARTMENT yield, information on
1-800-662-2739 (CREW) your account, and
Text Telephone: certain transactions
1-800-662-2738
For information on your
account, account
transactions, and account
statements
</TABLE>
(C) 1998 Vanguard Marketing
Corporation, Distributor
P096N
<PAGE>
PART B
VANGUARD CALIFORNIA TAX-FREE FUND
VANGUARD FLORIDA INSURED TAX-FREE FUND
VANGUARD NEW JERSEY TAX-FREE FUND
VANGUARD NEW YORK TAX-FREE FUND
VANGUARD OHIO TAX-FREE FUND
VANGUARD PENNSYLVANIA TAX-FREE FUND
(COLLECTIVELY THE "Funds" and Individually the "Fund")
March 27, 1998
This Statement of Additional Information is not a prospectus but should be
read in conjunction with the appropriate Fund's current Prospectus dated March
27, 1998. To obtain this Prospectus, please call:
Vanguard's Investor Information Department
1-800-662-7447
TABLE OF CONTENTS Page
Investment Limitations .................................................B-1
Investment Policies ....................................................B-3
Risk Factors ...........................................................B-5
Florida Intangible Personal Property Tax ...............................B-12
Yield and Total Return .................................................B-13
Calculation of Yield ...................................................B-14
Performance Measures ...................................................B-16
Investment Management ..................................................B-18
Portfolio Transactions .................................................B-18
Purchase of Shares .....................................................B-19
Redemption of Shares ...................................................B-19
Share Price ............................................................B-20
Management of the Fund .................................................B-21
Description of Shares and Voting Rights ................................B-27
Financial Statements ...................................................B-28
Appendix A - Description of Municipal Bonds and their Ratings ..........B-28
Throughout this Statement of Additional Information, "the Fund" is intended
to refer to each Fund listed on the cover page, and "the Portfolio" is intended
to refer to each Portfolio of each Fund, unless otherwise indicated.
INVESTMENT LIMITATIONS
The following restrictions supplement the Fund's investment limitations set
forth in the Prospectus. Except as indicated otherwise, these restrictions are
fundamental policies of each Portfolio, which cannot be changed without the
approval of a majority (as defined in the Investment Company Act of 1940 (the
"1940 Act")) of the Portfolio's outstanding voting shares.
1. Each Portfolio will not invest in securities other than Municipal
Securities except that a Portfolio may make temporary investments in certain
short-term taxable securities issued by or on behalf of municipal or
corporate issuers, obligations of the United States Government and its
agencies or instrumentalities, commercial paper, bank certificates of
deposit, and any such items subject to short-term repurchase agreements;
B-1
<PAGE>
2. Each Portfolio will limit the aggregate value of all holdings (except
U.S. Government and cash items), as defined under Subchapter M of the
Internal Revenue Code (the "Code"), each of which exceeds 5% of the
Portfolio's total assets, to an aggregate amount of 50% of such assets;
3. Each Portfolio will limit the aggregate value of holdings of a single
issuer (except U.S. Government and cash items, as defined in the Code) to a
maximum of 25% of the Portfolio's total assets;
4. Each Portfolio will not borrow money except for temporary or emergency
purposes and then only in an amount not exceeding 10% of the value of the net
assets of that Portfolio. The Portfolio will repay all borrowing before
making additional investments. Interest paid on such borrowings will reduce
income;
5. Each Portfolio will not pledge, mortgage or hypothecate its assets to
any extent greater than 10% of the value of the total assets of the
Portfolio;
6. Each Portfolio will not issue senior securities as defined in the 1940
Act;
7. Each Portfolio will not engage in the business of underwriting
securities issued by other persons, except to the extent that the Portfolio
may technically be deemed an underwriter under the Securities Act of 1933, as
amended, in disposing of portfolio securities;
8. Each Portfolio will not purchase or sell real estate, but this shall
not prevent investments in municipal bonds secured by real estate or
interests therein;
9. Each Portfolio will not make loans to other persons, except by the
purchase of bonds, debentures or similar obligations. In addition, although
the Portfolios have no present intention to do so, each Portfolio reserves
the right to lend its investment securities to qualified institutions in
accordance with guidelines of the Securities and Exchange Commission;
10. Each Portfolio will not purchase on margin or sell short, except as
specified below in Investment Limitation No. 12;
11. Each Portfolio (with the exception of the New York Money Market
Portfolio) will not purchase or retain securities of an issuer if those
Trustees of the Fund, each of whom owns more than 1/2 of 1% of such
securities, together own more than 5% of the securities of such issuer;
12. Each portfolio will not purchase or sell commodities or commodities
contracts, except that the California Insured Intermediate-Term, California
Insured Long-Term, New Jersey Insured Long-Term, New York Insured Long-Term,
Ohio Insured Long Term, and Pennsylvania Insured Long-Term Portfolios, and
the Vanguard Florida Insured Tax-Free Fund may invest in bond futures
contracts, bond options and options on bond futures contracts to the extent
that not more than 5% of a portfolio's assets are required as deposits on
futures contracts and (with the exception of the florida insured tax-free
fund) not more than 20% of the portfolio's assets are invested in futures
contracts and/or options transactions at any time;
13. Each Portfolio will not invest its assets in securities of other
investment companies except as they may be part of a merger, consolidation,
reorganization or acquisition of assets or otherwise, to the extent permitted
by Section 12 of the 1940 Act;
14. Each Portfolio will not invest in put, call, straddle or spread
options (except as described above in investment limitation No. 12) or
interests in oil, gas or other mineral exploration or development programs;
15. Each Portfolio (with the exception of the New York Money Market
Portfolio, and the Portfolios of New Jersey Tax-Free Fund) will not purchase
an industrial revenue bond if as a result of such purchase (i) more than 5%
of the Portfolio's total assets, determined at market value at the time of
the proposed investment, would be invested in industrial revenue bonds where
the payment of principal and interest is the responsibility of a company with
less than three (3) years' operating history, or (ii) more than 20% of the
Portfolio's total assets, determined at market value at the time of the
proposed investment, would be invested in industrial development bonds. These
restrictions do not apply to municipal obligations where the payment of
principal and interest is the responsibility of a government or the political
subdivision of a government; and
16. Each Portfolio will not purchase or otherwise acquire any security, if
as a result, more than 15% (10% with respect to the Money Market Portfolios
of the Funds) of its net assets would be invested in securities that are
illiquid (included in this limitation is the Fund's investment in The
Vanguard Group, Inc.).
B-2
<PAGE>
The investment limitations set forth above are considered at the time that
investment securities are purchased. If a percentage restriction is adhered to
at the time the investment is made, a later increase in percentage resulting
from a change in the market value of assets will not constitute a violation of
such restriction. Notwithstanding these limitations, each Portfolio 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 (1) wholly
owned by the Fund and one or more other investment companies and (2) primarily
engaged in the business of providing, at cost, management, administrative,
distribution and/or related services to the Fund and such other investment
companies.
INVESTMENT POLICIES
Futures Contracts
Each Portfolio of the Fund (except the Money Market Portfolio) may enter into
futures contracts, options, and options on futures contracts for several
reasons: to simulate full investment in the underlying securities while
retaining a cash balance for Fund management purposes, to facilitate trading, to
reduce transaction costs, or to seek higher investment returns from intermarket
arbitrage opportunities when a futures contract is mispriced relative to the
underlying security or index. 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
which 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.
Most futures 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 which 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
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. The
Fund expects to earn interest income on its initial margin deposit.
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, changes in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder.
Traders in futures contracts may be broadly classified as either "hedgers" or
"speculators." Hedgers use the futures markets primarily to offset unfavorable
changes in the value of securities otherwise held for investment purposes or
expected to be acquired by them. Speculators are less inclined to own the
securities underlying the futures contracts which they trade, and use futures
contracts with the expectation of realizing profits from fluctuations in the
prices of underlying securities. Under CFTC regulations, the Portfolios may use
futures transactions for bona fide hedging purposes only, except that a
Portfolio may establish non-hedging futures positions if the aggregate initial
margin and premiums for such positions do not exceed 5% of the value of the
Portfolio's assets.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the use
of futures contracts may be a more effective means of hedging this exposure.
Restrictions on the Use of Futures Contracts
A Portfolio 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 the applicable Fund's total assets.
In addition, a Portfolio will not enter into futures contracts to the extent
that its outstanding obligations to purchase securities under these contracts
would exceed 20% of the Portfolio's total assets.
B-3
<PAGE>
Risk Factors in Futures Transactions
Positions in futures contracts may be closed out only on an Exchange which
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, a Portfolio would continue to be required
to make daily cash payments to maintain its required margin. In such situations,
if the Portfolio 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 Portfolio may be required to make delivery of the
instruments underlying futures contracts it holds. The inability to close
options and futures positions also could have an adverse impact on the ability
to effectively hedge.
The Vanguard Florida Insured Tax-Free Fund, the California Insured
Intermediate-Term Portfolio, and the Insured Long-Term Portfolio of each Fund
will minimize the risk that they will be unable to close out a futures contract
by only entering into futures which 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 initial margin requirement for the contract. However, because the
futures strategies of the Portfolios are engaged in only for hedging purposes
and will not be leveraged, the Adviser does not believe that the Portfolios are
subject to the risks of loss frequently associated with futures transactions.
The Portfolios would presumably have sustained comparable losses if, instead of
the futures contract, they had invested in the underlying financial instrument
and sold it after the decline.
Utilization of futures transactions by a Portfolio does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities or other characteristics than the portfolio securities
being hedged. It is also possible that a Portfolio 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 a Portfolio of margin deposits in
the event of bankruptcy of a broker with whom the Portfolio 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 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.
Other Types of Derivatives
In addition to futures and options, each Portfolio may invest in other types
of derivatives, including warrants, swap agreements and partnerships or grantor
trust derivative products. Derivatives are instruments whose value is linked to
or derived from an underlying security. Derivatives may be traded separately on
exchanges or in the over-the-counter market, or they may be imbedded in
securities. The most common imbedded derivative is the call option attached to
or imbedded in a callable bond. The owner of a traditional callable bond holds a
combination of a long position in a non-callable bond and a short position in a
call option on that bond.
Derivative instruments may be used individually or in combination to hedge
against unfavorable changes in interest rates, or to take advantage of
anticipated changes in interest rates. Derivatives may be structured with no or
a high degree of leverage. When derivatives are used as hedges, the risk
incurred is that the derivative instrument's value may change differently than
the value of the security being hedged. This "basis risk" is generally lower
than the risk associated with an unhedged position in the security being hedged.
Some derivatives may entail liquidity risk, i.e., the risk that the instrument
cannot be sold at a reasonable price in highly volatile markets. Leveraged
derivatives used for speculation are very volatile, and therefore, very risky.
However, the Portfolios will only utilize derivatives for hedging or arbitrage
purposes, and not for speculative purposes. Over-the-counter derivatives involve
a counterparty risk, i.e., the risk that the individual or institution on the
other side of the agreement will not or cannot meet its obligations under the
derivative agreement.
