<PAGE>
PROSPECTUS
OCTOBER 29, 1996
MERRILL LYNCH MASSACHUSETTS MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
Merrill Lynch Massachusetts Municipal Bond Fund (the "Fund") is a mutual
fund seeking to provide shareholders with as high a level of income exempt
from Federal and Massachusetts income taxes as is consistent with prudent
investment management. The Fund invests primarily in a non-diversified
portfolio of long-term, investment grade obligations issued by or on behalf of
The Commonwealth of Massachusetts, its political subdivisions, agencies and
instrumentalities and obligations of other qualifying issuers, such as issuers
located in Puerto Rico, the Virgin Islands and Guam, which pay interest exempt
from Federal and Massachusetts income taxes ("Massachusetts Municipal Bonds").
Dividends paid by the Fund are exempt from Federal and Massachusetts income
taxes to the extent they are paid from interest on Massachusetts Municipal
Bonds. The Fund may invest in certain tax-exempt securities classified as
"private activity bonds" that may subject certain investors in the Fund to an
alternative minimum tax. At times, the Fund may seek to hedge its portfolio
through the use of futures transactions and options. There can be no assurance
that the investment objective of the Fund will be realized. For more
information on the Fund's investment objective and policies, please see
"Investment Objective and Policies" on page 10.
----------------
Pursuant to the Merrill Lynch Select Pricing SM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select Pricing SM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances. See
"Merrill Lynch Select Pricing SM System" on page 4.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9081, Princeton, New Jersey 08543-9081 [(609)
282-2800], and other securities dealers which have entered into selected
dealer agreements with the Distributor, including Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"). The minimum initial purchase is
$1,000 and the minimum subsequent purchase is $50. Merrill Lynch may charge
its customers a processing fee (presently $4.85) for confirming purchases and
repurchases. Purchases and redemptions directly through the Fund's Transfer
Agent are not subject to the processing fee. See "Purchase of Shares" and
"Redemption of Shares".
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
----------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated October 29, 1996 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission (the
"Commission") and is available, without charge, by calling or by writing
Merrill Lynch Multi-State Municipal Series Trust (the "Trust") at the above
telephone number or address. The Statement of Additional Information is hereby
incorporated by reference into this Prospectus. The Fund is a separate series
of the Trust, an open-end management investment company organized as a
Massachusetts business trust.
----------------
FUND ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
<PAGE>
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(a) CLASS B(b) CLASS C CLASS D
---------- ---------- ----------------- -------
<S> <C> <C> <C> <C>
SHAREHOLDER
TRANSACTION
EXPENSES:
Maximum Sales
Charge Im-
posed on Pur-
chases (as a
percentage of
offering
price)....... 4.00%(c) None None 4.00%(c)
Sales Charge
Imposed on
Dividend
Reinvestments. None None None None
Deferred Sales
Charge (as a
percentage of
original pur-
chase price
or redemption
proceeds,
whichever is 4.0% during the first
lower)....... None(d) year, 1.0% for one year(f) None(d)
decreasing 1.0% annually
thereafter to 0.0% after
the fourth year(e)
Exchange Fee.. None None None None
ANNUAL FUND OP-
ERATING EX-
PENSES (AS A
PERCENTAGE OF
AVERAGE NET
ASSETS):
Management
Fees(g)...... 0.55% 0.55% 0.55% 0.55%
Rule 12b-1
Fees(h):
Account Main-
tenance
Fees......... None 0.25% 0.25% 0.10%
Distribution
Fees......... None 0.25% 0.35% None
(Class B shares convert
to
Class D shares
automatically
after approximately ten
years
and cease being subject
to distribution fees and
are
subject to lower account
maintenance fees)
Other Ex-
penses:
Custodian
Fees......... 0.01% 0.01% 0.01% 0.01%
Shareholder
Servicing
Costs(i)..... 0.05% 0.06% 0.06% 0.05%
Other......... 0.23% 0.23% 0.23% 0.23%
----- ----- ----- -----
Total Other 0.29% 0.30% 0.30% 0.29%
Expenses.... ----- ----- ----- -----
Total Fund Op-
erating Ex- 0.84% 1.35% 1.45% 0.94%
penses....... ===== ===== ===== =====
</TABLE>
- --------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and certain participants in fee-based programs. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class
D Shares"--page 24 and "Shareholder Services--Fee-Based Programs"--page
34.
(b) Class B shares convert to Class D shares automatically approximately 10
years after initial purchase. See "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares"--page 25.
(c) Reduced for purchases of $25,000 and over and waived for purchases of
Class A shares in connection with certain fee-based programs. Class A and
Class D purchases of $1,000,000 or more may not be subject to an initial
sales charge. See "Purchase of Shares--Initial Sales Charge Alternatives--
Class A and Class D Shares"--page 24.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
are not subject to an initial sales charge may instead be subject to a
CDSC of 1.0% of amounts redeemed within the first year after purchase.
Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder Services--
Fee-Based Programs"--page 34.
(Footnotes continued on next page)
2
<PAGE>
(e) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder Services--
Fee-Based Programs"--page 34.
(f) The CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder Services--
Fee-Based Programs"--page 34.
(g) See "Management of the Trust--Management and Advisory Arrangements"--page
20.
(h) See "Purchase of Shares--Distribution Plans"--page 28.
(i) See "Management of the Trust--Transfer Agency Services"--page 21.
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID FOR THE PERIOD OF:
--------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
An investor would pay the
following expenses on a
$1,000 investment
including the maximum $40
initial sales charge
(Class A and Class D
shares only) and assuming
(1) the Total Fund
Operating Expenses for
each class set forth on
page 2, (2) a 5% annual
return throughout the
periods and (3) redemption
at the end of the period:
Class A.................. $48 $66 $85 $140
Class B.................. $54 $63 $74 $162
Class C.................. $25 $46 $79 $174
Class D.................. $49 $69 $90 $151
An investor would pay the
following expenses on the
same $1,000 investment
assuming no redemption at
the end of the period:
Class A.................. $48 $66 $85 $140
Class B.................. $14 $43 $74 $162
Class C.................. $15 $46 $79 $174
Class D.................. $49 $69 $90 $151
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Commission regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION
OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR
ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF
THE EXAMPLE. Class B and Class C shareholders who hold their shares for an
extended period of time may pay more in Rule 12b-1 distribution fees than the
economic equivalent of the maximum front-end sales charge permitted under the
Conduct Rules of the National Association of Securities Dealers, Inc. (the
"NASD"). Merrill Lynch may charge its customers a processing fee (presently
$4.85) for confirming purchases and repurchases. Purchases and redemptions
directly through the Fund's Transfer Agent are not subject to the processing
fee. See "Purchase of Shares" and "Redemption of Shares".
3
<PAGE>
MERRILL LYNCH SELECT PRICING SM SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing SM System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D
are sold to investors choosing the initial sales charge alternatives, and
shares of Class B and Class C are sold to investors choosing the deferred
sales charge alternatives. The Merrill Lynch Select Pricing SM System is used
by more than 50 registered investment companies advised by Merrill Lynch Asset
Management, L.P. ("MLAM") or Fund Asset Management, L.P. ("FAM" or the
"Manager"), an affiliate of MLAM. Funds advised by MLAM or FAM which utilize
the Merrill Lynch Select Pricing SM System are referred to herein as "MLAM-
advised mutual funds".
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The CDSCs, distribution and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on Class D shares, are imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of
shares will be calculated in the same manner at the same time and will differ
only to the extent that account maintenance and distribution fees and any
incremental transfer agency costs relating to a particular class are borne
exclusively by that class. Each class has different exchange privileges. See
"Shareholder Services--Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The distribution-
related revenues paid with respect to a class will not be used to finance the
distribution expenditures of another class. Sales personnel may receive
different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing SM System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing SM System that the investor
believes is most beneficial under his particular circumstances. More detailed
information as to each class of shares is set forth under "Purchase of
Shares".
4
<PAGE>
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(/1/) FEE FEE CONVERSION FEATURE
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.00% initial No No No
sales charge(/2/)(/3/)
- ------------------------------------------------------------------------------------
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to
at a rate of 4.0% during the D shares automatically
first year, decreasing 1.0% after approximately
annually to 0.0%(/4/) ten years(/5/)
- ------------------------------------------------------------------------------------
C 1.0% CDSC for one year(/6/) 0.25% 0.35% No
- ------------------------------------------------------------------------------------
D Maximum 4.00% initial 0.10% No No
sales charge(/3/)
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs are imposed if the redemption occurs within
the applicable CDSC time period. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares--Eligible Class A
Investors".
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class
A shares in connection with certain fee-based programs. Class A and Class
D share purchases of $1,000,000 or more may not be subject to an initial
sales charge but instead may be subject to a 1.0% CDSC if redeemed within
one year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Class A" and "Class D"
below.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-
based programs may be modified. Also, Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made have an eight
year conversion period. If Class B shares of the Fund are exchanged for
Class B shares of another MLAM-advised mutual fund, the conversion period
applicable to the Class B shares acquired in the exchange will apply, and
the holding period for the shares exchanged will be tacked onto the
holding period for the shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class A shares.
Investors that currently own Class A shares of the Fund in a
shareholder account are entitled to purchase additional Class A
shares of the Fund in that account. Other eligible investors include
participants in certain fee-based programs. In addition, Class A
shares will be offered at net asset value to Merrill Lynch & Co.,
Inc. ("ML & Co.") and its subsidiaries (the term "subsidiaries", when
used herein with respect to ML & Co., includes MLAM, the Manager and
certain other entities directly or indirectly wholly-owned and
controlled by ML & Co.) and their directors and employees, and to
members of the Boards of MLAM-advised mutual funds. The maximum
initial sales charge is 4.00%, which is reduced for purchases of
$25,000 and over and waived for purchases of Class A shares in
connection with certain fee-based programs. Purchases of $1,000,000
or more may not be subject to an initial sales charge, but if the
initial sales charge is waived, such purchases may be subject to a
1.0% CDSC if the shares are redeemed within one year after purchase.
Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. Sales charges also are
reduced under a right of accumulation which takes into account the
investor's
5
<PAGE>
holdings of all classes of all MLAM-advised mutual funds. See "Purchase
of Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares".
Class B: Class B shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.25% of the Fund's average net
assets attributable to Class B shares, as well as a CDSC if they are
redeemed within four years of purchase. Such CDSC may be modified in
connection with redemptions to fund participation in certain fee-based
programs. Approximately ten years after issuance, Class B shares will
convert automatically into Class D shares of the Fund, which are
subject to a lower account maintenance fee of 0.10% and no
distribution fee; Class B shares of certain other MLAM-advised mutual
funds into which exchanges may be made convert into Class D shares
automatically after approximately eight years. If Class B shares of
the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares
acquired in the exchange will apply, as will the Class D account
maintenance fee of the acquired fund upon the conversion, and the
holding period for the shares exchanged will be tacked on to the
holding period for the shares acquired. Automatic conversion of Class
B shares into Class D shares will occur at least once each month on
the basis of the relative net asset values of the shares of the two
classes on the conversion date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D
shares will not be deemed a purchase or sale of the shares for Federal
income tax purposes. Shares purchased through reinvestment of
dividends on Class B shares also will convert automatically to Class D
shares. The conversion period for dividend reinvestment shares is
modified as described under "Purchase of Shares--Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares
to Class D Shares".
Class C: Class C shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.35% of the Fund's average net
assets attributable to Class C shares. Class C shares are also subject
to a CDSC of 1.0% if they are redeemed within one year of purchase.
Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. Although Class C shares
are subject to a CDSC for only one year (as compared to four years for
Class B), Class C shares have no conversion feature and, accordingly,
an investor that purchases Class C shares will be subject to account
maintenance fees and higher distribution fees that will be imposed on
Class C shares for an indefinite period subject to annual approval by
the Trust's Board of Trustees and regulatory limitations.
Class D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.10% of the
Fund's average net assets attributable to Class D shares. Class D
shares are not subject to an ongoing distribution fee or any CDSC when
they are redeemed. Purchases of $1,000,000 or more may not be subject
to an initial sales charge, but if the initial sales charge is waived
such purchases may be subject to a CDSC of 1.0% if the shares are
redeemed within one year after purchase. Such CDSC may be waived in
connection with redemptions to fund participation in certain fee-based
programs. The schedule of initial sales charges and reductions for the
Class D shares is the same as the schedule for Class A shares, except
that there is no waiver for purchases of Class D shares in connection
with certain fee-based programs. Class D shares also will be issued
upon conversion of Class B shares as described above under "Class B".
See "Purchase of Shares--Initial Sales Charge Alternatives--Class A
and Class D Shares".
6
<PAGE>
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing SM System that the investor believes is most beneficial under his
particular circumstances.
Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class
A shares rather than Class D shares because there is an account maintenance
fee imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative
particularly attractive because similar sales charge reductions are not
available with respect to the CDSCs imposed in connection with purchases of
Class B or Class C shares. Investors not qualifying for reduced initial sales
charges who expect to maintain their investment for an extended period of time
also may elect to purchase Class A or Class D shares, because over time the
accumulated ongoing account maintenance and distribution fees on Class B or
Class C shares may exceed the initial sales charge and, in the case of Class D
shares, the account maintenance fee. Although some investors that previously
purchased Class A shares may no longer be eligible to purchase Class A shares
of other MLAM-advised mutual funds, those previously purchased Class A shares,
together with Class B, Class C and Class D share holdings, will count toward a
right of accumulation which may qualify the investor for reduced initial sales
charges on new initial sales charge purchases. In addition, the ongoing Class
B and Class C account maintenance and distribution fees will cause Class B and
Class C shares to have higher expense ratios, pay lower dividends and have
lower total returns than the initial sales charge shares. The ongoing Class D
account maintenance fees will cause Class D shares to have a higher expense
ratio, pay lower dividends and have a lower total return than Class A shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the
benefit of putting all of the investor's dollars to work from the time the
investment is made. The deferred sales charge alternatives may be particularly
appealing to investors who do not qualify for a reduction in initial sales
charges. Both Class B and Class C shares are subject to ongoing account
maintenance fees and distribution fees; however, the ongoing account
maintenance and distribution fees potentially may be offset to the extent any
return is realized on the additional funds initially invested in Class B or
Class C shares. In addition, Class B shares will be converted into Class D
shares of the Fund after a conversion period of approximately ten years, and
thereafter investors will be subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all their funds invested initially and intend
to hold their shares for an extended period of time. Investors in Class B
shares should take into account whether they intend to redeem their shares
within the CDSC period and, if not, whether they intend to remain invested
until the end of the conversion period and thereby take advantage of the
reduction in ongoing fees resulting from the conversion into Class D shares.
Other investors, however, may elect to purchase Class C shares if they
determine that it is advantageous to have all their assets invested initially
and they are uncertain as to the length of time they intend to hold their
assets in MLAM-advised mutual funds. Although Class C shareholders are subject
to a shorter CDSC period at a lower rate, they are subject to higher
distribution fees and forgo the Class B conversion feature, making their
investment subject to account maintenance and distribution fees for an
indefinite period of time. In addition, while both Class B and Class C
distribution fees are subject to the limitations on asset-based sales charges
imposed by the NASD, the Class B distribution fees are further limited under a
voluntary waiver of asset-based sales charges. See "Purchase of Shares--
Limitations on the Payment of Deferred Sales Charges".
7
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in connection
with the annual audits of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements for the year ended July
31, 1996 and the independent auditors' report thereon are included in the
Statement of Additional Information. The following per share data and ratios
have been derived from information provided in the Fund's audited financial
statements. Further information about the performance of the Fund is contained
in the Fund's most recent annual report to shareholders which may be obtained,
without charge, by calling or by writing the Trust at the telephone number or
address on the front cover of this Prospectus.
<TABLE>
<CAPTION>
CLASS A CLASS B
-------------------------------------------- ------------------------------------------------
FOR THE FOR THE
PERIOD PERIOD
FEBRUARY 28, FEBRUARY 28,
FOR THE YEAR ENDED JULY 31, 1992+ TO FOR THE YEAR ENDED JULY 31, 1992+ TO
------------------------------ JULY 31, ---------------------------------- JULY 31,
1996 1995 1994 1993 1992 1996 1995 1994 1993 1992
------ ------ ------ ------ ------------ ------- ------- ------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period.... $10.46 $10.48 $11.07 $10.68 $10.00 $ 10.46 $ 10.48 $ 11.07 $ 10.68 $ 10.00
------ ------ ------ ------ ------ ------- ------- ------- ------- -------
Investment income --
net................... .56 .56 .58 .63 .25 .51 .50 .53 .57 .23
Realized and unrealized
gain (loss) on
investments -- net..... .14 (.02) (.43) .42 .68 .14 (.02) (.43) .42 .68
------ ------ ------ ------ ------ ------- ------- ------- ------- -------
Total from investment
operations............. .70 .54 .15 1.05 .93 .65 .48 .10 .99 .91
------ ------ ------ ------ ------ ------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income --
net................... (.56) (.56) (.58) (.63) (.25) (.51) (.50) (.53) (.57) (.23)
Realized gain on
investments -- net..... -- -- (.15) (.03) -- -- -- (.15) (.03) --
In excess of realized
gain on investments --
net................... -- -- (.01) -- -- -- -- (.01) -- --
------ ------ ------ ------ ------ ------- ------- ------- ------- -------
Total dividends and
distributions.......... (.56) (.56) (.74) (.66) (.25) (.51) (.50) (.69) (.60) (.23)
------ ------ ------ ------ ------ ------- ------- ------- ------- -------
Net asset value, end of
period................. $10.60 $10.46 $10.48 $11.07 $10.68 $ 10.60 $ 10.46 $ 10.48 $ 11.07 $ 10.68
====== ====== ====== ====== ====== ======= ======= ======= ======= =======
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 6.78% 5.35% 1.26% 10.08% 9.44%# 6.23% 4.82% .75% 9.53% 9.22%#
====== ====== ====== ====== ====== ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .84% .88% .62% .42% .12%* 1.35% 1.39% 1.12% .93% .62%*
====== ====== ====== ====== ====== ======= ======= ======= ======= =======
Expenses................ .84% .91% .85% .95% 1.16%* 1.35% 1.42% 1.36% 1.45% 1.68%*
====== ====== ====== ====== ====== ======= ======= ======= ======= =======
Investment income --
net................... 5.23% 5.42% 5.33% 5.75% 5.82%* 4.72% 4.91% 4.83% 5.24% 5.32%*
====== ====== ====== ====== ====== ======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of
period
(in thousands)......... $5,887 $6,630 $8,367 $7,093 $4,828 $59,868 $66,927 $76,436 $71,429 $38,947
====== ====== ====== ====== ====== ======= ======= ======= ======= =======
Portfolio turnover...... 56.05% 89.62% 72.13% 39.37% 18.86% 56.05% 89.62% 72.13% 39.37% 18.86%
====== ====== ====== ====== ====== ======= ======= ======= ======= =======
</TABLE>
- --------
+ Commencement of Operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
8
<PAGE>
<TABLE>
<CAPTION>
CLASS C CLASS D
--------------------- --------------------
FOR THE FOR THE
FOR THE PERIOD FOR THE PERIOD
YEAR OCTOBER 21, YEAR OCTOBER 21,
ENDED 1994+ TO ENDED 1994+ TO
JULY 31, JULY 31, JULY 31, JULY 31,
1996 1995 1996 1995
--------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period............................. $10.46 $10.03 $10.47 $10.03
------ ------ ------ ------
Investment income -- net............ .49 .37 .55 .42
Realized and unrealized gain on
investments -- net................. .14 .43 .14 .44
------ ------ ------ ------
Total from investment operations.... .63 .80 .69 .86
------ ------ ------ ------
Less dividends from investment
income -- net...................... (.49) (.37) (.55) (.42)
------ ------ ------ ------
Net asset value, end of period...... $10.60 $10.46 $10.61 $10.47
====== ====== ====== ======
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.. 6.12% 8.13%# 6.67% 8.70%#
====== ====== ====== ======
RATIOS TO AVERAGE NET ASSETS:
Expenses............................ 1.45% 1.56%* .94% 1.04%*
====== ====== ====== ======
Investment income -- net............ 4.61% 4.68%* 5.12% 5.22%*
====== ====== ====== ======
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)......................... $1,185 $ 432 $1,290 $ 750
====== ====== ====== ======
Portfolio turnover.................. 56.05% 89.62% 56.05% 89.62%
====== ====== ====== ======
</TABLE>
- --------
+ Commencement of Operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
9
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and Massachusetts income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective while providing investors with the opportunity to invest in a
portfolio of securities consisting primarily of long-term obligations issued by
or on behalf of The Commonwealth of Massachusetts, its political subdivisions,
agencies and instrumentalities and obligations of other qualifying issuers,
such as issuers located in Puerto Rico, the Virgin Islands and Guam, which pay
interest exempt, in the opinion of bond counsel to the issuer, from Federal and
Massachusetts income taxes. Obligations bearing interest exempt from Federal
income taxes are referred to herein as "Municipal Bonds" and obligations the
interest on which is exempt from both Federal and Massachusetts income taxes
are referred to as "Massachusetts Municipal Bonds". Unless otherwise indicated,
reference to Municipal Bonds shall be deemed to include Massachusetts Municipal
Bonds. The Fund at all times, except during temporary defensive periods, will
maintain at least 65% of its total assets invested in Massachusetts Municipal
Bonds. The investment objective of the Fund as set forth in the first sentence
of this paragraph is a fundamental policy and may not be changed without
shareholder approval. At times, the Fund may seek to hedge its portfolio
through the use of futures transactions to reduce volatility in the net asset
value of Fund shares.
Municipal Bonds may include several types of bonds. The Fund may also invest
in variable rate demand obligations ("VRDOs"). The interest on Municipal Bonds
may bear a fixed rate or be payable at a variable or floating rate. At least
80% of the Municipal Bonds purchased by the Fund primarily will be what are
commonly referred to as "investment grade" securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ("Moody's") (currently
Aaa, Aa, A and Baa), Standard & Poor's Ratings Group ("Standard & Poor's")
(currently AAA, AA, A and BBB) or Fitch Investors Service, Inc. ("Fitch")
(currently AAA, AA, A and BBB). If Municipal Bonds are unrated, such securities
will possess creditworthiness comparable, in the opinion of the Manager, to
obligations in which the Fund may invest. Bonds rated in the fourth highest
rating category, while considered "investment grade", have certain speculative
characteristics and are more likely to be downgraded to non-investment grade
than obligations rated in one of the top three rating categories. See Appendix
II--"Ratings of Municipal Bonds" in the Statement of Additional Information for
more information regarding ratings of debt securities. An issue of rated
Massachusetts Municipal Bonds may cease to be rated or its rating may be
reduced below "investment grade" subsequent to its purchase by the Fund. If an
obligation is downgraded below investment grade, the Manager will consider
factors such as price, credit risk, market conditions, financial condition of
the issuer and interest rates to determine whether to continue to hold the
obligation in the Fund's portfolio.
The Fund may invest up to 20% of its total assets in Municipal Bonds that are
rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch, or which
in the Manager's judgment, possess similar credit characteristics. Such
securities, sometimes referred to as "high yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and
repay principal in accordance with the terms of the security and generally
involve a greater volatility of price than securities in higher rating
categories. The market prices of high-yielding, lower-rated securities may
fluctuate more than higher-rated securities and may decline significantly in
periods of general economic difficulty, which may follow periods of rising
interest rates. In purchasing such securities, the Fund will rely on the
Manager's judgment, analysis
10
<PAGE>
and experience in evaluating the creditworthiness of the issuer of such
securities. The Manager will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of its management and regulatory
matters. See "Investment Objective and Policies" in the Statement of Additional
Information for a more detailed discussion of the pertinent risk factors
involved in investing in "high yield" or "junk" bonds and Appendix II--"Ratings
of Municipal Bonds" in the Statement of Additional Information for additional
information regarding ratings of debt securities. The Fund does not intend to
purchase debt securities that are in default or which the Manager believes will
be in default.
Certain Municipal Bonds may be entitled to the benefits of letters of credit
or similar credit enhancements issued by financial institutions. In such
instances, the Trustees and the Manager will take into account in assessing the
quality of such bonds not only the creditworthiness of the issuer of such bonds
but also the creditworthiness of the financial institution.
The Fund's investments may also include VRDOs and VRDOs in the form of
participation interests ("Participating VRDOs") in variable rate tax-exempt
obligations held by a financial institution. The VRDOs in which the Fund will
invest are tax-exempt obligations which contain a floating or variable interest
rate adjustment formula and an unconditional right of demand on the part of the
holder thereof to receive payment of the unpaid principal balance plus accrued
interest on a short notice period not to exceed seven days. Participating VRDOs
provide the Fund with a specified undivided interest (up to 100%) of the
underlying obligation and the right to demand payment of the unpaid principal
balance plus accrued interest on the Participating VRDOs from the financial
institution on a specified number of days' notice, not to exceed seven days.
There is, however, the possibility that because of a default or insolvency, the
demand feature of VRDOs or Participating VRDOs may not be honored. The Fund has
been advised by its counsel that the Fund should be entitled to treat the
income received on Participating VRDOs as interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of the
unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed illiquid securities. A VRDO with a demand notice
period exceeding seven days will therefore be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for
such determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Massachusetts income taxes. However, to the extent that
suitable Massachusetts Municipal Bonds are not available for investment by the
Fund, the Fund may purchase Municipal Bonds issued by other states, their
agencies and instrumentalities, the interest income on which is exempt, in the
opinion of bond counsel, from Federal, but not Massachusetts, taxation. The
Fund may also invest in securities not issued by or on behalf of a state or
territory or by an agency or instrumentality thereof, if the Fund nevertheless
believes such securities to be exempt from Federal income taxation ("Non-
Municipal Tax-Exempt Securities"). Non-Municipal Tax-Exempt Securities may
include securities issued by other investment companies that invest in
municipal bonds, to the extent such investments are permitted by the Investment
Company Act of 1940, as amended (the "1940 Act"). Other Non-Municipal Tax-
Exempt Securities could include trust certificates or other instruments
evidencing interests in one or more long-term municipal securities.
11
<PAGE>
Under normal circumstances, except when acceptable securities are unavailable
as determined by the Manager, the Fund will invest at least 65% of its total
assets in Massachusetts Municipal Bonds. For temporary defensive periods or to
provide liquidity, the Fund has the authority to invest as much as 35% of its
total assets in tax-exempt or taxable money market obligations with a maturity
of one year or less (such short-term obligations being referred to herein as
"Temporary Investments"), except that taxable Temporary Investments shall not
exceed 20% of the Fund's net assets. The Temporary Investments, VRDOs and
Participating VRDOs in which the Fund may invest also will be in the following
rating categories at the time of purchase: MIG-1/VMIG-1 through MIG-4/VMIG-4
for notes and VRDOs and Prime-1 through Prime-3 for commercial paper (as
determined by Moody's), SP-1 or SP-2 for notes and A-1 through A-3 for VRDOs
and commercial paper (as determined by Standard & Poor's), or F-1 through F-3
for notes, VRDOs and commercial paper (as determined by Fitch) or, if unrated,
of comparable quality in the opinion of the Manager. The Fund at all times will
have at least 80% of its net assets invested in securities the interest on
which is exempt from Federal taxation. However, interest received on certain
otherwise tax-exempt securities which are classified as "private activity
bonds" (in general, bonds that benefit non-governmental entities), may be
subject to a Federal alternative minimum tax. The percentage of the Fund's net
assets invested in "private activity bonds" will vary during the year. See
"Distributions and Taxes". In addition, the Fund reserves the right to invest
temporarily a greater portion of its assets in Temporary Investments for
defensive purposes, when, in the judgment of the Manager, market conditions
warrant. The investment objective of the Fund is a fundamental policy of the
Fund which may not be changed without a vote of a majority of the outstanding
shares of the Fund. The Fund's hedging strategies, which are described in more
detail under "Financial Futures Transactions and Options", are not fundamental
policies and may be modified by the Trustees of the Trust without the approval
of the Fund's shareholders.
POTENTIAL BENEFITS
Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and
Massachusetts income taxes by investing in a professionally managed portfolio
consisting primarily of long-term Massachusetts Municipal Bonds. The Fund also
provides liquidity because of its redemption features and relieves the investor
of the burdensome administrative details involved in managing a portfolio of
tax-exempt securities. The benefits of investing in the Fund are at least
partially offset by the expenses involved in operating an investment company.
Such expenses primarily consist of the management fee and operational costs,
and in the case of certain classes of shares, the account maintenance and
distribution costs.
SPECIAL AND RISK CONSIDERATIONS RELATING TO MUNICIPAL BONDS
The risks and special considerations involved in investments in Municipal
Bonds vary with the types of instruments being acquired. Investments in Non-
Municipal Tax-Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as derivative instruments. See "Description of Municipal Bonds"
and "Financial Futures Transactions and Options".
Moreover, the Fund ordinarily will invest at least 65% of its total assets in
Massachusetts Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of Massachusetts Municipal Bonds than is a
municipal bond mutual fund that is not concentrated in issuers of Massachusetts
Municipal Bonds to this degree. The Commonwealth of Massachusetts is
experiencing a moderate economic recovery.
12
<PAGE>
The budgeted operating funds of Massachusetts ended fiscal 1993 with a surplus
of revenues and other sources over expenditures and other uses, and with
aggregate ending fund balances of approximately $562.5 million. Massachusetts
ended fiscal 1994 and fiscal 1995 with positive closing fund balances of $589.3
million and $726.0 million, respectively. As of the date of this Prospectus and
according to the Executive Office for Administration and Finance, fiscal 1996
is expected to end with positive budgetary fund balances totaling approximately
$613.0 million. Currently, Massachusetts' general obligation bonds are rated by
Standard & Poor's, Fitch and Moody's as A+, A+ and A-1, respectively. From time
to time, the rating agencies may further change their ratings in response to
budgetary matters or other economic indicators. The Manager does not believe
that the current economic conditions in Massachusetts will have a significant
adverse effect on the Fund's ability to invest in high quality Massachusetts
Municipal Bonds. See Appendix I--"Economic and Financial Conditions in
Massachusetts" in the Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction and equipping of a wide range of public
facilities (including water, sewer, gas, electricity, solid waste, health care,
transportation, education and housing facilities), refunding of outstanding
obligations and obtaining funds for general operating expenses and loans to
other public institutions and facilities. In addition, certain types of bonds
are issued by or on behalf of public authorities to finance various privately
operated facilities, including certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. For purposes of this Prospectus,
such obligations are referred to as Municipal Bonds if the interest paid
thereon is excluded from gross income for purposes of Federal income taxation
and, as Massachusetts Municipal Bonds if the interest thereon is exempt from
Federal income tax and exempt from Massachusetts personal income tax, even
though such bonds may be "private activity bonds" as discussed below.
