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PROSPECTUS September 18, 1997
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EVERGREEN(SM) KEYSTONE STATE TAX FREE FUNDS (logo)
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KEYSTONE PENNSYLVANIA TAX FREE FUND
CLASS Y SHARES
The Keystone Pennsylvania Tax Free Fund (the "Fund") seeks the
highest possible current income exempt from federal income taxes, while
preserving capital. In addition, the Fund also seeks to provide a maximum
level of income to its shareholders that is exempt from the personal
income taxes of Pennsylvania by investing principally in municipal
obligations exempt from federal income tax and municipal obligations
issued by the Commonwealth of Pennsylvania and its political subdivisions,
agencies and instrumentalities. This Prospectus provides information
regarding the Class Y shares offered by the Fund. The Fund is a series of
Keystone State Tax Free Fund (the "Trust"), an open-end, nondiversified,
management investment company. This Prospectus sets forth concise
information about the Fund that a prospective investor should know before
investing. The address of the Fund is 200 Berkeley Street, Boston,
Massachusetts 02116.
A Statement of Additional Information for the Fund and certain other
funds in the Evergreen Keystone Funds dated July 21, 1997, as supplemented
from time to time, has been filed with the Securities and Exchange
Commission and is incorporated by reference herein. The Statement of
Additional Information provides information regarding certain matters
discussed in this Prospectus and other matters which may be of interest to
investors, and may be obtained without charge by calling the Fund at (800)
343-2898. There can be no assurance that the investment objective of the
Fund will be achieved. Investors are advised to read this Prospectus
carefully.
AN INVESTMENT IN THE FUND IS NOT A DEPOSIT OR AN OBLIGATION OF, OR
GUARANTEED OR ENDORSED BY, ANY BANK, AND SHARES ARE NOT INSURED OR
OTHERWISE PROTECTED BY THE U.S. GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE
CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER GOVERNMENT AGENCY AND
INVOLVES RISK, INCLUDING POSSIBLE LOSS OF PRINCIPAL.
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.
KEEP THIS PROSPECTUS FOR FUTURE REFERENCE
EVERGREEN(SM) is a Service Mark of Evergreen Asset Management Corp.
Copyright 1995, Evergreen Asset Management Corp.
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TABLE OF CONTENTS
<TABLE>
<S> <C>
EXPENSE INFORMATION 3
DESCRIPTION OF THE FUND
Investment Objective and Policies 4
Investment Restrictions 5
MANAGEMENT OF THE FUND
Investment Adviser 8
Portfolio Manager 9
Sub-Administrator 9
PURCHASE AND REDEMPTION OF SHARES
How to Buy Shares 9
How to Redeem Shares 10
Exchange Privilege 11
Shareholder Services 12
Effect of Banking Laws 12
OTHER INFORMATION
Dividends, Distributions and Taxes 13
General Information 14
ADDITIONAL INVESTMENT INFORMATION i
APPENDIX A A-1
</TABLE>
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EXPENSE INFORMATION
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The table set forth below summarizes the shareholder transaction costs
associated with an investment in the Class Y shares of the Fund. For further
information see "Purchase and Redemption of Shares".
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Maximum Sales Charge Imposed on Purchases None
Sales Charge on Dividend Reinvestments None
Contingent Deferred Sales Charge None
Redemption Fee None
</TABLE>
The following table shows for the Fund the annual operating expenses (as
a percentage of average net assets) attributable to Class Y shares, together
with examples of the cumulative effect of such expenses on a hypothetical $1,000
investment for the periods specified assuming (i) a 5% annual return and (ii)
redemption at the end of each period.
KEYSTONE PENNSYLVANIA TAX FREE FUND
<TABLE>
<CAPTION>
EXAMPLE
ANNUAL OPERATING -------
EXPENSES+ Class Y
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<S> <C> <C> <C>
Management Fees 0.48% After 1 Year $ 6
12b-1 Fees None After 3 Years $19
Other Expenses 0.10% After 5 Years $32
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Total 0.58% After 10 Years $73
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</TABLE>
+ The estimated annual operating expenses and examples reflect fee waivers and
reimbursements for the Fund's Class Y shares for the fiscal year ending March
31, 1998. Actual expenses for Class Y shares of the Fund for the same period
are estimated to be 0.63%. Total Fund Operating Expenses include indirectly
paid expenses.