B-4
<PAGE>
Federal Tax Treatment of Futures Contracts
Except for transactions they have identified as hedging transactions, the
California Insured Intermediate-Term Portfolio, the Insured Long-Term Portfolio
of each Fund, and Vanguard Florida Insured Tax-Free Fund are required for
federal income tax purposes to recognize as income for each taxable year their
net unrealized gains and losses on certain futures contracts held 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 a Portfolio may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. A Portfolio 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 Portfolio.
In order for each Portfolio 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
Portfolio's business of investing in securities. 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.
Each Portfolio 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 Portfolio's fiscal year) on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Portfolio's other investments and shareholders will be advised on the nature
of the transactions.
Municipal Lease Obligations
Each Portfolio of the Fund may invest in municipal lease obligations. These
securities are sometimes considered illiquid because of the inefficiency and
thinness of the market in which they are traded. Under the supervision of the
Fund's Board of Trustees, the Fixed Income Group may determine to treat certain
municipal lease obligations as liquid, and therefore not subject to the Fund's
15% limit on illiquid securities (10% for the Money Market Portfolios). The
factors that the Group may consider in making these liquidity determinations
include: (1) the frequency of trades and quotations for the security; (2) the
number of dealers willing to purchase or sell the security and the number of
other potential buyers; (3) the willingness of dealers to underwrite and make a
market in the security; (4) the nature of the marketplace trades, including the
time needed to dispose of the security, the method of soliciting offers, and the
mechanics of transfer; and (5) factors unique to a particular security,
including general credit worthiness of the issuer, the importance to the issuer
of the property covered by the lease and the likelihood that the marketability
of the securities will be maintained throughout the time the security is held by
the Portfolio.
RISK FACTORS
California Risk Factors
Vanguard California Tax-Free Fund invests primarily in the obligations of
California state and various local governments, including counties, cities,
special districts, agencies and authorities. In general, the credit quality and
credit risk of any issuer's debt depend on the state and local economy, the
health of the issuer's finances, the amount of the issuer's debt, the quality of
management, and the strength of legal provisions in debt documents that protect
debt holders. Credit risk is usually lower wherever the economy is strong,
growing and diversified; financial operations are sound; and the debt burden is
reasonable.
The credit risk associated with direct obligations of the State of California
and State agencies, including general obligation and revenue bonds, lease debt,
and notes, is now average. For most of the last two decades, the State's general
obligation bonds had enjoyed the highest rating by either Moody's Investors
Service, Inc. or Standard & Poor's Corporation. California's high credit quality
reflected the growth of its strong and diversified economy, a low debt position,
wealth levels higher than the national average, and a generally sound and stable
financial position. However, California's credit quality has declined since the
onset of the national recession in 1990.
B-5
<PAGE>
California's economy, largest among the states, is also one of the largest in
the world. The State's population, nearly 30 million in 1990, has doubled since
1960 and constitutes over 12% of the U.S. total. Rapid growth is continuing,
with rates more than twice that of the national average during the 1980s.
Personal income growth lagged behind U.S. growth in the 1980s, but per capita
income was still 10% above the national average in 1990. A growing, young
population, a strong higher education system, and excellent ports continue to
bolster California's economic prospects. Employment and income are not
concentrated in any one sector. In fact, California's economy closely mirrors
that of the U.S. One caveat to this observation concerns the defense industry.
For many years, California has led the Nation in receipt of total direct U.S.
military expenditures. However, as the State's economy expanded, the
concentration in defense has lessened. Nonetheless, a U.S. policy has resulted
in lower defense spending, parts of California, especially the Los Angeles
Region, have been adversely affected, and these trends might continue.
The economy and financial operations of California are exposed to the risk of
cyclical national recessions. In a recession, credit quality can drop if debt
issuers do not maintain a balance between revenues and expenditures. This
occurred in the early 1980s when Moody's and Standard & Poor's downgraded the
State. Subsequently, State finances were restored to sound levels, and credit
ratings were upgraded. California was especially hard hit by the recent national
recession and experienced three credit-rating downgrades by each of the two
major rating agencies. The effects of recession were not strongly felt in
California until 1991. Led by declines in defense-related activities and
construction (especially commercial real estate), the State lost over 800,000
jobs between 1990-1993, or about 6% of non-agricultural employment. The
recession resulted in a failure by State government to realize revenue and
spending targets. The State budget was chronically imbalanced in 1991 and 1992.
State aid was reduced, spreading fiscal stress to local governments, including
schools.
California has recently emerged from the depths of the recession, recovering
most of the jobs lost earlier in the decade. Job growth has been prevalent in
the high technology, entertainment, and foreign trade sectors. Despite the
recent economic expansion, both State and local governments continue to be
vulnerable to fiscal stress.
Despite the overall strength of California credit quality, there are a number
of additional risks. The adoption by voters of revenue and expenditure
limitations, commencing with Articles XIIIA and XIIIB of the California
Constitution in the late 1970s and Articles XIIIC and XIIID in 1996, have placed
many local governments under a degree of fiscal stress which continues. Court
decisions and the adoption of subsequent propositions have softened many of the
effects of these limitations. However, it should be noted that California voters
have demonstrated a willingness to utilize the statutory initiative process to
curtail the financial operations of state and local government, as well as to
increase public debt. This willingness is a continuing risk to debt holders.
Another risk resulting from Article XIIIA concerns the security provisions
for debt repayment. Since 1986, general obligation debt issued by local
governments has required voter approval by a two-thirds majority. As a result,
most tax-backed debt now issued by California local governments is not general
obligation debt, does not have "full faith and credit" backing, and has higher
credit risk and more limited bondholder rights.
Some risks in California apply more to local issuers than to state
government. In areas of very rapid population growth, the costs of building
public infrastructure are very high, large amounts of municipal bonds are being
sold, and debt burden is increasing. In some parts of southern California, there
is also a fear that population growth may possibly limit future economic growth
due to transportation and air pollution problems.
Finally, California is subject to unique natural hazard risks. Earthquakes
and wildfires can cause localized economic harm which could limit the ability of
governments to repay debt. Cycles of drought and flooding are also concerns
insofar as they affect agricultural production, power generation, and the supply
of drinking water. In addition, drought can limit the ability of certain public
utilities to repay debt.
Florida Risk Factors
Vanguard Florida Insured Tax-Free Fund invests primarily in the debt
obligations of Florida state government, the State's agencies and authorities,
and various local governments, including counties, cities, towns, special
districts, and authorities. In general, the credit quality and credit risk of
any issuer's debt depend on the state and local economy, the health of the
issuer's finances, the amount of the issuer's debt, the quality of management,
and the strength of legal provisions in debt documents that protect debt
holders. Credit risk is usually lower wherever the economy is strong, growing
and diversified, financial operations are sound, and the debt burden is
reasonable.
B-6
<PAGE>
The average credit rating among American states for full "faith and credit"
state debt is "Aa" as determined by Moody's Investors Service, Inc. and "AA" as
determined by Standard & Poor's Corporation. Against this measure and the
criteria listed above, the credit risk associated with direct obligations of the
State of Florida and the State's agencies and authorities, including general
obligation and revenue bonds, lease debt, and notes, is comparable with the
average for U.S. states. Florida's general obligation bonds have been rated in
the AA category by both rating agencies for over two decades, during which
period the State's obligations could be characterized as providing high-grade
security with a very strong capacity for timely repayment of debt. In 1997,
Standard & Poor's upgraded the State of Florida's rating to AA+ reflecting
healthy finances and a strong economy.
The State of Florida's economy is characterized by a large service sector, a
dependence on the tourism and construction industries, and a large retirement
population. The management of rapid growth has been the major challenge facing
state and local governments. While attracting many senior citizens, Florida also
offers a favorable business environment and growing employment opportunities
that have continued to generate working-age population in-migration. As this
growth continues, particularly within the retirement population, the demand for
both public and private services will increase, which may strain the service
sector's capacity and impede the State's budget balancing efforts.
During the 1980s, Florida outperformed the nation as measured by such
economic indicators as employment growth and income levels. Florida's job
creation rate in the non-agriculture sector was the highest of the eleven most
populous states. Fueling this growth in jobs were the continued boom in the
tourism industry and related service sectors and a dynamic construction and
construction-related manufacturing sector. Florida's economy did not suffer the
dislocation and restructuring of the more manufacturing-based economies of the
Midwest and the North during the 1980s and was less exposed to the decline of
the textile industry besieging much of the Southeast.
The primary vulnerability of the Florida economy is exposure to the business
cycle affecting both the tourism and construction industries. Gasoline prices
and supply can impact tourism. An economic recession reached Florida in 1991 and
impacted the service sector considerably, causing the State to experience an
actual job loss for the first time in decades. While Florida's aerospace and
defense contracting industries are now in decline, the State's manufacturing
economy has diversified into high-tech and electronic equipment and has been
strengthened by a growth in exports. Furthermore, construction jobs as a percent
of total jobs in the State declined during the late '80s, reducing cyclical
risk. The outlook for the Florida economy at the end of 1990's is continued
expansion fueled by population growth, a diversifying services and manufacturing
economy, and a robust tourism sector.
Personal income levels in Florida are greater than the U.S. average and
continue to grow at a faster rate. These levels in Florida are also less
sensitive to economic downturns than in the U.S., as a whole, since Florida is
home to a greater concentration of senior citizens who rely on dividends,
interest, Social Security, and pension benefits, which fluctuate less with the
business cycle than does employment income.
Debt levels in the State of Florida are moderate to high, reflecting the
tremendous capital demands associated with rapid population growth. Florida is
unusual among states in that all general obligation "full faith and credit" debt
issues of municipalities must be approved by public referendum and are,
therefore, relatively rare. Most debt instruments issued by local municipalities
and authorities have a more narrow pledge of security, such as a sales tax
stream, special assessment revenue, user fees, utility taxes, or fuel taxes.
Credit quality of such debt instruments tends to be somewhat lower than that of
general obligation debt. The State of Florida issues general obligation debt for
a variety of purposes; however, the State constitution requires a specific
revenue stream to be pledged to State general obligation bonds as well.
The market for Florida bonds secured by municipal leases suffered for a
period in the early 1990's due to the default of the State of Florida on a
private placement lease financing of an office building in 1989 and several
episodes of public consideration (although never carried out) by Brevard County
to not appropriate funds to meet its obligation under a tax-exempt lease
financing. More recently the Florida municipal lease market has performed well
with strong liquidity.
B-7
<PAGE>
The State of Florida generated steadily increasing fund balances during the
1980s as the State experienced record growth. However, the State experienced
budget strain during the early 1990s due to an economic recession. The State's
dependence on the sales tax as a primary source of revenue compounded the
recession's impact. State officials acted quickly and responsibly to maintain a
balanced budget by revising revenue projections and controlling spending. Such
responsible fiscal management enhances overall credit quality in the State of
Florida.