The two principal classifications of Municipal Bonds are "general obligation"
bonds and "revenue" bonds which latter category includes industrial development
bonds ("IDBs") and, for bonds issued after August 15, 1986, private activity
bonds. General obligation bonds are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest. The
taxing power of any governmental entity may be limited, however, by provisions
of its state constitution or laws, and an entity's creditworthiness will depend
on many factors, including potential erosion of the tax base due to population
declines, natural disasters, declines in the state's industrial base or
inability to attract new industries, economic limits on the ability to tax
without eroding the tax base, state legislative proposals or voter initiatives
to limit ad valorem real property taxes and the extent to which the entity
relies on Federal or state aid, access to capital markets or other factors
beyond the state or entity's control. Accordingly, the capacity of the issuer
of a general obligation bond as to the timely payment of interest and the
repayment of principal when due is affected by the issuer's maintenance of its
tax base.
Revenue 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 tax or other specific revenue source such as payments from the
user of the facility being financed; accordingly, the timely payment of
interest and the repayment of principal in accordance with the terms of the
revenue or special obligation bond is a function of the economic viability of
such facility or such revenue source. The Fund will not invest in revenue bonds
where the entity supplying the revenues from which the issuer is paid,
including predecessors, has a record of less than three years of continuous
business operations if such investments, together with investments in other
unseasoned
13
<PAGE>
issuers, would exceed 5% of the Fund's total assets. Investments involving
entities with less than three years of continuous business operations may pose
somewhat greater risks due to the lack of a substantial operating history for
such entities. The Manager believes, however, that the potential benefits of
such investments outweigh the potential risks, particularly given the Fund's
limitations on such investments.
The Fund may purchase IDBs and private activity bonds. IDBs and private
activity bonds are, in most cases, tax-exempt securities issued by states,
municipalities or public authorities to provide funds, usually through a loan
or lease arrangement, to a private entity for the purpose of financing
construction or improvement of a facility to be used by the entity. Such bonds
are secured primarily by revenues derived from loan repayments or lease
payments due from the entity which may or may not be guaranteed by a parent
company or otherwise secured. IDBs and private activity bonds are generally not
secured by a pledge of the taxing power of the issuer of such bonds. Therefore,
an investor should be aware that repayment of such bonds generally depends on
the revenues of a private entity and be aware of the risks that such an
investment may entail. Continued ability of an entity to generate sufficient
revenues for the payment of principal and interest on such bonds will be
affected by many factors including the size of the entity, capital structure,
demand for its products or services, competition, general economic conditions,
governmental regulation and the corporation's dependence on revenues for the
operation of the particular facility being financed. The Fund may also invest
in so-called "moral obligation" bonds, which are normally issued by special
purpose authorities. If an issuer of moral obligation bonds is unable to meet
its obligations, repayment of such bonds becomes a moral commitment, but not a
legal obligation of the state or municipality in question.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the
value of the particular index. Interest and principal payable on the Municipal
Bonds may also be based on relative changes among particular indices. Also, the
Fund may invest in so-called "inverse floating obligations" or "residual
interest bonds" on which the interest rates typically decline as market rates
increase and increase as market rates decline. The Fund's return on such types
of Municipal Bonds (and Non-Municipal Tax-Exempt Securities) will be subject to
risk with respect to the value of the particular index, which may include
reduced or eliminated interest payments and losses of invested principal. Such
securities have the effect of providing a degree of investment leverage, since
they may increase or decrease in value in response to changes, as an
illustration, in market interest rates at a rate which is a multiple (typically
two) of the rate at which fixed-rate long-term tax-exempt securities increase
or decrease in response to such changes. As a result, the market values of such
securities will generally be more volatile than the market values of fixed-rate
tax-exempt securities. To seek to limit the volatility of these securities, the
Fund may purchase inverse floating obligations with shorter-term maturities or
which contain limitations on the extent to which the interest rate may vary.
Certain investments in such obligations may be illiquid. The Fund may not
invest in such illiquid obligations if such investments, together with other
illiquid investments, would exceed 15% of the Fund's total assets. The Manager
believes, however, that indexed and inverse floating obligations represent
flexible portfolio management instruments for the Fund which allow the Fund to
seek potential investment rewards, hedge
14
<PAGE>
other portfolio positions or vary the degree of investment leverage relatively
efficiently under different market conditions.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called
"lease obligations") relating to such equipment, land or facilities. Although
lease obligations do not constitute general obligations of the issuer for which
the issuer's unlimited taxing power is pledged, a lease obligation is
frequently backed by the issuer's covenant to budget for, appropriate and make
the payments due under the lease obligation. However, certain lease obligations
contain "non-appropriation" clauses which provide that the issuer has no
obligation to make lease or installment purchase payments in future years
unless money is appropriated for such purpose on a yearly basis. Although "non-
appropriation" lease obligations are secured by the leased property,
disposition of the property in the event of foreclosure might prove difficult.
These securities represent a type of financing that has not yet developed the
depth of marketability associated with more conventional securities. Certain
investments in lease obligations may be illiquid. The Fund may not invest in
illiquid lease obligations if such investments, together with other illiquid
investments, would exceed 15% of the Fund's total assets. The Fund may,
however, invest without regard to such limitation in lease obligations which
the Manager, pursuant to guidelines which have been adopted by the Board of
Trustees and subject to the supervision of the Board, determines to be liquid.
The Manager will deem lease obligations liquid if they are publicly offered and
have received an investment grade rating of Baa or better by Moody's, or BBB or
better by Standard & Poor's or Fitch. Unrated lease obligations, or those rated
below investment grade, will be considered liquid if the obligations come to
the market through an underwritten public offering and at least two dealers are
willing to give competitive bids. In reference to obligations rated below
investment grade, the Manager must, among other things, also review the
creditworthiness of the municipality obligated to make payment under the lease
obligation and make certain specified determinations based on such factors as
the existence of a rating or credit enhancement such as insurance, the
frequency of trades or quotes for the obligation and the willingness of dealers
to make a market in the obligation.
The value of bonds and other fixed-income obligations may fall when interest
rates rise and rise when interest rates fall. In general, bonds and other
fixed-income obligations with longer maturities will be subject to greater
volatility resulting from interest rate fluctuations than will similar
obligations with shorter maturities. Under normal conditions, it is generally
anticipated that the Fund's average weighted maturity would be in excess of ten
years.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation which may be enacted in the future may affect
the availability of Municipal Bonds for investment by the Fund.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to
15
<PAGE>
require a mandatory tender for the purchase of related Municipal Bonds, subject
to certain conditions. A Call Right that is not exercised prior to the maturity
of the related Municipal Bond will expire without value. The economic effect of
holding both the Call Right and the related Municipal Bond is identical to that
of holding a Municipal Bond as a non-callable security. Certain investments in
such obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% of the Fund's total assets.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS
The Fund may purchase or sell Municipal Bonds on a delayed delivery basis or
a when-issued basis at fixed purchase terms. These transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future. The purchase will be recorded on the date the Fund enters
into the commitment and the value of the obligation will thereafter be
reflected in the calculation of the Fund's net asset value. The value of the
obligation on the delivery date may be more or less than its purchase price. A
separate account of the Fund will be established with its custodian consisting
of cash, cash equivalents or liquid securities having a market value at all
times at least equal to the amount of the forward commitment.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
The Fund is authorized to purchase and sell certain exchange traded financial
futures contracts ("financial futures contracts") solely for the purpose of
hedging its investments in Municipal Bonds against declines in value and to
hedge against increases in the cost of securities it intends to purchase.
However, any transactions involving financial futures or options (including
puts and calls associated therewith) will be in accordance with the Fund's
investment policies and limitations. A financial futures contract obligates the
seller of a contract to deliver and the purchaser of a contract to take
delivery of the type of financial instrument covered by the contract, or in the
case of index-based futures contracts to make and accept a cash settlement, at
a specific future time for a specified price. A sale of financial futures
contracts may provide a hedge against a decline in the value of portfolio
securities because such depreciation may be offset, in whole or in part, by an
increase in the value of the position in the financial futures contracts. A
purchase of financial futures contracts may provide a hedge against an increase
in the cost of securities intended to be purchased, because such appreciation
may be offset, in whole or in part, by an increase in the value of the position
in the futures contracts. Distributions, if any, of net long-term capital gains
from certain transactions in futures or options are taxable at long-term
capital gains rates for Federal income tax purposes, regardless of the length
of time the shareholder has owned Fund shares. See "Distributions and Taxes--
Taxes".
The Fund deals in financial futures contracts traded on the Chicago Board of
Trade based on The Bond Buyer Municipal Bond Index, a price-weighted measure of
the market value of 40 large, recently issued tax-exempt bonds. There can be no
assurance, however, that a liquid secondary market will exist to terminate any
particular financial futures contract at any specific time. If it is not
possible to close a financial futures position entered into by the Fund, the
Fund would continue to be required to make daily cash payments of variation
margin in the event of adverse price movements. In such a situation, if the
Fund has insufficient cash, it may have to sell portfolio securities to meet
daily variation margin requirements at a time when it may be disadvantageous to
do so. The inability to close financial futures positions also could have an
adverse impact on the Fund's ability to hedge effectively. There is also the
risk of loss by the Fund of margin deposits
16
<PAGE>
in the event of bankruptcy of a broker with whom the Fund has an open position
in a financial futures contract.
The Fund may purchase and sell financial futures contracts on U.S.
Government securities and write and purchase put and call options on such
futures contracts as a hedge against adverse changes in interest rates as
described more fully in the Statement of Additional Information. With respect
to U.S. Government securities, currently there are financial futures contracts
based on long-term U.S. Treasury bonds, Treasury notes, Government National
Mortgage Association ("GNMA") Certificates and three-month U.S. Treasury
bills.
Subject to policies adopted by the Trustees, the Fund also may engage in
other financial futures contracts transactions and options thereon, such as
financial futures contracts or options on other municipal bond indexes which
may become available if the Manager of the Fund and the Trustees of the Trust
should determine that there is normally a sufficient correlation between the
prices of such futures contracts and the Municipal Bonds in which the Fund
invests to make such hedging appropriate.
Utilization of futures transactions and options thereon involves the risk of
imperfect correlation in movements in the price of futures contracts and
movements in the price of the security which is the subject of the hedge. If
the price of the futures contract moves more or less than the price of the
security that is the subject of the hedge, the Fund will experience a gain or
loss which will not be completely offset by movements in the price of such
security. There is a risk of imperfect correlation where the securities
underlying futures contracts have different maturities, ratings or geographic
mixes than the security being hedged. In addition, the correlation may be
affected by additions to or deletions from the index which serves as a basis
for a financial futures contract. Finally, in the case of futures contracts on
U.S. Government securities and options on such futures contracts, the
anticipated correlation of price movements between the U.S. Government
securities underlying the futures or options and Municipal Bonds may be
adversely affected by economic, political, legislative or other developments
which have a disparate impact on the respective markets for such securities.
Under regulations of the Commodity Futures Trading Commission ("CFTC"), the
futures trading activities described herein will not result in the Fund being
deemed to be a "commodity pool", as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, the Fund may
purchase and sell futures contracts and options thereon (i) for bona fide
hedging purposes, and (ii) for non-hedging purposes, if the aggregate initial
margins and premiums required to establish positions in such contracts and
options does not exceed 5% of the liquidation value of the Fund's portfolio
assets after taking into account unrealized profits and unrealized losses on
any such contracts and options. (However, as stated above, the Fund intends to
engage in options and futures transactions only for hedging purposes.) Margin
deposits may consist of cash or securities acceptable to the broker and the
relevant contract market.
When the Fund purchases a futures contract, or writes a put option or
purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., high grade commercial paper and daily tender adjustable
notes) or liquid securities in a segregated account with the Fund's custodian,
so that the amount so segregated plus the amount of initial and variation
margin held in the account of its broker equals the market value of the
futures contracts, thereby ensuring that the use of such futures contract is
unleveraged. It is not anticipated that transactions in futures contracts will
have the effect of increasing portfolio turnover.
17
<PAGE>
Although certain risks are involved in options and futures transactions, the
Manager believes that, because the Fund will engage in futures transactions
only for hedging purposes, the futures portfolio strategies of the Fund will
not subject the Fund to certain risks frequently associated with speculation in
futures transactions. The Fund must meet certain Federal income tax
requirements under the Internal Revenue Code of 1986, as amended (the "Code"),
in order to qualify for the special tax treatment afforded regulated investment
companies, including a requirement that less than 30% of its gross income be
derived from the sale or other disposition of securities held for less than
three months. Additionally, the Fund is required to meet certain
diversification requirements under the Code.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by commodity exchanges
which limit the amount of fluctuation in a futures contract price during a
single trading day. Once the daily limit has been reached in the contract, no
trades may be entered into at a price beyond the limit, thus preventing the
liquidation of open futures positions. Prices have in the past moved beyond the
daily limit on a number of consecutive trading days.
The successful use of transactions in futures also depends on the ability of
the Manager to forecast correctly the direction and extent of interest rate
movements within a given time frame. To the extent these rates remain stable
during the period in which a futures contract is held by the Fund or moves in a
direction opposite to that anticipated, the Fund may realize a loss on the
hedging transaction which is not fully or partially offset by an increase in
the value of portfolio securities. As a result, the Fund's total return for
such period may be less than if it had not engaged in the hedging transaction.
Furthermore, the Fund will only engage in hedging transactions from time to
time and may not necessarily be engaging in hedging transactions when movements
in interest rates occur.
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
REPURCHASE AGREEMENTS
As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer in U.S.
Government securities or an affiliate thereof. Under such agreements, the
seller agrees, upon entering into the contract, to repurchase the security from
the Fund at a mutually agreed upon time and price, thereby determining the
yield during the term of the agreement. This results in a fixed rate of return
insulated from market fluctuations during such period. The Fund may not invest
in repurchase agreements maturing in more than seven days if such investments,
together with the Fund's other illiquid investments, would exceed 15% of the
Fund's total assets. In the event of a default by the seller under a repurchase
agreement, the Fund may suffer time delays and incur costs or possible losses
in connection with the disposition of the underlying securities.
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that are
described in the Statement of Additional Information. Investment restrictions
and policies which are fundamental policies may not be changed without the
approval of the holders of a majority of the Fund's outstanding voting
securities, as
18
<PAGE>
defined in the 1940 Act which means the lesser of (i) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares are
represented or (ii) more than 50% of the outstanding shares. Among its
fundamental policies, the Fund may not invest more than 25% of its assets,
taken at market value at the time of each investment, in the securities of
issuers in any particular industry (excluding the U.S. Government and its
agencies and instrumentalities) (For purposes of this restriction, states,
municipalities and their political subdivisions are not considered to be part
of any industry). Investment restrictions and policies that are non-fundamental
policies may be changed by the Board of Trustees without shareholder approval.
As a non-fundamental policy, the Fund may not borrow amounts in excess of 20%
of its total assets taken at market value (including the amount borrowed), and
then only from banks as a temporary measure for extraordinary or emergency
purposes. In addition, the Fund will not purchase securities while borrowings
are outstanding.
As a non-fundamental policy, the Fund will not invest in securities which
cannot be readily resold because of legal or contractual restrictions or which
cannot otherwise be marketed, redeemed or put to the issuer or a third party,
if at the time of acquisition more than 15% of its total assets would be
invested in such securities. [This restriction shall not apply to securities
which mature within seven days or securities which the Board of Trustees of the
Trust has otherwise determined to be liquid pursuant to applicable law.]
The Fund is classified as non-diversified within the meaning of the 1940 Act,
which means that the Fund is not limited by the 1940 Act in the proportion of
its assets that it may invest in obligations of a single issuer. However, the
Fund's investments will be limited so as to qualify as a "regulated investment
company" for purposes of the Code. See "Distributions and Taxes--Taxes". To
qualify, among other requirements, the Trust will limit the Fund's investments
so that, at the close of each quarter of the taxable year, (i) not more than
25% of the market value of the Fund's total assets will be invested in the
securities of a single issuer, and (ii) with respect to 50% of the market value
of its total assets, not more than 5% of the market value of its total assets
will be invested in the securities of a single issuer and the Fund will not own
more than 10% of the outstanding voting securities of a single issuer. For
purposes of this restriction, the Fund will regard each state and each
political subdivision, agency or instrumentality of such state and each multi-
state agency of which such state is a member and each public authority which
issues securities on behalf of a private entity as a separate issuer, except
that if the security is backed only by the assets and revenues of a non-
government entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal tax requirements. A fund
which elects to be classified as "diversified" under the 1940 Act must satisfy
the foregoing 5% and 10% requirements with respect to 75% of its total assets.
To the extent that the Fund assumes large positions in the obligations of a
small number of issuers, the Fund's total return may fluctuate to a greater
extent than that of a diversified company as a result of changes in the
financial condition or in the market's assessment of the issuers.
Investors are referred to the Statement of Additional Information for a
complete description of the Fund's investment restrictions.
19
<PAGE>
MANAGEMENT OF THE TRUST
TRUSTEES
The Trustees of the Trust consist of six individuals, five of whom are not
"interested persons" of the Trust as defined in the 1940 Act. The Trustees are
responsible for the overall supervision of the operations of the Trust and the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the 1940 Act.
The Trustees are:
Arthur Zeikel*--President of the Manager and its affiliate, MLAM; President
and Director of Princeton Services, Inc. ("Princeton Services"); Executive Vice
President of ML & Co.; and Director of the Distributor.
James H. Bodurtha--Director and Executive Vice President, The China Business
Group, Inc.
Herbert I. London--John M. Olin Professor of Humanities, New York University.
Robert R. Martin--Former Chairman, Kinnard Investments, Inc.
Joseph L. May--Attorney in private practice.
Andre F. Perold--Professor, Harvard Business School.
- --------
* Interested person, as defined in the 1940 Act, of the Trust.
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager, which is an affiliate of MLAM and is owned and controlled by ML
& Co., a financial services holding company, acts as the manager for the Fund
and provides the Fund with management services. The Manager or MLAM acts as the
investment adviser for more than 130 registered investment companies. MLAM also
offers portfolio management and portfolio analysis services to individuals and
institutions. As of September 30, 1996, the Manager and MLAM had a total of
approximately $214.1 billion in investment company and other portfolio assets
under management, including accounts of certain affiliates of the Manager.
Subject to the direction of the Trustees, the Manager is responsible for the
actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager. The Manager performs certain of the
other administrative services and provides all the office space, facilities,
equipment and necessary personnel for management of the Fund.
Fred K. Stuebe is the Portfolio Manager of the Fund and is responsible for
the day-to-day management of the Fund's investment portfolio. He has been a
Vice President of MLAM since 1989.
Pursuant to the management agreement between the Manager and the Trust on
behalf of the Fund (the "Management Agreement"), the Manager is entitled to
receive from the Fund a monthly fee based upon the
20
<PAGE>
average daily net assets of the Fund at the following annual rates: 0.55% of
the average daily net assets not exceeding $500 million; 0.525% of the average
daily net assets exceeding $500 million but not exceeding $1.0 billion; and
0.50% of the average daily net assets exceeding $1.0 billion. For the fiscal
year ended July 31, 1996, the total fee paid by the Fund to the Manager was
$406,646 (based on average net assets of approximately $73.9 million).
The Management Agreement obligates the Trust on behalf of the Fund to pay
certain expenses incurred in the Fund's operations, including, among other
things, the management fee, legal and audit fees, unaffiliated Trustees' fees
and expenses, registration fees, custodian and transfer agency fees, accounting
and pricing costs, and certain of the costs of printing proxies, shareholder
reports, prospectuses and statements of additional information. Accounting
services are provided to the Fund by the Manager, and the Fund reimburses the
Manager for its costs in connection with such services. For the fiscal year
ended July 31, 1996, the Fund reimbursed the Manager $38,780 for accounting
services. For the fiscal year ended July 31, 1996, the ratio of total expenses
to average net assets was 0.84% for Class A shares, 1.35% for Class B shares,
1.45% for Class C shares and 0.94% for Class D shares.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Manager
(together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Manager and, as described below,
impose additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed
investment. The substantive restrictions applicable to all employees of the
Manager include a ban on acquiring any securities in a "hot" initial public
offering and a prohibition from profiting on short-term trading in securities.
In addition, no employee may purchase or sell any security which at the time is
being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Manager. Furthermore, the Codes provide for trading "blackout periods" which
prohibit trading by investment personnel of the Fund within periods of trading
by the Fund in the same (or equivalent) security (15 or 30 days depending upon
the transaction).
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. (the "Transfer Agent"), which is
a wholly-owned subsidiary of ML & Co., acts as the Trust's transfer agent
pursuant to a transfer agency, dividend disbursing agency and shareholder
servicing agency agreement (the "Transfer Agency Agreement"). Pursuant to the
Transfer Agency Agreement, the Transfer Agent is responsible for the issuance,
transfer and redemption of shares and the opening and maintenance of
shareholder accounts. Pursuant to the Transfer Agency Agreement, the Fund pays
the Transfer Agent an annual fee of $11.00 per Class A and Class D shareholder
account and $14.00 per Class B and Class C shareholder account, and the
Transfer Agent is entitled to reimbursement from the Fund for out-of-pocket
expenses incurred by the Transfer Agent under the Transfer Agency
21
<PAGE>
Agreement. For the fiscal year ended July 31, 1996, the Fund paid the Transfer
Agent a total fee of $42,366 pursuant to the Transfer Agency Agreement for
providing transfer agency services. At August 31, 1996, the Fund had 130 Class
A shareholder accounts, 1,957 Class B shareholder accounts, 42 Class C
shareholder accounts and 33 Class D shareholder accounts. At this level of
accounts, the annual fee paid to the Transfer Agent would aggregate
approximately $29,779, plus miscellaneous and out-of-pocket expenses.
PURCHASE OF SHARES
The Distributor, an affiliate of the Manager, MLAM and Merrill Lynch, acts
as the distributor of the shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000 and the minimum subsequent purchase is $50.
The Fund offers its shares in four classes at a public offering price equal
to the next determined net asset value per share plus sales charges imposed
either at the time of purchase or on a deferred basis depending upon the class
of shares selected by the investor under the Merrill Lynch Select Pricing SM
System, as described below. The applicable offering price for purchase orders
is based upon the net asset value of the Fund next determined after receipt of
the purchase orders by the Distributor. As to purchase orders received by
securities dealers prior to the close of business on the New York Stock
Exchange (the "NYSE") (generally, 4:00 P.M., New York time), which includes
orders received after the close of business on the previous day, the
applicable offering price will be based on the net asset value determined as
of 15 minutes after the close of business on the NYSE on that day, provided
the Distributor in turn receives the order from the securities dealer prior to
30 minutes after the close of business on the NYSE on that day. If the
purchase orders are not received by the Distributor prior to 30 minutes after
the close of business on the NYSE, such orders shall be deemed received on the
next business day. The Trust or the Distributor may suspend the continuous
offering of the Fund's shares of any class at any time in response to
conditions in the securities markets or otherwise and may thereafter resume
such offering from time to time. Any order may be rejected by the Distributor
or the Trust. Neither the Distributor nor the dealers are permitted to
withhold placing orders to benefit themselves by a price change. Merrill Lynch
may charge its customers a processing fee (presently $4.85) to confirm a sale
of shares to such customers. Purchases directly through the Fund's Transfer
Agent are not subject to the processing fee.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing SM System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the
amount of the purchase, the length of time the investor expects to hold the
shares and other relevant circumstances. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the
investment thereafter being subject to a CDSC and ongoing distribution fees
and higher account maintenance fees. A discussion of the factors that
investors should consider in determining the method of purchasing shares under
the Merrill Lynch Select Pricing SM System is set forth under "Merrill Lynch
Select Pricing SM System" on page 4.
22
<PAGE>
Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
The CDSCs, distribution and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on Class D shares, will be imposed directly against those classes and not
against all assets of the Fund and, accordingly, such charges will not affect
the net asset value of any other class or have any impact on investors
choosing another sales charge option. Dividends paid by the Fund for each
class of shares will be calculated in the same manner at the same time and
will differ only to the extent that account maintenance and distribution fees
and any incremental transfer agency costs relating to a particular class are
borne exclusively by that class. Class B, Class C and Class D shares each have
exclusive voting rights with respect to the Rule 12b-1 distribution plan
adopted with respect to such class pursuant to which account maintenance
and/or distribution fees are paid. See "Distribution Plans" below. Each class
has different exchange privileges. See "Shareholder Services--Exchange
Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in
that the sales charges applicable to each class provide for the financing of
the distribution of the shares of the Fund. The distribution-related revenues
paid with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised
that only Class A and Class D shares may be available for purchase through
securities dealers, other than Merrill Lynch, which are eligible to sell
shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing SM System,
followed by a more detailed description of each class.
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION CONVERSION
CLASS SALES CHARGE(/1/) FEE FEE FEATURE
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.0% initial sales No No No
charge(/2/)(/3/)
- ---------------------------------------------------------------------------------------
B CDSC for a period of 4 years, 0.25% 0.25% B shares convert to
at a rate of 4.0% during the D shares automatically
first year, decreasing 1.0% after approximately
annually to 0.0% (/4/) ten years(/5/)
- ---------------------------------------------------------------------------------------
C 1.0% CDSC for one year(/6/) 0.25% 0.35% No
- ---------------------------------------------------------------------------------------
D Maximum 4.0% initial 0.10% No No
sales charge(/3/)
</TABLE>
- --------
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs are imposed if the redemption occurs within
the applicable CDSC time period. The charge will be assessed on an amount
equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors".
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class
A shares in connection with certain fee-based programs. Class A and Class
D share purchases of $1,000,000 or more may not be subject to an initial
sales charge but instead may be subject to a 1.0% CDSC if redeemed within
one year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
(footnotes continued on next page)
23
<PAGE>
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-
based programs may be modified. Also, Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made have an eight
year conversion period. If Class B shares of the Fund are exchanged for
Class B shares of another MLAM-advised mutual fund, the conversion period
applicable to the Class B shares acquired in the exchange will apply, and
the holding period for the shares exchanged will be tacked onto the
holding period for the shares acquired.
(6) The CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
Investors choosing the initial sales charge alternatives who are eligible to
purchase Class A shares should purchase Class A rather than Class D shares
because there is an account maintenance fee imposed on Class D shares.
The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternative is the next determined net asset
value plus varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE DISCOUNT TO
AS PERCENTAGE AS PERCENTAGE* SELECTED DEALERS
OF OFFERING OF THE NET AS PERCENTAGE OF THE
AMOUNT OF PURCHASE PRICE AMOUNT INVESTED OFFERING PRICE
- ------------------ ------------- --------------- --------------------
<S> <C> <C> <C>
Less than $25,000........... 4.00% 4.17% 3.75%
$25,000 but less than
$50,000.................... 3.75 3.90 3.50
$50,000 but less than
$100,000................... 3.25 3.36 3.00
$100,000 but less than
$250,000................... 2.50 2.56 2.25
$250,000 but less than
$1,000,000................. 1.50 1.52 1.25
$1,000,000 and over**....... 0.00 0.00 0.00
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more and on Class A purchases in connection with certain fee-
based programs. If the sales charge is waived in connection with a purchase
of $1,000,000 or more, such purchases may be subject to a CDSC of 1.0% if
the shares are redeemed within one year after purchase. Such CDSC may be
waived in connection with redemptions to fund participation in certain fee-
based programs. The charge will be assessed on an amount equal to the
lesser of the proceeds of redemption or the cost of the shares being
redeemed.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and
Class D shares of the Fund will receive a concession equal to most of the
sales charge, they may be deemed to be underwriters under the Securities Act
of 1933, as amended. For the fiscal year ended July 31, 1996, the Fund sold
11,145 Class A shares for aggregate net proceeds of $120,133. The gross sales
charges for the sale of Class A shares of the Fund for the year were $580, of
which $43 and $537 were received by the Distributor and Merrill Lynch,
respectively. For the fiscal year ended July 31, 1996, the Distributor
received no CDSCs with respect to redemption within one year after purchase of
Class A shares purchased subject to a front-end sales charge waiver. For the
fiscal year ended July 31, 1996, the Fund sold 95,688 Class D shares for
aggregate net proceeds of $1,010,719. The gross sales charges for the sale of
Class D shares of the Fund for the year were $2,286, of which $207 and $2,079
were received by the Distributor and Merrill Lynch, respectively. For the
fiscal year ended July 31, 1996, the Distributor received no CDSCs with
respect to redemption within one year after purchase of Class D shares
purchased subject to a front-end sales charge waiver.
24
<PAGE>
Eligible Class A Investors. Class A shares are offered to a limited group of
investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A
shares of the Fund in that account. Class A shares are available at net asset
value to corporate warranty insurance reserve fund programs provided that the
program has $3 million or more initially invested in MLAM-advised mutual
funds. Also eligible to purchase Class A shares at net asset value are
participants in certain investment programs including TMA SM Managed Trusts to
which Merrill Lynch Trust Company provides discretionary trustee services,
collective investment trusts for which Merrill Lynch Trust Company serves as
trustee, and purchases made in connection with certain fee-based programs. In
addition, Class A shares are offered at net asset value to ML & Co., and its
subsidiaries and their directors and employees and to members of the Boards of
MLAM-advised investment companies, including the Trust. Certain persons who
acquired shares of certain MLAM-advised closed-end funds in their initial
offerings who wish to reinvest the net proceeds from a sale of their closed-
end fund shares of common stock in shares of the Fund also may purchase Class
A shares of the Fund if certain conditions set forth in the Statement of
Additional Information are met. In addition, Class A shares of the Fund and
certain other MLAM-advised mutual funds are offered at net asset value to
shareholders of Merrill Lynch Senior Floating Rate Fund, Inc. and, if certain
conditions set forth in the Statement of Additional Information are met, to
shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch
High Income Municipal Bond Fund, Inc. who wish to reinvest the net proceeds
from a sale of certain of their shares of common stock pursuant to a tender
offer conducted by such funds in shares of the Fund and certain other MLAM-
advised mutual funds.
Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges
also may be reduced under a Right of Accumulation and a Letter of Intention.
Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors". See
"Shareholder Services--Fee-Based Programs". Class A and Class D shares are
offered at net asset value to Employee Access Accounts SM available through
qualified employers which provide employer-sponsored retirement and savings
plans that are eligible to purchase such shares at net asset value. Class A
and Class D shares are offered at net asset value to shareholders of Merrill
Lynch Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal
Bond Fund, Inc. who wish to reinvest in shares of the Fund the net proceeds
from a sale of certain of their shares of common stock, pursuant to tender
offers conducted by those funds.
Class D shares are offered at net asset value without sales charge to an
investor who has a business relationship with a Merrill Lynch financial
consultant, if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Additional information concerning these reduced initial sales charges is set
forth in the Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.
25
<PAGE>
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net
asset value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four-year CDSC,
while Class C shares are subject only to a one-year 1.0% CDSC. On the other
hand, approximately ten years after Class B shares are issued, such Class B
shares, together with shares issued upon dividend reinvestment with respect to
those shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See "Conversion of Class B
Shares to Class D Shares" below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets and Class B and Class C
shares are subject to distribution fees of 0.25% and 0.35%, respectively, of
net assets as discussed below under "Distribution Plans". The proceeds from the
account maintenance fees are used to compensate Merrill Lynch for providing
continuing account maintenance activities.
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.
Proceeds from the CDSCs and the distribution fees are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for
selling Class B and Class C shares from the dealer's own funds. The combination
of the CDSC and the ongoing distribution fee facilitates the ability of the
Fund to sell the Class B and Class C shares without a sales charge being
deducted at the time of purchase. Approximately ten years after issuance, Class
B shares will convert automatically into Class D shares of the Fund, which are
subject to a lower account maintenance fee and no distribution fee; Class B
shares of certain other MLAM-advised mutual funds into which exchanges may be
made convert into Class D shares automatically after approximately eight years.
If Class B shares of the Fund are exchanged for Class B shares of another MLAM-
advised mutual fund, the conversion period applicable to the Class B shares
acquired in the exchange will apply, and the holding period for the shares
exchanged will be tacked on to the holding period for the shares acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C shares
is limited by the NASD asset-based sales charge rule. See "Limitations on the
Payment of Deferred Sales Charges" below. The proceeds from the ongoing account
maintenance fees are used to compensate Merrill Lynch for providing continuing
account maintenance activities. Class B shareholders of the Fund exercising the
exchange privilege described under "Shareholder Services--Exchange Privilege"
will continue to be subject to the Fund's CDSC schedule if such schedule is
higher than the CDSC schedule relating to the Class B shares acquired as a
result of the exchange.
Contingent Deferred Sales Charges--Class B Shares. Class B shares which are
redeemed within four years of purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no sales
charge will be imposed on increases in net asset value above the initial
purchase price. In addition, no charge will be assessed on shares derived from
reinvestment of dividends or capital gains distributions.
26
<PAGE>
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CDSC AS A
PERCENTAGE OF
DOLLAR AMOUNT
SUBJECT TO
YEAR SINCE PURCHASE PAYMENT MADE CHARGE
-------------------------------- -------------
<S> <C>
0-1.......................................................... 4.0%
1-2.......................................................... 3.0%
2-3.......................................................... 2.0%
3-4.......................................................... 1.0%
4 and thereafter............................................. 0.0%
</TABLE>
For the fiscal year ended July 31, 1996, the Distributor received CDSCs of
$166,231 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch.
In determining whether a CDSC is applicable to a redemption, the calculation
will be determined in the manner that results in the lowest applicable rate
being charged. Therefore, it will be assumed that the redemption is first of
shares held for over four years or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the four-year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of
shares from a shareholder's account to another account will be assumed to be
made in the same order as a redemption.
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares upon dividend reinvestment. If at such time the investor
makes his first redemption of 50 shares (proceeds of $600), 10 shares will not
be subject to a CDSC because of dividend reinvestment. With respect to the
remaining 40 shares, the CDSC is applied only to the original cost of $10 per
share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 2.0% (the
applicable rate in the third year after purchase).
The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Code) of a shareholder. Additional information
concerning the waiver of the Class B CDSC is set forth in the Statement of
Additional Information. The terms of the CDSC may be modified in connection
with redemptions of fund participation in certain fee-based programs. See
"Shareholder Services--Fee-Based Programs".
Contingent Deferred Sales Charges--Class C Shares. Class C shares which are
redeemed within one year of purchase may be subject to a 1.0% CDSC charged as a
percentage of the dollar amount subject thereto. The charge will be assessed on
an amount equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed. Accordingly, no Class C CDSC will be imposed on
increases in net asset value above the initial purchase price. In addition, no
Class C CDSC will be assessed on shares derived from reinvestment of dividends
or capital gains distributions. For the fiscal year ended July 31, 1996, the
Distributor received CDSCs of $2,058 with respect to redemptions of Class C
shares, all of which were paid to Merrill Lynch. No Class C CDSC will be
assessed in connection with redemptions to fund participation in certain fee-
based programs. See "Shareholder Services--Fee-Based Programs".
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over one year or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the one-year period. The charge will not be applied to
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dollar amounts representing an increase in the net asset value since the time
of purchase. A transfer of shares from a shareholder's account to another
account will be assumed to be made in the same order as a redemption.
Conversion of Class B Shares to Class D Shares. After approximately ten years
(the "Conversion Period"), Class B shares will be converted automatically into
Class D shares of the Fund. Class D shares are subject to an ongoing account
maintenance fee of 0.10% of net assets but are not subject to the distribution
fee that is borne by Class B shares. Automatic conversion of Class B shares
into Class D shares will occur at least once each month (on the "Conversion
Date") on the basis of the relative net asset values of the shares of the two
classes on the Conversion Date, without the imposition of any sales load, fee
or other charge. Conversion of Class B shares to Class D shares will not be
deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class
D shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert
approximately ten years after initial purchase. If, during the Conversion
Period, a shareholder exchanges Class B shares with an eight-year Conversion
Period for Class B shares with a ten-year Conversion Period, or vice versa, the
Conversion Period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked on
to the holding period for the shares acquired.
The Conversion Period may be modified for certain fee-based programs. See
"Shareholder Services--Fee-Based Programs".
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the 1940 Act (each a "Distribution
Plan") with respect to the account maintenance and/or distribution fees paid by
the Fund to the Distributor with respect to such classes. The Class B and Class
C Distribution Plans provide for the payment of account maintenance fees and
distribution fees, and the Class D Distribution Plan provides for the payment
of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to compensate
the Distributor and Merrill Lynch (pursuant to a sub-agreement) in connection
with account maintenance activities.
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The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rate of 0.25% and
0.35%, respectively, of the average daily net assets of the Fund attributable
to the shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) for providing shareholder and
distribution services, and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling Class B and Class
C shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C
shares through dealers without the assessment of an initial sales charge and at
the same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fee and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
For the fiscal year ended July 31, 1996, the Fund paid the Distributor
$328,420 pursuant to the Class B Distribution Plan (based on average net assets
subject to such Class B Distribution Plan of approximately $65.7 million), all
of which was paid to Merrill Lynch for providing account maintenance and
distribution-related activities and services in connection with Class B shares.
For the fiscal year ended July 31, 1996, the Fund paid the Distributor $4,692
pursuant to the Class C Distribution Plan (based on average net assets subject
to such Class C Distribution Plan of approximately $781,962), all of which was
paid to Merrill Lynch for providing account maintenance and distribution-
related activities and services in connection with Class C shares. For the
fiscal year ended July 31, 1996, the Fund paid the Distributor $1,002 pursuant
to the Class D Distribution Plan (based on average net assets subject to such
Class D Distribution Plan of approximately $1.0 million), all of which was paid
to Merrill Lynch for providing account maintenance activities in connection
with Class D shares. At August 31, 1996, the net assets of the Fund subject to
the Class B Distribution Plan aggregated approximately $59.0 million. At this
asset level, the annual fee payable pursuant to such Class B Distribution Plan
would aggregate approximately $294,947. At August 31, 1996, the net assets of
the Fund subject to the Class C Distribution Plan aggregated $1.2 million. At
this asset level, the annual fee payable pursuant to such Class C Distribution
Plan would aggregate approximately $7,077. At August 31, 1996, the net assets
of the Fund subject to the Class D Distribution Plan aggregated approximately
$1.3 million. At this asset level, the annual fee payable pursuant to such
Class D Distribution Plan would aggregate approximately $1,295.
Payments under the Distribution Plans are based on a percentage of average
daily net assets attributable to the shares regardless of the amount of
expenses incurred, and, accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Trustees for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and market expenses, corporate overhead
and interest expense. On the direct expense and revenue/cash basis, revenues
consist of the account maintenance fees, distribution fees and CDSCs, and the
expenses consist of financial consultant compensation.
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As of December 31, 1995, the fully allocated accrual revenues incurred by the
Distributor and Merrill Lynch for the period since the commencement of
operations of Class B shares exceeded fully allocated accrual expenses by
approximately $1,225,000 (1.78% of Class B net assets at that date). As of July
31, 1996, direct cash revenues for the period since the commencement of
operations of Class B shares exceeded direct cash expenses by $736,430 (1.23%
of Class B net assets at that date). Similar fully allocated accrual data for
Class C shares is not presented because such revenues and expenses for the
period from October 21, 1994 (commencement of operations) to December 31, 1995
are de minimis. As of July 31, 1996, direct cash revenues for the period since
the commencement of operations of Class C shares exceeded direct cash expenses
by $2,704 (0.23% of Class C net assets at that date).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee
and the CDSC borne by the Class B and Class C shares, but not the account
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges) plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances
payments in excess of the amount payable under the NASD formula will not be
made.
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Trustees of the Trust will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Trustees will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the account maintenance fees, the
distribution fees and/or the CDSCs received with respect to one class will not
be used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those
Class B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to Class
D Shares".
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<PAGE>
REDEMPTION OF SHARES
The Trust is required to redeem for cash all shares of the Fund upon receipt
of a written request in proper form. The redemption price is the net asset
value per share next determined after the initial receipt of proper notice of
redemption. Except for any CDSC which may be applicable, there will be no
charge for redemption if the redemption request is sent directly to the
Transfer Agent. Shareholders liquidating their holdings will receive upon
redemption all dividends reinvested through the date of redemption. The value
of shares at the time of redemption may be more or less than the shareholder's
cost, depending on the market value of the securities held by the Fund at such
time.
REDEMPTION
A shareholder wishing to redeem shares may do so, without charge, by
tendering the shares directly to the Transfer Agent, Merrill Lynch Financial
Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289.
Redemption requests delivered other than by mail should be delivered to Merrill
Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484. Proper notice of redemption in the case of shares deposited
with the Transfer Agent may be accomplished by a written letter requesting
redemption. Proper notice of redemption in the case of shares for which
certificates have been issued may be accomplished by a written letter as noted
above accompanied by certificates for the shares to be redeemed. Redemption
requests should not be sent to the Trust. The notice in either event requires
the signature(s) of all persons in whose name(s) the shares are registered,
signed exactly as such name(s) appear(s) on the Transfer Agent's register. The
signature(s) on the redemption request must be guaranteed by an "eligible
guarantor institution" as such term is defined in Rule 17Ad-15 under the
Securities Exchange Act of 1934, as amended, the existence and validity of
which may be verified by the Transfer Agent through the use of industry
publications. Notarized signatures are not sufficient. In certain instances,
the Transfer Agent may require additional documents such as, but not limited
to, trust instruments, death certificates, appointments as executor or
administrator, or certificates of corporate authority. For shareholders
redeeming directly with the Transfer Agent, payments will be mailed within
seven days of receipt of a proper notice of redemption.
At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal funds or certified
check drawn on a United States bank). The Trust may delay or cause to be
delayed the mailing of a redemption check until such time as it has assured
itself that good payment has been collected for the purchase of such Fund
shares, which will not exceed 10 days.
REPURCHASE
The Trust also will repurchase Fund shares through a shareholder's listed
securities dealer. The Trust normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after receipt of the order by the dealer, provided that the
request for repurchase is received by the dealer prior to the close of business
on the NYSE (generally, 4:00 P.M., New York time) on the day received and such
request is received by the Trust from such dealer not later than 30 minutes
after the close of business on the NYSE on the same day. Dealers have the
responsibility of submitting such repurchase requests to the Trust not later
than 30 minutes after the close of business on the NYSE, in order to obtain
that day's closing price.
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The foregoing repurchase arrangements are for the convenience of shareholders
and do not involve a charge by the Trust (other than any applicable CDSC).
Securities firms which do not have selected dealer agreements with the
Distributor, however, may impose a transaction charge on the shareholder for
transmitting the notice of repurchase to the Trust. Merrill Lynch may charge
its customers a processing fee (presently $4.85) to confirm a repurchase of
shares of such customers. Repurchases directly through the Fund's Transfer
Agent are not subject to the processing fee. The Trust reserves the right to
reject any order for repurchase, which right of rejection might adversely
affect shareholders seeking redemption through the repurchase procedure.
However, a shareholder whose order for repurchase is rejected by the Trust may
redeem Fund shares as set forth above.
Redemption payments will be made within seven days of the proper tender of
the certificates, if any, and stock power or letter requesting redemption, in
each instance with signatures guaranteed as noted above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
privilege to reinstate their accounts by purchasing Class A or Class D shares
of the Fund, as the case may be, at net asset value without a sales charge up
to the dollar amount redeemed. The reinstatement privilege may be exercised by
sending a notice of exercise along with a check for the amount to be reinstated
to the Transfer Agent within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
Financial Consultant within 30 days after the date the request for redemption
was accepted by the Transfer Agent or the Distributor. The reinstatement will
be made at the net asset value per share next determined after the notice of
reinstatement is received and cannot exceed the amount of the redemption
proceeds.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services and investment plans
designed to facilitate investment in shares of the Fund. Full details as to
each of such services, copies of the various plans described below, and
instructions as to how to participate in the various services or plans, or to
change options with respect thereto can be obtained from the Trust by calling
the telephone number on the cover page hereof or from the Distributor or
Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements at least quarterly from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and long-term capital gains distributions. These statements will also
show any other activity in the account since the preceding statement.
Shareholders will receive separate transaction confirmations for each purchase
or sale transaction other than automatic investment purchases and the
reinvestments of ordinary income dividends and long-term capital gains
distributions. A shareholder may make additions to his or her Investment
Account at any time by mailing a check directly to the Transfer Agent.
Shareholders may also maintain their accounts through Merrill Lynch. Upon the
transfer of shares out of a Merrill Lynch brokerage
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account, an Investment Account in the transferring shareholder's name will be
opened automatically at the Transfer Agent. Shareholders considering
transferring their Class A or Class D shares from Merrill Lynch to another
brokerage firm or financial institution should be aware that, if the firm to
which the Class A or Class D shares are to be transferred will not take
delivery of shares of the Fund, a shareholder either must redeem the Class A
or Class D shares (paying any applicable CDSC) so that the cash proceeds can
be transferred to the account at the new firm or such shareholder must
continue to maintain an Investment Account at the Transfer Agent for those
Class A or Class D shares. Shareholders interested in transferring their Class
B or Class C shares from Merrill Lynch and who do not wish to have an
Investment Account maintained for such shares at the Transfer Agent may
request their new brokerage firm to maintain such shares in an account
registered in the name of the brokerage firm for the benefit of the
shareholder at the Transfer Agent.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated at any time in
accordance with the rules of the Commission.
Under the Merrill Lynch Select Pricing SM System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-
advised mutual fund if the shareholder holds any Class A shares of the second
fund in his or her account in which the exchange is made at the time of the
exchange or is otherwise eligible to purchase Class A shares of the second
fund. If the Class A shareholder wants to exchange Class A shares for shares
of a second MLAM-advised mutual fund, and the shareholder does not hold
Class A shares of the second fund in his or her account at the time of the
exchange and is not otherwise eligible to acquire Class A shares of the second
fund, the shareholder will receive Class D shares of the second fund as a
result of the exchange. Class D shares also may be exchanged for Class A
shares of a second MLAM-advised mutual fund at any time as long as, at the
time of the exchange, the shareholder holds Class A shares of the second fund
in the account in which the exchange is made or is otherwise eligible to
purchase Class A shares of the second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously
paid on the Class A or Class D shares being exchanged and the sales charge
payable at the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the same
class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC are exchangeable on the basis
of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares
of the Fund is "tacked" to the holding period for the newly acquired shares of
the other fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares
are held in a money
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market fund, however, will not count toward satisfaction of the holding period
requirement for reduction of any CDSC imposed on such shares, if any, and, with
respect to Class B shares, toward satisfaction of the Conversion Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.
Exercise of the exchange privilege is treated as a sale for Federal income
tax purposes. For further information, see "Shareholder Services--Exchange
Privilege" in the Statement of Additional Information.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
All dividends and capital gains distributions are reinvested automatically in
full and fractional shares of the Fund, without a sales charge, at the net
asset value per share at the close of business on the monthly payment date for
such dividends and distributions. A shareholder may at any time, by written
notification or by telephone (1-800-MER-FUND) to the Transfer Agent, elect to
have subsequent dividends or both dividends and capital gains distributions
paid in cash, rather than reinvested, in which event payment will be mailed
monthly. Cash payments can also be directly deposited to the shareholder's bank
account. No CDSC will be imposed upon redemption of shares issued as a result
of the automatic reinvestment of dividends or capital gains distributions.
SYSTEMATIC WITHDRAWAL PLANS
A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his or her Investment Account through automatic payment by check
or through automatic payment by direct deposit to his or her bank account on
either a monthly or quarterly basis. Alternatively, a Class A or Class D
shareholder whose shares are held within a CMA (R) or CBA (R) account may elect
to have shares redeemed on a monthly, bimonthly, quarterly, semiannual or
annual basis through the CMA (R)/CBA (R) Systematic Redemption Program, subject
to certain conditions.
AUTOMATIC INVESTMENT PLANS
Regular additions of Class A, Class B, Class C and Class D shares may be made
to an investor's Investment Account by prearranged charges of $50 or more to
his or her regular bank account. Alternatively, investors who maintain CMA (R)
or CBA (R) accounts may arrange to have periodic investments made in the Fund
in their CMA (R) or CBA (R) account or in certain related accounts in amounts
of $100 or more through the CMA (R) or CBA (R) Automated Investment Program.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives for
securities transactions, (each referred to in this paragraph as a "Program")
may permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of
shares held therein or the automatic exchange thereof to another class at net
asset value, which may be shares of a money market fund.
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In addition, upon termination of participation in a Program, shares that have
been held for less than specified periods within such Program may be subject to
a fee based upon the current value of such shares. These Programs also
generally prohibit such shares from being transferred to another account at
Merrill Lynch, to another broker-dealer or to the Transfer Agent. Except in
limited circumstances (which may also involve an exchange as described above),
such shares must be redeemed and another class of shares purchased (which may
involve the imposition of initial or deferred sales charges and distribution
and account maintenance fees) in order for the investment not to be subject to
Program fees. Additional information regarding a specific Program (including
charges and limitations on transferability applicable to shares that may be
held in such Program) is available in such Program's client agreement and from
Merrill Lynch Investor Services at (800) MER-FUND (637-3863).
PORTFOLIO TRANSACTIONS
The Trust has no obligation to deal with any dealer or group of dealers in
the execution of transactions in portfolio securities of the Fund. Municipal
Bonds and other securities in which the Fund invests are traded primarily in
the over-the-counter market. Where possible, the Trust deals directly with the
dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Trust to obtain the best net results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread), the size, type and difficulty of the
transactions involved, the firm's general execution and operations facilities,
and the firm's risk in positioning the securities involved and the provision of
supplemental investment research by the firm. While reasonably competitive
spreads or commissions are sought, the Fund will not necessarily be paying the
lowest spread or commission available. The sale of shares of the Fund may be
taken into consideration as a factor in the selection of brokers or dealers to
execute portfolio transactions for the Fund. The portfolio securities of the
Fund generally are traded on a net basis and normally do not involve either
brokerage commissions or transfer taxes. The cost of portfolio securities
transactions of the Fund primarily consists of dealer or underwriter spreads.
Under the 1940 Act, persons affiliated with the Trust, including Merrill Lynch,
are prohibited from dealing with the Trust as a principal in the purchase and
sale of securities unless such trading is permitted by an exemptive order
issued by the Commission. The Trust has obtained an exemptive order permitting
it to engage in certain principal transactions with Merrill Lynch involving
high quality short-term municipal bonds subject to certain conditions. In
addition, the Trust may not purchase securities, including Municipal Bonds, for
the Fund during the existence of any underwriting syndicate of which Merrill
Lynch is a member except pursuant to procedures approved by the Trustees of the
Trust which comply with rules adopted by the Commission. The Trust has applied
for an exemptive order permitting it to, among other things, (i) purchase high
quality tax-exempt securities from Merrill Lynch when Merrill Lynch is a member
of an underwriting syndicate and (ii) purchase tax-exempt securities from and
sell tax-exempt securities to Merrill Lynch in secondary market transactions.
An affiliated person of the Trust may serve as its broker in over-the-counter
transactions conducted for the Fund on an agency basis only.
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The net investment income of the Fund is declared as dividends daily prior to
the determination of the net asset value which is calculated 15 minutes after
the close of business on the NYSE (generally, 4:00 P.M.,
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New York time) on that day. The net investment income of the Fund for dividend
purposes consists of interest earned on portfolio securities, less expenses, in
each case computed since the most recent determination of the net asset value.
Expenses of the Fund, including the management fees and the account maintenance
and distribution fees, are accrued daily. Dividends of net investment income
are declared daily and reinvested monthly in the form of additional full and
fractional shares of the Fund at net asset value as of the close of business on
the "payment date" unless the shareholder elects to receive such dividends in
cash. Shares will accrue dividends as long as they are issued and outstanding.
Shares are issued and outstanding from the settlement date of a purchase order
to the day prior to the settlement date of a redemption order.
All net realized long- or short-term capital gains, if any, are declared and
distributed to the Fund's shareholders at least annually. Capital gains
distributions will be reinvested automatically in shares unless the shareholder
elects to receive such distributions in cash.
The per share dividends and distributions on each class of shares will be
reduced as a result of any account maintenance, distribution and transfer
agency fees applicable to that class. See "Additional Information--
Determination of Net Asset Value".
See "Shareholder Services" for information as to how to elect either dividend
reinvestment or cash payments. Portions of dividends and distributions which
are taxable to shareholders as described below are subject to income tax
whether they are reinvested in shares of the Fund or received in cash.
TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Code. If
it so qualifies, the Fund (but not its shareholders) will not be subject to
Federal income tax to the extent that it distributes its net investment income
and net realized capital gains. The Trust intends to cause the Fund to
distribute substantially all of such income. So long as the Fund qualifies as a
regulated investment company under the Code, it will not be subject to any
Massachusetts income tax.
To the extent that the dividends distributed to the Fund's Class A, Class B,
Class C and Class D shareholders (together, the "shareholders") are derived
from interest income exempt from Federal tax under Code Section 103(a) and are
properly designated as "exempt-interest dividends" by the Trust, they will be
excludable from a shareholder's gross income for Federal income tax purposes.
Exempt-interest dividends are included, however, in determining the portion, if
any, of a person's social security benefits and railroad retirement benefits
subject to Federal income taxes. The portion of such exempt-interest dividends
properly identified in a year-end statement as directly attributable to
interest on Massachusetts Municipal Bonds ("Massachusetts exempt-interest
dividends") also will be exempt from Massachusetts personal income taxes.
Corporate shareholders and shareholders subject to income taxation by states
other than Massachusetts will realize a lower after-tax rate of return than
individual Massachusetts shareholders since the dividends distributed by the
Fund generally will not be exempt, to any significant degree, from income
taxation by such other states. The Trust will inform shareholders annually as
to the portion of the Fund's distributions which constitutes exempt-interest
dividends and the portion which is exempt from Massachusetts personal income
taxes. Interest on indebtedness incurred or continued to purchase or carry Fund
shares is not deductible for Federal income tax or Massachusetts corporate
excise tax purposes, to the extent attributable to exempt-interest dividends,
and is not deductible for Massachusetts personal income tax purposes to the
extent attributable to Massachusetts exempt-interest dividends. Persons who may
be "substantial users" (or "related
36
<PAGE>
persons" of substantial users) of facilities financed by industrial development
bonds or private activity bonds held by the Fund should consult their tax
advisors before purchasing Fund shares.
Exempt-interest and capital gain dividends paid to a corporate shareholder
will be subject to Massachusetts corporate excise tax, and the value of the
shares of the Fund may be taken into account in calculating the property
component of such tax.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered taxable ordinary income for Federal income tax purposes and taxable
dividend income for Massachusetts tax purposes. Distributions, if any, from an
excess of net long-term capital gains over net short-term capital losses
derived from the sale of securities or from certain transactions in futures or
options ("capital gain dividends") are taxable as long-term capital gains for
Federal income tax purposes, regardless of the length of time the shareholder
has owned Fund shares and, for Massachusetts income tax purposes, are taxed as
capital gain income, unless they are attributable to the sale of certain
Massachusetts Municipal Bonds issued pursuant to legislation that specifically
exempts capital gains on their sale from Massachusetts personal income
taxation. Distributions by the Fund, whether from exempt-interest income,
ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of tax-exempt
obligations purchased at a market discount will be treated as ordinary income
rather than capital gain. This rule may increase the amount of ordinary income
dividends received by shareholders. Distributions in excess of the Fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains to such holder (assuming the shares are held as a capital asset).
Any loss upon the sale or exchange of shares held for six months or less will
be disallowed to the extent of any exempt-interest dividends received by the
shareholder. In addition, any such loss that is not disallowed under the rule
stated above will be treated as long-term capital loss to the extent of any
capital gain dividends received by the shareholder. If the Fund pays a dividend
in January which was declared in the previous October, November or December to
shareholders of record on a specified date in one of such months, then such
dividend will be treated for tax purposes as being paid by the Fund and
received by its shareholders on December 31 of the year in which such dividend
was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. This alternative minimum tax applies
to interest received on certain "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference," which could subject certain investors in such bonds,
including shareholders of the Fund, to an alternative minimum tax. The Fund
will purchase such "private activity bonds" and the Trust will report to
shareholders within 60 days after the Fund's taxable year-end the portion of
the Fund's dividends declared during the year which constitutes an item of tax
preference for alternative minimum tax purposes. The Code further provides that
corporations are subject to an alternative minimum tax based, in part, on
certain differences between taxable income as adjusted for other tax
preferences and the corporation's "adjusted current earnings", which more
closely reflect a corporation's economic income. Because an exempt-interest
dividend paid by the Fund will be included in adjusted current earnings, a
corporate shareholder may be required to pay alternative minimum tax on exempt-
interest dividends paid by the Fund.
37
<PAGE>
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the Class
D shares acquired will be the same as such shareholder's basis in the Class B
shares converted, and the holding period of the acquired Class D shares will
include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will be
reduced (or the gain increased) to the extent any sales charge paid to the Fund
on the exchanged shares reduces any sales charge such shareholder would have
owed upon purchase of the new shares in the absence of the exchange privilege.
Instead, such sales charge will be treated as an amount paid for the new
shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Massachusetts tax laws
presently in effect. For the complete provisions, reference should be made to
the pertinent Code sections, the Treasury regulations promulgated thereunder
and the applicable Massachusetts personal income and corporate excise tax laws.
The Code and the Treasury regulations, as well as the Massachusetts tax laws,
are subject to change by legislative, judicial or administrative action either
prospectively or retroactively.
Shareholders are urged to consult their tax advisors regarding the
availability of any exemptions from state or local taxes (other than those
imposed by Massachusetts) and with specific questions as to Federal, foreign,
state or local taxes.
38
<PAGE>
PERFORMANCE DATA
From time to time the Fund may include its average annual total return, yield
and tax-equivalent yield for various specified time periods in advertisements
or information furnished to present or prospective shareholders. Average annual
total return, yield and tax-equivalent yield are computed separately for
Class A, Class B, Class C and Class D shares in accordance with formulas
specified by the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including any CDSC that would be applicable to a
complete redemption of the investment at the end of the specified period such
as in the case of Class B and Class C shares and the maximum sales charge in
the case of Class A and Class D shares. Dividends paid by the Fund with respect
to all shares, to the extent any dividends are paid, will be calculated in the
same manner at the same time on the same day and will be in the same amount,
except that account maintenance and distribution charges and any incremental
transfer agency costs relating to each class of shares will be borne
exclusively by that class. The Fund will include performance data for all
classes of shares of the Fund in any advertisement or information including
performance data of the Fund.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return
calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return and (2) the maximum applicable sales
charges will not be included with respect to annual or annualized rates of
return calculations. Aside from the impact on the performance data calculations
of including or excluding the maximum applicable sales charges, actual annual
or annualized total return data generally will be lower than average annual
total return data since the average annual rates of return reflect compounding;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time. In advertisements distributed to investors whose
purchases are subject to waiver of the CDSC in the case of Class B and Class C
shares or reduced sales charges in the case of Class A and Class D shares, the
performance data may take into account the reduced, and not the maximum, sales
charge or may not take into account the CDSC and therefore may reflect greater
total return since, due to the reduced sales charges or waiver of the CDSC, a
lower amount of expenses is deducted. See "Purchase of Shares". The Fund's
total return may be expressed either as a percentage or as a dollar amount in
order to illustrate such total return on a hypothetical $1,000 investment in
the Fund at the beginning of each specified period.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average daily number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per
share on the last day of the period. Tax equivalent yield quotations will be
computed by dividing (a) the part of the Fund's yield that is tax-exempt by (b)
one minus a stated tax rate and (c) adding the result to that part, if any, of
the Fund's yield that is not tax-exempt. The yield for the 30-day period ended
July 31, 1996 was 4.83% for Class A shares, 4.52% for Class B shares, 4.42% for
Class C shares and 4.73% for Class D shares and the tax-equivalent yield for
the same period (based on a Federal income tax rate of 28%) was 6.71% for Class
A shares, 6.28% for Class B shares, 6.14% for Class C shares and 6.57% for
Class D shares.