From time to time, the Fund's investment adviser may, at its discretion,
reduce or waive its fees or reimburse the Fund for certain expenses in order to
reduce expense ratios. The Fund's investment adviser may cease these waivers and
reimbursements at any time.
The purpose of the foregoing table is to assist an investor in
understanding the various costs and expenses that an investor in Class Y shares
of the Fund will bear directly or indirectly. The amounts set forth both in the
table and in the examples are estimated amounts for the Fund's fiscal year
ending March 31, 1998. THE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE
SHOWN. For a more complete description of the various costs and expenses borne
by the Fund see "Management of the Fund".
3
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DESCRIPTION OF THE FUND
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INVESTMENT OBJECTIVE AND POLICIES
The Fund seeks the highest possible current income exempt from federal
income taxes, while preserving capital.
Since the Fund considers preservation of capital as well as the level of
tax-exempt income, the Fund may realize less income than a mutual fund willing
to expose shareholders' capital to greater risk.
The investment objective of the Fund and the requirement that the Fund
invest, under ordinary circumstances, at least 80% of its assets in federally
tax-exempt municipal obligations that are also exempt from certain taxes in
Pennsylvania, are fundamental and may not be changed without the approval of a
majority of the Fund's outstanding shares as defined in the Investment Company
Act of 1940 ("1940 Act"), which means the lesser of (1) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares are
represented or (2) more than 50% of the outstanding shares (a "1940 Act
Majority").
There can be no assurance that the Fund will achieve its investment
objective since there is uncertainty in every investment.
The Fund also seeks the highest possible current income exempt from
Pennsylvania state and local taxes while preserving capital. The Fund also seeks
to hold securities exempt from Pennsylvania personal property tax.
Under ordinary circumstances, the Fund invests substantially all and at
least 80% of its assets in federally tax-exempt obligations, including municipal
bonds, notes and commercial paper obligations that are obligations issued by or
on behalf of states, territories and possessions of the United States ("U.S."),
the District of Columbia and their political subdivisions, agencies and
instrumentalities, the interest from which is exempt from federal income taxes,
including the alternative minimum tax. Thus, it is possible that up to 20% of
the Fund's assets could be in securities subject to the alternative minimum tax
and/or in taxable obligations.
Municipal bonds include fixed, variable or floating rate general
obligation and revenue bonds (including municipal lease obligations, resource
recovery bonds and zero coupon bonds). Municipal notes include tax anticipation
notes, bond anticipation notes, revenue anticipation notes and project notes.
Municipal commercial paper obligations are unsecured promissory notes issued by
municipalities to meet short-term credit needs.
Under ordinary circumstances, the Fund invests substantially all and at
least 80% of its assets in municipal obligations the interest from which is
exempt from federal taxes and Pennsylvania state income taxes. The securities
include debt obligations of the Commonwealth of Pennsylvania and its political
subdivisions, agencies, authorities and instrumentalities and debt obligations
of other qualifying issuers, such as Puerto Rico and the Virgin Islands. In
addition, the Fund attempts to invest in municipal obligations exempt from
Pennsylvania local income taxes and seeks to hold, on the annual assessment
date, municipal obligations exempt from Pennsylvania personal property taxes.
For a further discussion of Pennsylvania tax treatment and the factors
affecting investment in Pennsylvania municipal obligations, see Appendix A.
MUNICIPAL OBLIGATIONS
Municipal obligations include debt obligations issued by or on behalf of
a political subdivision of the U.S. or any agency or instrumentality thereof to
obtain funds for various public purposes. In addition, municipal obligations
include certain types of industrial development bonds that have been or may be
issued by or on behalf of public authorities to finance privately operated
facilities. General obligation bonds involve the credit of an issuer possessing
taxing power and are payable from the issuer's general unrestricted revenues.
Their payment may be dependent upon an appropriation by the issuer's legislative
body and may be subject to quantitative limitations on the issuer's taxing
power. Limited obligation or revenue bonds are payable only from the revenues of
a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source, such as the user
of the facility.