During the mid to late 1990's State finances have been particularly strong
with large surpluses and strong reserves. State officials, however, still face
tremendous capital and operating pressures due to the growth that will continue
to strain the State's narrow revenue base. Future budgets may require a wider
revenue base to meet such demands; the most likely candidate for such revenue
enhancement is a tax on consumer services. The creation of a Florida personal
income tax is a very remote possibility, since it would require an amendment to
the State's Constitution and a higher level of political support than has
currently been generated.
New Jersey Risk Factors
Vanguard New Jersey Tax-Free Fund invests primarily in the obligations of New
Jersey State government and various local governments, including counties,
cities, special districts, agencies and authorities. In general, the credit
quality and credit risk of any issuer's debt depend on the state and local
economy, the health of the issuer's finances, the amount of the issuer's debt,
the quality of management, and the strength of legal provisions in debt
documents that protect debt holders. Credit risk is usually lower wherever the
economy is strong, growing and diversified; financial operations are sound; and
the debt burden is reasonable.
The average rating among American states for full faith and credit state debt
is "Aa" and "AA" by Moody's Investors Service, Inc. and Standard & Poor's
Corporation, respectively. Against this measure and the criteria listed above,
the credit risk associated with direct obligations of the State of New Jersey
and state agencies, including general obligation and revenue bonds, and lease
debt, compares very favorably. For most of the last two decades, the State's
general obligation bonds have enjoyed the highest rating by either Moody's
Investors Service, Inc. or Standard & Poor's. In the early 1990s, however, both
Moody's and Standard & Poor's slightly downgraded the State's credit rating to
the high "AA" level due to an economy and state finances weakened by recession.
In general, New Jersey's high credit quality over time reflects the strong
growth and diversification of its economy, a moderate debt position, wealth
levels much higher than the national average, and a historically sound and
stable financial position.
New Jersey's economy continues to gradually emerge from the depths of the
1990-92 national recession. Between 1989 and 1992, the State lost 8.7% of its
employment total or about one job in twelve. Significant job losses occurred in
the construction, manufacturing, wholesale and retail trades, and in financial
and real estate services. The only sectors to experience growth during the
period were the healthcare and government sectors. Unemployment rates exceeded
the national average and reached a high of 9.8% in July of 1992. Economic
variables indicate a slowly improving New Jersey economy, as evidenced by a
decrease in the unemployment rate since 1993. However, this progress could be
mitigated by layoffs in the pharmaceutical industry and AT&T, New Jersey's
largest employer.
The most recent cyclical weakening of the New Jersey economy follows an
unprecedented period of diversification and growth for the State in the 1980s.
Like many other northeastern and "rust-belt" states, New Jersey's economy
declined during the 1970s. This set the stage for a remarkable period of
transformation in the 1980s. The State economy changed from a
manufacturing-dominated base to an economy balanced among manufacturing, trade
and services, closely mirroring the U.S. economy. Population growth exceeded the
regional average during this time, and growth in employment and income outpaced
the U.S. average. This growth occurred not only in the developed northeastern
and Delaware River Valley areas, but also in central New Jersey around Princeton
and the Atlantic coastal region. Despite the recession of 1990 to 1992, New
Jersey remains a wealthy state, and continues to be the second wealthiest after
Connecticut. Per capita state income is over a third higher than the U.S.
average.
New Jersey's debt burden is moderate in relation to the State's wealth and
resources, but has increased significantly since 1991 as the State has financed
capital outlays previously funded out of current revenues and stepped up debt
issuance to stimulate a weakened economy. Tax-supported debt as measured against
income and population is close to average levels among the states. Debt
retirement is rapid even though debt service has a modest claim on State
revenues. New debt issuance is expected to be manageable.
B-8
<PAGE>
After a decade of sound financial operations in the 1980s, characterized by
robust increases in revenues and fund balances, New Jersey faced several years
of budgetary distress in the early 1990s. Declining tax revenues and swelling
expenditures for Medicaid, public assistance, and corrections generated repeated
budget gaps that the State was able to close only by utilizing non-recurring
revenue sources. Continued high credit quality will depend on the resolve of
State leaders and taxpayers to maintain fiscal balance while diminishing a
reliance on one-time revenue sources. Most recently an improving State and
national economy has resulted in increased revenues and some moderation in
budgeting strain. However, the significant income tax cuts recently enacted in
the State may prove to strain state finances if an economic slowdown were to
occur.
A positive credit factor for local government in New Jersey is the strong
State oversight of local government operations. The State can and has seized
control of mismanaged jurisdictions. In general, the high level of wealth and
the strong economic base in the State have resulted in credit quality for local
government that is among the highest in the U.S. In addition, the State
guarantees the debt service of many local government bond issues. As State
finances remain under pressure, however, local governments may see levels of
state aid reduced, a development that could result in a dilution of local credit
quality. Successful tax appeals by property owners in many municipalities have
also reduced revenues for some local governments.
Despite the strengths of New Jersey credit quality, there are risks. New
Jersey has a number of older urban centers, including Newark and Camden, that
present a continuing vulnerability with respect to economic and social problems.
The State is facing educational finance reforms which could affect the credit
quality of certain school districts as well as State financial operations. State
taxes were increased in 1990 to balance the State's budget and then reduced in
1992 after a "taxpayer revolt" reversed the political power balance in the State
legislature. Finally, overbuilding in the residential and commercial real estate
sector has weakened property values as well as the general health of the
construction industry and related financial institutions.
New York Risk Factors
Vanguard New York Tax-Free Fund invests primarily in the obligations of New
York state government, state agencies, state authorities and various local
governments, including counties, cities, towns, special districts, and
authorities. In general, the credit quality and credit risk of any issuer's debt
depend on the state and local economy, the health of the issuer's finances, the
amount of the issuer's debt, the quality of management, and the strength of
legal provisions in debt documents that protect debt holders. Credit risk is
usually lower wherever the economy is strong, growing and diversified; financial
operations are sound; and the debt burden is reasonable.
The average rating among American states for full faith and credit state debt
is "Aa" and "AA" by Moody's Investors Service, Inc. and Standard & Poor's
Corporation, respectively. Against this measure and the criteria listed above,
the credit risk associated with direct obligations of the State of New York and
State agencies and authorities, including general obligation and revenue bonds,
"moral obligation" bonds, lease debt, appropriation debt, and notes, compares
somewhat unfavorably. During most of the last two decades, the State's general
obligation bonds have been rated just below this average by both rating
agencies. Additionally, the State's credit quality could be characterized as
more volatile than that of other states, since the State's credit rating has
been upgraded and downgraded much more often than usual. This rating has
fluctuated between "Aa" and "AA" since the early 1970s. Nonetheless, during this
period the State's obligations could still be characterized as providing upper
medium grade security, with a strong capacity for timely repayment of debt.
The wealth of New York State, as well as the size and diversity of its
economy, serve to limit the credit risk of its securities. New York ranks third
among the states in per capita personal income, which is 19% above the U.S.
average. During most of the 1980s, economic indicators for New York, including
income and employment growth and unemployment rates, outperformed the nation as
a whole. The engine of growth for the State in the past decade was the surge in
financial and other services, especially in New York City. Manufacturing centers
in upstate New York, which more closely parallels the Midwestern economy,
suffered during the 1970s and early 1980s. The upstate economy continues to be
characterized by cities with aging populations and aging manufacturing plants.
B-9
<PAGE>
Credit risk in New York State is heightened by a large and increasing debt
burden, historically marginal financial operations, limited revenue-raising
flexibility, and the uncertainty of the future credit quality of New York City,
which comprises 40% of the State's population and economy. Combined State and
local debt per capita is about 50% above the U.S. average, and debt service
expenditures have been growing as a claim on the State and City budget. New
York's debt structure is also complicated. To circumvent voter approval, most
State debt is issued by agencies, is not backed by the State's full faith and
credit and, therefore, has lower credit ratings. In the past, the State had to
rely on short-term borrowing to meet its obligations, but this practice has
ended.
Buoyed by rapid economic growth in the mid-1980s, the State's financial
operations generated surpluses. Beginning in 1988, however, unforeseen
consequences of federal tax reform, combined with a weakening economy, resulted
in a series of State budget deficits. New York's heavy commitment to local aid
and social welfare programs allowed expenditure growth to exceed available
revenues. This lack of budgetary discipline caused the State's credit ratings to
fall. Moreover, New York's ability to raise revenues is limited, since combined
state and local taxes are among the highest in the nation as a percent of
personal income. Recent state budgets have been balanced, and consistent
operating surpluses have been recorded although the State continues to have a
nearly $3 billion GAAP accumulated deficit. State personal income tax cuts have
been offset by strong revenue performance emanating from Wall Street and by
solid expenditure restraint.
New York State's future credit quality will be heavily influenced by the
future of New York City. As the City's economic boom in the 1980s lifted the
State, the severe downturn in the financial services and real estate sectors,
which are concentrated in the City, has been serving as a drag on the State's
economy. Stabilization or recovery in these areas is crucial to the economic and
fiscal health of the City and the State. Moreover, the City faces daunting
challenges in combating deteriorating infrastructure and serious social problems
of housing, health, education and public safety. So far, City government has
demonstrated an ability to keep abreast of these problems, but the City's and
the State's ability to meet these challenges will be a continuing risk factor.
Buoyed by Wall Street, the addition of 140,000 private sector jobs over the
1994-97 period and public sector workforce attrition, the City has posted
recurring operating surpluses. The largest, $856 million, is projected for
fiscal year 1997. The City will shortly be creating a new vehicle to access the
debt markets, called the Transitional Finance Authority, as G.O. capacity is
limited due to archaic statutory issuing formulas.
Major areas of credit strength continue to exist in localities in Long
Island, and north of New York City where affluent population bases continue to
exist.
Ohio Risk Factors
Ohio Tax-Free Fund will invest most of its net assets in securities issued by
or on behalf of (or in certificates of participation in lease-purchase
obligations of) the State of Ohio, political subdivisions of the State, or
agencies or instrumentalities of the State or its political subdivisions ("Ohio
Obligations"). The Fund is therefore susceptible to general or particular
political, economic or regulatory factors that may affect issuers of Ohio
Obligations. The following information constitutes only a brief summary of some
of the many complex factors that may affect the Fund. The information does not
apply to "conduit" obligations on which the public issuer itself has no
financial responsibility. This information is derived from official statements
of certain Ohio issuers published in connection with their issuance of
securities and from other publicly available documents, and is believed to be
accurate. No independent verification has been made of any of the following
information.
The timely payment of principal of and interest on Ohio Obligations has been
guaranteed by bond insurance purchased by the issuers, the Fund or other
parties. The timely payment of debt service on Ohio Obligations that are so
insured may not be subject to the factors referred to in this section of the
Prospectus.
Ohio is the seventh most populous state. Its 1990 Census count of 10,847,000
indicates a 0.5% population increase from 1980.