39
<PAGE>
Total return, yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance. The
Fund's total return, yield and tax-equivalent yield will vary depending on
market conditions, the securities comprising the Fund's portfolio, the Fund's
operating expenses and the amount of realized and unrealized net capital gains
or losses during the period. The value of an investment in the Fund will
fluctuate and an investor's shares, when redeemed, may be worth more or less
than their original cost.
On occasion, the Fund may compare its performance to performance data
published by Lipper Analytical Services, Inc., Morningstar Publications, Inc.
("Morningstar"), and CDA Investment Technology, Inc. or to data contained in
publications such as Money Magazine, U.S. News & World Report, Business Week,
Forbes Magazine and Fortune Magazine. From time to time, the Fund may include
the Fund's Morningstar risk-adjusted performance ratings in advertisements or
supplemental sales literature. As with other performance data, performance
comparisons should not be considered indicative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined by
the Manager once daily 15 minutes after the close of business on the NYSE
(generally, 4:00 P.M., New York time), on each day during which the NYSE is
open for trading. The net asset value per share is computed by dividing the sum
of the value of the securities held by the Fund plus any cash or other assets
minus all liabilities by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the fees payable to the
Manager and the Distributor, are accrued daily.
The per share net asset value of the Class A shares will generally be higher
than the per share net asset value of shares of the other classes, reflecting
the daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to Class B and Class C shares and
the daily expense accruals of the account maintenance fees applicable with
respect to Class D shares; moreover, the per share net asset value of Class D
shares generally will be higher than the per share net asset value of Class B
and Class C shares, reflecting the daily expense accruals of the distribution
fees, higher account maintenance fees and higher transfer agency fees
applicable with respect to Class B and Class C shares. It is expected, however,
that the per share net asset value of the classes will tend to converge
(although not necessarily meet) immediately after the payment of dividends or
distributions which will differ by approximately the amount of the expense
accrual differentials between the classes.
ORGANIZATION OF THE TRUST
The Trust is an unincorporated business trust organized on August 2, 1985
under the laws of Massachusetts. On October 1, 1987, the Trust changed its name
from "Merrill Lynch Multi-State Tax-Exempt Series Trust" to "Merrill Lynch
Multi-State Municipal Bond Series Trust" and on December 22, 1987 the Trust
changed its name to "Merrill Lynch Multi-State Municipal Series Trust". The
Trust is an open-end management investment company comprised of separate series
("Series"), each of which is a separate portfolio offering shares to selected
groups of purchasers. Each of the Series is to be managed
40
<PAGE>
independently in order to provide to shareholders who are residents of the
state to which such Series relates as high a level of income exempt from
Federal and, in certain cases, state and local income taxes as is consistent
with prudent investment management. The Trustees are authorized to create an
unlimited number of Series and, with respect to each Series, to issue an
unlimited number of full and fractional shares of beneficial interest of $.10
par value of different classes. Shareholder approval is not required for the
authorization of additional Series or classes of a Series of the Trust. At the
date of this Prospectus, the shares of the Fund are divided into Class A, Class
B, Class C and Class D shares. Class A, Class B, Class C and Class D shares
represent interests in the same assets of the Fund and are identical in all
respects except that Class B, Class C and Class D shares bear certain expenses
related to the account maintenance associated with such shares, and Class B and
Class C shares bear certain expenses related to the distribution of such
shares. Each class has exclusive voting rights with respect to matters relating
to account maintenance and distribution expenditures as applicable. See
"Purchase of Shares". The Trustees of the Trust may classify and reclassify the
shares of the any Series into additional classes at a future date.
Shareholders are entitled to one vote for each full share and to fractional
votes for fractional shares held in the election of Trustees (to the extent
hereinafter provided) and on other matters submitted to the vote of
shareholders. There normally will be no meeting of shareholders for the purpose
of electing Trustees unless and until such time as less than a majority of the
Trustees holding office have been elected by shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. Shareholders may, in accordance with the terms of the Declaration of
Trust, cause a meeting of shareholders to be held for the purpose of voting on
the removal of Trustees. Also, the Trust will be required to call a special
meeting of shareholders of a Series in accordance with the requirements of the
1940 Act to seek approval of new management and advisory arrangements, of a
material increase in distribution fees or of a change in the fundamental
policies, objectives or restrictions of a Series. Except as set forth above,
the Trustees shall continue to hold office and appoint successor Trustees. Each
issued and outstanding share is entitled to participate equally in dividends
and distributions declared by the respective Series and in net assets of such
Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities except that, as noted above, Class B, Class C and Class
D shares bear certain additional expenses. The obligations and liabilities of a
particular Series are restricted to the assets of that Series and do not extend
to the assets of the Trust generally. The shares of each Series, when issued,
will be fully-paid and non-assessable by the Trust.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts, the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, FL 32232-5289
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this
matter please call your Merrill Lynch Financial Consultant or Merrill Lynch
Financial Data Services, Inc. at 800-637-3863.
41
<PAGE>
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Trust at the address or
telephone number set forth on the cover page of this Prospectus.
----------------
The Declaration of Trust establishing the Trust, dated August 2, 1985, a copy
of which together with all amendments thereto (the "Declaration"), is on file
in the office of the Secretary of the Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Multi-State Municipal Series Trust" refers to the
Trustees under the Declaration collectively as Trustees, but not as individuals
or personally; and no Trustee, shareholder, officer, employee or agent of the
Trust shall be held to any personal liability, nor shall resort be had to such
person's private property for the satisfaction of any obligation or claim of
the Trust, but the "Trust Property" only shall be liable.
42
<PAGE>
MERRILL LYNCH MASSACHUSETTS MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART 1)
- -------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
[_] Class A shares [_] Class B shares [_] Class C shares [_] Class D shares
of Merrill Lynch Massachusetts Municipal Bond Fund and establish an Investment
Account as described in the Prospectus. In the event that I am not eligible to
purchase Class A shares, I understand that Class D shares will be purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $............ payable to Merrill Lynch Financial
Data Services, Inc., as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the right of accumulation as outlined in the Statement of
Additional Information: (Please list all funds. Use a separate sheet of
paper if necessary.)
1. .................................. 4. ..................................
2. .................................. 5. ..................................
3. .................................. 6. ..................................
Name...........................................................................
First Name Initial Last Name
Name of Co-Owner (if any)......................................................
First Name Initial Last Name
Address........................................................................
................................................. Date........................
(Zip Code)
Occupation........................... Name and Address of Employer ........
.....................................
.....................................
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owners, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.)
- -------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
Ordinary Income Dividends Long-Term Capital Gains
SELECT [_] Reinvest SELECT [_] Reinvest
ONE: [_] Cash ONE: [_] Cash
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: [_] Check
or [_] Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by
direct deposit to my bank account and, if necessary, debit entries and
adjustments for any credit entries made to my account in accordance with the
terms I have selected on the Merrill Lynch Massachusetts Municipal Bond Fund
Authorization Form.
Specify type of account (check one): [_] checking [_] savings
Name on your account ..........................................................
Bank Name .....................................................................
Bank Number ...................... Account Number ............................
Bank Address ..................................................................
I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE WRITTEN
NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Signature of Depositor ........................................................
Signature of Depositor ............................... Date...................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED
CHECK MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD
ACCOMPANY THIS APPLICATION.
43
<PAGE>
MERRILL LYNCH MASSACHUSETTS MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART
1) -- (CONTINUED)
- -------------------------------------------------------------------------------
3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
[ ]
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security Number or Taxpayer Identification Number and (2)
that I am not subject to backup withholding (as discussed in the Prospectus
under "Distribution and Taxes--Taxes") either because I have not been notified
that I am subject thereto as a result of a failure to report all interest or
dividends, or the Internal Revenue Service ("IRS") has notified me that I am
no longer subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDER-REPORTING AND
IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS
BEEN TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS
CERTIFICATION TO OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
- -------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
..................., 19......
Dear Sir/Madam: Date of Initial Purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch Massachusetts Municipal Bond Fund or any other investment company with
an initial sales charge or deferred sales charge for which Merrill Lynch Funds
Distributor, Inc. acts as distributor over the next 13-month period which will
equal or exceed:
[_] $25,000 [_] $50,000 [_] $100,000 [_] $250,000 [_] $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch Massachusetts
Municipal Bond Fund Prospectus.
I agree to the terms and conditions of this Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Massachusetts Municipal Bond Fund held as
security.
By: ................................. .....................................
Signature of Owner Signature of Co-Owner
(If registered in joint names, both must sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name............................. (2) Name.............................
Account Number....................... Account Number.......................
- -------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp
- - - We hereby authorize Merrill Lynch
Funds Distributor, Inc. to act as
our agent in connection with
transactions under this
authorization form and agree to
notify the Distributor of any
purchases or sales made under a
Letter of Intention, Automatic
Investment Plan or Systematic
Withdrawal Plan. We guarantee the
shareholder's signature.
- - -
This form when completed, should .....................................
be mailed to: Dealer Name and Address
Merrill Lynch Massachusetts By: .................................
Municipal Bond Fund Authorized Signature of Dealer
c/o Merrill Lynch Financial Data
Services, Inc. [ ][ ][ ] [ ][ ][ ] [ ]
P.O. Box 45289 Branch Code F/C No. .............
Jacksonville, FL 32232-5289 F/C Last Name
[ ][ ][ ] [ ][ ][ ] [ ][ ]
Dealer's Customer A/C No.
44
<PAGE>
MERRILL LYNCH MASSACHUSETTS MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART 2)
- -------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR
AUTOMATIC INVESTMENT PLANS ONLY.
- -------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION
(Please Print)
Name of Owner...................... Social Security No. or
First Name Initial Last Name Taxpayer Identification
Number
Name of Co-Owner (if any)..........
First Name
Initial
Last Name
Address............................ Account Number ....................
(if existing account)
...................................
(Zip Code)
- -------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for quarterly,
of [_] Class A or [_] Class D shares in Merrill Lynch Massachusetts Municipal
Bond Fund at cost or current offering price. Withdrawals to be made either
(check one) [_] Monthly on the 24th day of each month, or [_] Quarterly on the
24th day of March, June, September and December. If the 24th falls on a
weekend or holiday, the next succeeding business day will be utilized. Begin
systematic withdrawal on or as soon as possible
-------------------
(month)
thereafter.
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): [_] $
-------
or [_] % of the current value of [_] Class A or [_] Class D shares in the
-------
account.
SPECIFY WITHDRAWAL METHOD: [_] check or [_] direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a)I hereby authorize payment by check
[_] as indicated in Item 1.
[_] to the order of..........................................................
Mail to (check one)
[_] the address indicated in Item 1.
[_] Name (Please Print)......................................................
Address .......................................................................
..........................................................................
Signature of Owner................................ Date..................
Signature of Co-Owner (if any)............................................
(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING
OR TERMINATING THIS SERVICE.
Specify type of account (check one): [_] checking [_] savings
Name on your Account...........................................................
Bank Name......................................................................
Bank Number........................ Account Number............................
Bank Address...................................................................
........................................................................
Signature of Depositor................................. Date..................
Signature of Depositor.........................................................
(If joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID"
OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS APPLICATION.
45
<PAGE>
MERRILL LYNCH MASSACHUSETTS MUNICIPAL BOND FUND -- AUTHORIZATION FORM (PART
2) -- (CONTINUED)
- -------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account as described
below each month to purchase: (choose one)
[_] Class A shares [_] Class B shares
[_] Class C shares [_] Class D shares
of Merrill Lynch Massachusetts Municipal Bond Fund subject to the terms set
forth below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.
MERRILL LYNCH FINANCIAL DATA AUTHORIZATION TO HONOR ACH DEBITS
SERVICES, INC. DRAWN BY MERRILL LYNCH FINANCIAL
DATA SERVICES, INC.
You are hereby authorized to draw an
ACH debit each month on my bank To...............................Bank
account for investment in Merrill (Investor's Bank)
Lynch Massachusetts Municipal Bond
Fund, as indicated below: Bank Address.........................
Amount of each ACH debit $........
City...... State...... Zip Code......
Account No. ......................
As a convenience to me, I hereby
Please date and invest ACH debits on request and authorize you to pay and
the 20th of each month charge to my account ACH debits
beginning or as soon thereafter drawn on my account by and payable
as possible. to Merrill Lynch Financial Data
(Month) Services, Inc. I agree that your
I agree that you are drawing these rights in respect to each such debit
ACH debits voluntarily at my request shall be the same as if it were a
and that you shall not be liable for check drawn on you and signed
any loss arising from any delay in personally by me. This authority is
preparing or failure to prepare any to remain in effect until revoked
such debit. If I change banks or personally by me in writing. Until
desire to terminate or suspend this you receive such notice, you shall
program, I agree to notify you be fully protected in honoring any
promptly in writing. I hereby such debit. I further agree that if
authorize you to take any action to any such debit be dishonored,
correct erroneous ACH debits of my whether with or without cause and
bank account or purchases of Fund whether intentionally or
shares including liquidating shares inadvertently, you shall be under no
of the Fund and crediting my bank liability.
account. I further agree that if a
debit is not honored upon
presentation, Merrill Lynch Financial ............ .....................
Data Services, Inc. is authorized to Date Signature of
discontinue immediately the Automatic Depositor
Investment Plan and to liquidate
sufficient shares held in my account ............ .....................
to offset the purchase made with the Bank Signature of Depositor
dishonored debit. Account (If joint account,
Number both must sign)
............ .....................
Date Signature of
Depositor
......................
Signature of Depositor
(If joint account,
both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" SHOULD ACCOMPANY THIS APPLICATION.
46
<PAGE>
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
State Street Bank and Trust Company
P.O. Box 351
Boston, Massachusetts 02101
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400
COUNSEL
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY
BE MADE.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Fee Table.................................................................. 2
Merrill Lynch Select Pricing SM System..................................... 4
Financial Highlights....................................................... 8
Investment Objective and Policies.......................................... 10
Potential Benefits........................................................ 12
Special and Risk Considerations Relating to Municipal Bonds............... 12
Description of Municipal Bonds............................................ 13
Call Rights............................................................... 15
When-Issued Securities and Delayed Delivery Transactions.................. 16
Financial Futures Transactions and Options................................ 16
Repurchase Agreements..................................................... 18
Investment Restrictions................................................... 18
Management of the Trust.................................................... 20
Trustees.................................................................. 20
Management and Advisory Arrangements...................................... 20
Code of Ethics............................................................ 21
Transfer Agency Services.................................................. 21
Purchase of Shares......................................................... 22
Initial Sales Charge Alternatives--Class A and Class D Shares............. 24
Deferred Sales Charge Alternatives--Class B and Class C Shares............ 25
Distribution Plans........................................................ 28
Limitations on the Payment of Deferred Sales Charges...................... 30
Redemption of Shares....................................................... 31
Redemption................................................................ 31
Repurchase................................................................ 31
Reinstatement Privilege--Class A and Class D Shares....................... 32
Shareholder Services....................................................... 32
Investment Account........................................................ 32
Exchange Privilege........................................................ 33
Automatic Reinvestment of Dividends and Capital Gains Distributions....... 34
Systematic Withdrawal Plans............................................... 34
Automatic Investment Plans................................................ 34
Fee-Based Programs........................................................ 34
Portfolio Transactions..................................................... 35
Distributions and Taxes.................................................... 35
Distributions............................................................. 35
Taxes..................................................................... 36
Performance Data........................................................... 39
Additional Information..................................................... 40
Determination of Net Asset Value.......................................... 40
Organization of the Trust................................................. 40
Shareholder Reports....................................................... 41
Shareholder Inquiries..................................................... 42
Authorization Form......................................................... 43
</TABLE>
Code #16148-1096
[LOGO] MERRILL LYNCH
Merrill Lynch
Massachusetts Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
[ART]
PROSPECTUS
October 29, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be retained for future reference.
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH MASSACHUSETTS MUNICIPAL BOND FUND
MERRILL LYNCH MULTI-STATE MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 . PHONE NO. (609) 282-2800
----------------
Merrill Lynch Massachusetts Municipal Bond Fund (the "Fund") is a series of
Merrill Lynch Multi-State Municipal Series Trust (the "Trust"), an open-end
management investment company organized as a Massachusetts business trust. The
investment objective of the Fund is to provide shareholders with as high a
level of income exempt from Federal and Massachusetts personal income taxes as
is consistent with prudent investment management. The Fund invests primarily in
a non-diversified portfolio of long-term investment grade obligations issued by
or on behalf of The Commonwealth of Massachusetts, its political subdivisions,
agencies and instrumentalities and obligations of other qualifying issuers,
such as issuers located in Puerto Rico, the Virgin Islands and Guam, which pay
interest exempt from Federal and Massachusetts income taxes. There can be no
assurance that the investment objective of the Fund will be realized.
Pursuant to the Merrill Lynch Select PricingSM System, the Fund offers four
classes of shares, each with a different combination of sales charges, ongoing
fees and other features. The Merrill Lynch Select PricingSM System permits an
investor to choose the method of purchasing shares that the investor believes
is most beneficial given the amount of the purchase, the length of time the
investor expects to hold the shares and other relevant circumstances.
----------------
The Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the prospectus of the Fund, dated October
29, 1996 (the "Prospectus"), which has been filed with the Securities and
Exchange Commission (the "Commission") and can be obtained, without charge, by
calling or by writing the Fund at the above telephone number or address. This
Statement of Additional Information has been incorporated by reference into the
Prospectus. Capitalized terms used but not defined herein have the same
meanings as in the Prospectus.
----------------
FUND ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC. -- DISTRIBUTOR
----------------
The date of this Statement of Additional Information is October 29, 1996.
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as high
a level of income exempt from Federal and Massachusetts personal income taxes
as is consistent with prudent investment management. The Fund seeks to achieve
its objective by investing primarily in a portfolio of long-term obligations
issued by or on behalf of The Commonwealth of Massachusetts, its political
subdivisions, agencies and instrumentalities and obligations of other
qualifying issuers, such as issuers located in Puerto Rico, the Virgin Islands
and Guam, which pay interest exempt, in the opinion of bond counsel to the
issuer, from Federal and Massachusetts personal income taxes. Obligations
exempt from Federal income taxes are referred to herein as "Municipal Bonds"
and obligations exempt from both Federal and Massachusetts income taxes are
referred to as "Massachusetts Municipal Bonds". Unless otherwise indicated,
references to Municipal Bonds shall be deemed to include Massachusetts
Municipal Bonds. The Fund anticipates that at all times, except during
temporary defensive periods, it will maintain at least 65% of its total assets
invested in Massachusetts Municipal Bonds. At times, the Fund will seek to
hedge its portfolio through the use of futures transactions to reduce
volatility in the net asset value of Fund shares. Reference is made to
"Investment Objective and Policies" in the Prospectus for a discussion of the
investment objective and policies of the Fund.
Municipal Bonds may include general obligation bonds of the State and its
political subdivisions, revenue bonds to finance utility systems, highways,
bridges, port and airport facilities, colleges, hospitals, housing facilities,
etc., and industrial development bonds or private activity bonds. The interest
on such obligations may bear a fixed rate or be payable at a variable or
floating rate. The Municipal Bonds purchased by the Fund will be primarily what
are commonly referred to as "investment grade" securities, which are
obligations rated at the time of purchase within the four highest quality
ratings as determined by either Moody's Investors Service, Inc. ("Moody's")
(currently Aaa, Aa, A and Baa), Standard & Poor's Ratings Group ("Standard &
Poor's") (currently AAA, AA, A and BBB) or Fitch Investors Service, Inc.
("Fitch") (currently AAA, AA, A and BBB). If unrated, such securities will
possess creditworthiness comparable, in the opinion of the manager of the Fund,
Fund Asset Management, L.P. (the "Manager"), to other obligations in which the
Fund may invest.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and Massachusetts income taxes. However, to the extent that
suitable Massachusetts Municipal Bonds are not available for investment by the
Fund, the Fund may purchase Municipal Bonds issued by other states, their
agencies and instrumentalities, the interest income on which is exempt, in the
opinion of bond counsel, from Federal but not Massachusetts taxation. The Fund
also may invest in securities not issued by or on behalf of a state or
territory or by an agency or instrumentality thereof, if the Fund nevertheless
believes such securities to be exempt from Federal income taxation ("Non-
Municipal Tax-Exempt Securities"). Non-Municipal Tax-Exempt Securities may
include securities issued by other investment companies that invest in
municipal bonds, to the extent permitted by applicable law. Other Non-Municipal
Tax-Exempt Securities could include trust certificates or other instruments
evidencing interests in one or more long-term municipal securities.
Except when acceptable securities are unavailable as determined by the
Manager, the Fund, under normal circumstances, will invest at least 65% of its
total assets in Massachusetts Municipal Bonds. For temporary periods or to
provide liquidity, the Fund has the authority to invest as much as 35% of its
assets in tax-exempt or taxable money market obligations with a maturity of one
year or less (such short-term
2
<PAGE>
obligations being referred to herein as "Temporary Investments"), except that
taxable Temporary Investments shall not exceed 20% of the Fund's net assets.
The Fund at all times will have at least 80% of its net assets invested in
securities exempt from Federal income taxation. However, interest received on
certain otherwise tax-exempt securities which are classified as "private
activity bonds" (in general bonds that benefit non-governmental entities) may
be subject to an alternative minimum tax. The Fund may purchase such private
activity bonds. See "Distributions and Taxes". In addition, the Fund reserves
the right to invest temporarily a greater portion of its assets in Temporary
Investments for defensive purposes, when, in the judgment of the Manager,
market conditions warrant. The investment objective of the Fund set forth in
this paragraph is a fundamental policy of the Fund which may not be changed
without a vote of a majority of the outstanding shares of the Fund. The Fund's
hedging strategies are not fundamental policies and may be modified by the
Trustees of the Trust without the approval of the Fund's shareholders.
Municipal Bonds may at times be purchased or sold on a delayed delivery basis
or a when-issued basis. These transactions arise when securities are purchased
or sold by the Fund with payment and delivery taking place in the future, often
a month or more after the purchase. The payment obligation and the interest
rate are each fixed at the time the buyer enters into the commitment. The Fund
will make only commitments to purchase such securities with the intention of
actually acquiring the securities, but the Fund may sell these securities prior
to the settlement date if it is deemed advisable. Purchasing Municipal Bonds on
a when-issued basis involves the risk that the yields available in the market
when the delivery takes place may actually be higher than those obtained in the
transaction itself; if yields so increase, the value of the when-issued
obligations generally will decrease. The Fund will maintain a separate account
at its custodian bank consisting of cash, cash equivalents or high-grade,
liquid Municipal Bonds or Temporary Investments (valued on a daily basis) equal
at all times to the amount of the when-issued commitment.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
Also, the Fund may invest in so-called "inverse floating obligations" or
"residual interest bonds" on which the interest rates typically decline as
market rates increase and increase as market rates decline. For example, to the
extent the Fund invests in these types of Municipal Bonds, the Fund's return on
such Municipal Bonds will be subject to risk with respect to the value of the
particular index, which may include reduced or eliminated interest payments and
losses of invested principal. Such securities have the effect of providing a
degree of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate
which is a multiple (typically two) of the rate at which fixed-rate long-term
tax exempt securities increase or decrease in response to such changes. As a
result, the market values of such securities will generally be more volatile
than the market values of fixed-rate tax exempt securities. To seek to limit
the volatility of these securities, the Fund may purchase inverse floating
obligations with shorter term maturities or which contain limitations on the
extent to which the interest rate may vary. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% of the Fund's total assets. The Manager believes, however,
that indexed and inverse floating obligations represent flexible portfolio
management instruments for the Fund which allow the Fund to seek
3
<PAGE>
potential investment rewards, hedge other portfolio positions or vary the
degree of investment leverage relatively efficiently under different market
conditions.
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a
mandatory tender for the purchase of related Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to the maturity of
the related Municipal Bond will expire without value. The economic effect of
holding both the Call Right and the related Municipal Bond is identical to
holding a Municipal Bond as a non-callable security. Certain investments in
such obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments,
would exceed 15% of the Fund's total assets.
The Fund may invest up to 20% of its total assets in Municipal Bonds which
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or
which, in the Manager's judgment, possess similar credit characteristics ("high
yield securities"). See Appendix II--"Ratings of Municipal Bonds" for
additional information regarding ratings of debt securities. The Manager
considers the ratings assigned by Standard & Poor's, Moody's or Fitch as one of
several factors in its independent credit analysis of issuers.
High yield securities are considered by Standard & Poor's, Moody's and Fitch
to have varying degrees of speculative characteristics. Consequently, although
high yield securities can be expected to provide higher yields, such securities
may be subject to greater market price fluctuations and risk of loss of
principal than lower yielding, higher rated debt securities. Investments in
high yield securities will be made only when, in the judgment of the Manager,
such securities provide attractive total return potential relative to the risk
of such securities, as compared to higher quality debt securities. The Fund
generally will not invest in debt securities in the lowest rating categories
(those rated CC or lower by Standard & Poor's or Fitch or Ca or lower by
Moody's) unless the Manager believes that the financial condition of the issuer
or the protection afforded the particular securities is stronger than would
otherwise be indicated by such low ratings.
Issuers or obligors of high yield securities may be highly leveraged and may
not have available to them more traditional methods of financing. Therefore,
the risks associated with acquiring the securities of such issuers or obligors
generally are greater than is the case with higher rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, issuers or obligors of high yield securities may be more likely to
experience financial stress, especially if such issuers or obligors are highly
leveraged. In addition, the market for high yield municipal securities is
relatively new and has not weathered a major economic recession, and it is
unknown what effects such a recession might have on such securities. During
such periods, such issuers may not have sufficient revenues to meet their
interest payment obligations. The issuer's ability to service its debt
obligations also may be adversely affected by specific issuer developments, or
the issuer's inability to meet specific projected business forecasts, or the
unavailability of additional financing. The risk of loss due to default by the
issuer is significantly greater for the holders of high yield securities
because such securities may be unsecured and may be subordinated to other
creditors of the issuer.
High yield securities frequently have call or redemption features that would
permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends
to shareholders.
4
<PAGE>
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. Because not all
dealers maintain markets in all high yield securities, there is no established
secondary market for many of these securities, and the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. To the extent that a secondary trading market for high
yield securities does exist, it generally is not as liquid as the secondary
market for higher rated securities. Reduced secondary market liquidity may have
an adverse impact on market price and the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. Reduced secondary market liquidity for certain
securities also may make it more difficult for the Fund to obtain accurate
market quotations for purposes of valuing the Fund's portfolio. Market
quotations generally are available on many high yield securities only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices for actual sales.
It is expected that a significant portion of the high yield securities
acquired by the Fund will be purchased upon issuance, which may involve special
risks because the securities so acquired are new issues. In such instances the
Fund may be a substantial purchaser of the issue and therefore have the
opportunity to participate in structuring the terms of the offering. Although
this may enable the Fund to seek to protect itself against certain of such
risks, the considerations discussed herein would nevertheless remain
applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent that it is required to seek recovery upon a default on a portfolio
holding or participate in the restructuring of the obligation.
DESCRIPTION OF
MUNICIPAL BONDS AND TEMPORARY INVESTMENTS
Set forth below is a description of the Municipal Bonds and Temporary
Investments in which the Fund may invest. A more complete discussion concerning
futures and options transactions is set forth under "Investment Objective and
Policies" in the Prospectus. Information with respect to ratings assigned to
tax-exempt obligations which the Fund may purchase is set forth in Appendix II
to this Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refunding of outstanding obligations and obtaining funds for general operating
expenses and loans to other public institutions and facilities. In addition,
certain types of industrial development bonds or private activity bonds are
issued by or on behalf of public authorities to finance various privately owned
or operated facilities. Such obligations are included within the term Municipal
Bonds if the interest paid thereon is, in the opinion of bond counsel, excluded
from gross income for Federal income tax purposes and, in the case of
Massachusetts Municipal Bonds, exempt from Massachusetts personal income taxes.
Other types of industrial development bonds or private activity bonds,
5
<PAGE>
the proceeds of which are used for the construction, equipment or improvement
of privately operated industrial or commercial facilities, may constitute
Municipal Bonds, although the current Federal tax laws place substantial
limitations on the size of such issues.
The two principal classifications of Municipal Bonds are "general obligation"
bonds and "revenue" bonds which latter category includes industrial development
bonds ("IDBs") and, for bonds issued after August 15, 1986, private activity
bonds. General obligation bonds are secured by the issuer's pledge of faith,
credit and taxing power for the payment of principal and interest. Revenue
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 or
limited tax or other specific revenue source such as payments from the user of
the facility being financed. IDBs and, in the case of bonds issued after August
15, 1986, private activity bonds are in most cases revenue bonds and generally
do not constitute the pledge of the credit or taxing power of the issuer of
such bonds. Generally, the payment of the principal of and interest on such
bonds depends solely on the ability of the user of the facility 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, unless a line of
credit, bond insurance or other security is furnished. The Fund may invest in
Municipal Bonds that are so-called "moral obligation" bonds, which are normally
issued by special purpose public authorities. If an issuer of moral obligation
bonds is unable to meet its obligations, repayment of such bonds becomes a
moral commitment, but not a legal obligation, of the state or municipality in
question.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called
"lease obligations") relating to such equipment, land or facilities. Although
lease obligations do not constitute general obligations of the issuer for which
the issuer's unlimited taxing power is pledged, a lease obligation is
frequently backed by the issuer's covenant to budget for, appropriate and make
the payments due under the lease obligation. Certain investments in lease
obligations may be illiquid. The Fund may not invest in illiquid lease
obligations if such investments, together with all other illiquid investments,
would exceed 15% of the Fund's total assets. The Fund may, however, invest
without regard to such limitation in lease obligations which the Manager,
pursuant to the guidelines which have been adopted by the Board of Trustees and
subject to the supervision of the Board of Trustees, determines to be liquid.