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The Fund invests principally in municipal obligations that are as of the
date of investment rated within the four highest grades by Standard & Poor's
Rating Group ("S&P") (AAA, AA, A and BBB), by Moody's Investors Service
("Moody's") (Aaa, Aa, A and Baa), by Fitch Investors Service, Inc. ("Fitch")
(AAA, AA, A and BBB) or, if not rated or rated under a different system, are of
comparable quality to obligations so rated as determined by the Fund's
investment adviser.
While the Fund may invest in securities of any maturity, it is currently
expected that the Fund will not invest in securities with maturities of more
than 30 years or less than 5 years (other than certain money market securities).
OTHER ELIGIBLE INVESTMENTS
The Fund may invest up to 20% of its assets under ordinary circumstances
and up to 100% of its assets for temporary defensive purposes in the following
types of instruments: (1) commercial paper, including master demand notes, that
at the date of investment is rated A-1 (the highest grade by S&P), PRIME-1 (the
highest grade by Moody's) or, if not rated by such services, is issued by a
company that at the date of investment has an outstanding issue rated A or
better by S&P or Moody's; (2) obligations, including certificates of deposit and
bankers' acceptances, of banks or savings and loan associations that have at
least $1 billion in assets as of the date of their most recently published
financial statements and are members of the Federal Deposit Insurance
Corporation, including U.S. branches of foreign banks and foreign branches of
U.S. banks; (3) corporate obligations (maturing in 13 months or less) that at
the date of investment are rated A or better by S&P or Moody's; (4) obligations
issued or guaranteed by the U.S. government or by any agency or instrumentality
of the U.S. government; (5) qualified "private activity" industrial development
bonds, the income from which, while exempt from federal income tax under Section
103 of the Internal Revenue Code of 1986, as amended (the "Code"), is includable
in the calculation of the federal alternative minimum tax; and (6) municipal
obligations, the income from which is exempt from federal income tax, but not
exempt from income tax, personal property tax or intangibles tax in Pennsylvania
and where such taxes apply.
The Fund may assume a temporary defensive position upon its investment
adviser's determination that market conditions so warrant. When the Fund invests
for defensive purposes, it seeks to limit the loss of principal and is not
pursuing its investment objectives.
The Fund may enter into repurchase agreements. The Fund may also enter
into reverse repurchase agreements, purchase and sell securities on a
when-issued and delayed-delivery basis, write covered call and put options and
purchase call and put options, including purchasing call and put options to
close out existing positions. The Fund may also engage in financial futures
contracts and related options transactions for hedging purposes, but not for
speculation. The Fund may invest in municipal obligations denominated in foreign
currencies. The Fund may use subsequently developed investment techniques that
are related to any of its investment policies. The Fund will supplement its
prospectuses as appropriate in the event that the employment of such techniques
is determined to constitute a material change in investment policy for the Fund.
The Fund is not expected to enter into repurchase agreements in the ordinary
course of business.
In addition to the options and futures mentioned above, the Fund, may, if
consistent with its investment objectives, also invest in certain other types of
"derivative investments," including structured securities.
For further information about the types of investments and investment
techniques available to the Fund, including the associated risks, see the
"Special Risk Considerations" and "Additional Investment Information" sections
of this Prospectus and the Statement of Additional Information.
INVESTMENT RESTRICTIONS
The Fund has adopted the fundamental restrictions summarized below, which
may not be changed without the vote of a 1940 Act Majority of the Fund's
outstanding shares. These restrictions and certain other fundamental and
nonfundamental restrictions are set forth in the Statement of Additional
Information. Unless otherwise stated, all references to the Fund's assets are in
terms of current market value.
The Fund may not:
(1) purchase any security of any issuer (other than issues of the U.S.
government, its agencies or instrumentalities) if as a result more than 25% of
its total assets would be invested in a single industry, including industrial
development bonds from the same facility or similar types of facilities;
governmental issuers of municipal
5
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bonds are not regarded as members of an industry, and the Fund may invest more
than 25% of its assets in industrial development bonds;
(2) invest more than 10% of its assets in securities with legal or
contractual restrictions on resale or in securities for which market quotations
are not readily available, or in repurchase agreements maturing in more than
seven days;
(3) borrow money or enter into reverse repurchase agreements, except that
the Fund may enter into reverse repurchase agreements and may borrow money from
banks for temporary or emergency purposes in aggregate amounts up to one-third
of the value of the Fund's net assets; provided that while borrowings from banks
(not including reverse repurchase agreements) exceed 5% of the Fund's net
assets, any such borrowings will be repaid before additional investments are
made; and
(4) make loans, except that the Fund may purchase or hold debt securities
consistent with its investment objective, lend portfolio securities valued at
not more than 15% of its total assets to broker-dealers and enter into
repurchase agreements.