While diversifying more into the service and other non-manufacturing areas,
the Ohio economy continues to rely in part on durable goods manufacturing
largely concentrated in motor vehicles and equipment, steel, rubber products and
household appliances. As a result, general economic activity, as in many other
industrially-developed states, tends to be more cyclical than in some other
states and in the nation as a whole. Agriculture is an important segment of the
economy, with over half the State's area devoted to farming and approximately
15% of total employment in agribusiness. The State's economy has also benefited
by improved manufacturing productivity and a strong export position which helped
shield the State's economy from domestic recession in the early 1990s.
B-10
<PAGE>
There can be no assurance that future national, regional or statewide
economic difficulties, and the resulting impact on State or local government
finances generally, will not adversely affect the market value of Ohio
Obligations held in the Fund or the ability of particular obligors to make
timely payments of debt service on (or lease payments relating to) those
Obligations.
Ohio's debt burden is moderate, and the State and most local governments
observe prudent debt management practices. The State government maintained
positive year-end balances in its general revenue account during the 1980s,
achieved through timely revisions in tax and spending plans. During the economic
recovery of the mid-1980s, the State accumulated sizable fund balances in its
general revenue fund and maintained a healthy budget stabilization (or "rainy
day") fund. This strong financial position provided the State with far more
flexibility than most states to weather the revenue shortfalls and increased
human services expenditures generated by the most recent recession. The State's
finances remain sound and poised to generate enhanced balances as the national
economy affects a sustained recovery from the recession of the early 1990s.
Current cash and fund balance levels are exceptionally strong today. Cash
balances at 6/30/97 were $1.4 billion.
The State operates on the basis of a fiscal biennium for its appropriations
and expenditures, and is precluded by law from ending its July 1 to June 30
fiscal year ("FY") or fiscal biennium in a deficit position. Most State
operations are financed through the General Revenue Fund ("GRF"), for which
personal income and sales-use taxes are the major sources. Growth and depletion
of GRF ending fund balances show a consistent pattern related to national
economic conditions, with the ending FY balance reduced during less favorable
and increased during more favorable economic periods. The State has
well-established procedures for, and has timely taken, necessary actions to
ensure resource/expenditure balances during less favorable economic periods.
These procedures include general and selected reductions in appropriations
spending.
The Ohio Constitution also authorizes the issuance of State obligations for
certain purposes, the owners of which do not have the right to have excises or
taxes levied to pay debt service. Such State obligations are generally secured
by biennial appropriation lease agreements with the State.
In general, payment obligations under lease-purchase agreements of Ohio
public agencies (in which certificates of participation may be issued) are
limited in duration to the agencies' fiscal periods, and are dependent upon
appropriations being made available for the subsequent fiscal period.
Additionally, State and local agencies issue revenue obligations that are
payable from revenues from or relating to certain facilities (but not from
taxes). By judicial interpretation, these obligations are not "debt" within
constitutional provisions.
Local school districts in Ohio receive a major portion (on a statewide basis,
recent approximately 46%) of their operating moneys from State subsidies, but
are dependent on local property taxes, and in 98 districts from voter-authorized
income taxes, for significant portions of their budgets. Litigation, similar to
that in other states, is pending questioning the constitutionality of Ohio's
system of school funding. A small number of the State's 612 local school
districts have in any year required special assistance to avoid year-end
deficits. A current program provides for school district cash need borrowing
directly from commercial lenders, with diversion of State subsidy distributions
to repayment if needed.
Ohio's 943 incorporated cities and villages rely primarily on property and
municipal income taxes for their operations, and, with other local governments,
receive local government support and property tax relief moneys distributed by
the State. For those few municipalities that on occasion have faced significant
financial problems, there are statutory procedures for a joint state/local
commission to monitor the municipality's fiscal affairs and for development of a
financial plan to eliminate deficits and cure any defaults. Since inception in
1979, these procedures have been applied to 23 cities and villages; for 18 of
them the fiscal situation was resolved and the procedures terminated.
At present the State itself does not levy ad valorem taxes on real or
tangible personal property. Those taxes are levied by political subdivisions and
other local taxing districts. The Ohio Constitution has since 1934 limited the
amount of the aggregate levy (including a levy for un-voted general obligations)
of property taxes by all overlapping subdivisions, without a vote of the
electors or a municipal charter provision, to 1% of true value in money, and
statutes limit the amount of that aggregate levy to 10 mills per $1 of assessed
valuation (commonly referred to as the "ten-mill limitation"). Voted general
obligations of subdivisions are payable from property taxes that are unlimited
as to amount or rate.
B-11
<PAGE>
Pennsylvania Risk Factors
Vanguard Pennsylvania Tax-Free Fund invests primarily in the obligations of
Pennsylvania state government, state agencies and various local governments,
including counties, cities, townships, special districts, and authorities. In
general, the credit quality and credit risk of any issuer's debt depend on the
state and local economy, the health of the issuer's finances, the amount of the
issuer's debt, the quality of management, and the strength of legal provisions
in debt documents that protect debt holders. Credit risk is usually lower
wherever the economy is strong, growing and diversified; financial operations
are sound; and the debt burden is reasonable.
The average rating among American states for full faith and credit state debt
is "Aa" and "AA" by Moody's Investors Service, Inc. and Standard & Poor's
Corporation, respectively. Against this measure and the criteria listed above,
the credit risk associated with direct obligations of Pennsylvania and state
agencies, including general obligation and revenue bonds, lease debt, and notes,
compares slightly unfavorably. During most of the last two decades,
Pennsylvania's general obligation bonds have been rated just below this average
by both rating agencies. Nonetheless, during this period Pennsylvania's
obligations could still be characterized as providing upper medium grade
security, with a strong capacity for timely repayment of debt. Recently, the
State's rating was upgraded by Moody's Investors Service and the State now has
ratings of "Aa3"/"AA-".
Factors contributing positively to credit quality in Pennsylvania include a
favorable debt structure, a diversifying economic base, and conservatively
managed financial operations on the part of state government. Tax-supported debt
is only slightly above average state levels on a per capita basis and as a
percent of state personal income. Over the past two decades, this debt burden
has improved considerably in Pennsylvania, and debt continues to be rapidly
retired, while state borrowing plans are modest.
In the past twenty years, Pennsylvania's economy has undergone a healthy,
though traumatic, transformation. Manufacturing employment has declined from 35%
of total state employment in 1970 to 17.9% of total employment in 1995, only
slightly above the U.S. average. Growth in service sector jobs offset the loss
of manufacturing jobs, and Pennsylvania's economy is now much more closely
aligned with the national economy. In the future, economic booms and busts
should be milder than in the past and more closely follow national averages. The
positive change in the economy has not been without costs. Growth levels in
employment, population and personal income lagged behind U.S. averages in the
1980s. During this period, per capita personal income slipped to about the U.S.
average. Many communities dominated by a single industry were particularly hurt,
and recent growth in the state economy has bypassed much of the state outside of
the immediate Philadelphia and Pittsburgh metropolitan areas. As a result, the
credit quality of these areas is often marginal.
During the 1991-1992 national economic recession, Pennsylvania fared a bit
worse than the U.S. average, but better than many neighboring Northeastern and
Mid-Atlantic states. Led by continuing declines in manufacturing, employment
decreased about 4%, or double the U.S. loss rate. Pennsylvania has subsequently
experienced economic recovery in line with the U.S. More recently, the State's
economy has shown some growth with current unemployment rates approximating
those of the nation.
Fiscally, Pennsylvania has historically maintained balanced budgets, a result
of sound and conservative budgeting policies. During the period of economic
growth in the late 1980s, operating surpluses were recorded, and a "rainy day"
fund was established. That recent recession tested these policies, but the
Commonwealth emerged from the recession with its finances and credit quality
intact. In 1990 and 1991, as the recession worsened, budget balances were
eliminated, and the Commonwealth ended fiscal 1991 in a deficit position.
However, a combination of expenditure restraint and broad-based tax increases
enabled the Commonwealth to end 1992 with a surplus. Finances are now stable and
healthy, and the Commonwealth has a comfortable accumulated surplus. Due to this
improvement, cash flow borrowing has been substantially reduced. Tax revenue is
coming in above forecasted levels.
The risk factors in Pennsylvania's credit quality may be summarized as slow
growth, an aging population, average income, and a continuing challenge to
maintain balanced budgets. In addition, a number of local governments in the
Commonwealth, most notably Philadelphia, face continuing fiscal stress, and were
unable to address serious economic, social and healthcare problems within
revenue constraints. Philadelphia's credit prospects have recently improved
significantly but remain a challenge to the credit quality of Pennsylvania,
longer term.
B-12
<PAGE>
FLORIDA INTANGIBLE PERSONAL PROPERTY TAX
Although Florida does not have a state personal income tax, it does impose an
intangible personal property tax on certain financial assets, including mutual
fund shares. The most common examples of personal property subject to the tax
are shares of stock issued by corporations, bonds issued by corporations or
state, county or municipal governments outside the State of Florida, and shares
of ownership in mutual funds. Unlike most state and local taxes which are
assessed on ordinary income and capital gains derived from mutual fund shares,
the Florida intangible tax is based on the net asset value of these shares.
Under Florida law, shares of a mutual fund will be exempt from the intangibles
tax to the extent that, on the annual assessment date (January 1), its assets
are solely invested in exempt Florida securities, exempt U.S. government
securities, or other exempt securities. If, on the annual assessment date,
Vanguard Florida Insured Tax-Free Fund's assets are invested in both exempt and
non-exempt securities, only that portion of a share's net asset value
represented by U.S. government securities (including qualifying obligations of
U.S. territories and possessions) will be exempt from the intangibles tax. Under
this rule, shares of the Vanguard Florida Insured Tax-Free Fund are expected to
be exempt from the Florida intangible personal property tax.
YIELD AND TOTAL RETURN
California Tax-Free Fund
The yields of the California Insured Long-Term Portfolio, the California
Insured Intermediate-Term Portfolio and the California Money Market Portfolio
for the 30-day period ending November 30, 1997 were +4.81%, +4.37%, and +3.55%,
respectively.
The average annual total returns of the California Insured Long-Term
Portfolio for the one-, five-, and ten-year periods ended November 30, 1997,
were +6.52%, +7.50% and +8.83%, respectively. The average annual total returns
of the California Insured Intermediate-Term Portfolio for the one-year period
and the period from inception (March 4, 1994) to November 30, 1997 were +5.91%
and +6.84%, respectively. The average annual total returns of the California
Money Market Portfolio for the one, five and ten-year periods ended November 30,
1997, were +3.41%, +3.08% and +3.96%, respectively. Total return is computed by
finding the average compounded rates of return over the one-year period set
forth above that would equate an initial amount invested at the beginning of the
period to the ending redeemable value of the investment.
Florida Insured Tax-Free Fund
The yield of the Florida Insured Tax-Free Fund for the 30-day period ended
November 30, 1997 was +4.69%.
The average annual total returns of Florida Insured Tax-Free Fund for the
one- and five-year periods ended November 30, 1997 were +6.54% and +7.52%,
respectively. The average annual total return for the Fund since its inception
on September 1, 1992 was +7.73%.