The Manager will deem lease obligations liquid if they are publicly offered and
have received an investment grade rating of Baa or better by Moody's, or BBB or
better by Standard & Poor's or Fitch. Unrated lease obligations, or those rated
below investment grade, will be considered liquid if the obligations come to
the market through an underwritten public offering and at least two dealers are
willing to give competitive bids. In reference to the latter, the Manager must,
among other things, also review the creditworthiness of the municipality
obligated to make payment under the lease obligation and make certain specified
determinations based on such factors as the existence of a rating or credit
enhancement such as insurance, the frequency of trades or quotes for the
obligation and the willingness of dealers to make a market in the obligation.
Yields on Municipal Bonds are dependent on a variety of factors, including
the general condition of the money market and of the municipal bond market, the
size of a particular offering, the financial condition of the issuer, the
general conditions of the Municipal Bond market, the maturity of the
obligation, and the rating
6
<PAGE>
of the issue. The ability of the Fund to achieve its investment objective is
also dependent on the continuing ability of the issuers of the bonds in which
the Fund invests to meet their obligations for the payment of interest and
principal when due. There are variations in the risks involved in holding
Municipal Bonds, both within a particular classification and between
classifications, depending on numerous factors. Furthermore, the rights of
owners of Municipal Bonds and the obligations of the issuer of such Municipal
Bonds may be subject to applicable bankruptcy, insolvency and similar laws and
court decisions affecting the rights of creditors generally and to general
equitable principles, which may limit the enforcement of certain remedies.
DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject to
the limitations set forth under "Investment Objective and Policies". The tax-
exempt money market securities may include municipal notes, municipal
commercial paper, municipal bonds with remaining maturity of less than one
year, variable rate demand notes and participations therein. Municipal notes
include tax anticipation notes, bond anticipation notes and grant anticipation
notes. Anticipation notes are sold as interim financing in anticipation of tax
collection, bond sales, government grants or revenue receipts. Municipal
commercial paper refers to short-term unsecured promissory notes generally
issued to finance short-term credit needs. The taxable money market securities
in which the Fund may invest as Temporary Investments consist of U.S.
Government securities, U.S. Government agency securities, domestic bank or
savings institution certificates of deposit and bankers' acceptances, short-
term corporate debt securities such as commercial paper, and repurchase
agreements. These Temporary Investments must have a stated maturity not in
excess of one year from the date of purchase.
Variable rate demand obligations ("VRDOs") are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period not to exceed seven days. There is, however, the possibility that
because of default or insolvency the demand feature of VRDOs and Participating
VRDOs, described below, may not be honored. The interest rates are adjustable
at intervals (ranging from daily to up to one year) to some prevailing market
rate for similar investments, such adjustment formula being calculated to
maintain the market value of the VRDO at approximately the par value of the
VRDOs on the adjustment date. The adjustments typically are set at a rate
determined by the remarketing agent or based upon the Public Securities
Association Index or some other appropriate interest rate adjustment index. The
Fund may invest in all types of tax-exempt instruments currently outstanding or
to be issued in the future which satisfy the short-term maturity and quality
standards of the Fund.
The Fund also may invest in VRDOs in the form of participation interests
("Participating VRDOs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank. Participating VRDOs provide
the Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the Participating VRDOs from the financial institution upon
a specified number of days' notice, not to exceed seven days. In addition, a
Participating VRDO is backed by an irrevocable letter of credit or guaranty of
the financial institution. The Fund would have an undivided interest in the
underlying obligation and thus participate on the same basis as the financial
institution in such obligation except that the financial institution typically
retains fees out of the interest paid on the obligation for servicing the
obligation, providing the letter of credit
7
<PAGE>
and issuing the repurchase commitment. The Fund has been advised by its counsel
that the Fund should be entitled to treat the income received on Participating
VRDOs as interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of the
unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
period exceeding seven days will therefore be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and will be ultimately responsible
for such determination.
The Trust has established the following standards with respect to money
market securities and VRDOs in which the Fund invests. Commercial paper
investments at the time of purchase must be rated A-1 through A-3 by Standard &
Poor's, Prime-1 through Prime-3 by Moody's or F-1 through F-3 by Fitch or, if
not rated, issued by companies having an outstanding debt issue rated at least
A by Standard & Poor's, Fitch or Moody's. Investments in corporate bonds and
debentures (which must have maturities at the date of purchase of one year or
less) must be rated at the time of purchase at least A by Standard & Poor's,
Moody's or Fitch. Notes and VRDOs at the time of purchase must be rated SP-1/A-
1 through SP-2/A-3 by Standard & Poor's, MIG-l/VMIG-1 through MIG-4/VMIG-4 by
Moody's or F-1 through F-3 by Fitch. Temporary Investments, if not rated, must
be of comparable quality to securities rated in the above rating categories in
the opinion of the Manager. The Fund may not invest in any security issued by a
commercial bank or a savings institution unless the bank or institution is
organized and operating in the United States, has total assets of at least one
billion dollars and is a member of the Federal Deposit Insurance Corporation
("FDIC"), except that up to 10% of total assets may be invested in certificates
of deposit of small institutions if such certificates are fully insured by the
FDIC.
REPURCHASE AGREEMENTS
The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the
Federal Reserve System or a primary dealer in U.S. Government securities or an
affiliate thereof. Under such agreements, the seller agrees, upon entering into
the contract, to repurchase the security at a mutually agreed upon time and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during
such period. In repurchase agreements, the prices at which the trades are
conducted do not reflect accrued interest on the underlying obligations. Such
agreements usually cover short periods, such as under one week. Repurchase
agreements may be construed to be collateralized loans by the purchaser to the
seller secured by the securities transferred to the purchaser. In the case of a
repurchase agreement, the Fund will require the seller to provide additional
collateral if the market value of the securities falls below the repurchase
price at any time during the term of the repurchase agreement. In the event of
default by the seller under a repurchase agreement construed to be a
collateralized loan, the underlying securities are not owned by the Fund but
only constitute collateral for the seller's obligation to pay the repurchase
price. Therefore, the Fund may suffer time delays and incur costs or possible
losses in connection with the disposition of the collateral. In the event of a
default under such a repurchase agreement, instead of the contractual fixed
rate of return, the rate of return to the Fund will depend on intervening
fluctuations of the market value of such security and the
8
<PAGE>
accrued interest on the security. In such event, the Fund would have rights
against the seller for breach of contract with respect to any losses arising
from market fluctuations following the failure of the seller to perform. The
Fund may not invest in repurchase agreements maturing in more than seven days
if such investments, together with all other illiquid investments, would exceed
15% of the Fund's total assets.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold". Therefore,
amounts earned under such agreements will not be considered tax-exempt
interest.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to the discussion concerning futures transactions under
"Investment Objective and Policies" in the Prospectus. Set forth below is
additional information concerning these transactions.
As described in the Prospectus, the Fund may purchase and sell exchange
traded financial futures contracts ("financial futures contracts") to hedge its
portfolio of Municipal Bonds against declines in the value of such securities
and to hedge against increases in the cost of securities the Fund intends to
purchase. However, any transactions involving financial futures or options will
be in accordance with the Fund's investment policies and limitations. To hedge
its portfolio, the Fund may take an investment position in a futures contract
which will move in the opposite direction from the portfolio position being
hedged. While the Fund's use of hedging strategies is intended to moderate
capital changes in portfolio holdings and thereby reduce the volatility of the
net asset value of Fund shares, the Fund anticipates that its net asset value
will fluctuate. Set forth below is information concerning futures transactions.
Description of Futures Contracts. A futures contract is an agreement between
two parties to buy and sell a security, or in the case of an index-based
futures contract, to make and accept a cash settlement for a set price on a
future date. A majority of transactions in futures contracts, however, do not
result in the actual delivery of the underlying instrument or cash settlement,
but are settled through liquidation, i.e., by entering into an offsetting
transaction. Futures contracts have been designed by boards of trade which have
been designated "contracts markets" by the Commodity Futures Trading Commission
("CFTC").
The purchase or sale of a futures contract differs from the purchase or sale
of a security in that no price or premium is paid or received. Instead, an
amount of cash or securities acceptable to the broker and the relevant contract
market, which varies, but is generally about 5% of the contract amount, must be
deposited with the broker. This amount is known as "initial margin" and
represents a "good faith" deposit assuring the performance of both the
purchaser and seller under the futures contract. Subsequent payments to and
from the broker, called "variation margin", are required to be made on a daily
basis as the price of the futures contract fluctuates making the long and short
positions in the futures contract more or less valuable, a process known as
"mark to the market". At any time prior to the settlement date of the futures
contract, the position may be closed out by taking an opposite position which
will operate to terminate the position in the futures contract. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the broker, and the purchaser realizes a loss or
gain. In addition, a nominal commission is paid on each completed sale
transaction.
9
<PAGE>
The Fund may deal in financial futures contracts based on a long-term
municipal bond index developed by the Chicago Board of Trade ("CBT") and The
Bond Buyer (the "Municipal Bond Index"). The Municipal Bond Index is comprised
of 40 tax-exempt municipal revenue and general obligations bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or
Standard & Poor's and must have a remaining maturity of 19 years or more. Twice
a month new issues satisfying the eligibility requirements are added to, and an
equal number of old issues are deleted from, the Municipal Bond Index. The
value of the Municipal Bond Index is computed daily according to a formula
based on the price of each bond in the Municipal Bond Index, as evaluated by
six dealer-to-dealer brokers.
The Municipal Bond Index futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a nonprofit organization managed by the
exchange membership which also is responsible for handling daily accounting of
deposits or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to U.S. Government
securities, currently there are financial futures contracts based on long-term
U.S. Treasury bonds, Treasury notes, Government National Mortgage Association
("GNMA") Certificates and three-month U.S. Treasury bills. The Fund may
purchase and write call and put options on futures contracts on U.S. Government
securities in connection with its hedging strategies.
Subject to policies adopted by the Trustees, the Fund also may engage in
other futures contracts transactions such as futures contracts on other
municipal bond indices which may become available if the Manager and the
Trustees should determine that there is normally a sufficient correlation
between the prices of such futures contracts and the Municipal Bonds in which
the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as
a result of the shortening of maturities. The sale of futures contracts
provides an alternative means of hedging against declines in the value of its
investments in Municipal Bonds. As such values decline, the value of the Fund's
positions in the futures contracts will tend to increase, thus offsetting all
or a portion of the depreciation in the market value of the Fund's Municipal
Bond investments which are being hedged. While the Fund will incur commission
expenses in selling and closing out futures positions, commissions on futures
transactions are lower than transaction costs incurred in the purchase and sale
of Municipal Bonds. In addition, the ability of the Fund to trade in the
standardized contracts available in the futures markets may offer a more
effective defensive position than a program to reduce the average maturity of
the portfolio securities due to the unique and varied credit and technical
characteristics of the municipal debt instruments available to the Fund.
Employing futures as a hedge also may permit the Fund to assume a defensive
posture without reducing the yield on its investments beyond any amounts
required to engage in futures trading.
10
<PAGE>
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
futures contracts as a hedge against any increase in the cost of such Municipal
Bonds, resulting from an increase in interest rates or otherwise, that may
occur before such purchases can be effected. Subject to the degree of
correlation between the Municipal Bonds and the futures contracts, subsequent
increases in the cost of Municipal Bonds should be reflected in the value of
the futures held by the Fund. As such purchases are made, an equivalent amount
of futures contracts will be closed out. Due to changing market conditions and
interest rate forecasts, however, a futures position may be terminated without
a corresponding purchase of portfolio securities.
Call Options on Futures Contracts. The Fund also may purchase and sell
exchange traded call and put options on financial futures contracts on U.S.
Government securities. The purchase of a call option on a futures contract is
analogous to the purchase of a call option on an individual security. Depending
on the pricing of the option compared to either the futures contract on which
it is based, or on the price of the underlying debt securities, it may or may
not be less risky than ownership of the futures contract or underlying debt
securities. Like the purchase of a futures contract, the Fund will purchase a
call option on a futures contract to hedge against a market advance when the
Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in
the Fund's portfolio holdings.
Put Options on Futures Contracts. The purchase of options on a futures
contract is analogous to the purchase of protective put options on portfolio
securities. The Fund will purchase put options on futures contracts to hedge
the Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial hedge
against increasing prices of the securities which are deliverable upon exercise
of the futures contract. If the futures price at expiration is higher than the
exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any increase in the price of Municipal
Bonds which the Fund intends to purchase.
The writer of an option on a futures contract is required to deposit initial
and variation margin pursuant to requirements similar to those applicable to
futures contracts. Premiums received from the writing of an option will be
included in initial margin. The writing of an option on a futures contract
involves risks similar to those relating to futures contracts.
The Trust has received an order from the Commission exempting it from the
provisions of Section 17(f) and Section 18(f) of the Investment Company Act of
1940, as amended (the "1940 Act"), in connection with its strategy of investing
in futures contracts. Section 17(f) relates to the custody of securities and
other assets of an investment company and may be deemed to prohibit certain
arrangements between the Trust and commodities brokers with respect to initial
and variation margin. Section 18(f) of the 1940 Act prohibits an open-end
investment company such as the Trust from issuing a "senior security" other
than a borrowing from a bank. The staff of the Commission has in the past
indicated that a futures contract may be a "senior security" under the 1940
Act.
11
<PAGE>
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
futures contracts and options thereon (i) for bona fide hedging purposes, and
(ii) for non-hedging purposes, if the aggregate initial margin and premiums
required to establish positions in such contracts and options does not exceed
5% of the liquidation value of the Fund's portfolio assets after taking into
account unrealized profits and unrealized losses on any such contracts and
options. (However, the Fund intends to engage in options and futures
transactions only for hedging purposes.) Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
When the Fund purchases futures contracts or a call option with respect
thereto or writes a put option on a futures contract, an amount of cash, cash
equivalents or liquid securities will be deposited in a segregated account with
the Fund's custodian so that the amount so segregated, plus the amount of
initial and variation margin held in the account of its broker, equals the
market value of the futures contract, thereby ensuring that the use of such
futures is unleveraged.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the futures contract which is
not completely offset by movements in the price of the hedged securities. To
compensate for imperfect correlations, the Fund may purchase or sell futures
contracts in a greater dollar amount than the hedged securities if the
volatility of the hedged securities is historically greater than the volatility
of the futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
The particular municipal bonds comprising the index underlying the Municipal
Bond Index financial futures contract may vary from the Municipal Bonds held by
the Fund. As a result, the Fund's ability to hedge effectively all or a portion
of the value of its Municipal Bonds through the use of such financial futures
contracts will depend in part on the degree to which price movements in the
index underlying the financial futures contract correlate with the price
movements of the Municipal Bonds held by the Fund. The correlation may be
affected by disparities in the average maturity, ratings, geographical mix or
structure of the Fund's investments as compared to those comprising the
Municipal Bond Index, and general economic or political factors. In addition,
the correlation between movements in the value of the Municipal Bond Index may
be subject to change over time as additions to and deletions from the Municipal
Bond Index alter its structure. The correlation between futures contracts on
U.S. Government securities and the Municipal Bonds held by the Fund may be
adversely affected by similar factors and the risk of imperfect correlation
between movements in the prices of such futures contracts and the prices of the
Municipal Bonds held by the Fund may be greater.
The Fund expects to liquidate a majority of the futures contracts it enters
into through offsetting transactions on the applicable contract market. There
can be no assurance, however, that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close out a futures position. In the event of adverse price movements, the
Fund would continue to be required to
12
<PAGE>
make daily cash payments of variation margin. In such situations, if the Fund
has insufficient cash, it may be required to sell portfolio securities to meet
daily variation margin requirements at a time when it may be disadvantageous to
do so. The inability to close out futures positions also could have an adverse
impact on the Fund's ability to hedge effectively its investments in Municipal
Bonds. The Fund will enter into a futures position only if, in the judgment of
the Manager, there appears to be an actively traded secondary market for such
futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a futures contract or
option is held by the Fund or such rates move in a direction opposite to that
anticipated, the Fund may realize a loss on the hedging transaction which is
not fully or partially offset by an increase in the value of portfolio
securities. As a result, the Fund's total return for such period may be less
than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. Because the Fund will engage in the
purchase and sale of futures contracts solely for hedging purposes, however,
any losses incurred in connection therewith should, if the hedging strategy is
successful, be offset in whole or in part by increases in the value of
securities held by the Fund or decreases in the price of securities the Fund
intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option on
a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be reflected fully in the value of the
option purchased.
Municipal Bond Index futures contracts were approved for trading in 1986.
Trading in such futures contracts may tend to be less liquid than that in other
futures contracts. The trading of futures contracts also is subject to certain
market risks, such as inadequate trading activity, which could at times make it
difficult or impossible to liquidate existing positions.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental restrictions
and policies relating to the investment of its assets and its activities. The
fundamental policies set forth below may not be changed without the approval of
the holders of a majority of the Fund's outstanding voting securities (which
for this purpose and under the 1940 Act means the lesser of (i) 67% of the
Fund's shares present at a meeting at which more than 50% of the outstanding
shares of the Fund are represented or (ii) more than 50% of the Fund's
outstanding shares). The Fund may not:
1. Invest more than 25% of its assets, taken at market value at the time
of each investment, in the securities of issuers in any particular industry
(excluding the U.S. Government and its agencies and instrumentalities). For
purposes of this restriction, states, municipalities and their political
subdivisions are not considered part of any industry.
13
<PAGE>
2. Make investments for the purpose of exercising control or management.
3. Purchase or sell real estate, except that, to the extent permitted by
applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers' acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (ii) the Fund may to the extent permitted
by applicable law, borrow up to an additional 5% of its total assets for
temporary purposes, (iii) the Fund may obtain such short-term credit as may
be necessary for the clearance of purchases and sales of portfolio
securities and (iv) the Fund may purchase securities on margin to the
extent permitted by applicable law. The Fund may not pledge its assets
other than to secure such borrowings or, to the extent permitted by the
Fund's investment policies as set forth in its Prospectus and Statement of
Additional Information, as they may be amended from time to time, in
connection with hedging transactions, short sales, when-issued and forward
commitment transactions and similar investment strategies.
7. Underwrite securities of other issuers, except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act"), in selling portfolio securities.
8. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Make short sales of securities or maintain a short position, except to
the extent permitted by applicable law. The Fund currently does not intend
to engage in short sales, except short sales "against the box".
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall
14
<PAGE>
not apply to securities which mature within seven days or securities which
the Board of Trustees of the Trust has otherwise determined to be liquid
pursuant to applicable law.
d. Invest in warrants if, at the time of acquisition, its investments in
warrants, valued at the lower of cost or market value, would exceed 5% of
the Fund's total assets; included within such limitation, but not to exceed
2% of the Fund's total assets, are warrants which are not listed on the New
York Stock Exchange (the "NYSE") or American Stock Exchange or a major
foreign exchange. For purposes of this restriction, warrants acquired by a
Fund in units or attached to securities may be deemed to be without value.
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, if more
than 5% of the Fund's total assets would be invested in such securities.
This restriction shall not apply to mortgage-backed securities, asset-
backed securities or obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
f. Purchase or retain the securities of any issuer, if those individual
officers and Trustees of the Trust, the officers and general partner of the
Manager, the directors of such general partner or the officers and
directors of any subsidiary thereof each owning beneficially more than one-
half of one percent of the securities of such issuer own in the aggregate
more than 5% of the securities of such issuer.
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time.
i. Notwithstanding fundamental investment restriction (6) above, borrow
amounts in excess of 20% of its total assets, taken at market value
(including the amount borrowed), and then only from banks as a temporary
measure for extraordinary or emergency purposes. In addition, the Fund will
not purchase securities while borrowings are outstanding.
In addition, to comply with Federal income tax requirements for qualification
as a "regulated investment company", the Fund's investments will be limited in
a manner such that, at the close of each quarter of each fiscal year, (a) no
more than 25% of the Fund's total assets are invested in the securities of a
single issuer, and (b) with regard to at least 50% of the Fund's total assets,
no more than 5% of its total assets are invested in the securities of a single
issuer. For purposes of this restriction, the Fund will regard each state and
each political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity as a separate issuer,
except that if the security is backed only by the assets and revenues of a non-
governmental entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal income tax requirements.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Trust, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates
15
<PAGE>
except for brokerage transactions permitted under the 1940 Act involving only
usual and customary commissions or transactions pursuant to an exemptive order
under the 1940 Act. Included among such restricted transactions will be
purchases from or sales to Merrill Lynch of securities in transactions in which
it acts as principal. See "Portfolio Transactions". An exemptive order has been
obtained which permits the Trust to effect principal transactions with Merrill
Lynch in high quality, short-term, tax-exempt securities subject to conditions
set forth in such order.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and the portfolio manager
of the Trust, including their ages and their principal occupations for at least
the last five years, is set forth below. Unless otherwise noted, the address of
each Trustee and executive officer is P.O. Box 9011, Princeton, New Jersey
08543-9011.
Arthur Zeikel (64)--President and Trustee(1)(2)--President of the Manager
(which term as used herein includes the Manager's corporate predecessors) since
1977; President of Merrill Lynch Asset Management, L.P. ("MLAM", which term as
used herein includes MLAM's corporate predecessors) since 1977; President and
Director of Princeton Services, Inc. ("Princeton Services") since 1993;
Executive Vice President of Merrill Lynch & Co., Inc. ("ML & Co.") since 1990;
Director of Merrill Lynch Funds Distributor, Inc. ("MLFD" or the "Distributor")
since 1977.
James H. Bodurtha (52)--Trustee(2)--36 Popponesset Road, Cotuit,
Massachusetts 02635. Director and Executive Vice President, The China Business
Group, Inc. since 1996; Chairman and Chief Executive Officer, China Enterprise
Management Corporation from 1993 to 1996; Chairman, Berkshire Corporation since
1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
Herbert I. London (57)--Trustee(2)--113-115 University Place, New York, New
York 10003. John M. Olin Professor of Humanities, New York University since
1993 and Professor thereof since 1980; Dean, Gallatin Division of New York
University from 1978 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson
Institute from 1984 to 1985; Trustee, Hudson Institute since 1980; Director,
Damon Corporation since 1991; Overseer, Center for Naval Analyses from 1983 to
1993; Limited Partner, Hypertech L.P. since 1996.
Robert R. Martin (69)--Trustee(2)--513 Grand Hill, St. Paul, Minnesota 55102.
Chairman and Chief Executive Officer, Kinnard Investments, Inc. from 1990 to
1993; Executive Vice President, Dain Bosworth from 1974 to 1989; Director,
Carnegie Capital Management from 1977 to 1985 and Chairman thereof in 1979;
Director, Securities Industry Association from 1981 to 1982 and Public
Securities Association from 1979 to 1980; Chairman of the Board, WTC
Industries, Inc. in 1994; Trustee, Northland College since 1992.
Joseph L. May (67)--Trustee(2)--424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to 1983;
Vice President, Wayne-Gossard Corporation from 1972 to 1983; Chairman,
16
<PAGE>
The May Corporation (personal holding company) from 1972 to 1983; Director,
Signal Apparel Co. from 1972 to 1989.
Andre F. Perold (44)--Trustee(2)--Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and
Associate Professor from 1983 to 1989; Trustee, The Common Fund, since 1989;
Director, Quantec Limited since 1991.
Terry K. Glenn (56)--Executive Vice President(1)(2)--Executive Vice
President of the Manager and MLAM since 1983; Executive Vice President and
Director of Princeton Services since 1993; President of MLFD since 1986 and
Director thereof since 1991; President of Princeton Administrators, L.P. since
1988.
Vincent R. Giordano (52)--Vice President(1)(2)--Portfolio Manager of the
Manager and MLAM since 1977 and Senior Vice President of the Manager and MLAM
since 1984; Vice President of MLAM from 1980 to 1984; Senior Vice President of
Princeton Services since 1993.
Kenneth A. Jacob (45)--Vice President(1)(2)--Vice President of the Manager
and MLAM since 1984.
Fred K. Stuebe (46)--Portfolio Manager(1)(2)--Vice President of MLAM since
1989.
Donald C. Burke (36)--Vice President(1)(2)--Vice President and Director of
Taxation of MLAM since 1990; employee of Deloitte & Touche LLP from 1982 to
1990.
Gerald M. Richard (47)--Treasurer(1)(2)--Senior Vice President and Treasurer
of the Manager and MLAM since 1984; Senior Vice President and Treasurer of
Princeton Services since 1993; Treasurer of MLFD since 1984 and Vice President
thereof since 1981.
Jerry Weiss (38)--Secretary(1)(2)--Vice President of MLAM since 1990;
Attorney in private practice from 1982 to 1990.
- --------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director or officer of certain other
investment companies for which the Manager or MLAM acts as investment
adviser or manager.
At September 30, 1996, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 1% of the outstanding shares of
Common Stock of ML & Co. and owned an aggregate of less than 1% of the
outstanding shares of the Fund.
COMPENSATION OF TRUSTEES
The Trust pays each Trustee not affiliated with the Manager (each a "non-
affiliated Trustee") a fee of $10,000 per year plus $1,000 per meeting
attended, together with such Trustee's actual out-of-pocket expenses relating
to attendance at meetings. The Trust also compensates members of its Audit and
Nominating Committee (the "Committee"), which consists of all the non-
affiliated Trustees, a fee of $2,000 per year plus $500 per meeting attended.
The Trust reimburses each non-affiliated Trustee for his out-of-pocket
expenses relating to attendance at Board and Committee meetings. The fees and
expenses of the Trustees are allocated to the respective series of the Trust
on the basis of asset size. For the fiscal year ended July 31, 1996, fees and
expenses paid to non-affiliated Trustees which were allocated to the Fund
aggregated $3,731.
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<PAGE>
The following table sets forth for the fiscal year ended July 31, 1996,
compensation paid by the Fund to the non-affiliated Trustees and for the
calendar year ended December 31, 1995, the aggregate compensation paid by all
registered investment companies (including the Fund) advised by the Manager and
its affiliate, MLAM ("FAM/MLAM Advised Funds") to the non-affiliated Trustees:
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PENSION OR FROM FUND AND
RETIREMENT OTHER
BENEFITS FAM/MLAM
ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF FUND'S PAID TO
NAME OF TRUSTEE FROM FUND EXPENSES TRUSTEE(1)
- --------------- ------------ -------------- -------------
<S> <C> <C> <C>
James H. Bodurtha..................... $712 None $157,500*
Herbert I. London..................... $712 None $157,500
Robert R. Martin...................... $712 None $157,500
Joseph L. May......................... $712 None $157,500
Andre F. Perold....................... $712 None $157,500
</TABLE>
- --------
(1) The Trustees serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Bodurtha (22 registered investment companies consisting of 46 portfolios);
Mr. London (22 registered investment companies consisting of 46
portfolios); Mr. Martin (22 registered investment companies consisting of
46 portfolios); Mr. May (22 registered investment companies consisting of
46 portfolios); and Mr. Perold (22 registered investment companies
consisting of 46 portfolios).
* $157,500 represents the amount Mr. Bodurtha would have received if he had
been a Trustee for the entire calendar year ended December 31, 1995. Mr.
Bodurtha was elected to the Trust's Board of Trustees effective June 23,
1995.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Trust--Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or its
affiliates. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If the Manager or its affiliates purchase or sell
securities for the Fund or other funds for which they act as manager or for
their advisory clients and such sales or purchases arise for consideration at
or about the same time, transactions in such securities will be made, insofar
as feasible, for the respective funds and clients in a manner deemed equitable
to all. To the extent that transactions on behalf of more than one client of
the Manager or its affiliates during the same period may increase the demand
for securities being purchased or the supply of securities being sold, there
may be an adverse effect on price.
Pursuant to a management agreement between the Trust on behalf of the Fund
and the Manager (the "Management Agreement"), the Manager receives for its
services to the Fund monthly compensation based upon the average daily net
assets of the Fund at the following annual rates: 0.55% of the average daily
net assets not exceeding $500 million; 0.525% of the average daily net assets
exceeding $500 million but not exceeding $1.0 billion; and 0.50% of the average
daily net assets exceeding $1.0 billion. For the fiscal years ended July 31,
1994, 1995 and 1996, the total advisory fees payable by the Fund to the Manager
were $465,743, $433,979 and $406,646, respectively. During the fiscal years
ended July 31, 1994 and 1995, the Manager voluntarily waived $199,488 and
$22,680, respectively, of such fees. No fees were waived during the fiscal year
ended July 31, 1996.