PORTFOLIO TURNOVER. A portfolio turnover rate of 100% would occur if all of the
Fund's portfolio securities were replaced in one year. The portfolio turnover
rate experienced by the Fund directly affects the transaction costs relating to
the purchase and sale of securities which the Fund bears directly. A high rate
of portfolio turnover will increase such costs. See the Statement of Additional
Information for further information regarding the practices of the Fund
affecting portfolio turnover.
NONDIVERSIFICATION. The Fund is a nondiversified portfolio of an investment
company and, as such, there is no limit on the percentage of assets which can be
invested at any time in the securities of any single issuer. An investment in
the Fund, therefore, will entail greater risk than would exist in a diversified
investment company because the higher percentage of investments among fewer
issuers may result in greater fluctuation in the total market value of the
Fund's portfolio. The Fund intends to comply with Subchapter M of the Code which
requires that at the end of each quarter of each taxable year, with regard to at
least 50% of the Fund's total assets, no more than 5% of the total assets may be
invested in the securities of a single issuer and that with respect to the
remainder of the Fund's total assets, no more than 25% of its total assets are
invested in the securities of a single issuer.
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS. The Fund may invest in
repurchase agreements. Repurchase agreements are agreements by which the Fund
purchases a security (usually U.S. government securities) for cash and obtains a
simultaneous commitment from the seller (usually a bank or broker/dealer) to
repurchase the security at an agreed-upon price and specified future date. The
repurchase price reflects an agreed-upon interest rate for the time period of
the agreement. The Fund's risk is the inability of the seller to pay the
agreed-upon price on the delivery date. However, this risk is tempered by the
ability of the Fund to sell the security in the open market in the case of a
default. In such a case, the Fund may incur costs in disposing of the security
which would increase Fund expenses. The Fund's investment adviser will monitor
the creditworthiness of the firms with which the Fund enters into repurchase
agreements.
The Fund may borrow money by entering into "reverse repurchase
agreements" by which the Fund may agree to sell portfolio securities to
financial institutions such as banks and broker-dealers, and to repurchase them
at a mutually agreed upon date and price, for temporary or emergency purposes.
At the time the Fund enters into a reverse repurchase agreement, it will place
in a segregated custodial account cash, U.S. government securities or liquid
high grade debt obligations having a value at least equal to the repurchase
price (including accrued interest) and will subsequently monitor the account to
ensure that such equivalent value is maintained. Reverse repurchase agreements
involve the risk that the market value of the securities sold by the Fund may
decline below the repurchase price of those securities.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS. The Fund may purchase securities
on a when-issued or delayed delivery basis. These transactions are arrangements
in which the Fund purchases securities with payment and delivery scheduled for a
future time. The seller's failure to complete these transactions may cause the
Fund to miss a price or yield considered to be advantageous. Settlement dates
may be a month or more after entering into these transactions, and the market
values of the securities purchased may vary from the purchase prices.
Accordingly, the Fund may pay more or less than the market value of the
securities on the settlement date. The Fund may dispose of a commitment prior to
settlement if the Fund's investment adviser deems it appropriate to do so. In
addition, the Fund may enter into transactions to sell its purchase commitments
to third parties at current market
6
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values and simultaneously acquire other commitments to purchase similar
securities at later dates. The Fund may realize short-term profits or losses
upon the sale of such commitments.
LENDING OF PORTFOLIO SECURITIES. In order to generate additional income, the
Fund may lend its portfolio securities on a short-term or long-term basis to
broker/dealers. The Fund will only enter into loan arrangements with
creditworthy borrowers and will receive collateral in the form of cash or U.S.
government securities equal to at least 100% of the value of the securities
loaned. As a matter of fundamental investment policy, which cannot be changed
without shareholder approval, the Fund will not lend any of its assets except
portfolio securities up to 15% of the value of its net assets. There is the risk
that when lending portfolio securities, the securities may not be available to
the Fund on a timely basis and the Fund may, therefore, lose the opportunity to
sell the securities at a desirable price. In addition, in the event that a
borrower of securities would file for bankruptcy or become insolvent,
disposition of the securities may be delayed pending court action.