New Jersey Tax-Free Fund
The yield of the New Jersey Insured Long-Term Portfolio and the New Jersey
Money Market Portfolio for the 30-day period ended November 30, 1997 was +4.73%
and +3.51%, respectively.
The average annual total returns of the New Jersey Insured Long-Term
Portfolio for the one- and five-year periods ended November 30, 1997, and since
its inception on February 3, 1988, were +6.40%, +7.10% and +8.19%, respectively.
The average annual total returns of the New Jersey Money Market Portfolio for
the one- and five-year periods ended November 30, 1997, and since its inception
on February 3, 1988, were +3.32%, +2.99% and +3.95%, respectively. Total return
is computed by finding the average compounded rates of return over the period
set forth above that would equate an initial amount invested at the beginning of
the period to the ending redeemable value of the investment.
New York Tax-Free Fund
The yield of the New York Insured Long-Term Portfolio and the New York Money
Market Portfolio for the 30-day period ended November 30, 1997 was +4.73% and
+0.8%, respectively.
B-13
<PAGE>
The average annual total returns of the New York Insured Long-Term Portfolio
for the one-, five-, and ten-year periods ended November 30, 1997 were +6.36%,
+7.28% and +8.76%, respectively. The average annual total return of the New York
Money Market Portfolio since its inception on September 3, 1997 was +0.8%. Total
return is computed by finding the average compounded rates of return over the
period set forth above that would equate an initial amount invested at the
beginning of the period to the ending redeemable value of the investment.
Ohio Tax-Free Fund
The yield of the Ohio Insured Long-Term Portfolio and the Ohio Money Market
Portfolio for the 30-day period ended November 30, 1997 was +4.70% and +3.64%,
respectively.
The average annual total returns of the Ohio Insured Long-Term Portfolio for
the one- and five-year periods ended November 30, 1997, and since its inception
on June 18, 1990, were +6.30%, +7.11% and +8.30%, respectively. The average
annual total returns of the Ohio Money Market Portfolio for the one- and
five-year periods ended November 30, 1997, and since its inception on June 18,
1990, were +3.49%, +3.13% and +3.48%, respectively.
Pennsylvania Tax-Free Fund
The yield of the Pennsylvania Insured Long-Term Portfolio and the
Pennsylvania Money Market Portfolio for the 30-day period ended November 30,
1997 was +4.77% and +3.67%, respectively. Yield is calculated daily and premium
and discounts on asset-backed securities are not amortized.
The average annual total returns of the Pennsylvania Insured Long-Term
Portfolio for the one-, five-, and ten-year periods ended November 30, 1997 were
+6.21%, +7.09% and +8.80%, respectively. The average total returns of the
Pennsylvania Money Market Portfolio for the one- and five-year periods ended
November 30, 1997, and since its inception on June 13, 1988, were +3.49%, +3.10%
and +3.99%, respectively. Total return is computed by determining the average
compounded rates of return over the period set forth above that would equate an
initial amount invested at the beginning of the period to the ending redeemable
value of the investment.
CALCULATION OF YIELD
The current yield of the Money Market Portfolio of each Fund is calculated
daily on a base period return of a hypothetical account having a beginning
balance of one share for a particular period of time (generally 7 days). The
return is determined by dividing the net change (exclusive of any capital
changes) in such account by its average net asset value for the period, and then
multiplying it by 365/7 to get annualized current yield. The calculation of net
change reflects the value of additional shares purchased with the dividends by
the Portfolio, including dividends on both the original share and on such
additional shares. An effective yield, which reflects the effects of compounding
and represents an annualization of the current yield with all dividends
reinvested, may also be calculated for the Portfolio by addition 1 to the net
change, raising the sum to the 365/7 power, and subtracting 1 from the result.
Set forth below is an example, for purposes of illustration only, of the
current and effective yield calculations for the Money Market Portfolio of each
applicable Fund for the 7-day base period ended November 30, 1997:
California Tax-Free Fund
<TABLE>
<CAPTION>
Money Market Portfolio
----------------------
11/30/97
--------
<S> <C>
Value of account at beginning of period ......................$1.00000
Value of same account at end of period* ......................$1.00068
--------
Net Change in account value ..................................$ .00068
Annualized Current Net Yield
(Net Change x 365/7)[divided by] average net asset value ......3.55%
Effective Yield
[(Net Change) + 1]365/7 - 1 ...................................3.61%
Average Weighted Maturity of Investments ......................65 days
* Exclusive of any capital changes.
B-14
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
New Jersey Tax-Free
Money Market Portfolio
----------------------
11/30/97
--------
<S> <C>
Value of account at beginning of period ......................$1.00000
Value of same account at end of period* ......................$1.00067
--------
Net Change in account value ..................................$ .00067
Annualized Current Net Yield
(Net Change x 365/7)[divided by] average net asset value ......3.51%
Effective Yield
[(Net Change) + 1]365/7 - 1 ...................................3.56%
Average Weighted Maturity of Investments ......................56 days
* Exclusive of any capital changes
</TABLE>
<TABLE>
<CAPTION>
New York Tax-Free Fund
Money Market Portfolio
----------------------
11/30/97
--------
<S> <C>
Value of account at beginning of period ........................$1.00000
Value of same account at end of period* ........................$1.00069
--------
Net Change in account value ....................................$ .00069
Annualized Current Net Yield
(Net Change x 365/7)[divided by] average net asset value ........3.63%
Effective Yield
[(Net Change) + 1]365/7 - 1 .....................................3.67%
Average Weighted Maturity of Investments ........................53 days
* Exclusive of any capital changes.
</TABLE>
<TABLE>
<CAPTION>
Ohio Tax-Free Fund
Money Market Portfolio
----------------------
11/30/97
--------
<S> <C>
Value of account at beginning of period .......................$1.00000
Value of same account at end of period* .......................$1.00070
--------
Net Change in account value ...................................$ .00070
Annualized Current Net Yield
(Net Change x 365/7) [divided by] average net asset value .......3.64%
Effective Yield
[(Net Change) + 1]365/7 - 1 ....................................3.70%
Average Weighted Maturity of Investments .......................60 days
* Exclusive of any capital changes.
</TABLE>
<TABLE>
<CAPTION>
Pennsylvania Tax-Free Fund
Money Market Portfolio
----------------------
11/30/97
--------
<S> <C>
Value of account at beginning of period .......................$1.00000
Value of same account at end of period* .......................$1.00070
--------
Net Change in account value ...................................$ .00070
Annualized Current Net Yield
(Net Change x 365/7) [divided by] average net asset value ......3.67%
Effective Yield
[(Net Change) + 1]365/7 - 1 ....................................3.73%
Average Weighted Maturity of Investments .......................43 days
* Exclusive of any capital changes.
</TABLE>
B-15
<PAGE>
Each Money Market Portfolio seeks to maintain, but does not guarantee, a
constant net asset value of $1.00 per share. The yield of the Portfolio will
fluctuate. Although the Money Market Portfolios invest in high-quality
instruments, the shares of the Portfolios are not insured or guaranteed by the
U.S. Government. Each Fund has obtained private insurance that partially
protects its Money Market Portfolio against default of principal or interest
payments on the instruments it holds, and against bankruptcy by issuers and
credit enhances of these instruments. Treasury and other U.S. Government
securities held by the Portfolios are excluded from this coverage. The
annualization of a week's dividend is not a representation by the Portfolio as
to what an investment in the Portfolio will actually yield in the future. Actual
yields will depend on such variables as investment quality, average maturity,
the type of instruments the Portfolio invests in, changes in interest rates on
instruments, changes in the expenses of the Fund and other factors. Yields are
one basis investors may use to analyze the Portfolios of the Fund, and other
investment vehicles; however, yields of other investment vehicles may not be
comparable because of the factors set forth in the preceding sentence,
differences in the time periods compared, and differences in the methods used in
valuing portfolio instruments, computing net asset value and calculating yield.
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 use one or more of the following unmanaged indexes for
comparative performance purposes.
Standard and Poor's 500 Composite Stock Price Index--is a well diversified list
of 500 companies representing the U.S. Stock Market.
Standard & Poor's MidCap 400 Index--is composed of 400 medium sized domestic
stocks.
Standard & Poor's/SmallCap 600/BARRA Value Index--contains stocks of the S&P
SmallCap 600 Index which have a lower than average price-to-book ratio.
Standard & Poor's/SmallCap 600/BARRA Growth Index--contains stocks of the S&P
SmallCap 600 Index which have a higher than average price-to-book ratio.
Russell 1000 Value Index--consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the lowest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000.
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 and Poor's 500 Index.
Russell 3000 Stock Index--a diversified portfolio of approximately 3,000 common
stocks accounting for over 90% of the market value of publicly traded stocks in
the U.S.
Russell 2000 Stock Index--a subset of approximately 2,000 of the smallest stocks
contained in the Russell 3000; a widely-used benchmark for small capitalization
common stocks.
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, Asia 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 Indexconsists 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.
B-16
<PAGE>
Salomon Brothers Broad Investment-Grade Bond Index--is a market-weighted index
that contains over 4,800 individually priced investment-grade corporate bonds
rated BBB or better, U.S. Treasury/agency issues and mortgage pass-through
securities.
Lehman Long-Term Treasury Bond Index--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 Index--consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index--all publicly offered fixed-rate,
non-convertible 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.
Lehman Brothers Long-Term Corporate Bond Index--is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed rate,
non-convertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Bond Index--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 and 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, 12.5 % Standard & Poor's Utilities Index and 12.5% Standard & Poor's
Telephone Index).
Lehman Long-Term Corporate AA or Better Bond Index--consists of all publicly
issued, fixed rate, non-convertible 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.
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 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.
Lipper Small Company Growth Fund Average--the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company. From time to time, Vanguard may advertise using the average performance
and/or the average expense ratio of the small company growth funds. (This fund
category was first established in 1982. For years prior to 1982, the results of
the Lipper Small Company Growth category were estimated using the returns of the
Funds that constituted the Group at its inception.)
B-17
<PAGE>
Lipper Balanced Fund Average--an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
Lipper Non-Government Money Market Fund Average--an industry benchmark of
average non-government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
Lipper Government Money Market Fund Average--an industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
Lipper General Equity Fund Average--an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
Lipper Fixed Income Fund Average--an industry benchmark of average fixed income
funds with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
INVESTMENT MANAGEMENT
The Fund receives all investment advisory services on an "internalized,"
at-cost basis from an experienced investment management staff employed directly
by The Vanguard Group, Inc. ("Vanguard"), a subsidiary jointly owned by the Fund
and the other Funds in The Vanguard Group of Investment Companies. The
investment management staff is supervised by the Senior Officers of the Fund.
The investment management staff is responsible for: maintaining the specified
standards; making changes in specific issues in light of changes in the
fundamental basis for purchasing such securities; and adjusting the Fund to meet
cash inflow (or outflow), which reflects net purchases and exchanges of shares
by investors (or net redemptions of shares) and reinvestment of the Fund's
income.