18
<PAGE>
The Management Agreement obligates the Manager to provide investment advisory
services and to pay all compensation of and furnish office space for officers
and employees of the Trust connected with investment and economic research,
trading and investment management of the Trust, as well as the fees of all
Trustees of the Trust who are affiliated persons of ML & Co. or any of its
affiliates. The Fund pays all other expenses incurred in its operation and a
portion of the Trust's general administrative expenses allocated on the basis
of the asset size of the respective series of the Trust ("Series"). Expenses
that will be borne directly by the Series include, among other things,
redemption expenses, expenses of portfolio transactions, expenses of
registering the shares under Federal and state securities laws, pricing costs
(including the daily calculation of net asset value), expenses of printing
shareholder reports, prospectuses and statements of additional information
(except to the extent paid by the Distributor as described below), fees for
legal and auditing services, Commission fees, interest, certain taxes, and
other expenses attributable to a particular Series. Expenses which will be
allocated on the basis of asset size of the respective Series include fees and
expenses of unaffiliated Trustees, state franchise taxes, costs of printing
proxies and other expenses related to shareholder meetings, and other expenses
properly payable by the Trust. The organizational expenses of the Trust were
paid by the Trust, and as additional Series are added to the Trust, the
organizational expenses are allocated among the Series (including the Fund) in
a manner deemed equitable by the Trustees. Depending upon the nature of a
lawsuit, litigation costs may be assessed to the specific Series to which the
lawsuit relates or allocated on the basis of the asset size of the respective
Series. The Trustees have determined that this is an appropriate method of
allocation of expenses. Accounting services are provided to the Fund by the
Manager and the Fund reimburses the Manager for its costs in connection with
such services. For the fiscal years ended July 31, 1994, 1995 and 1996, the
Fund reimbursed the Manager $36,930, $49,939 and $38,780, respectively, for
such services. As required by the Fund's distribution agreements, the
Distributor will pay the promotional expenses of the Fund incurred in
connection with the offering of shares of the Fund. Certain expenses in
connection with the account maintenance and the distribution of Class B and
Class C shares will be financed by the Fund pursuant to the Distribution Plans
in compliance with Rule 12b-1 under the 1940 Act. See "Purchase of Shares--
Distribution Plans".
The Manager is a limited partnership, the partners of which are ML & Co. and
Princeton Services. ML & Co. and Princeton Services are "controlling persons"
of the Manager as defined under the 1940 Act because of their ownership of its
voting securities or their power to exercise a controlling influence over its
management or policies.
Duration and Termination. Unless earlier terminated as described herein, the
Management Agreement will remain in effect from year to year if approved
annually (a) by the Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees who are not parties to
such contract or interested persons (as defined in the 1940 Act) of any such
party. Such contracts are not assignable and may be terminated without penalty
on 60 days' written notice at the option of either party thereto or by vote of
the shareholders of the Fund.
19
<PAGE>
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing SM System: shares of Class A and Class D are sold to investors
choosing the initial sales charge alternatives, and shares of Class B and
Class C are sold to investors choosing the deferred sales charge alternatives.
Each Class A, Class B, Class C and Class D share of the Fund represents
identical interests in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of
the ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements.
Class B, Class C and Class D shares each have exclusive voting rights with
respect to the Rule 12b-1 distribution plan adopted with respect to such class
pursuant to which account maintenance and/or distribution fees are paid. Each
class has different exchange privileges. See "Shareholder Services--Exchange
Privilege".
The Merrill Lynch Select Pricing SM System is used by more than 50
registered investment companies advised by MLAM or its affiliate, the Manager.
Funds advised by MLAM or the Manager which utilize the Merrill Lynch Select
PricingSM System are referred to herein as "MLAM-advised mutual funds".
The Fund has entered into four separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the
offering of each class of shares of the Fund. After the prospectuses,
statements of additional information and periodic reports have been prepared,
set in type and mailed to shareholders, the Distributor pays for the printing
and distribution of copies thereof used in connection with the offering to
dealers and prospective investors. The Distributor also pays for other
supplementary sales literature and advertising costs. The Distribution
Agreements are subject to the same renewal requirements and termination
provisions as the Management Agreement described above.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
The gross sales charges for the sale of Class A shares for the fiscal year
ended July 31, 1994 were $39,200, of which the Distributor received $4,115 and
Merrill Lynch received $35,085. The gross sales charges for the sale of Class
A shares for the fiscal year ended July 31, 1995 were $2,027, of which the
Distributor received $189 and Merrill Lynch received $1,838. The gross sales
charges for the sale of Class A shares for the fiscal year ended July 31, 1996
were $580, of which the Distributor received $43 and Merrill Lynch received
$537. The gross sales charges for the sale of Class D shares for the period
October 21, 1994 (commencement of operations) to July 31, 1995 were $7,055, of
which the Distributor received $621 and Merrill Lynch received $6,434. The
gross sales charges for the sale of Class D shares for the fiscal year ended
July 31, 1996 were $2,286, of which the Distributor received $207 and Merrill
Lynch received $2,079. For the fiscal years ended July 31, 1994, 1995 and
1996, the Distributor received no CDSCs with respect to redemption within one
year after purchase of Class A shares purchased subject to a front-end sales
charge waiver. For the period October 21, 1994 (commencement of operations) to
July 31, 1995 and for the fiscal year ended July 31, 1996, the Distributor
received no CDSCs with respect to redemption within one year after purchase of
Class D shares purchased subject to a front-end sales charge waiver.
20
<PAGE>
The term "purchase", as used in the Prospectus and this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his spouse and their children under the
age of 21 years purchasing shares for his or their own account and to single
purchases by a trustee or other fiduciary purchasing shares for a single trust
estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company", as
that term is defined in the 1940 Act, but does not include purchases by any
such company which has not been in existence for at least six months or which
has no purpose other than the purchase of shares of the Fund or shares of
other registered investment companies at a discount; provided, however, that
it shall not include purchases by any group of individuals whose sole
organizational nexus is that the participants therein are credit cardholders
of a company, policyholders of an insurance company, customers of either a
bank or broker-dealer or clients of an investment adviser.
Closed-End Fund Investment Option. Class A shares of the Fund and certain
other MLAM-advised mutual funds ("Eligible Class A shares") are offered at net
asset value to shareholders of certain closed-end funds advised by the Manager
or MLAM who purchased such closed-end fund shares prior to October 21, 1994,
the date the Merrill Lynch Select Pricing SM System commenced operations, and
wish to reinvest the net proceeds of a sale of their closed-end fund shares of
common stock in Eligible Class A shares, if the conditions set forth below are
satisfied. Alternatively, closed-end fund shareholders who purchased such
shares on or after October 21, 1994 and wish to reinvest the net proceeds from
a sale of their closed-end fund shares are offered Class A shares (if eligible
to buy Class A shares) or Class D shares of the Fund and other MLAM-advised
mutual funds ("Eligible Class D shares"), if the following conditions are met.
First, the sale of closed-end fund shares must be made through Merrill Lynch,
and the net proceeds therefrom must be immediately reinvested in Eligible
Class A or Class D shares. Second, the closed-end fund shares must either have
been acquired in the initial public offering or be shares representing
dividends from shares of common stock acquired in such offering. Third, the
closed-end fund shares must have been continuously maintained in a Merrill
Lynch securities account. Fourth, there must be a minimum purchase of $250 to
be eligible for the investment option.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund,
Inc. will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond
Fund, Inc. will receive Class D shares of the Fund, except that shareholders
already owning Class A shares of the Fund will be eligible to purchase
additional Class A shares pursuant to this option, if such additional Class A
shares will be held in the same account as the existing Class A shares and the
other requirements pertaining to the reinvestment privilege are met. In order
to exercise this investment option, a shareholder of one of the above-
referenced continuously offered closed-end funds (an "eligible fund") must
sell his or her shares of common stock of the eligible fund (the "eligible
shares") back to the eligible fund in connection with a tender offer conducted
by the eligible fund and reinvest the proceeds immediately in the designated
class of shares of the Fund. This investment option is available only with
respect to eligible shares as to which no Early Withdrawal Charge or CDSC
(each as defined in the eligible fund's prospectus) is applicable. Purchase
orders from eligible fund shareholders wishing to exercise this investment
option will be accepted only on the day that the related tender offer
terminates and will be effected at the net asset value of the designated class
of the Fund on such day.
21
<PAGE>
REDUCED INITIAL SALES CHARGES
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value
or cost, whichever is higher, of the purchaser's combined holdings of all
classes of shares of the Fund and of other MLAM-advised mutual funds. For any
such right of accumulation to be made available, the Distributor must be
provided at the time of purchase, by the purchaser or the purchaser's
securities dealer, with sufficient information to permit confirmation of
qualification. Acceptance of the purchase order is subject to such
confirmation. The right of accumulation may be amended or terminated at any
time. Shares held in the name of a nominee or custodian under pension, profit-
sharing, or other employee benefit plans may not be combined with other shares
to qualify for the right of accumulation.
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or
any MLAM-advised mutual funds made within a 13-month period starting with the
first purchase pursuant to a Letter of Intention in the form provided in the
Prospectus. The Letter of Intention is available only to investors whose
accounts are maintained at the Fund's Transfer Agent. The Letter of Intention
is not available to employee benefit plans for which Merrill Lynch provides
plan participant, record keeping services. The Letter of Intention is not a
binding obligation to purchase any amount of Class A or Class D shares;
however, its execution will result in the purchaser paying a lower sales
charge at the appropriate quantity purchase level. A purchase not originally
made pursuant to a Letter of Intention may be included under a subsequent
Letter of Intention executed within 90 days of such purchase if the
Distributor is informed in writing of this intent within such 90-day period.
The value of Class A or Class D shares of the Fund and of other MLAM-advised
mutual funds presently held, at cost or maximum offering price (whichever is
higher), on the date of the first purchase under the Letter of Intention, may
be included as a credit toward the completion of such Letter, but the reduced
sales charge applicable to the amount covered by such Letter will be applied
only to new purchases. If the total amount of shares does not equal the amount
stated in the Letter of Intention (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the expiration of such Letter, the
difference between the sales charge on the Class A or Class D shares purchased
at the reduced rate and the sales charge applicable to the shares actually
purchased through the Letter. Class A or Class D shares equal to at least five
percent of the intended amount will be held in escrow during the 13-month
period (while remaining registered in the name of the purchaser) for this
purpose. The first purchase under the Letter of Intention must be at least
five percent of the dollar amount of such Letter. If a purchase during the
term of such Letter would otherwise be subject to a further reduced sales
charge based on the right of accumulation, the purchaser will be entitled on
that purchase and subsequent purchases to that further reduced percentage
sales charge, but there will be no retroactive reduction of the sales charges
on any previous purchase. The value of any shares redeemed or otherwise
disposed of by the purchaser prior to termination or completion of the Letter
of Intention will be deducted from the total purchases made under such Letter.
An exchange from a MLAM-advised money market fund into the Fund that creates a
sales charge will count toward completing a new or existing Letter of
Intention from the Fund.
Employee Access Accounts SM. Class A or Class D shares are offered at net
asset value to Employee Access Accounts available through qualified employers
that provide employer-sponsored retirement or
22
<PAGE>
savings plans that are eligible to purchase such shares at net asset value.
The initial minimum for such accounts is $500, except that the initial minimum
for shares purchased for such accounts pursuant to the Automatic Investment
Program is $50.
TMA SM Managed Trusts. Class A shares are offered to TMA SM Managed Trusts
to which Merrill Lynch Trust Company provides discretionary trustee services
at net asset value.
Purchase Privilege of Certain Persons. Trustees of the Trust, members of the
Boards of other MLAM-advised investment companies, ML & Co. and its
subsidiaries (the term "subsidiaries", when used herein with respect to ML &
Co., includes MLAM, the Manager and certain other entities directly or
indirectly wholly-owned and controlled by ML & Co.), and their directors and
employees, and any trust, pension, profit-sharing or other benefit plan for
such persons, may purchase Class A shares of the Fund at net asset value.
Class D shares of the Fund are offered at net asset value, without sales
charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that
it will purchase Class D shares of the Fund with proceeds from a redemption of
a mutual fund that was sponsored by the financial consultant's previous firm
and was subject to a sales charge either at the time of purchase or on a
deferred basis; and second, the investor also must establish that such
redemption had been made within 60 days prior to the investment in the Fund,
and the proceeds from the redemption had been maintained in the interim in
cash or a money market fund.
Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund sponsored by
a non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares
of such other fund were subject to a sales charge either at the time of
purchase or on a deferred basis; and second, such purchase of Class D shares
must be made within 90 days after such notice.
Class D shares of the Fund are offered at net asset value, without sales
charge, to an investor who has a business relationship with a Merrill Lynch
financial consultant and who has invested in a mutual fund for which Merrill
Lynch has not served as a selected dealer if the following conditions are
satisfied: first, the investor must advise Merrill Lynch that it will purchase
Class D shares of the Fund with proceeds from the redemption of shares of such
other mutual fund and that such shares have been outstanding for a period of
no less than six months; and second, such purchase of Class D shares must be
made within 60 days after the redemption and the proceeds from the redemption
must be maintained in the interim in cash or a money market fund.
Acquisition of Certain Investment Companies. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation
with a personal holding company or a public or private investment company. The
value of the assets or company acquired in a tax-free transaction may be
adjusted in appropriate cases to reduce possible adverse tax consequences to
the Fund which might result from an acquisition of assets having net
23
<PAGE>
unrealized appreciation which is disproportionately higher at the time of
acquisition than the realized or unrealized appreciation of the Fund. The
issuance of Class D shares for consideration other than cash is limited to bona
fide reorganizations, statutory mergers or other acquisitions of portfolio
securities which (i) meet the investment objectives and policies of the Fund,
(ii) are acquired for investment and not for resale (subject to the
understanding that the disposition of the Fund's portfolio securities shall at
all times remain within its control); and (iii) are liquid securities, the
value of which is readily ascertainable, which are not restricted as to
transfer either by law or liquidity of market (except that the Fund may acquire
through such transactions restricted or illiquid securities to the extent the
Fund does not exceed applicable limits on acquisition of such securities set
forth under "Investment Objective and Policies" herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be
needed in obtaining such investments.
DISTRIBUTION PLANS
Reference is made to "Purchase of Shares--Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
1940 Act (each a "Distribution Plan") with respect to the account maintenance
and/or distribution fees paid by the Fund to the Distributor with respect to
such classes.
Payments of the account maintenance and/or distribution fees are subject to
the provisions of Rule 12b-1 under the 1940 Act. Among other things, each
Distribution Plan provides that the Distributor shall provide and the Trustees
shall review quarterly reports of the disbursement of the account maintenance
and/or distribution fees paid to the Distributor. In their consideration of
each Distribution Plan, the Trustees must consider all factors they deem
relevant, including information as to the benefits of the Distribution Plan to
the Fund and its related class of shareholders. Each Distribution Plan further
provides that, so long as the Distribution Plan remains in effect, the
selection and nomination of Trustees who are not "interested persons" of the
Trust, as defined in the 1940 Act (the "Independent Trustees"), shall be
committed to the discretion of the Independent Trustees then in office. In
approving each Distribution Plan in accordance with Rule 12b-1, the Independent
Trustees concluded that there is reasonable likelihood that such Distribution
Plan will benefit the Fund and its related class of shareholders. Each
Distribution Plan can be terminated at any time, without penalty, by the vote
of a majority of the Independent Trustees or by the vote of the holders of a
majority of the outstanding related class of voting securities of the Fund. A
Distribution Plan cannot be amended to increase materially the amount to be
spent by the Fund without the approval of the related class of shareholders and
all material amendments are required to be approved by the vote of Trustees,
including a majority of the Independent Trustees who have no direct or indirect
financial interest in such Distribution Plan, cast in person at a meeting
called for that purpose. Rule 12b-1 further requires that the Trust preserve
copies of such Distribution Plan and any report made pursuant to such plan for
a period of not less than six years from the date of such Distribution Plan or
such report, the first two years in an easily accessible place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the National
Association of Securities Dealers, Inc. ("NASD") imposes a limitation on
certain asset-based sales charges such as the distribution fee and the
contingent deferred sales charge ("CDSC") borne by the Class B and Class C
shares but not the account
24
<PAGE>
maintenance fee. The maximum sales charge rule is applied separately to each
class. As applicable to the Fund, the maximum sales charge rule limits the
aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs will be paid to the Fund rather than to the Distributor; however,
the Fund will continue to make payments of the account maintenance fee. In
certain circumstances the amount payable pursuant to the voluntary maximum may
exceed the amount payable under the NASD formula. In such circumstances payment
in excess of the amount payable under the NASD formula will not be made.
25
<PAGE>
The following table sets forth comparative information as of July 31, 1996
with respect to the Class B and Class C shares of the Fund indicating the
maximum allowable payments that can be made under the NASD maximum sales
charge rule and, with respect to the Class B shares, the Distributor's
voluntary maximum.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF JULY 31, 1996
------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
ALLOWABLE ALLOWABLE AMOUNTS DISTRIBUTION
ELIGIBLE AGGREGATE INTEREST ON MAXIMUM PREVIOUSLY AGGREGATE FEE AT CURRENT
GROSS SALES UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
-------- --------- ----------- ------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B SHARES, FOR THE
PERIOD FEBRUARY 28,
1992 (COMMENCEMENT OF
OPERATIONS) TO JULY 31,
1996:
Under NASD Rule As
Adopted................ $93,527 $5,845 $1,638 $7,483 $1,551 $5,932 $150
Under Distributor's Vol-
untary Waiver.......... $93,527 $5,845 $ 468 $6,313 $1,551 $4,762 $150
CLASS C SHARES, FOR THE
PERIOD OCTOBER 21, 1994
(COMMENCEMENT OF
OPERATIONS) TO JULY 31,
1996:
Under NASD Rule As
Adopted................ $ 1,216 $ 76 $ 7 $ 83 $ 5 $ 78 $ 4
</TABLE>
- --------
(1) Purchase price of all eligible Class B or Class C shares sold during the
periods indicated other than shares acquired through dividend reinvestment
and the exchange privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1%, as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals.
(4) Provided to illustrate the extent to which the current level of
distribution fee payments (not including any CDSC payments) is amortizing
the unpaid balance. No assurance can be given that payments of the
distribution fee will reach either the voluntary maximum or the NASD
maximum.
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended only for any period during which trading on the
NYSE is restricted as determined by the Commission or the NYSE is closed
(other than customary weekend and holiday closings), for any period during
which an emergency exists, as defined by the Commission, as a result of which
disposal of portfolio securities or determination of the net asset value of
the Fund is not reasonably practicable, and for such other periods as the
Commission may by order permit for the protection of shareholders of the Fund.
DEFERRED SALES CHARGES--CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares", while Class B shares
redeemed within four years of purchase are subject to a CDSC under most
circumstances, the charge is waived on redemptions of Class B shares following
the death or
26
<PAGE>
disability of a Class B shareholder. Redemptions for which the waiver applies
are any partial or complete redemption following the death or disability (as
defined in the Internal Revenue Code of 1986 as amended (the "Code")) of a
Class B shareholder (including one who owns the Class B shares as joint tenant
with his or her spouse), provided the redemption is requested within one year
of the death or initial determination of disability. For the fiscal years ended
July 31, 1994, 1995 and 1996, the Distributor received CDSCs of $258,962,
$294,149 and $166,231, respectively, with respect to redemptions of Class B
shares, all of which were paid to Merrill Lynch. For the fiscal period October
21, 1994 (commencement of operations) to July 31, 1995 and for the fiscal year
ended July 31, 1996, the Distributor received CDSCs of $73 and $2,058,
respectively, with respect to redemptions of Class C shares, all of which were
paid to Merrill Lynch.
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies" and "Portfolio
Transactions" in the Prospectus.
Under the 1940 Act, persons affiliated with the Trust are prohibited from
dealing with the Fund as a principal in the purchase and sale of securities
unless such trading is permitted by an exemptive order issued by the
Commission. Since over-the-counter transactions are usually principal
transactions, affiliated persons of the Trust, including Merrill Lynch, may not
serve as dealer in connection with transactions with the Fund. The Trust has
obtained an exemptive order permitting it to engage in certain principal
transactions with Merrill Lynch involving high quality short-term municipal
bonds subject to certain conditions. For the year ended July 31, 1994, the Fund
engaged in ten transactions pursuant to such order for an aggregate market
value of $9,309,470. For the year ended July 31, 1995, the Fund engaged in 19
transactions pursuant to such order for an aggregate market value of
$17,100,000. For the year ended July 31, 1996, the Fund engaged in five
transactions pursuant to such order for an aggregate market value of
$2,800,000. The Trust has applied for an exemptive order permitting it to,
among other things, (i) purchase high quality tax-exempt securities from
Merrill Lynch when Merrill Lynch is a member of an underwriting syndicate and
(ii) purchase tax-exempt securities from and sell tax-exempt securities to
Merrill Lynch in secondary market transactions. Affiliated persons of the Trust
may serve as broker for the Fund in over-the-counter transactions conducted on
an agency basis. Certain court decisions have raised questions as to the extent
to which investment companies should seek exemptions under the 1940 Act in
order to seek to recapture underwriting and dealer spreads from affiliated
entities. The Trustees have considered all factors deemed relevant, and have
made a determination not to seek such recapture at this time. The Trustees will
reconsider this matter from time to time.
As a non-fundamental restriction, the Trust will prohibit the purchase or
retention by the Fund of the securities of any issuer if the officers and
Trustees of the Trust, the officers and general partner of the Manager, the
directors of such general partner or the officers and directors of any
subsidiary thereof each owning beneficially more than one-half of one per cent
of the securities of such issuer own in the aggregate more than five percent of
the securities of such issuer. In addition, under the 1940 Act, the Fund may
not purchase securities from any underwriting syndicate of which Merrill Lynch
is a member except pursuant to an exemptive order or rules adopted by the
Commission. Rule 10f-3 under the 1940 Act sets forth conditions under which the
Fund may purchase municipal bonds in such transactions. The rule sets forth
requirements relating to, among other things, the terms of an issue of
municipal bonds purchased by the Fund, the amount
27
<PAGE>
of municipal bonds which may be purchased in any one issue and the assets of
the Fund which may be invested in a particular issue.
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who
provide supplemental investment research (such as information concerning tax-
exempt securities, economic data and market forecasts) to the Manager may
receive orders for transactions by the Fund. Information so received will be in
addition to and not in lieu of the services required to be performed by the
Manager under its Management Agreement and the expenses of the Manager will not
necessarily be reduced as a result of the receipt of such supplemental
information.
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the Conduct Rules of the NASD and policies established by the Trustees of the
Trust, the Manager may consider sales of shares of the Fund as a factor in the
selection of brokers or dealers to execute portfolio transactions for the Fund.
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Manager. While it is not possible to predict turnover rates
with any certainty, at present it is anticipated that the Fund's annual
portfolio turnover rate, under normal circumstances after the Fund's portfolio
is invested in accordance with its investment objective, will be less than
100%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by
the monthly average of the value of the portfolio securities owned by the Fund
during the particular fiscal year. For purposes of determining this rate, all
securities whose maturities at the time of acquisition are one year or less are
excluded.) The portfolio turnover for the years ended July 31, 1995 and 1996
was 89.62% and 56.05%, respectively.
Section 11(a) of the Securities and Exchange Act of 1934, as amended,
generally prohibits members of the U.S. national securities exchanges from
executing exchange transactions for their affiliates and institutional accounts
which they manage unless the member (i) has obtained prior express
authorization from the account to effect such transactions, (ii) at least
annually furnishes the account with a statement setting forth the aggregate
compensation received by the member in effecting such transactions, and (iii)
complies with any rules the Commission has prescribed with respect to the
requirements of clauses (i) and (ii). To the extent Section 11(a) would apply
to Merrill Lynch acting as a broker for the Fund in any of its portfolio
transactions executed on any such securities exchange of which it is a member,
appropriate consents have been obtained from the Fund and annual statements as
to aggregate compensation will be provided to the Fund.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined by
the Manager once daily, Monday through Friday, as of 15 minutes after the close
of business on the NYSE (generally, 4:00 P.M., New York time) on each day
during which the NYSE is open for trading. The NYSE is not open on New Year's
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Net asset value per share is computed by
dividing the sum of the value of the securities held by the Fund plus any cash
or other assets minus all liabilities by the total number of shares outstanding
at such time, rounded to the nearest cent. Expenses, including the fees payable
to the Manager and Distributor, are accrued daily. The per share net asset
value of Class B, Class C and Class D shares
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generally will be lower than the per share net asset value of Class A shares,
reflecting the daily expense accruals of the account maintenance, distribution
fees, and higher transfer agency fees applicable with respect to the Class B
and Class C shares and the daily expense accruals of the account maintenance
fees with respect to Class D shares; moreover, the per share net asset value of
Class B and Class C shares generally will be lower than the per share net asset
value of Class D shares, reflecting the daily expense accruals of the
distribution fees, higher account maintenance fees and higher transfer agency
fees applicable with respect to Class B and Class C shares of the Fund. It is
expected, however, that the per share net asset value of the four classes will
tend to converge (although not necessarily meet) immediately after the payment
of dividends, which will differ by approximately the amount of the expense
accrual differentials between the classes.
The Municipal Bonds and other portfolio securities in which the Fund invests
are traded primarily in over-the-counter municipal bond and money markets and
are valued at the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers that make
markets in the securities. One bond is the "yield equivalent" of another bond
when, taking into account market price, maturity, coupon rate, credit rating
and ultimate return of principal, both bonds will theoretically produce an
equivalent return to the bondholder. Financial futures contracts and options
thereon, which are traded on exchanges, are valued at their settlement prices
as of the close of such exchanges. Short-term investments with a remaining
maturity of 60 days or less are valued on an amortized cost basis, which
approximates market value. Securities and assets for which market quotations
are not readily available are valued at fair value as determined in good faith
by or under the direction of the Trustees of the Trust, including valuations
furnished by a pricing service retained by the Trust, which may utilize a
matrix system for valuations. The procedures of the pricing service and its
valuations are reviewed by the officers of the Trust under the general
supervision of the Trustees.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services described below which are
designed to facilitate investment in shares of the Fund. Full details as to
each of such services and copies of the various plans described below can be
obtained from the Trust, the Distributor or Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
Investment Account and will receive statements, at least quarterly, from the
Transfer Agent. These statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends and long-term capital gains distributions. These statements will also
show any other activity in the account since the previous statement.
Shareholders also will receive separate confirmations for each purchase or sale
transaction other than automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gains distributions. A
shareholder may make additions to his or her Investment Account at any time by
mailing a check directly to the Transfer Agent.
Share certificates are issued only for full shares and only upon the specific
request of the shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be
aware that, if the firm to which the Class A or Class D
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shares are to be transferred will not take delivery of shares of the Fund, a
shareholder either must redeem the Class A or Class D shares (paying any
applicable CDSC) so that the cash proceeds can be transferred to the account at
the new firm or such shareholder must continue to maintain an Investment
Account at the Transfer Agent for those Class A or Class D shares. Shareholders
interested in transferring their Class B or Class C shares from Merrill Lynch
and who do not wish to have an Investment Account maintained for such shares at
the Transfer Agent may request their new brokerage firm to maintain such shares
in an account registered in the name of the brokerage firm for the benefit of
the shareholder at the Transfer Agent. If the new brokerage firm is willing to
accommodate the shareholder in this manner, the shareholder must request that
he or she be issued certificates for his or her shares, and then must turn the
certificates over to the new firm for re-registration as described in the
preceding sentence.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if he or she is an eligible Class A investor as
described in the Prospectus) or Class B, Class C or Class D shares at the
applicable public offering price either through the shareholder's securities
dealer, or by mail directly to the Transfer Agent, acting as agent for such
securities dealers. Voluntary accumulation also can be made through a service
known as the Fund's Automatic Investment Plan whereby the Fund is authorized
through pre-authorized checks or automatic clearing house debits of $50 or more
to charge the regular bank account of the shareholder on a regular basis to
provide systematic additions to the Investment Account of such shareholder.
Alternatively, investors who maintain CMA (R) or CBA (R) accounts may arrange
to have periodic investments made in the Fund in their CMA (R) or CBA (R)
account or in certain related accounts in amounts of $100 or more through the
CMA(R) or CBA(R) Automated Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
automatically reinvested in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund as of the close of
business on the monthly payment date for such dividends and distributions.
Shareholders may elect in writing to receive either their income dividends or
capital gains distributions, or both, in cash, in which event payment will be
mailed on or about the payment date.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or capital gains distributions reinvested in shares of the Fund or vice
versa and, commencing ten days after the receipt by the Transfer Agent of such
notice, such instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS--CLASS A AND CLASS D SHARES
A Class A and Class D shareholder may elect to make systematic withdrawals
from an Investment Account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
Class A or Class D shares of the Fund having a value, based on cost or the
current offering price, of $5,000 or more, and monthly withdrawals are
available for shareholders with Class A or Class D shares with such a value of
$10,000 or more.
At the time of each withdrawal payment, sufficient Class A or Class D shares
are redeemed from those on deposit in the shareholder's account to provide the
withdrawal payment specified by the shareholder. The
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shareholder may specify either a dollar amount or a percentage of the value of
his Class A or Class D shares. Redemptions will be made at net asset value as
determined 15 minutes after the close of business on the NYSE (generally, 4:00
P.M., New York time) on the 24th day of each month or the 24th day of the last
month of each quarter, whichever is applicable. If the NYSE is not open for
business on such date, the Class A or Class D shares will be redeemed at the
close of business on the following business day. The check for the withdrawal
payment will be mailed, or the direct deposit for the withdrawal payment will
be made, on the next business day following redemption. When a shareholder is
making systematic withdrawals, dividends and distributions on all Class A or
Class D shares in the Investment Account are reinvested automatically in the
Fund's Class A or Class D shares, respectively. A shareholder's Systematic
Withdrawal Plan may be terminated at any time, without charge or penalty, by
the shareholder, the Trust, the Transfer Agent or the Distributor. Withdrawal
payments should not be considered as dividends, yield or income. Each
withdrawal is a taxable event. If periodic withdrawals continuously exceed
reinvested dividends, the shareholder's original investment may be reduced
correspondingly. Purchases of additional Class A or Class D shares concurrent
with withdrawals are ordinarily disadvantageous to the shareholder because of
sales charges and tax liabilities. The Trust will not knowingly accept
purchase orders for Class A or Class D shares of the Fund from investors who
maintain a Systematic Withdrawal Plan unless such purchase is equal to at
least one year's scheduled withdrawals or $1,200, whichever is greater.
Periodic investments may not be made into an Investment Account in which the
shareholder has elected to make systematic withdrawals.