BORROWING. As a matter of fundamental policy, which may not be changed without
shareholder approval, the Fund may not borrow money except as a temporary
measure to facilitate redemption requests which might otherwise require the
untimely disposition of portfolio investments and for extraordinary or emergency
purposes, provided that the aggregate amount of such borrowings shall not exceed
one-third of the value of the total net assets at the time of such borrowing.
ILLIQUID SECURITIES. The Fund intends to follow policies of the Securities and
Exchange Commission as they are adopted from time to time with respect to
illiquid securities, including, at this time, (1) treating as illiquid
securities which may not be sold or disposed of within seven days at
approximately the value at which the Fund has valued such securities on its
books and (2) limiting its holdings of such securities to 15% of net assets.
Securities eligible for resale pursuant to Rule 144A under the Securities Act of
1933, which have been determined to be liquid, will not be considered by the
Fund's investment adviser to be illiquid or not readily marketable and,
therefore, are not subject to the aforementioned 15% limit. The inability of the
Fund to dispose of illiquid or not readily marketable investments readily or at
a reasonable price could impair the Fund's ability to raise cash for redemptions
or other purposes. The liquidity of securities purchased by the Fund which are
eligible for resale pursuant to Rule 144A will be monitored by the Fund's
investment adviser on an ongoing basis, subject to the oversight of the
Trustees. In the event that such a security is deemed to be no longer liquid,
the Fund's holdings will be reviewed to determine what action, if any, is
required to ensure that the retention of such security does not result in the
Fund having more than 15% of its net assets invested in illiquid or not readily
marketable securities.
MUNICIPAL LEASE OBLIGATIONS. The Fund may purchase municipal leases, which are
issued by state and local governments or authorities to finance the acquisition
of equipment and facilities. The Fund may purchase municipal lease obligations
in the form of participation interests which represent undivided proportional
interests in lease payments by a governmental or non-profit entity. The lease
payments and other rights under the lease provide for and secure the payments on
the certificates. Lease obligations may be limited by municipal charter or the
nature of the appropriation for the lease. In particular, lease obligations may
be subject to periodic appropriation. If the entity does not appropriate funds
for future lease payments, the entity cannot be compelled to make such payments.
Furthermore, a lease may provide that the certificate trustee cannot accelerate
lease obligations upon default. The trustee would only be able to enforce lease
payments as they become due. In the event of a default or failure of
appropriation, it is unlikely that the trustee would be able to obtain an
acceptable substitute source of payment or that the substitute source of payment
would generate tax-exempt income.
RESOURCE RECOVERY BONDS. The Fund may purchase resource recovery bonds, which
may be general obligations of the issuing municipality or supported by corporate
or bank guarantees. The viability of the resource recovery project,
environmental protection regulations and project operator tax incentives may
affect the value and credit quality of resource recovery bonds.
ZERO COUPON DEBT SECURITIES. The Fund may purchase zero coupon debt securities.
These securities do not make regular interest payments. Instead, they are sold
at a deep discount from their face value. In calculating their daily dividends,
each day the Fund takes into account as income a portion of the difference
between these securities' purchase price and their face values. Because they do
not pay current income, the prices of zero coupon debt securities can be very
volatile when interest rates change.
SPECIAL RISK CONSIDERATIONS
Like any investment, your investment in the Fund involves an element of
risk. Before you invest in the Fund, you should carefully evaluate your ability
to assume the risks your investment in the Fund poses.
7
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By itself, the Fund does not constitute a balanced investment program and
is not designed for investors seeking capital appreciation or maximum tax-exempt
income irrespective of fluctuations in principal or marketability. Shares of the
Fund would not be suitable for tax-exempt institutions and may not be suitable
for certain retirement plans that are unable to benefit from the Fund's
federally tax-exempt dividends. In addition, the Fund may not be an appropriate
investment for entities that are "substantial users" of facilities financed by
industrial development bonds or related persons thereof.