A change in securities held by the Fund is known as "portfolio turnover" and
may involve the payment by the Fund of dealer mark-ups, underwriting commissions
and other transaction costs on the sales of securities as well as on the
reinvestment of the proceeds in other securities. The annual portfolio turnover
rate for each of the Fund's Portfolios is set forth under the heading "Financial
Highlights" in the Fund's Prospectus. The portfolio turnover rate is not a
limiting factor when management deems it desirable to sell or purchase
securities. It is impossible to predict whether or not the portfolio turnover
rate in future years will vary significantly from the rates in recent years.
PORTFOLIO TRANSACTIONS
How Transactions Are Effected
The types of securities in which the Portfolios invest are generally
purchased and sold through principal transactions, meaning that the Portfolios
normally purchase securities directly from the issuer or a primary market-maker
acting as principal for the securities on a net basis. Brokerage commissions are
not paid on these transactions, although the purchase price for securities
usually includes an undisclosed compensation. Purchases from underwriters of
securities typically include a commission or concession paid by the issuer to
the underwriter, and purchases from dealers serving as market makers typically
include a dealer's mark-up (i.e., a spread between the bid and the asked
prices). During the fiscal years ended November 30, 1995, 1996 and 1997, the
Fund did not pay any brokerage commissions.
How Brokers and Dealers are Selected
Vanguards Fixed Income Group chooses brokers or dealers to handle the
purchase and sale of the Portfolios' securities, and is responsible for getting
the best available price and most favorable execution for all transactions. When
the Portfolios purchase a newly issued security at a fixed price, the Group may
designate certain members of the underwriting syndicate to receive compensation
associated with that transaction. Certain dealers have agreed to rebate a
portion of such compensation directly to the Portfolios to offset their
management expenses. The Group is required to seek best execution of all
transactions and is not authorized to pay a brokerage commission in excess of
that which another broker might have charged for effecting the same transaction
solely on account of the receipt of research or other services.
B-18
<PAGE>
How the Reasonableness of Brokerage Commissions is Evaluated
As previously explained, the types of securities that the Fund purchases do
not normally involve the payment of brokerage commissions. If any brokerage
commissions are paid, however, the Fixed Income Group will evaluate their
reasonableness by considering: (a) historical commission rates; (b) rates which
other institutional investors are paying, based upon publicly available
information; (c) rates quoted by brokers and dealers; (d) the size of a
particular transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular transaction in
terms of both execution and settlement; (f) the level and type of business done
with a particular firm over a period of time; and (g) the extent to which the
broker or dealer has capital at risk in the transaction.
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offering 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 under circumstances where certain economies can be
achieved in sales of the Fund's shares.
Stock Certificates. Your purchase will be made in full and fractional shares
of the Fund calculated to three decimal places. Shares are normally held on
deposit for shareholders by the Fund, which will send to shareholders a
statement of shares owned at the time of each transaction. This saves the
shareholders the trouble of safekeeping the certificates and saves the Fund the
cost of issuing certificates. Share certificates for the California Insured
Intermediate-Term Portfolio, and the Insured Long-Term Portfolios of each Fund
are available upon written request at no additional cost to shareholders. No
certificates will be issued for fractional shares of these Portfolios, for any
shares of the Money Market Portfolios, or for shares of the Florida Insured
Tax-Free 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.
If the Board of Trustees determines that it would be detrimental to the best
interests of the remaining shareholders of the Fund to make payment wholly or
partly in cash, the Fund may pay the redemption price in whole or in part by a
distribution in kind of securities held by the Fund in lieu of cash in
conformity with applicable rules of the Commission. Investors may incur
brokerage charges on the sale of such securities so received in payment of
redemptions.
No charge is made by the Fund for redemptions except for wire redemptions of
under $5,000 which may be charged a maximum fee of $5.00. Any redemption may be
more or less than the shareholder's cost depending on the market value of the
securities held by the Fund.
Signature Guarantees. To protect your account, the Fund, and Vanguard from
fraud, signature guarantees are required for certain redemptions. Signature
guarantees enable the Fund to verify the identity of the person who has
authorized a redemption from your account. Signature guarantees are required in
connection with: (1) all redemptions, regardless of the amount involved, when
the proceeds are to be paid to someone other than the registered owners; and (2)
share transfer requests.
A signature guarantee may be obtained from banks, brokers and any other
financial institution that Vanguard deems acceptable.
The signature guarantees must appear either: (1) on the written request for
redemption, (2) on a separate instrument for assignment ("stock power") which
should specify the total number of shares to be redeemed, or (3) on all stock
certificates tendered for redemption and, if shares held by the Fund are also
being redeemed, on the letter or stock power.
B-19
<PAGE>
SHARE PRICE
Each Portfolio's share price, or "net asset value" per share, is calculated
by dividing the total assets of the Portfolio, less all liabilities, by the
total number of shares outstanding. The net asset value is determined as of the
close of the New York Stock Exchange (the "Exchange"), generally 4:00 p.m.
Eastern time, on each day that the Exchange is open for trading.
Short term instruments (those with remaining maturities of 60 days or less)
may be valued at cost, plus or minus any amortized discount or premium, which
approximates market value.
Bonds and other fixed income securities may be valued on the basis of prices
provided by a pricing service when such prices are believed to reflect the fair
market value of such securities. The prices provided by a pricing service may be
determined without regard to bid or last sale prices of each security, but take
into account institutional-size transactions in similar groups of securities as
well as any developments related to specific securities.
Other assets and securities for which no quotations are readily available or
which are restricted as to sale (or resale) are valued by such methods as the
Board of Directors deems in good faith to reflect fair value.
It is the policy of each Money Market Portfolio to attempt to maintain a net
asset value of $1.00 per share for sales and redemptions. The instruments held
by each Money Market Portfolio are valued on the basis of amortized cost, which
does not take into account unrealized capital gains or losses. This involves
valuing an instrument at its cost and thereafter assuming a constant
amortization to maturity of any discount or premium, regardless of the impact of
fluctuating interest rates on the market value of the instrument. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price which
each Money Market Portfolio would receive it if sold the instrument.
The use of amortized cost and the maintenance of each Money Market
Portfolio's net asset value at $1.00 is based on its election to operate under
Rule 2a-7 under the Investment Company Act of 1940. As a condition of operating
under that rule, each Money Market Portfolio must maintain a dollar-weighted
average portfolio maturity of 90 days or less, purchase only instruments having
remaining maturities of 397 days or less, and invest only in securities that are
determined by methods approved by the Trustees to present minimal credit risks
and that are of high quality as determined by the requisite rating services, or
in the case of an instrument not so rated, determined by methods approved by the
Trustees to be of comparable quality. The Trustees have also agreed to establish
procedures reasonably designed, taking into account current market conditions
and each Money Market Portfolio's investment objective, to stabilize the net
asset value per share as computed for purposes of sales and redemptions at
$1.00.
The share price for each Portfolio can be found daily in the mutual fund
listings of most major newspapers under the heading of Vanguard Funds.
B-20
<PAGE>
MANAGEMENT OF THE FUND
Officers and Trustees
The Fund's Officers, under the supervision of the Board of Trustees, manage
the day-to-day operations of the Fund. The Trustees set broad policies for the
Fund and choose its Officers. A list of the Trustees and Officers of the Fund
and a brief statement of their present positions and principal occupations
during the past five years is set forth below. As of November 30, 1997, the
Trustees owned less than 1% of the Fund's outstanding shares. The mailing
address of the Fund's Trustees and Officers is Post Office Box 876, Valley
Forge, PA 19482.
JOHN C. BOGLE, (DOB: 5/8/1929) Senior Chairman and Trustee*
Senior 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, (DOB: 7/29/1954) Chairman, Chief Executive Officer & Trustee*
Chairman, Chief Executive Officer and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, (DOB: 9/28/1935) Trustee
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corporation.
BARBARA BARNES HAUPTFUHRER, (DOB: 10/11/1928) Trustee
Director of The Great Atlantic and Pacific Tea Company, IKON Office Solutions,
Inc., Raytheon Company, Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; and Trustee Emerita of Wellesley
College.
BURTON G. MALKIEL, (DOB: 8/28/1932) 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 Telecommunications Company.
ALFRED M. RANKIN, (DOB: 10/8/1941) Trustee
Chairman, President, Chief Executive Officer, and Director of NACCO Industries,
Inc.; Director of The BF Goodrich Company, and The Standard Products Company.
B-21
<PAGE>
JOHN C. SAWHILL, (DOB: 6/12/1936) Trustee
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co., President of New York University;
Director of Pacific Gas and Electric Company, Procter and Gamble Company, and
NACCO Industries.
JAMES O. WELCH, JR., (DOB: 5/13/1931) Trustee
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corporation.
J. LAWRENCE WILSON, (DOB: 3/2/1936) Trustee
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of Cummins
Engine Company, and The Mead Corporation; and Trustee of Vanderbilt University.
RICHARD F. HYLAND, (DOB: 3/22/1937) Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment companies in
The Vanguard Group.
RAYMOND J. KLAPINSKY, (DOB: 12/7/1938) Secretary*
Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of each
of the investment companies in The Vanguard Group.
KAREN E. WEST, (DOB: 9/13/1946) 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.
The Vanguard Group
The Fund is a member of The Vanguard Group of Investment Companies. Through
their jointly-owned subsidiary, The Vanguard Group, Inc. ("Vanguard"), the Fund
and the other funds (the "Vanguard Funds") in the Group obtain at-cost virtually
all of their corporate management, administrative and distribution services.
Vanguard also provides investment advisory services on an at-cost basis to
several of the Vanguard Funds, including the Fund.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Vanguard Funds and
also furnishes the Vanguard Funds with necessary office space, furnishings and
equipment. Each Vanguard Fund pays its share of Vanguard's net expenses which
are allocated among the Vanguard Funds under methods approved by the Board of
Trustees (Directors) of each Vanguard Fund. In addition, each Vanguard Fund
bears its own direct expenses such as legal, auditing and custodian fees. In
order to generate additional revenues for Vanguard and thereby reduce the
Vanguard Fund's expenses, Vanguard also provides certain administrative services
to other organizations.
The Fund's Officers are also Officers and employees of Vanguard. No Officer
or employee owns, or is permitted to own, any securities of any external adviser
for the Vanguard Funds.