Alternatively, a Class A or Class D shareholder whose shares are held within
a CMA (R) or CBA (R) Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA (R) or
CBA (R) Systematic Redemption Program. The minimum fixed dollar amount
redeemable is $25. The proceeds of systematic redemptions will be posted to
the shareholder's account three business days after the date the shares are
redeemed. Monthly systematic redemptions will be made at net asset value on
the first Monday of each month, bimonthly systematic redemptions will be made
at net asset value on the first Monday of every other month, and quarterly,
semiannual or annual redemptions are made at net asset value on the first
Monday of months selected at the shareholder's option. If the first Monday of
the month is a holiday, the redemption will be processed at net asset value on
the next business day. The Systematic Redemption Program is not available if
Fund shares are being purchased within the account pursuant to the Automatic
Investment Program. For more information on the CMA (R) or CBA (R) Systematic
Redemption Program, eligible shareholders should contact their Financial
Consultant.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds. Under the Merrill Lynch Select
Pricing SM System, Class A shareholders may exchange Class A shares of the
Fund for Class A shares of a second MLAM-advised mutual fund if the
shareholder holds any Class A shares of the second fund in his account in
which the exchange is made at the time of the exchange or is otherwise
eligible to purchase Class A shares of the second fund. If the Class A
shareholder wants to exchange Class A shares for shares of a second MLAM-
advised mutual fund, and the shareholder does not hold Class A shares of the
second fund in his account at the time of the exchange and is not otherwise
eligible to acquire Class A shares of the second fund, the shareholder will
receive Class D shares of the second fund as a result of the exchange. Class D
shares also may be exchanged for Class A shares of a second MLAM-advised
mutual fund at any time as long as, at the time of the exchange, the
shareholder holds Class
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A shares of the second fund in the account in which the exchange is made or is
otherwise eligible to purchase Class A shares of the second fund. Class B,
Class C and Class D shares are exchangeable with shares of the same class of
other MLAM-advised mutual funds. For purposes of computing the CDSC that may be
payable upon a disposition of the shares acquired in the exchange, the holding
period for the previously owned shares of the Fund is "tacked" to the holding
period for the newly acquired shares of the other fund as more fully described
below. Class A, Class B, Class C and Class D shares are also exchangeable for
shares of certain MLAM-advised money market funds as follows: Class A shares
may be exchanged for shares of Merrill Lynch Ready Assets Trust, Merrill Lynch
Retirement Reserves Money Fund (available only for exchanges within certain
retirement plans), Merrill Lynch U.S.A. Government Reserves and Merrill Lynch
U.S. Treasury Money Fund; Class B, Class C and Class D shares may be exchanged
for shares of Merrill Lynch Government Fund, Merrill Lynch Institutional Fund,
Merrill Lynch Institutional Tax-Exempt Fund and Merrill Lynch Treasury Fund.
Shares with a net asset value of at least $100 are required to qualify for the
exchange privilege, and any shares utilized in an exchange must have been held
by the shareholder for 15 days. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of another MLAM-advised mutual
fund ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount
equal to the difference, if any, between the sales charge previously paid on
the outstanding Class A or Class D shares and the sales charge payable at the
time of the exchange on the new Class A or Class D shares. With respect to
outstanding Class A or Class D shares as to which previous exchanges have taken
place, the "sales charge previously paid" shall include the aggregate of the
sales charges paid with respect to such Class A or Class D shares in the
initial purchase and any subsequent exchange. Class A or Class D shares issued
pursuant to dividend reinvestment are sold on a no-load basis in each of the
funds offering Class A or Class D shares. For purposes of the exchange
privilege, Class A or Class D shares acquired through dividend reinvestment
shall be deemed to have been sold with a sales charge equal to the sales charge
previously paid on the Class A or Class D shares on which the dividend was
paid. Based on this formula, Class A or Class D shares of the Fund generally
may be exchanged into the Class A or Class D shares of the other funds or into
shares of certain money market funds without a sales charge.
In addition, each of the funds with Class B or Class C shares outstanding
("outstanding Class B or Class C shares") offers to exchange its Class B or
Class C shares for Class B or Class C shares, respectively, of another MLAM-
advised mutual fund ("new Class B or Class C shares") on the basis of relative
net asset value per Class B or Class C share, without the payment of any CDSC
that might otherwise be due on redemption of the outstanding shares. Class B
shareholders of the Fund exercising the exchange privilege will continue to be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the new Class B shares acquired through use of the
exchange privilege. In addition, Class B shares of the Fund acquired through
use of the exchange privilege will be subject to the Fund's CDSC schedule if
such schedule is higher than the CDSC schedule relating to the Class B shares
of the fund from which the exchange has been made. For purposes of computing
the sales charge that may be payable on a disposition of the new Class B or
Class C shares, the holding period for the outstanding Class B or Class C
shares is "tacked" to the holding period of the new Class B or Class C shares.
For example, an investor may exchange Class B shares of the Fund for those of
Merrill Lynch Special Value Fund, Inc. ("Special Value Fund") after having held
the Fund's Class B shares for two and a half years. The 2% CDSC that generally
would apply to
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a redemption would not apply to the exchange. Three years later the investor
may decide to redeem the Class B shares of the Special Value Fund and receive
cash. There will be no CDSC due on this redemption, since by "tacking" the two
and a half year holding period of the Fund's Class B shares to the three year
holding period for the Special Value Fund Class B shares, the investor will be
deemed to have held the new Class B shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of certain
money market funds advised by the Manager or its affiliates, but the period of
time that Class B or Class C shares are held in a money market fund will not
count towards satisfaction of the holding period requirement for purposes of
reducing the CDSC or, with respect to the Class B shares, towards satisfaction
of the conversion period. However, shares of a money market fund which were
acquired as a result of an exchange for Class B or Class C shares of the Fund
may, in turn, be exchanged back into Class B or Class C shares, respectively,
of any fund offering such shares, in which event the holding period for Class B
or Class C shares of the newly-acquired fund will be aggregated with previous
holding periods for purposes of reducing the CDSC. Thus, for example, an
investor may exchange Class B shares of the Fund for shares of Merrill Lynch
Institutional Fund ("Institutional Fund") after having held the Fund Class B
shares for two and a half years and three years later decide to redeem the
shares of the Institutional Fund for cash. At the time of this redemption, the
2% CDSC that would have been due had the Class B shares of the Fund been
redeemed for cash rather than exchanged for shares of the Institutional Fund
will be payable. If, instead of such redemption the shareholder exchanged such
shares for Class B shares of a fund which the shareholder continued to hold for
an additional two and a half years, any subsequent redemption would not incur a
CDSC.
Before effecting an exchange, shareholders of the Fund should obtain a
currently effective prospectus of the fund into which the exchange is to be
made.
To exercise the exchange privilege, a shareholder should contact his or her
Merrill Lynch Financial Consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of the other funds described above
with shares for which certificates have not been issued, may exercise the
exchange privilege by wire through their securities dealers. The Fund reserves
the right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated at any time in accordance with the
rules of the Commission. The Fund reserves the right to limit the number of
times an investor may exercise the exchange privilege. Certain funds may
suspend the continuous offering of their shares at any time and thereafter may
resume such offering from time to time. The exchange privilege is available
only to U.S. shareholders in states where the exchange legally may be made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, the Fund
(but not its shareholders) will not be subject to Federal income tax to the
extent that it distributes its net investment income and net realized capital
gains. The Trust intends to cause the Fund to distribute substantially all of
such income. So long as the Fund qualifies as a regulated investment company
under the Code, it will not be subject to any Massachusetts income tax.
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As discussed in the Fund's Prospectus, the Trust has established other series
in addition to the Fund (together with the Fund, the "Series"). Each Series of
the Trust is treated as a separate corporation for Federal income tax purposes.
Each Series, therefore, is considered to be a separate entity in determining
its treatment under the rules for RICs described in the Prospectus. Losses in
one Series do not offset gains in another Series, and the requirements (other
than certain organizational requirements) for qualifying for RIC status are
determined at the Series level rather than at the Trust level.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. The required distributions, however, are based
only on the taxable income of a RIC. The excise tax, therefore, generally will
not apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends.
The Trust intends to qualify the Fund to pay "exempt-interest dividends" as
defined in Section 852(b)(5) of the Code. Under such section if, at the close
of each quarter of the Fund's taxable year, at least 50% of the value of its
total assets consists of obligations exempt from Federal income tax ("tax-
exempt obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be qualified
to pay exempt-interest dividends to its Class A, Class B, Class C and Class D
shareholders (together, the "shareholders"). Exempt-interest dividends are
dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Trust as exempt-
interest dividends in a written notice mailed to the Fund's shareholders within
60 days after the close of the Fund's taxable year. For this purpose, the Fund
will allocate interest from tax-exempt obligations (as well as ordinary income,
capital gains and tax preference items, discussed below) among the Class A,
Class B, Class C and Class D shareholders according to a method (which it
believes is consistent with the Commission rule permitting the issuance and
sale of multiple classes of shares) that is based on the gross income allocable
to Class A, Class B, Class C and Class D shareholders during the taxable year
or such other method as the Internal Revenue Service may prescribe. To the
extent that the dividends distributed to the Fund's shareholders are derived
from interest income exempt from Federal income tax under Code Section 103(a)
and are properly designated as exempt-interest dividends, they will be
excludable from a shareholder's gross income for Federal income tax purposes.
Exempt-interest dividends are included, however, in determining the portion, if
any, of a person's social security and railroad retirement benefits subject to
Federal income taxes. Interest on indebtedness incurred or continued to
purchase or carry shares of a RIC paying exempt-interest dividends, such as the
Fund, will not be deductible by the investor for Federal income tax or
Massachusetts corporate excise tax purposes, to the extent attributable to
exempt-interest dividends. Shareholders are advised to consult their tax
advisers with respect to whether exempt-interest dividends retain the exclusion
under Code Section 103(a) if a shareholder would be treated as a "substantial
user" or "related person" under Code Section 147(a) with respect to property
financed with the proceeds of an issue of "industrial development bonds" or
"private activity bonds", if any, held by the Fund.
The portion of the Fund's exempt-interest dividends directly attributable to
interest received by the Fund from Massachusetts Municipal Bonds and properly
identified in a year-end statement ("Massachusetts exempt-interest dividends")
also will be exempt from Massachusetts personal income taxes. Interest on
indebtedness incurred or continued to purchase or carry shares of the Fund will
not be deductible for
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Massachusetts personal income tax purposes to the extent attributable to
Massachusetts exempt-interest dividends. Corporate shareholders and
shareholders subject to income taxation by states other than Massachusetts will
realize a lower after tax rate of return than Massachusetts shareholders since
the dividends distributed by the Fund generally will not be exempt, to any
significant degree, from income taxation by such other states. The Trust will
inform shareholders annually regarding the portion of the Fund's distributions
which constitutes exempt-interest dividends and the portion which constitutes
Massachusetts exempt-interest dividends. The Fund will allocate exempt-interest
dividends among Class A, Class B, Class C and Class D shareholders for
Massachusetts income tax purposes based on a method similar to that described
above for Federal income tax purposes.
Distributions from investment income and capital gains of the Fund, including
exempt-interest dividends, will be subject to the Massachusetts corporate
excise tax and may also be subject to state taxes in states other than
Massachusetts and local taxes in cities other than those in Massachusetts. The
value of Fund shares owned by a corporation also may be subject to the property
component of the Massachusetts corporate excise tax, and to taxes in other
states that tax intangible property. Accordingly, investors in the Fund,
including, in particular, corporate investors which may be subject to the
Massachusetts corporate excise tax, should consult their tax advisers with
respect to the application of such taxes to an investment in the Fund and to
the receipt of Fund dividends and with respect to their Massachusetts tax
situation in general.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered taxable ordinary income for Federal income tax purposes and taxable
dividend income for Massachusetts tax purposes. Distributions, if any, from an
excess of net long-term capital gains over net short-term capital losses
derived from the sale of securities or from certain transactions in futures or
options ("capital gain dividends") are taxable as long-term capital gains for
Federal income tax purposes, regardless of the length of time the shareholder
has owned Fund shares, and for Massachusetts income tax purposes will be taxed
as capital gain income, unless they are attributable to the sale of certain
Massachusetts Municipal Bonds issued pursuant to legislation that specifically
exempts capital gains on their sale from Massachusetts personal income
taxation. Distributions by the Fund, whether from exempt-interest income,
ordinary income or capital gains, will not be eligible for the dividends
received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of tax-exempt
obligations purchased at a market discount will be treated as ordinary income
rather than capital gain. This rule may increase the amount of ordinary income
dividends received by shareholders. Distributions in excess of the Fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains to such holder (assuming the shares are held as a capital asset).
Any loss upon the sale or exchange of Fund shares held for six months or less
will be disallowed to the extent of any exempt-interest dividends received by
the shareholder. In addition, any such loss that is not disallowed under the
rule stated above will be treated as long-term capital loss to the extent of
any capital gain dividends received by the shareholder. If the Fund pays a
dividend in January which was declared in the previous October, November or
December to shareholders of record on a specific date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which such
dividend was declared.
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The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies
to interest received on certain "private activity bonds" issued after August
7, 1986. Private activity bonds are bonds which, although tax-exempt, are used
for purposes other than those generally performed by governmental units and
which benefit non-governmental entities (e.g., bonds used for industrial
development or housing purposes). Income received on such bonds is classified
as an item of "tax preference", which could subject certain investors in such
bonds, including shareholders of the Fund, to an alternative minimum tax. The
Fund will purchase such "private activity bonds" and the Trust will report to
shareholders within 60 days after the Fund's taxable year-end the portion of
the Fund's dividends declared during the year which constitutes an item of tax
preference for alternative minimum tax purposes. The Code further provides
that corporations are subject to an alternative minimum tax based, in part, on
certain differences between taxable income as adjusted for other tax
preferences and the corporation's "adjusted current earnings", which more
closely reflect a corporation's economic income. Because an exempt-interest
dividend paid by the Fund will be included in adjusted current earnings, a
corporate shareholder may be required to pay alternative minimum tax on
exempt-interest dividends paid by the Fund.
The Fund may invest in high yield securities as described in the Prospectus.
Furthermore, the Fund may also invest in instruments the return on which
includes nontraditional features such as indexed principal or interest
payments ("nontraditional instruments"). These instruments may be subject to
special tax rules under which the Fund may be required to accrue and
distribute income before amounts due under the obligations are paid. In
addition, it is possible that all or a portion of the interest payments on
such high yield securities and/or nontraditional instruments could be
recharacterized as taxable ordinary income.
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the
Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D
shares will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will
be reduced (or the gain increased) to the extent any sales charge paid to the
Fund on the exchanged shares reduces any sales charge such shareholder would
have owed upon purchase of the new shares in the absence of the exchange
privilege. Instead, such sales charge will be treated as an amount paid for
the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30
days before and ending 30 days after the date that the shares are disposed of.
In such a case, the basis of the shares acquired will be adjusted to reflect
the disallowed loss.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% U.S. withholding tax under existing
provisions of the Code applicable to foreign individuals and entities unless a
reduced rate of withholding or a withholding exemption is provided under
applicable treaty law. Nonresident shareholders are urged to consult their own
tax advisors concerning the applicability of the U.S. withholding tax.
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Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
ENVIRONMENTAL TAX
The Code previously imposed a deductible tax (the "Environmental Tax") on a
corporation's modified alternative minimum taxable income (computed without
regard to the alternative tax net operating loss deduction and the deduction
for the Environmental Tax) at a rate of $12 per $10,000 (0.12%) of alternative
minimum taxable income in excess of $2,000,000. The Environmental Tax has
expired for tax years beginning after December 31, 1995, but may be reinstated
in the future. The Environmental Tax was imposed even if the corporation was
not required to pay an alternative minimum tax because the corporation's
regular income tax liability exceeded its minimum tax liability. The Code
provides, however, that a RIC, such as the Fund, would not be subject to the
Environmental Tax. However, exempt-interest dividends paid by the Fund that
create alternative minimum taxable income for corporate shareholders (as
described above) could subject corporate shareholders of the Fund to the
Environmental Tax.
TAX TREATMENT OF OPTION AND FUTURES TRANSACTIONS
The Fund may purchase or sell municipal bond index futures contracts and
interest rate futures contracts on U.S. Government securities ("financial
futures contracts"). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is
available to the Fund or an exception applies, such options and financial
futures contracts that are "Section 1256 contracts" will be "marked to market"
for Federal income tax purposes at the end of each taxable year, i.e., each
such option or financial futures contract will be treated as sold for its fair
market value on the last day of the taxable year, and any gain or loss
attributable to Section 1256 contracts will be 60% long-term and 40% short-term
capital gain or loss. Application of these rules to Section 1256 contracts held
by the Fund may alter the timing and character of distributions to
shareholders. The mark-to-market rules outlined above, however, will not apply
to certain transactions entered into by the Fund solely to reduce the risk of
changes in price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles", may affect the
taxation of the Fund's sales of securities and transactions in financial
futures contracts and related options. Under Section 1092, the Fund may be
required to postpone recognition for tax purposes of losses incurred in certain
sales of securities and certain closing transactions in financial futures
contracts or the related options.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other
disposition of securities held for less than three months.
37
<PAGE>
Accordingly, the Fund may be restricted in effecting closing transactions
within three months after entering into an option or financial futures
contract.
----------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and Massachusetts tax laws
presently in effect. For the complete provisions, reference should be made to
the pertinent Code sections, the Treasury regulations promulgated thereunder
and the applicable Massachusetts personal income and corporate excise tax laws.
The Code and the Treasury regulations, as well as the Massachusetts tax laws,
are subject to change by legislative, judicial or administrative action either
prospectively or retroactively.
Shareholders are urged to consult their own tax advisors regarding the
availability of any exemptions from state or local taxes (other than those
imposed by Massachusetts) and with specific questions as to Federal, foreign,
state or local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield and tax-equivalent yield, in
advertisements or information furnished to present or prospective shareholders.
From time to time, the Fund may include the Fund's Morningstar risk-adjusted
performance ratings in advertisements or supplemental sales literature. Total
return and yield and tax-equivalent yield figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return, yield and tax-equivalent yield are determined
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
Average annual total return quotations for the specified periods are computed
by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including the maximum sales charge in the case of
Class A and Class D shares and the CDSC that would be applicable to a complete
redemption of the investment at the end of the specified period in the case of
the Class B and Class C shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted
and (2) the maximum applicable sales charges will not be included with respect
to annual or annualized rates of return calculations. Aside from the impact on
the performance data calculations of including or excluding the maximum
applicable sales charges, actual annual or annualized total return data
generally will be lower than average annual total return data since the average
rates of return reflect compounding of return; aggregate total return data
generally will be higher than average annual total return data since the
aggregate rates of return reflect compounding over a longer period of time.
38
<PAGE>
Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for
the periods indicated.
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS D SHARES
-------------------------- ---------------------------- -------------------------- ----------------------------
REDEEMABLE REDEEMABLE REDEEMABLE REDEEMABLE
EXPRESSED AS VALUE OF A EXPRESSED AS A VALUE OF A EXPRESSED AS VALUE OF A EXPRESSED AS A VALUE OF A
A PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL A PERCENTAGE HYPOTHETICAL PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END OF $1,000 AT THE END OF $1,000 AT THE END OF $1,000 AT THE END OF
PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------ ------------ ------------- -------------- ------------- ------------ ------------- -------------- -------------
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
One year ended
July 31, 1996... 2.51% $1,025.10 2.23% $1,022.30 5.12% $1,051.20 2.41% $1,024.10
Inception
(February 28,
1992) to July
31, 1996........ 6.43% $1,317.50 6.87% $1,342.00
Inception
(October 21,
1994) to July
31, 1996........ 8.04% $1,147.50 6.22% $1,113.20
<CAPTION>
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Year ended July
31, 1996........ 6.78% $1,067.80 6.23% $1,062.30 6.12% $1,061.20 6.67% $1,066.70
Year ended July
31, 1995........ 5.35% $1,053.50 4.82% $1,048.20
Inception
(October 21,
1994) to July
31, 1995........ 8.13% $1,081.30 8.70% $1,087.00
Year ended July
31, 1994........ 1.26% $1,012.60 0.75% $1,007.50
Year ended July
31, 1993........ 10.08% $1,100.80 9.53% $1,095.30
Inception
(February 28,
1992) to July
31, 1992........ 9.44% $1,094.40 9.22% $1,092.20
<CAPTION>
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGE)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Inception
(February 28,
1992) to July
31, 1996........ 31.75% $1,317.50 34.20% $1,342.00
Inception
(October 21,
1994) to July
31, 1996........ 14.75% $1,147.50 11.32% $1,113.20
<CAPTION>
YIELD
<S> <C> <C> <C> <C> <C> <C> <C> <C>
30 days ended
July 31, 1996... 4.83% 4.52% 4.42% 4.73%
<CAPTION>
TAX EQUIVALENT YIELD*
<S> <C> <C> <C> <C> <C> <C> <C> <C>
30 days ended
July 31, 1996... 6.71% 6.28% 6.14% 6.57%
</TABLE>
- ----
* Based on a Federal income tax rate of 28%.
39
<PAGE>
In order to reflect the reduced sales charges in the case of Class A or Class
D shares or the waiver of the CDSC in the case of Class B or Class C shares
applicable to certain investors, as described under "Purchase of Shares" and
"Redemption of Shares", respectively, the total return data quoted by the Fund
in advertisements directed to such investors may take into account the reduced,
and not the maximum, sales charge or may take into account the CDSC and
therefore may reflect greater total return since, due to the reduced sales
charges or the waiver of sales charges, a lower amount of expenses is deducted.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust provides that the Trust shall be comprised of
separate Series each of which will consist of a separate portfolio which will
issue separate shares. The Trust is presently comprised of the Fund, Merrill
Lynch Arizona Municipal Bond Fund, Merrill Lynch Arkansas Municipal Bond Fund,
Merrill Lynch Colorado Municipal Bond Fund, Merrill Lynch Connecticut Municipal
Bond Fund, Merrill Lynch Florida Municipal Bond Fund, Merrill Lynch Maryland
Municipal Bond Fund, Merrill Lynch Michigan Municipal Bond Fund, Merrill Lynch
Minnesota Municipal Bond Fund, Merrill Lynch New Jersey Municipal Bond Fund,
Merrill Lynch New Mexico Municipal Bond Fund, Merrill Lynch New York Municipal
Bond Fund, Merrill Lynch North Carolina Municipal Bond Fund, Merrill Lynch Ohio
Municipal Bond Fund, Merrill Lynch Oregon Municipal Bond Fund, Merrill Lynch
Pennsylvania Municipal Bond Fund and Merrill Lynch Texas Municipal Bond Fund.
The Trustees are authorized to create an unlimited number of Series and, with
respect to each Series, to issue an unlimited number of full and fractional
shares of beneficial interest, par value $.10 per share, of different classes
and to divide or combine the shares into a greater or lesser number of shares
without thereby changing the proportionate beneficial interests in the Series.
Shareholder approval is not necessary for the authorization of additional
Series or classes of a Series of the Trust. At the date of this Statement of
Additional Information, the shares of the Fund are divided into Class A, Class
B, Class C and Class D shares. Class A, Class B, Class C and Class D shares
represent interests in the same assets of the Fund and are identical in all
respects except that the Class B, Class C and Class D shares bear certain
expenses related to the account maintenance and/or distribution expenditures.
The Board of Trustees may classify and reclassify the shares of any Series into
additional classes at a future date.
All shares of the Trust have equal voting rights, except that only shares of
the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B, Class C and Class D shares have exclusive
voting rights with respect to matters relating to the account maintenance
and/or distribution expenses being borne solely by such class. Each issued and
outstanding share is entitled to one vote and to participate equally in
dividends and distributions declared by the Fund and in the net assets of such
Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities, except that, as noted above, expenses related to the
account maintenance and/or distribution of the Class B, Class C and Class D
shares are borne solely by such class. There normally will be no meeting of
shareholders for the purposes of electing Trustees unless and until such time
as less than a majority of the Trustees holding office have been elected by
shareholders, at which time the Trustees then in office will call a
shareholders' meeting
40
<PAGE>
for the election of Trustees. Shareholders may, in accordance with the terms of
the Declaration of Trust, cause a meeting of shareholders to be held for the
purpose of voting on the removal of Trustees. Also, the Trust will be required
to call a special meeting of shareholders in accordance with the requirements
of the 1940 Act to seek approval of new management and advisory arrangements,
of a material increase in distribution fees or of a change in the fundamental
policies, objectives or restrictions of a Series.
The obligations and liabilities of a particular Series are restricted to the
assets of that Series and do not extend to the assets of the Trust generally.
The shares of each Series, when issued, will be fully paid and nonassessable,
have no preference, preemptive, conversion, exchange or similar rights, and are
freely transferable. Holders of shares of any Series are entitled to redeem
their shares as set forth elsewhere herein and in the Prospectus. Shares do not
have cumulative voting rights and the holders of more than 50% of the shares of
the Trust voting for the election of Trustees can elect all of the Trustees if
they choose to do so and in such event the holders of the remaining shares
would not be able to elect any Trustees. No amendments may be made to the
Declaration of Trust without the affirmative vote of a majority of the
outstanding shares of the Trust.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares of the Fund for $100,000. Such shares were acquired for investment and
can only be disposed of by redemption. The organizational expenses of the Fund
were paid by the Fund and are being amortized over a period not exceeding five
years. The proceeds realized by the Manager (or any subsequent holder) upon the
redemption of any of the shares initially purchased by it will be reduced by
the proportionate amount of unamortized organizational expenses which the
number of shares redeemed bears to the number of shares initially purchased.
Such organizational expenses include certain of the initial organizational
expenses of the Trust which have been allocated to the Fund by the Trustees. If
additional Series are added to the Trust, the organizational expenses will be
allocated among the Series in a manner deemed equitable by the Trustees.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A, Class
B, Class C and Class D shares of the Fund based on the value of the Fund's net
assets and number of shares outstanding on July 31, 1996 is calculated as set
forth below.
41
<PAGE>
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Net Assets....................... $5,887,586 $59,868,201 $1,184,666 $1,290,026
========== =========== ========== ==========
Number of Shares Outstanding..... 555,183 5,645,511 111,793 121,614
========== =========== ========== ==========
Net Asset Value Per Share (net
assets divided by number of
shares outstanding)............. $ 10.60 $ 10.60 $ 10.60 $ 10.61
Sales Charge (for Class A and
Class D shares: 4.00% of
offering price; 4.17% of net
asset value per share)*......... .44 ** ** .44
---------- ----------- ---------- ----------
Offering Price................... $ 11.04 $ 10.60 $ 10.60 $ 11.05
========== =========== ========== ==========
</TABLE>
- --------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge
is applicable.
** Class B and Class C shares are not subject to an initial sales charge but
may be subject to a CDSC on redemption of shares. See "Purchase of Shares--
Deferred Sales Charge Alternatives--Class B and Class C Shares" in the
Prospectus and "Redemption of Shares--Deferred Sales Charges--Class B and
Class C Shares" herein.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Fund. The independent
auditors are responsible for auditing the annual financial statements of the
Fund.
CUSTODIAN
State Street Bank and Trust Company, P.O. Box 351, Boston, Massachusetts
02101, acts as the custodian of the Fund's assets. The custodian is responsible
for safeguarding and controlling the Fund's cash and securities, handling the
delivery of securities and collecting interest on the Fund's investments.
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Trust's transfer agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Management of the Trust--Transfer Agency Services" in the Prospectus.
LEGAL COUNSEL
Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on July 31 of each year. The Trust sends to
shareholders of the Fund at least semi-annually reports showing the Fund's
portfolio and other information. An annual report, containing financial
statements audited by independent auditors, is sent to shareholders each year.
After the end of each year shareholders will receive Federal income tax
information regarding dividends and capital gains distributions.
42
<PAGE>
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act, to which reference is hereby
made.
The Declaration of Trust establishing the Trust dated August 2, 1985, a copy
of which, together with all amendments thereto (the "Declaration") is on file
in the office of the Secretary of the Commonwealth of Massachusetts, provides
that the name "Merrill Lynch Multi-State Municipal Series Trust" refers to the
Trustees under the Declaration collectively as Trustees, but not as individuals
or personally; and no Trustee, shareholder, officer, employee or agent of the
Trust shall be held to any personal liability; nor shall resort be had to any
such person's private property for the satisfaction of any obligation or claim
of the Trust but the "Trust Property" only shall be liable.
To the knowledge of the Trust, no person or entity owned beneficially 5% or
more of the Fund's shares on October 1, 1996.
43
<PAGE>
APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN MASSACHUSETTS
The following information is a brief summary of factors affecting the economy
of the state and does not purport to be a complete description of such factors.
Other factors will affect issuers. The summary is based primarily upon one or
more publicly available offering statements relating to debt offerings of state
issuers; however, it has not been updated nor will it be updated during the
year. The Trust has not independently verified the information.
Economic growth in the Commonwealth of Massachusetts (sometimes referred to
as the "Commonwealth") has slowed since 1988, particularly in the construction,
real estate, financial and manufacturing sectors, including certain high
technology areas. Economic conditions have improved somewhat since 1993. The
unemployment rate in Massachusetts averaged 6.9% during 1993, after rising
steadily during the previous three years, from 3.4% at the beginning of 1989.
As of July 1996, however, the Commonwealth's unadjusted unemployment rate was
4.6% as compared to a national average of 5.6%. Per capita personal income in
the Commonwealth is currently higher than the national average.
Ending fund balances in the budgeted operating funds for fiscal 1991 were
$237.1 million. Fiscal 1992 ended with positive fund balances of $549.4 million
after carrying forward the fund balances from fiscal 1991. Fiscal 1993 ended
with positive fund balances of $562.5 million.
In fiscal 1994, the total revenues of the budgeted operating funds of the
Commonwealth during such fiscal year increased by approximately 5.7% over the
prior fiscal year, to $15.550 billion. Expenditures increased by 5.6% over the
prior year, to $15.523 billion. As a result, the Commonwealth ended fiscal 1994
with a positive closing fund balance of $589.3 million. In fiscal 1995, which
ended June 30, 1995, the total revenues of the budgeted operating funds of the
Commonwealth during such fiscal year increased by approximately 5.4% over the
prior fiscal year, to $16.387 billion. Expenditures increased by 4.7% over the
prior fiscal year, to $16.251 billion. As a result, the Commonwealth ended
fiscal 1995 with a positive closing fund balance of $726.0 million. Budgeted
revenues and other sources in fiscal 1996 which ended June 30, 1996, were
estimated as of June 6, 1996 by the Executive Office for Administration and
Finance to be approximately $16.850 billion, including tax revenues of $11.684
billion. It is estimated that fiscal 1996 budgeted expenditures will be $16.963
billion.