To the extent that the Fund is not fully diversified, it may be more
susceptible to adverse economic, political or regulatory developments affecting
a single issuer than would be the case if the Fund was more broadly diversified.
Should the Fund need to raise cash to meet a large number of redemptions
it might have to sell portfolio securities at a time when it would be
disadvantageous to do so.
In addition, the market value of the fixed income securities in which the
Fund may invest may vary inversely to changes in prevailing interest rates.
SPECIAL RISK FACTORS RELATED TO INVESTING IN MUNICIPAL SECURITIES
It should be noted that municipal securities may be adversely affected by
local political and economic conditions and developments within a state. For
example, adverse conditions in a significant industry within Pennsylvania may
from time to time have a correspondingly adverse effect on specific issuers
within Pennsylvania or on anticipated revenue to the State itself; conversely,
an improving economic outlook for a significant industry may have a positive
effect on such issuers or revenues.
The value of municipal securities may also be affected by general
conditions in the money markets or the municipal bond markets, the levels of
federal and state income tax rates, the supply of tax-exempt bonds, the size of
the particular offering, the maturity of the obligation, the credit quality and
rating of the issue, and perceptions with respect to the level of interest
rates. In general, the values of bonds tend to appreciate when interest rates
decline and depreciate when interest rates rise. An expanded discussion of the
risks associated with the purchase of securities issued in Pennsylvania is
contained in the Statement of Additional Information.
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MANAGEMENT OF THE FUND
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INVESTMENT ADVISER
The management of the Fund is supervised by the Trustees of the Trust
("Trustees"). Keystone serves as investment adviser to the Fund. Keystone has
provided investment advisory and management services to investment companies and
private accounts since 1932. Keystone is located at 200 Berkeley Street, Boston,
Massachusetts 02116-5034. Keystone is an indirect wholly-owned subsidiary of
First Union National Bank ("FUNB"). FUNB is a subsidiary of First Union
Corporation ("First Union"). First Union is headquartered in Charlotte, North
Carolina, and had $143 billion in consolidated assets as of June 30, 1997. First
Union and its subsidiaries provide a broad range of financial services to
individuals and businesses throughout the United States. Keystone and its
affiliates manage or otherwise oversee the investment of over $62 billion in
assets belonging to a wide range of clients, including all of the Evergreen
Keystone Funds.
Pursuant to an Investment Advisory and Management Agreement with the
Trust (the "Advisory Agreement"), Keystone manages the investment and
reinvestment of the Fund's assets, supervises the operation of the Trust and the
Fund and provides all necessary office space, facilities and equipment.
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The Fund pays Keystone a fee for its services at the annual rate set
forth below:
<TABLE>
<CAPTION>
AGGREGATE
NET ASSET VALUE
MANAGEMENT OF THE SHARES
FEE OF THE FUND
<S> <C>
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0.55% of the first $ 50,000,000, plus
0.50% of the next $ 50,000,000, plus
0.45% of the next $100,000,000, plus
0.40% of the next $100,000,000, plus
0.35% of the next $100,000,000, plus
0.30% of the next $100,000,000, plus
0.25% of amounts over $500,000,000.
</TABLE>
Keystone's fee is computed as of the close of business each business day.
PORTFOLIO MANAGER
Jocelyn Turner is the Fund's portfolio manager. Ms. Turner has been Vice
President of Tax Exempt Fixed Income since she joined First Union (then with
First Fidelity Bank) in November 1992. Before that time, Ms. Turner was a
municipal bond fund portfolio manager and Vice President of Tax Exempt Fixed
Income at One Federal Asset Management, Boston, MA.
SUB-ADMINISTRATOR
BISYS Fund Services ("BISYS"), an affiliate of Evergreen Keystone
Distributor, Inc. ("EKD"), distributor for the Evergreen Keystone Funds, serves
as sub-administrator to the Fund and is entitled to receive a fee from EKIS
based on the aggregate average daily net assets of all the mutual funds
administered by EKIS for which subsidiaries of First Union also serve as
investment adviser. The sub-administration fee is calculated in accordance with
the following schedule:
<TABLE>
<CAPTION>
Sub-Administration Fee
- -----------------------
<S> <C>
0.0100% on the first $7 billion
0.0075% on the next $3 billion
0.0050% on the next $15 billion
0.0040% on assets in excess of $25 billion
</TABLE>
The total assets of the mutual funds administered by EKIS for which
subsidiaries of First Union also serve as investment adviser were approximately
$30.5 billion as of June 30, 1997.