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 Vanguard Group, Inc. ("Vanguard") was established and operates under a
Funds' Service Agreement which was approved by the shareholders of each of the
Vanguard Funds. The Funds' Service Agreement provides for the following
arrangement: (a) each Vanguard Fund may invest up to 0.40% of its current net
assets in Vanguard, and (b) there is no restriction on the maximum aggregate
cash investment that the Vanguard Funds may make in Vanguard. The amounts which
each of the Vanguard Funds has invested are adjusted from time to time in order
to maintain the proportionate relationship between each Fund's relative net
assets and its contribution to Vanguard's capital. At November 30, 1997, the
Funds' capital contribution was as follows: Vanguard California Tax-Free Fund
had contributed capital of $242,000 to Vanguard representing 1.2% of Vanguard's
capitalization. Vanguard Florida Insured Tax-Free Fund had contributed $41,000
to Vanguard, representing 0.2% of Vanguard's capitalization. Vanguard New Jersey
Tax-Free Fund had contributed $131,000 to Vanguard, representing 0.7% of
Vanguard's capitalization. Vanguard New York Tax-Free Fund had contributed
$83,000 to Vanguard, representing 0.4% of Vanguard's capitalization. Vanguard
Ohio Tax-Free Fund had contributed $37,000 to Vanguard, representing 0.2% of
Vanguard's capitalization. Vanguard Pennsylvania Tax-Free Fund had contributed
$224,000 to Vanguard, representing 1.1% of Vanguard's capitalization.
B-22
<PAGE>
Management. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During the
fiscal year ended November 30, 1997, each of the Funds' share of Vanguard's
actual net costs of operations relating to management and administrative
services (including transfer agency) were as follows: Vanguard California
Tax-Free Fund totaled approximately $4,089,000. Vanguard Florida Insured
Tax-Free Fund totaled approximately $785,000. Vanguard New Jersey Tax-Free Fund
totaled approximately $2,580. Vanguard New York Tax-Free Fund totaled
approximately $1,593,000. Vanguard Ohio Tax-Free Fund totaled approximately
$676,000. Vanguard Pennsylvania Tax-Free Fund totaled approximately $4,382,000.
Distribution. Vanguard provides all distribution and marketing activities for
the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as a Sales Agent for shares of the
Funds, in connection with any sales made directly to investors in the states of
Florida, Missouri, New York, Ohio, Texas and such other states as may be
required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Trustees
(Directors) and Officers of Vanguard determine the amount to be spent annually
on distribution activities, the manner and amount to be spent on each Fund, and
whether to organize new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon their relative net assets. The remaining
one half of these expenses is allocated among the Funds based upon each Fund's
sales for the preceding 24 months relative to the total sales of the Funds as a
Group, provided, however, that no Fund's aggregate quarterly rate of
contribution for distribution expenses of a marketing and promotional nature
shall exceed 125% of the average distribution expense rate for the Group, and
that no Fund shall incur annual distribution expenses in excess of 20/100 of 1%
of its average month-end net assets. During the year ended November 30, 1997,
the Group's distribution and marketing expenses attributable to the Funds were
as follows: Vanguard California Tax-Free Fund paid approximately $883,000.
Vanguard Florida Insured Tax-Free Fund paid approximately $137,000. Vanguard New
Jersey Tax-Free Fund paid approximately $509,000. Vanguard New York Tax-Free
Fund paid approximately $241,000. Vanguard Ohio Tax-Free Fund paid approximately
$142,000. Vanguard Pennsylvania Tax-Free Fund paid approximately $826,000.
Investment Advisory Services. Vanguard also provides investment advisory
services to: Vanguard Municipal Bond Fund; Vanguard Money Market Reserves;
Vanguard Admiral Funds; the several Portfolios of Vanguard Fixed Income
Securities Fund; Vanguard Institutional Index Fund; Vanguard Bond Index Fund;
Vanguard California Tax-Free Fund; Vanguard Florida Insured Tax-Free Fund;
Vanguard New Jersey Tax-Free Fund; Vanguard New York Tax-Free Fund; Vanguard
Ohio Tax-Free Fund; Vanguard Pennsylvania Tax-Free Fund; Vanguard Tax-Managed
Fund; the Aggressive Growth Portfolio of Vanguard Horizon Fund; the Total
International Portfolio of Vanguard STAR Fund; the REIT Index Portfolio of
Vanguard Specialized Portfolios; Vanguard Balanced Index Fund; Vanguard Index
Trust; Vanguard International Equity Index Fund; a secured Portfolio of Vanguard
Variable Insurance Fund; a portion of Vanguard/Windsor II; a portion of
Vanguard/Morgan Growth Fund; a portion of Vanguard Explorer Fund; as well as
several indexed separate accounts. These services are provided on an at-cost
basis from a money management staff employed directly by Vanguard. The
compensation and other expenses of this staff are paid by the Funds utilizing
these services. The following table shows, for the years ended November 30,
1995, 1996 and 1997, approximately how much the Funds paid of Vanguard's
investment advisory expenses.
B-23
<PAGE>
<TABLE>
<CAPTION>
Fund Year Ended 11/30/95 Year Ended 11/30/96 Year Ended 11/30/97
<S> <C> <C> <C>
Vanguard California Tax-Free Fund $286,000 $313,000 $470,000
Vanguard Florida Insured Tax-Free Fund $46,000 $58,000 $82,000
Vanguard New Jersey Tax-Free Fund $201,000 $211,000 $274,000
Vanguard New York Tax-Free Fund $101,000 $110,000 $150,000
Vanguard Ohio Tax-Free Fund $43,000 $49,000 $77,000
Vanguard Pennsylvania Tax-Free Fund $339,000 $357,000 $466,000
</TABLE>
Director/Trustee Compensation
The individuals in the tables below serve as Directors/Trustees of all Vanguard
Funds, and each Fund pays a proportionate share of the Directors'/Trustees'
compensation. The Funds employ their officers on a shared basis, as well.
However, officers are compensated by The Vanguard Group, Inc., not the Funds.
Independent Directors/Trustees. The Funds compensate their independent
Directors/Trustees--that is, the ones who are not also officers of the Fund--in
three ways:
o The independent Directors/Trustees receive an annual fee for their service to
the Funds, which is subject to reduction based on absences from scheduled
Board meetings.
o The independent Directors/Trustees are reimbursed for the travel and other
expenses that they incur in attending Board meetings.
o Upon retirement, the independent Directors/Trustees receive an aggregate
annual fee of $1,000 for each year served on the Board, up to fifteen years
of service. This annual fee is paid for ten years following retirement, or
until the Directors'/Trustees' death.
"Interested" Directors/Trustees. The Funds' interested Directors/Trustees--
Messrs. Bogle and Brennan--receive no compensation for their service in that
capacity. However, they are paid in their role as officers of The Vanguard
Group, Inc.
Compensation Table. The following tables provide compensation details for each
of the Trustees. For the Funds, we list the amounts paid as compensation and
accrued as retirement benefits by the Fund for each Trustee. In addition, the
table shows the total amount of benefits that we expect each Director/Trustee to
receive from all Vanguard Funds upon retirement, and the total amount of
compensation paid to each Director/Trustee by all Vanguard Funds. All
information shown is for the fiscal year ended November 30, 1997.
B-24
<PAGE>
<TABLE>
<CAPTION>
VANGUARD CALIFORNIA TAX-FREE FUND
COMPENSATION TABLE
Pension or Retire- Total Compensation
Aggregate ment Benefits Estimated Annual From All Vanguard
Compensation Accrued as Part of Benefits Upon Funds Paid to
Name of Trustees From Fund Fund Expenses Retirement Trustees (2)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) None None None None
John J. Brennan(1) None None None None
Barbara Barnes $859 $128 $15,000 $70,000
Hauptfuhrer
Robert E. Cawthorn $859 $107 $13,000 $70,000
Burton G. Malkiel $861 $ 86 $15,000 $70,000
Alfred M. Rankin, Jr. $859 $ 67 $15,000 $70,000
John C. Sawhill $859 $ 80 $15,000 $70,000
James O. Welch, Jr. $859 $ 99 $15,000 $70,000
J. Lawrence Wilson $859 $ 71 $15,000 $70,000
- ----------
(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 35 Vanguard Funds (34 in the case of Mr. Malkiel).
</TABLE>
<TABLE>
<CAPTION>
VANGUARD FLORIDA INSURED TAX-FREE FUND
COMPENSATION TABLE
Pension or Retire- Total Compensation
Aggregate ment Benefits Estimated Annual From All Vanguard
Compensation Accrued as Part of Benefits Upon Funds Paid to
Name of Trustees From Fund Fund Expenses Retirement Trustees (2)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) None None None None
John J. Brennan(1) None None None None
Barbara Barnes $151 $23 $15,000 $70,000
Hauptfuhrer
Robert E. Cawthorn $151 $19 $13,000 $70,000
Burton G. Malkiel $155 $15 $15,000 $70,000
Alfred M. Rankin, Jr. $151 $12 $15,000 $70,000
John C. Sawhill $151 $14 $15,000 $70,000
James O. Welch, Jr. $151 $17 $15,000 $70,000
J. Lawrence Wilson $151 $13 $15,000 $70,000
- ----------
(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 35 Vanguard Funds (34 in the case of Mr. Malkiel).
</TABLE>
B-25
<PAGE>
<TABLE>
<CAPTION>
VANGUARD NEW JERSEY TAX-FREE FUND
COMPENSATION TABLE
Pension or Retire- Total Compensation
Aggregate ment Benefits Estimated Annual From All Vanguard
Compensation Accrued as Part of Benefits Upon Funds Paid to
Name of Trustees From Fund Fund Expenses Retirement Trustees (2)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) None None None None
John J. Brennan(1) None None None None
Barbara Barnes $514 $77 $15,000 $70,000
Hauptfuhrer
Robert E. Cawthorn $514 $64 $13,000 $70,000
Burton G. Malkiel $514 $51 $15,000 $70,000
Alfred M. Rankin, Jr. $514 $40 $15,000 $70,000
John C. Sawhill $514 $48 $15,000 $70,000
James O. Welch, Jr. $514 $59 $15,000 $70,000
J. Lawrence Wilson $514 $43 $15,000 $70,000
- ----------
(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 35 Vanguard Funds (34 in the case of Mr. Malkiel).
</TABLE>
<TABLE>
<CAPTION>
VANGUARD NEW YORK TAX-FREE FUND
COMPENSATION TABLE
Pension or Retire- Total Compensation
Aggregate ment Benefits Estimated Annual From All Vanguard
Compensation Accrued as Part of Benefits Upon Funds Paid to
Name of Trustees From Fund Fund Expenses Retirement Trustees (2)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) None None None None
John J. Brennan(1) None None None None
Barbara Barnes $287 $43 $15,000 $70,000
Hauptfuhrer
Robert E. Cawthorn $287 $36 $13,000 $70,000
Burton G. Malkiel $291 $28 $15,000 $70,000
Alfred M. Rankin, Jr. $287 $23 $15,000 $70,000
John C. Sawhill $287 $27 $15,000 $70,000
James O. Welch, Jr. $287 $33 $15,000 $70,000
J. Lawrence Wilson $287 $24 $15,000 $70,000
- ----------
(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 35 Vanguard Funds (34 in the case of Mr. Malkiel).
</TABLE>
B-26
<PAGE>
<TABLE>
<CAPTION>
VANGUARD OHIO TAX-FREE FUND
COMPENSATION TABLE
Pension or Retire- Total Compensation
Aggregate ment Benefits Estimated Annual From All Vanguard
Compensation Accrued as Part of Benefits Upon Funds Paid to
Name of Trustees From Fund Fund Expenses Retirement Trustees (2)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) None None None None
John J. Brennan(1) None None None None
Barbara Barnes $140 $21 $15,000 $70,000
Hauptfuhrer
Robert E. Cawthorn $140 $18 $13,000 $70,000
Burton G. Malkiel $145 $14 $15,000 $70,000
Alfred M. Rankin, Jr. $140 $11 $15,000 $70,000
John C. Sawhill $140 $13 $15,000 $70,000
James O. Welch, Jr. $140 $16 $15,000 $70,000
J. Lawrence Wilson $140 $12 $15,000 $70,000
- ----------
(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 35 Vanguard Funds (34 in the case of Mr. Malkiel).
</TABLE>
<TABLE>
<CAPTION>
VANGUARD PENNSYLVANIA TAX-FREE FUND
COMPENSATION TABLE
Pension or Retire- Total Compensation
Aggregate ment Benefits Estimated Annual From All Vanguard
Compensation Accrued as Part of Benefits Upon Funds Paid to
Name of Trustees From Fund Fund Expenses Retirement Trustees (2)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) None None None None
John J. Brennan(1) None None None None
Barbara Barnes $867 $129 $15,000 $70,000
Hauptfuhrer
Robert E. Cawthorn $867 $108 $13,000 $70,000
Burton G. Malkiel $871 $ 87 $15,000 $70,000
Alfred M. Rankin, Jr. $867 $ 68 $15,000 $70,000
John C. Sawhill $867 $ 81 $15,000 $70,000
James O. Welch, Jr. $867 $ 99 $15,000 $70,000
J. Lawrence Wilson $867 $ 72 $15,000 $70,000
- ----------
(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 35 Vanguard Funds (34 in the case of Mr. Malkiel).
</TABLE>
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Funds were organized as Pennsylvania business trusts on the following
dates: Vanguard California Tax-Free Fund--October 16, 1985; Vanguard Florida
Insured Tax-Free Fund--May 22, 1992; Vanguard New Jersey Tax-Free
Fund--September 25, 1987; Vanguard New York Tax-Free Fund - October 16, 1985;
Vanguard Ohio Tax-Free Fund - March 16, 1990; Vanguard Pennsylvania Tax-Free
Fund--January 15, 1986.
The Declaration of Trust (as amended and restated on January 15, 1986 for
Vanguard California Tax-Free Fund, and for Vanguard New York Tax-Free Fund)
permits the Trustees to issue an unlimited number of shares of beneficial
interest, without par value, from an unlimited number of separate classes
("Portfolios") of shares. Currently, the California Tax-Free Fund is offering
shares of three Portfolios, the Florida Insured Tax-Free Fund is offering shares
of one Portfolio, and the New Jersey, New York, Ohio and Pennsylvania Tax-Free
Funds are offering shares of two Portfolios.
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The shares of the Fund are fully paid and non-assessable, 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 preemptive 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 Investment Company Act of 1940, 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.
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.
Upon completion of the distribution of the remaining proceeds or the
remaining assets of any Portfolio as provided in paragraphs 1) and 2) above the
Fund shall terminate 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 canceled 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 Fund. Therefore, the Declaration of Trust
contains an express disclaimer of shareholder liability for acts or obligations
of the Fund and requires that notice of such disclaimer be given in each
agreement, obligation, or instrument entered into or executed by the Fund or the
Trustees. The Declaration of Trust provides for indemnification out of the Fund
property of any shareholder held personally liable for the obligations of the
Fund. The Declaration of Trust also provides that the Fund shall, upon request,
assume the defense of any claim made against any shareholder for any act or
obligation of the Fund 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 Fund 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 Funds' respective financial statements as of and for the year ended
November 30, 1997, appearing in the Funds' respective 1997 Annual Reports to
Shareholders, and the respective reports thereon of Price Waterhouse LLP,
independent accountants, also appearing therein, are incorporated by reference
in this Statement of Additional Information. The Funds' respective 1997 Annual
Reports to Shareholders are available upon request.
APPENDIX A - DESCRIPTION OF MUNICIPAL BONDS AND THEIR RATINGS
Municipal Bonds - General. Municipal Bonds generally include debt obligations
issued by states and their political subdivisions, and duly constituted
authorities and corporations, to obtain funds to construct, repair or improve
various public facilities such as airports, bridges, highways, hospitals,
housing, schools, streets and water and sewer works. Municipal Bonds may also be
issued to refinance outstanding obligations as well as to obtain funds for
general operating expenses and for loan to other public institutions and
facilities.
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The two principal classifications of Municipal Bonds are "general obligation"
and "revenue" or "special tax" bonds. General obligation bonds are secured by
the issuer's pledge of its full faith, credit and taxing power for the payment
of principal and interest. Revenue or special tax bonds are payable only from
the revenues derived from a particular facility or class of facilities or, in
some cases, from the proceeds of a special excise or other tax, but not from
general tax revenues. The Fund may also invest in tax-exempt industrial
development bonds, short-term municipal obligations, demand notes and tax-exempt
commercial papers.
Industrial revenue bonds in most cases are revenue bonds and generally do not
have the pledge of the credit of the issuer. The payment of the principal and
interest on such industrial revenue bonds is dependent solely on the ability of
the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment. Short-term municipal obligations issued by states,
cities, municipalities or municipal agencies include Tax Anticipation Notes,
Revenue Anticipation Notes, Bond Anticipation Notes, Construction Loan Notes and
Short-Term Discount Notes.
Note obligations with demand or put options may have a stated maturity in
excess of one year, but permit any holder to demand payment of principal plus
accrued interest upon a specified number of days' notice. Frequently, such
obligations are secured by letters of credit or other credit support
arrangements provided by banks. The issuer of such notes normally has a
corresponding right, after a given period, to repay in its discretion the
outstanding principal of the note plus accrued interest upon a specific number
of days' notice to the bondholders. The interest rate on a demand note may be
based upon a known lending rate, such as a bank's prime rate, and be adjusted
when such rate changes, or the interest rate on a demand note may be a market
rate that is adjusted at specified intervals. The demand notes in which the Fund
will invest are payable on not more than 397 days' notice. Each note purchased
by the Fund will meet the quality criteria set out above for the Fund.
The yields of Municipal Bonds depend on, among other things, general money
market conditions, conditions in the Municipal Bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. and Standard & Poor's
Corporation represent their opinions of the quality of the Municipal Bonds rated
by them. It should be emphasized that such ratings are general and are not
absolute stands of quality. Consequently, Municipal Bonds with the same
maturity, coupon and rating may have different yields, while Municipal Bonds of
the same maturity and coupon, but with different ratings may have the same
yield. It will be the responsibility of the investment management staff to
appraise independently the fundamental quality of the bonds held by the Fund.
The Portfolios may purchase Municipal Bonds subject to so-called "demand
features." In such cases the Portfolio may purchase a security that is nominally
long-term but has many of the features of shorter-term securities. By virtue of
this demand feature, the security will be deemed to have a maturity date that is
earlier than its stated maturity date.
From time to time proposals have been introduced before Congress to restrict
or eliminate the Federal income tax exemption for interest on Municipal Bonds.
Similar proposals may be introduced in the future. If any such proposal were
enacted, it might restrict or eliminate the ability of the Fund to achieve its
investment objective. In that event, the Fund's Trustees and Officers would
reevaluate its investment objective and policies and consider recommending to
its shareholders changes in such objective and policies.
Similarly, from time to time proposals have been introduced before State and
local legislatures to restrict or eliminate the State and local income tax
exemption for interest on Municipal Bonds. Similar proposals may be introduced
in the future. If any such proposal were enacted, it might restrict or eliminate
the ability of each Portfolio to achieve its respective investment objective. In
that event, the Fund's Trustees and Officers would reevaluate its investment
objective and policies and consider recommending to its shareholders changes in
such objective and policies. (For more information please refer to "Risk
Factors" on page B-5.)
Ratings. Excerpts from Moody's Investors Service, Inc.'s Municipal Bond
ratings: Aaa--judged to be of the "best quality" and are referred to as "gilt
edge"; interest payments are protected by a large or by an exceptionally stable
margin and principal is secure; Aa--judged to be of "high quality by all
standards" but as to which margins of protection or other elements make
long-term risks appear somewhat larger than Aaa-rated Municipal Bonds; together
with Aaa group they comprise what are generally know as "high grade bonds";
A--possess many favorable investment attributes and are considered "upper medium
grade obligations." Factors giving security to principal and interest of A-rated
Municipal Bonds are considered adequate, but elements may be present which
suggest a susceptibility to impairment sometime in the future; Baa--considered
as medium grade obligations; i.e., they are neither highly protected nor poorly
secured; interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time; Ba--protection of
principal and interest payments may be very moderate; judged to have speculative
elements; their future cannot be considered as well-assured; B--lack
characteristics of a desirable investment; assurance of interest and principal
payments over any long period of time may be small; Caa--poor standing; may be
in default or there may be present elements of danger with respect to principal
and interest; Ca--speculative in a high degree; often in default; C--lowest
rated class of bonds; issues so rated can be regarded as having extremely poor
prospects for ever attaining any real investment standing.
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Description of Moody's ratings of state and municipal notes: Moody's ratings
for state and municipal notes and other short-term obligations are designated
Moody's Investment Grade ("MIG"). Symbols used will be as follows: MIG-1--Best
quality, enjoying strong protection from established cash flows of funds for
their servicing or from established and broad-based access to the market for
refinancing, or both; MIG-2--High quality with margins of protection ample
although not so large as in the preceding group.
Description of Moody's highest commercial paper rating: Prime-1
("P-1")--Judged to be of the best quality. Their short-term debt obligations
carry the smallest degree of investment risk.
Excerpts from Standard & Poor's Corporation's Municipal Bond ratings:
AAA--has the highest rating assigned by S&P; extremely strong capacity to pay
principal and interest; AA - has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in a small degree;
A--has a strong capacity to pay principal and interest, although somewhat more
susceptible to the adverse changes in circumstances and economic conditions; BBB
- - regarded as having an adequate capacity to pay principal and interest;
normally exhibit adequate protection parameters but adverse economic conditions
or changing circumstances are more likely to lead to a weakened capacity to pay
principal and interest than for bonds in A category;
BB--B--CCC--CC--predominantly speculative with respect to capacity to pay
interest and repay principal in accordance with terms of obligation; BB is being
paid; D--in default, and payment of principal and/or interest is in arrears.
The ratings from "AA" to "B" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Excerpt from Standard & Poor's Corporation's rating of municipal note issues:
SP-1+--very strong capacity to pay principal and interest; SP-1--strong capacity
to pay principal and interest.
Description of S&P's highest commercial papers ratings: A-1+--This
designation indicates the degree of safety regarding timely payment is
overwhelming. A-1--This designation indicates the degree of safety regarding
timely payment is very strong.
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