Standard & Poor's Ratings Group and Moody's Investors Service, Inc. have
rated the Commonwealth's general obligation bonds as A+ and A-1, respectively.
Fitch Investors Service, Inc. has recently rated the Commonwealth's bonds as
A+. From time to time, agencies may change their ratings.
Growth of tax revenues in the Commonwealth is limited by law. Tax revenues in
fiscal years 1988 through 1995 were lower than the limits set by law, and the
Executive Office for Administration and Finance estimates that state tax
revenues in fiscal 1996 will not reach the limits imposed by law. In addition,
effective July 1, 1990, limitations were placed on the amount of direct bonds
the Commonwealth may have outstanding in a fiscal year, and the amount of the
total appropriation in any fiscal year that may be expended for repayment of
principal of and payment of interest on general obligation debt of the
Commonwealth was limited to 10% of such appropriation. Bonds in the aggregate
principal amount of $1.416 billion issued in
44
<PAGE>
October and December 1990, under Chapter 151 of the Acts of 1990 to meet the
fiscal 1990 deficit, are excluded from the computation of these limitations,
and principal of and interest on such bonds are to be paid from up to 15% of
the Commonwealth's income tax receipts in each year that such principal or
interest is payable.
Furthermore, certain of the Commonwealth's cities and towns have at times
experienced serious financial difficulties which have adversely affected their
credit standing. The recurrence of such financial difficulties, or financial
difficulties of the Commonwealth, could adversely affect the market values and
marketability of outstanding obligations issued by the Commonwealth or its
public authorities or municipalities. In addition, the Massachusetts statutes
which limit the taxing authority of the Commonwealth or certain Massachusetts
governmental entities may impair the ability of issuers of some Massachusetts
obligations to pay debt service on their obligations.
In Massachusetts, the tax on personal property and real estate is virtually
the only source of tax revenues available to cities and towns to meet local
costs. "Proposition 2 1/2," an initiative petition adopted by the voters of the
Commonwealth of Massachusetts on November 4, 1980, limits the power of
Massachusetts cities and towns and certain tax-supported districts and public
agencies to raise revenue from property taxes to support their operations,
including the payment of certain debt service. Proposition 2 1/2 required many
cities and towns to reduce their property tax levels to a stated percentage of
the full and fair cash value of their taxable real estate and personal property
and limited the amount by which the total property taxes assessed by a city or
town might increase from year to year. Although the limitations of Proposition
2 1/2 on tax increases may be overridden and amounts for debt service and
capital expenditures excluded from such limitation by the voters of the
relevant municipality, Proposition 2 1/2 will continue to restrain
significantly the ability of cities and towns to pay for local services,
especially in light of cost increases due to an inflation rate generally
exceeding 2.5%.
To offset shortfalls experienced by local governments as a result of the
implementation of Proposition 2 1/2, the government of the Commonwealth
increased direct local aid from the 1981 level of $1.632 billion to the fiscal
1991 level of $2.608 billion. Direct local aid decreased from fiscal 1991 to
$2.359 billion in fiscal 1992, increased to $2.547 billion in fiscal 1993 and
increased to $2.727 billion in fiscal 1994. Fiscal 1995 expenditures for direct
local aid were $2.976 billion, which is an increase of approximately 9.1% above
the 1994 level. It is estimated that fiscal 1996 expenditures for direct local
aid will be $3.242 billion, which is an increase of approximately 8.9% above
the fiscal 1995 level.
The aggregate unfunded actuarial liabilities of the pension systems of the
Commonwealth and the unfunded liability of the Commonwealth related to local
retirement systems are significant--estimated to be approximately $9.651
billion as of January 1, 1993 (the last date that such liability was
calculated) on the basis of certain actuarial assumptions regarding, among
other things, future investment earnings, annual inflation rates, wage
increases and cost of living increases. No assurance can be given that these
assumptions will be realized. The legislature adopted a comprehensive pension
bill addressing the issue in January 1988, which requires the Commonwealth,
beginning in fiscal year 1989, to fund future pension liabilities currently and
amortize the Commonwealth's unfunded liabilities over 40 years in accordance
with funding schedules prepared by the Secretary for Administration and Finance
and approved by the legislature. The amounts required for funding of current
pension liabilities in fiscal years 1995, 1996, 1997 and 1998 are estimated to
be $959.9 million, $1.007 billion, $1.061 billion and $1.128 billion,
respectively.
45
<PAGE>
APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S ("MOODY'S") MUNICIPAL BOND
RATINGS
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt edge". Interest payments are protected by a large
or by an exceptionally stable margin and principal is secure. While
the various protective elements are likely to change, such changes as
can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-
term risks appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payment and principal security appear adequate for the present but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
46
<PAGE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
Short-term Notes: The four ratings of Moody's for short-term notes are
MIG1/VMIG1, MIG2/ VMIG2, MIG3/VMIG3 and MIG4/VMIG4; MIG1/VMIG1 denotes "best
quality . . . strong protection by established cash flows"; MIG2/VMIG2 denotes
"high quality" with ample margins of protection; MIG3/VMIG3 notes are of
"favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades"; MIG4/VMIG4 notes are of "adequate quality . . . [p]rotection
commonly regarded as required of an investment security is present . . . there
is specific risk."
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Excerpts from Moody's description of its corporate bond ratings: Aaa--judged
to be the best quality, carry the smallest degree of investment risk; Aa--
judged to be of high quality by all standards; A--possess many favorable
investment attributes and are to be considered as upper medium grade
obligations.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed
financial charges and high internal cash generation; and well established
access to a range of financial markets and assured sources of alternate
liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations. The effects of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
47
<PAGE>
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP ("STANDARD & POOR'S") MUNICIPAL
DEBT RATINGS
A Standard & Poor's municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers,
or lessees.
The debt rating is not a recommendation to purchase, sell or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default--capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded by, and relative position of, the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws
of bankruptcy and other laws affecting creditors' rights.
AAA Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the higher-rated issues only in small
degree.
A Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher-rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt
in higher-rated categories.
BB Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on balance, as
B predominately speculative with respect to capacity to pay interest and
CCC repay principal in accordance with the terms of the obligations. "BB"
CC indicates the lowest degree of speculation and "C" the highest degree
C of speculation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large
uncertainties or major exposures to adverse conditions.
CI
The rating "CI" is reserved for income bonds on which no interest is
being paid.
48
<PAGE>
D Debt rated "D" is in payment default. The "D" rating category is used
when interest payments or principal payments are not made on the date
due even if the applicable grace period has not expired, unless
Standard & Poor's believes that such payments will be made during such
grace period. The "D" rating also will be used upon the filing of a
bankruptcy petition if debt service payments are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF STANDARD & POOR'S CORPORATE BOND RATINGS
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. Debt
rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity to
pay interest and repay principal is extremely strong. Debt rated "AA" has a
very strong capacity to pay interest and to repay principal and differs from
the highest rated issues only in small degree. Debt rated "A" has a strong
capacity to pay interest and repay principal although it is somewhat more
susceptible to the adverse effects of changes in circumstances and economic
conditions than debt of a higher rated category. Debt rated "BBB" is regarded
as having an adequate capacity to pay interest and repay principal. Whereas it
normally exhibits adequate protection parameters, adverse economic conditions
or changing circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher rated
categories.
The ratings from "AA" to "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into four categories, ranging from "A" for
the highest quality obligations to "D" for the lowest. Ratings are applicable
to both taxable and tax-exempt commercial paper. Issues assigned the highest
rating are regarded as having the greatest capacity for timely payment. Issues
in this category are further refined with the designation 1, 2 and 3 to
indicate the relative degree of safety. The three designations in the "A"
category are as follows:
A-1This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined
to possess extremely strong safety characteristics are denoted with a
plus sign (+) designation.
A-2Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for
issues designated "A-1".
A-3Issues carrying this designation have a satisfactory capacity for
timely payment. They are, however, somewhat more vulnerable to the
adverse effects of changes in circumstances than obligations carrying
the higher designations.
B
Issues rated "B" are regarded as having only speculative capacity for
timely payment.
49
<PAGE>
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is used
when interest payments or principal payments are not made on the date
due, even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period.
A Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive
a note rating. Notes maturing beyond 3 years will most likely receive a long-
term debt rating. The following criteria will be used in making that
assessment.
--Amortization schedule (the larger the final maturity relative to other
maturities, the more likely it will be treated as a note).
--Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
SP-1 A very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will be
given a "+" designation.
SP-2 A satisfactory capacity to pay principal and interest.
SP-3 A speculative capacity to pay principal and interest.
Standard & Poor's may continue to rate note issues with a maturity greater
than three years in accordance with the same rating scale currently employed
for municipal bond ratings.
Unrated: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuer belongs to a group of securities that are not rated as
a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not published
in Standard & Poor's publications.
Suspension or withdrawal may occur if new and material circumstances arise,
the effects of which preclude satisfactory analysis; if there is no longer
available reasonable up-to-date information to permit a judgment to be formed;
if a bond is called for redemption; or for other reasons.
50
<PAGE>
DESCRIPTION OF FITCH INVESTORS SERVICE, INC.'S ("FITCH") INVESTMENT GRADE BOND
RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and of any
guarantor, as well as the economic and political environment that might affect
the issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other obligors,
underwriters, their experts, and other sources Fitch believes to be reliable.
Fitch does not audit or verify the truth or accuracy of such information.
Ratings may be changed, suspended, or withdrawn as a result of changes in, or
the unavailability of, information or for any other reasons.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated "AAA".
Because bonds rated in the "AAA" and "AA" categories are not
significantly vulnerable to foreseeable future developments, short-
term debt of these issuers is generally rated "F-1+".
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on
these bonds, and therefore, impair timely payment. The likelihood that
the ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
51
<PAGE>
Credit Trend Indicator: Credit trend indicators show whether credit
fundamentals are improving, stable, declining, or uncertain, as follows:
Improving UP ARROW
Stable LEFT ARROW/RIGHT ARROW
Declining DOWN ARROW
Uncertain UP ARROW/DOWN ARROW
Credit trend indicators are not predictions that any rating change will
occur, and have a longer-term time frame than issues placed on FitchAlert.
NR indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised or
lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or
liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
52
<PAGE>
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by
adverse economic changes. However, business and financial
alternatives can be identified which could assist the obligor
in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the
probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and
the need for reasonable business and economic activity
throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal.
DDD, DD and D Bonds are in default on interest and/or principal payments.
Such bonds are extremely speculative and should be valued on
the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. "DDD" represents the highest
potential for recovery on these bonds, and "D" represents the
lowest potential for recovery.
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD", "DD", or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating
are regarded as having the strongest degree of assurance for
timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than
issues rated "F-1+".
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as for issues assigned "F-1+" and
"F-1" ratings.
53
<PAGE>
F-3 Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate, however, near-term adverse changes could
cause these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter of
credit issued by a commercial bank.
INS The symbol "INS" indicates that the rating is based on an
insurance policy or financial guaranty issued by an insurance
company.
54
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
Merrill Lynch Massachusetts Municipal Bond Fund of Merrill Lynch Multi-State
Municipal Series Trust:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch Massachusetts Municipal Bond Fund
of Merrill Lynch Multi-State Municipal Series Trust as of July 31, 1996, the
related statements of operations for the year then ended and changes in net
assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the four-year period then ended
and for the period February 28, 1992 (commencement of operations) to July 31,
1992. These financial statements and the financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and the financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at July
31, 1996 by correspondence with the custodian. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
Massachusetts Municipal Bond Fund of Merrill Lynch Multi-State Municipal Series
Trust as of July 31, 1996, the results of its operations, the changes in its
net assets, and the financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
September 9, 1996
55
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Massachusetts--94.4%
<C> <C> <C> <S> <C>
BBB Baa1 $ 865 Boston, Massachusetts, Industrial Development Financing Authority,
Sewer Facility Revenue Bonds (Harbor Electric Energy Company Project),
AMT, 7.375% due 5/15/2015 $ 923
A1+ VMIG1++ 3,300 Boston, Massachusetts, Water and Sewer Commission Revenue Bonds, VRDN,
Series A, 3.25% due 11/01/2024 (a) 3,300
Massachusetts Bay Transportation Authority Revenue Bonds
(Massachusetts General Transportation Systems), Series A:
A+ A1 1,000 7% due 3/01/2021 1,158
A+ A1 1,750 Refunding, UT, 7% due 3/01/2011 1,996
AAA Aaa 1,000 Massachusetts Education Loan Authority, Educational Loan Revenue Bonds,
AMT, Issue E, Series A, 7.375% due 1/01/2012 (b) 1,084
Massachusetts State Health and Educational Facilities Authority
Revenue Bonds:
AAA Aaa 3,030 (Boston College), Series J, 6.625% due 7/01/2021 (e) 3,239
A A1 1,000 (Brigham and Women's Hospital), Series C, 7% due 6/01/2018 1,060
A A1 2,520 (Brigham and Women's Hospital), Series C, 6.75% due 6/01/2021 2,649
A1+ VMIG1++ 100 (Capital Asset Program), VRDN, Series C, 3.35% due 7/01/2005 (a)(d) 100
A1+ VMIG1++ 200 (Capital Asset Program), VRDN, Series D, 3.45% due 1/01/2035 (a)(d) 200
AAA Aaa 5,150 (Medical Center of Central Massachusetts), CARS, Series B, 9.22% due
6/23/2022 (b)(f) 5,871
AAA Aaa 2,500 (Newton Wellesley Hospital), Series D, 7% due 7/01/2015 (d) 2,710
AAA Aaa 1,000 (Northeastern University), Series E, 6.55% due 10/01/2022 (d) 1,074
NR* B 1,000 Refunding (New England Memorial Hospital), Series B, 6.125% due 7/01/2013 800
AAA Aaa 1,000 Refunding (Stonehill College), Series E, 6.60% due 7/01/2020 (d) 1,076
NR* A 2,335 Refunding (Wheaton College), Series C, 5.25% due 7/01/2019 2,154
Massachusetts State, HFA, Revenue Bonds (Residential Development) (c):
AAA Aaa 2,000 Series C, 6.875% due 11/15/2011 2,105
AAA Aaa 5,000 Series C, 6.90% due 11/15/2021 5,222
AAA Aaa 1,000 Series D, Section 8, 6.875% due 11/15/2021 1,043
</TABLE>
PORTFOLIO ABBREVIATIONS
To simplify the listings of Merrill Lynch Massachusetts Municipal
Bond Fund's portfolio holdings in the Schedule of Investments, we
have abbreviated the names of many of the securities according to
the list at the right.
AMT Alternative Minimum Tax (subject to)
CARS Complementary Auction Rate Securities
GO General Obligation Bonds
HFA Housing Finance Agency
PCR Pollution Control Revenue Bonds
S/F Single-Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes
56
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Massachusetts (concluded)
<C> <C> <C> <S> <C>
Massachusetts State, HFA, S/F Housing Revenue Bonds, AMT:
A+ Aa $1,500 Series 38, 7.20% due 12/01/2026 $ 1,591
A+ Aa 2,000 Series 40, 6.65% due 12/01/2027 2,053
AAA Aaa 2,000 Series 48, 6.35% due 6/01/2026 (d) 2,015
NR* VMIG1++ 1,400 Massachusetts State Industrial Finance Agency, PCR, Refunding (North
East Power Company), VRDN, 3.40% due 10/01/2022 (a) 1,400
Massachusetts State Industrial Finance Agency Revenue Bonds:
AAA Aaa 1,000 (Babson College), Series A, 6.50% due 10/01/2022 (d) 1,060
AAA Aaa 3,175 (Brandeis University), Series C, 6.80% due 10/01/2019 (d) 3,393
A+ A1 1,795 Refunding (Holy Cross College-II), 6.375% due 11/01/2002 (g) 1,980
A1+ VMIG1++ 100 Massachusetts State Municipal Wholesale Electric Company, Power Supply
System Revenue Bonds, VRDN, Series C, 3.35% due 7/01/2019 (a) 100
Massachusetts State Water Pollution Abatement Trust Revenue Bonds,
Series A:
A+ Aa 1,000 MWRA Loan Program, 5% due 8/01/2015 906
AA- Aa 1,680 Secured Loan Program, 6.375% due 2/01/2015 1,772
A A 6,000 Massachusetts State Water Resource Authority Revenue Bonds, Series A,
6.50% due 7/15/2019 6,497
AAA Aaa 1,000 South Essex, Massachusetts, Sewer District, GO, Refunding, Series A,
5.25% due 6/15/2024 (d) 926
AAA Aaa 1,210 Southern Berkshire, Massachusetts, Regional School District Revenue Bonds,
UT, 7% due 4/15/2003 (d) (g) 1,362
NR* Baa 1,500 Springfield, Massachusetts, School Project Loan, GO, Series B, 7.10% due
9/01/2011 1,613
Puerto Rico--3.9%
A Baa1 3,000 Puerto Rico Commonwealth Aqueduct and Sewer Authority Revenue
Refunding Bonds, 5% due 7/01/2019 2,642
Total Investments (Cost--$64,606)--98.3% 67,074
Other Assets Less Liabilities--1.7% 1,156
-------
Net Assets--100.0% $68,230
=======
<FN>
(a)The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate in
effect at July 31, 1996.
(b)AMBAC Insured.
(c)FNMA Collateralized.
(d)MBIA Insured.
(e)FGIC Insured.
(f)The interest rate is subject to change periodcally and inversely
based upon prevailing market rates. The interest rate shown is the
rate in effect at July 31, 1996.
(g)Prerefunded.
*Not Rated.
++Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
</TABLE>
57
<PAGE>
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of July 31, 1996
<C> <S> <C> <C>
Assets: Investments, at value (identified cost--$64,605,670) (Note 1a) $ 67,073,999
Cash 193,175
Receivables:
Interest $ 757,260
Securities sold 587,962
Beneficial interest sold 64,202 1,409,424
------------
Prepaid expenses and other assets (Note 1e) 7,410
Deferred organization expenses (Note 1e) 5,938
------------
Total assets 68,689,946
------------
Liabilities: Payables:
Beneficial interest redeemed 235,230
Dividends to shareholders (Note 1f) 80,546
Investment adviser (Note 2) 31,841
Distributor (Note 2) 26,145 373,762
------------
Accrued expenses and other liabilities 85,705
------------
Total liabilities 459,467
------------
Net Assets: Net assets $ 68,230,479
============
Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 55,518
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 564,551
Class C Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 11,179
Class D Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 12,161
Paid-in capital in excess of par 66,813,179
Accumulated realized capital losses on investments--net (Note 5) (1,621,661)
Accumulated distribution in excess of realized capital
gains--net (Note 1f) (72,777)
Unrealized appreciation on investments--net 2,468,329
------------
Net assets $ 68,230,479
============
Net Asset Value: Class A--Based on net assets of $5,887,586 and 555,183
shares of beneficial interest outstanding $ 10.60
============
Class B--Based on net assets of $59,868,201 and 5,645,511
shares of beneficial interest outstanding $ 10.60
============
Class C--Based on net assets of $1,184,666 and 111,793
shares of beneficial interest outstanding $ 10.60
============
Class D--Based on net assets of $1,290,026 and 121,614
shares of beneficial interest outstanding $ 10.61
============
See Notes to Financial Statements.
</TABLE>
58
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
Statement of Operations
<CAPTION>
For the Year Ended
July 31, 1996
<C> <S> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 4,499,849
(Note 1d):
Expenses: Investment advisory fees (Note 2) $ 406,646
Account maintenance and distribution fees--Class B (Note 2) 328,420
Professional fees 64,337
Accounting services (Note 2) 38,780
Transfer agent fees--Class B (Note 2) 38,290
Printing and shareholder reports 35,515
Registration fees (Note 1e) 17,968
Amortization of organization expenses (Note 1e) 10,399
Pricing fees 4,841
Account maintenance and distribution fees--Class C (Note 2) 4,692
Custodian fees 4,426
Trustees' fees and expenses 3,731
Transfer agent fees--Class A (Note 2) 3,129
Account maintenance fees--Class D (Note 2) 1,002
Transfer agent fees--Class D (Note 2) 482
Transfer agent fees--Class C (Note 2) 465
Other 2,156
------------
Total expenses 965,279
------------
Investment income--net 3,534,570
------------
Realized & Realized loss on investments--net (120,826)
Unrealized Change in unrealized appreciation on investments--net 1,137,298
Gain (Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 4,551,042
(Notes 1b, 1d & 3): ============
See Notes to Financial Statements.
</TABLE>
59
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
Statements of Changes in Net Assets
<CAPTION>
For the Year Ended July 31,
Increase (Decrease) in Net Assets: 1996 1995
<C> <S> <C> <C>
Operations: Investment income--net $ 3,534,570 $ 3,914,760
Realized loss on investments--net (120,826) (1,500,843)
Change in unrealized appreciation on investments--net 1,137,298 989,418
------------ ------------
Net increase in net assets resulting from operations 4,551,042 3,403,335
------------ ------------
Dividends to Investment income--net:
Shareholders Class A (338,974) (398,237)
(Note 1f): Class B (3,107,959) (3,492,562)
Class C (36,158) (7,152)
Class D (51,479) (16,809)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders (3,534,570) (3,914,760)
------------ ------------
Beneficial Interest Net decrease in net assets derived from beneficial
Transactions interest transactions (7,525,610) (9,552,246)
(Note 4): ------------ ------------
Net Assets: Total decrease in net assets (6,509,138) (10,063,671)
Beginning of year 74,739,617 84,803,288
------------ ------------
End of year $ 68,230,479 $ 74,739,617
============ ============
See Notes to Financial Statements.
</TABLE>
60
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights
<CAPTION>
Class A
For the
Period
The following per share data and ratios have been derived Feb. 28,
from information provided in the financial statements. 1992++ to
For the Year Ended July 31, July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.46 $ 10.48 $ 11.07 $ 10.68 $ 10.00
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .56 .56 .58 .63 .25
Realized and unrealized gain (loss) on
investments--net .14 (.02) (.43) .42 .68
-------- -------- -------- -------- --------
Total from investment operations .70 .54 .15 1.05 .93
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.56) (.56) (.58) (.63) (.25)
Realized gain on investments--net -- -- (.15) (.03) --
In excess of realized gain on
investments--net -- -- (.01) -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.56) (.56) (.74) (.66) (.25)
-------- -------- -------- -------- --------
Net asset value, end of period $ 10.60 $ 10.46 $ 10.48 $ 11.07 $ 10.68
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 6.78% 5.35% 1.26% 10.08% 9.44%+++
Return:** ======== ======== ======== ======== ========
Ratios to Expenses, net of reimbursement .84% .88% .62% .42% .12%*
Average ======== ======== ======== ======== ========
Net Assets: Expenses .84% .91% .85% .95% 1.16%*
======== ======== ======== ======== ========
Investment income--net 5.23% 5.42% 5.33% 5.75% 5.82%*
======== ======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 5,887 $ 6,630 $ 8,367 $ 7,093 $ 4,828
Data: ======== ======== ======== ======== ========
Portfolio turnover 56.05% 89.62% 72.13% 39.37% 18.86%
======== ======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
61
<PAGE>
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights (continued)
<CAPTION>
Class B
For the
Period
The following per share data and ratios have been derived Feb. 28,
from information provided in the financial statements. 1992++ to
For the Year Ended July 31, July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.46 $ 10.48 $ 11.07 $ 10.68 $ 10.00
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .51 .50 .53 .57 .23
Realized and unrealized gain (loss) on
investments--net .14 (.02) (.43) .42 .68
-------- -------- -------- -------- --------
Total from investment operations .65 .48 .10 .99 .91
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.51) (.50) (.53) (.57) (.23)
Realized gain on investments--net -- -- (.15) (.03) --
In excess of realized gain on
investments--net -- -- (.01) -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.51) (.50) (.69) (.60) (.23)
-------- -------- -------- -------- --------
Net asset value, end of period $ 10.60 $ 10.46 $ 10.48 $ 11.07 $ 10.68
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 6.23% 4.82% .75% 9.53% 9.22%+++
Return:** ======== ======== ======== ======== ========
Ratios to Expenses, net of reimbursement 1.35% 1.39% 1.12% .93% .62%*
Average ======== ======== ======== ======== ========
Net Assets: Expenses 1.35% 1.42% 1.36% 1.45% 1.68%*
======== ======== ======== ======== ========
Investment income--net 4.72% 4.91% 4.83% 5.24% 5.32%*
======== ======== ======== ======== ========
Supplemental Net assets, end of period (in thousands). $ 59,868 $ 66,927 $ 76,436 $ 71,429 $ 38,947
Data: ======== ======== ======== ======== ========
Portfolio turnover 56.05% 89.62% 72.13% 39.37% 18.86%
======== ======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
62
<PAGE>
FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights (concluded)
<CAPTION>
Class C Class D
For the For the
For the Period For the Period
The following per share data and ratios have been derived Year Oct. 21, Year Oct. 21,
from information provided in the financial statements. Ended 1994++ to Ended 1994++ to
July 31, July 31, July 31, July 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1996 1995
<S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 10.46 $ 10.03 $ 10.47 $ 10.03
Operating -------- -------- -------- --------
Performance: Investment income--net .49 .37 .55 .42
Realized and unrealized gain on investments--net .14 .43 .14 .44
-------- -------- -------- --------
Total from investment operations .63 .80 .69 .86
-------- -------- -------- --------
Less dividends from investment income--net (.49) (.37) (.55) (.42)
-------- -------- -------- --------
Net asset value, end of period $ 10.60 $ 10.46 $ 10.61 $ 10.47
======== ======== ======== ========
Total Investment Based on net asset value per share 6.12% 8.13%+++ 6.67% 8.70%+++
Return:** ======== ======== ======== ========
Ratios to Expenses 1.45% 1.56%* .94% 1.04%*
Average Net ======== ======== ======== ========
Assets: Investment income--net 4.61% 4.68%* 5.12% 5.22%*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $ 1,185 $ 432 $ 1,290 $ 750
Data: ======== ======== ======== ========
Portfolio turnover 56.05% 89.62% 56.05% 89.62%
======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns exclude the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
63
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch Massachusetts Municipal Bond Fund (the "Fund") is part
of Merrill Lynch Multi-State Municipal Series Trust (the "Trust").
The Fund is registered under the Investment Company Act of 1940 as a
non-diversified, open-end management investment company. The Fund
offers four classes of shares under the Merrill Lynch Select
Pricing SM System. Shares of Class A and Class D are sold with a
front-end sales charge. Shares of Class B and Class C may be subject
to a contingent deferred sales charge. All classes of shares have
identical voting, dividend, liquidation and other rights and the
same terms and conditions, except that Class B, Class C and Class D
Shares bear certain expenses related to the account maintenance of
such shares, and Class B and Class C Shares also bear certain
expenses related to the distribution of such shares. Each class has
exclusive voting rights with respect to matters relating to its
account maintenance and distribution expenditures. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter municipal bond and money markets and are valued at
the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Short-term
investments with remaining maturities of sixty days or less are
valued at amortized cost, which approximates market value.
Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust,
which may utilize a matrix system for valuations. The procedures of
the pricing service and its valuations are reviewed by the officers
of the Trust under the general supervision of the Trustees.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell interest
rate futures contracts and options on such futures contracts for the
purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required
by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Deferred organization expenses and prepaid registration fees--
Deferred organization expenses are charged to expense on a straight-
line basis over a
64
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies.......................................... 2
Description of Municipal Bonds and Temporary Investments................... 5
Description of Municipal Bonds............................................ 5
Description of Temporary Investments...................................... 7
Repurchase Agreements..................................................... 8
Financial Futures Transactions and Options................................ 9
Investment Restrictions.................................................... 13
Management of the Trust.................................................... 16
Trustees and Officers..................................................... 16
Compensation of Trustees.................................................. 17
Management and Advisory Arrangements...................................... 18
Purchase of Shares......................................................... 20
Initial Sales Charge Alternatives--Class A and Class D Shares............. 20
Reduced Initial Sales Charges............................................. 22
Distribution Plans........................................................ 24
Limitations on the Payment of Deferred Sales Charges...................... 25
Redemption of Shares....................................................... 26
Deferred Sales Charges--Class B and Class C Shares........................ 26
Portfolio Transactions..................................................... 27
Determination of Net Asset Value........................................... 28
Shareholder Services....................................................... 29
Investment Account........................................................ 29
Automatic Investment Plans................................................ 30
Automatic Reinvestment of Dividends and Capital Gains Distributions....... 30
Systematic Withdrawal Plans--Class A and Class D Shares................... 30
Exchange Privilege........................................................ 31
Distributions and Taxes.................................................... 33
Environmental Tax......................................................... 37
Tax Treatment of Option and Futures Transactions.......................... 37
Performance Data........................................................... 38
General Information........................................................ 40
Description of Shares..................................................... 40
Computation of Offering Price Per Share................................... 41
Independent Auditors...................................................... 42
Custodian................................................................. 42
Transfer Agent............................................................ 42
Legal Counsel............................................................. 42
Reports to Shareholders................................................... 42
Additional Information.................................................... 43
Appendix I--Economic and Financial Conditions in Massachusetts............. 44
Appendix II--Ratings of Municipal Bonds.................................... 46
Independent Auditors' Report............................................... 55
Financial Statements....................................................... 56
</TABLE>
Code # 16149-1096
[LOGO] MERRILL LYNCH
Merrill Lynch
Massachusetts Municipal
Bond Fund
Merrill Lynch Multi-State
Municipal Series Trust
[ART]
STATEMENT OF
ADDITIONAL
INFORMATION
October 29, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission file due to ASCII-incompatibility and cross-
references this material to the location of each occurrence in the text.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull