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PURCHASE AND REDEMPTION OF SHARES
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HOW TO BUY SHARES
Class Y shares are offered at net asset value without a front-end sales
charge or a contingent deferred sales charge. Class Y shares are only offered to
(i) persons who at or prior to December 31, 1994 owned shares in a mutual fund
advised by Evergreen Asset Management Corp. ("Evergreen Asset"), (ii) certain
institutional investors and (iii) investment advisory clients of FUNB or its
affiliates.
Eligible investors may purchase Class Y shares of the Fund through
broker-dealers, banks or other financial intermediaries, or directly through
EKD. In addition, you may purchase Class Y shares by mailing to the Fund, c/o
Evergreen Keystone Service Company ("EKSC"), P.O. Box 2121, Boston,
Massachusetts 02106-2121, a completed Application and a check payable to the
Fund. You may also telephone 1-800-343-2898 to obtain the number of an account
to which you can wire or electronically transfer funds and then send in a
completed Application. The minimum initial investment is $1,000, which may be
waived in certain situations. Subsequent investments in any amount may be made
by check, by wiring federal funds, by direct deposit or by an electronic funds
transfer.
There is no minimum amount for subsequent investments. Investments of $25
or more are allowed under the Systematic Investment Plan. Share certificates are
not issued. See the Application for more information. Only Class Y shares are
offered through this Prospectus (see "General Information" -- "Other Classes of
Shares").
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HOW THE FUND VALUES ITS SHARES. The net asset value of each Class of shares of
the Fund is calculated by dividing the value of the amount of the Fund's net
assets attributable to that Class by the outstanding shares of that Class.
Shares are valued each day the New York Stock Exchange (the "Exchange") is open
as of the close of regular trading (currently 4:00 p.m. Eastern time). The
Exchange is closed on New Year's Day, Dr. Martin Luther King Jr. Day, Presidents
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day. The securities in the Fund are valued at their current market
value determined on the basis of market quotations or, if such quotations are
not readily available, such other methods as the Trustees of the Trust believe
would accurately reflect fair market value.
ADDITIONAL PURCHASE INFORMATION. As a condition of this offering, if a purchase
is canceled due to nonpayment or because an investor's check does not clear, the
investor will be responsible for any loss the Fund or the Fund's investment
adviser incurs. If such investor is an existing shareholder, the Fund may redeem
shares from an investor's account to reimburse the Fund or the Fund's investment
adviser for any loss. In addition, such investors may be prohibited or
restricted from making further purchases in any of the Evergreen Keystone Funds.
The Fund will not accept third party checks other than those payable directly to
an account which has been in existence at least thirty days.
HOW TO REDEEM SHARES
You may "redeem" (i.e., sell) your Class Y shares in the Fund to the Fund
for cash, (at the net redemption value) on any day the Exchange is open, either
directly by writing to the Fund, c/o EKSC, or through your financial
intermediary. The amount you will receive is the net asset value adjusted for
fractions of a cent next calculated after the Fund receives your request in
proper form. Proceeds generally will be sent to you within seven days. However,
for shares recently purchased by check, the Fund will not send proceeds until it
is reasonably satisfied that the check has been collected (which may take up to
15 days). Once a redemption request has been telephoned or mailed, it is
irrevocable and may not be modified or canceled.
REDEEMING SHARES THROUGH YOUR FINANCIAL INTERMEDIARY. The Fund must receive
instructions from your financial intermediary before 4:00 p.m. (Eastern time)
for you to receive that day's net asset value. Your financial intermediary is
responsible for furnishing all necessary documentation to the Fund and may
charge you for this service. Certain financial intermediaries may require that
you give instructions earlier than 4:00 p.m. (Eastern time).
REDEEMING SHARES DIRECTLY BY MAIL OR TELEPHONE. Send a signed letter of
instruction or stock power form to the Fund, c/o EKSC; the registrar, transfer
agent and dividend-disbursing agent for the Fund. Stock power forms are
available from your financial intermediary, EKSC, and many commercial banks.
Additional documentation is required for the sale of shares by corporations,
financial intermediaries, fiduciaries and surviving joint owners. Signature
guarantees are required for all redemption requests for shares with a value of
more than $50,000. Currently, the requirement for a signature guarantee has been
waived on redemptions of $50,000 or less when the account address of record has
been the same for a minimum period of 30 days. The Fund and EKSC reserve the
right to withdraw this waiver at any time. A signature guarantee must be
provided by a bank or trust company (not a Notary Public), a member firm of a
domestic stock exchange or by other financial institutions whose guarantees are
acceptable under the Securities Exchange Act of 1934 and EKSC's policies.
Shareholders may withdraw amounts of $1,000 or more (up to $50,000) from
their accounts by calling the telephone number on the front page of this
Prospectus between the hours of 8:00 a.m. and 5:30 p.m. (Eastern time) each
business day (i.e., any weekday exclusive of days on which the Exchange or EKSCs
offices are closed). Redemption requests received after 4:00 p.m. (Eastern time)
will be processed using the net asset value determined on the next business day.
Such redemption requests must include the shareholder's account name, as
registered with the Fund, and the account number. During periods of drastic
economic or market changes, shareholders may experience difficulty in effecting
telephone redemptions. If you cannot reach the Fund by telephone, you should
follow the procedures for redeeming by mail or through a broker-dealer as set
forth herein. The telephone redemption service is not made available to
shareholders automatically. Shareholders wishing to use the telephone redemption
service must complete the appropriate sections on the Application and choose how
the redemption proceeds are to be paid. Redemption proceeds will either (i) be
mailed by check to the shareholder at the address in which the account is
registered or (ii) be wired to an account with the same registration as the
shareholder's account in the Fund at a designated commercial bank.
In order to insure that instructions received by EKSC are genuine when
you initiate a telephone transaction, you will be asked to verify certain
criteria specific to your account. At the conclusion of the transaction,
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you will be given a transaction number confirming your request, and written
confirmation of your transaction will be mailed the next business day. Your
telephone instructions will be recorded. Redemptions by telephone are allowed
only if the address and bank account of record have been the same for a minimum
period of 30 days. The Fund reserves the right at any time to terminate,
suspend, or change the terms of any redemption method described in this
Prospectus, except redemption by mail, and to impose fees.
Except as otherwise noted, the Fund, EKSC, and EKD will not assume
responsibility for the authenticity of any instructions received by any of them
from a shareholder in writing, over the Evergreen Keystone Express Line, or by
telephone. EKSC will employ reasonable procedures to confirm that instructions
received over the Evergreen Keystone Express Line or by telephone are genuine.
The Fund, EKSC, and EKD will not be liable when following instructions received
over the Evergreen Keystone Express Line or by telephone that EKSC reasonably
believes are genuine.
EVERGREEN KEYSTONE EXPRESS LINE. The Evergreen Keystone Express Line offers you
specific fund account information and price and yield quotations as well as the
ability to do account transactions, including investments, exchanges and
redemptions. You may access the Evergreen Keystone Express Line by dialing toll
free 1-800-346-3858 on any touch-tone telephone, 24 hours a day, seven days a
week.
GENERAL. The sale of shares is a taxable transaction for federal income tax
purposes. The Fund may temporarily suspend the right to redeem its shares when
(i) the Exchange is closed, other than customary weekend and holiday closings;
(ii) trading on the Exchange is restricted; (iii) an emergency exists and the
Fund cannot dispose of its investments or fairly determine their value; or (iv)
the Securities and Exchange Commission ("SEC") so orders. The Fund reserves the
right to close an account that through redemption has fallen below $1,000 and
has remained so for thirty days. Shareholders will receive sixty days' written
notice to increase the account value to at least $1,000 before the account is
closed. The Fund has elected to be governed by Rule 18f-1 under the 1940 Act
pursuant to which the Fund is obligated to redeem shares solely in cash, up to
the lesser of $250,000 or 1% of the Fund's total net assets, during any ninety
day period for any one shareholder.
EXCHANGE PRIVILEGE
HOW TO EXCHANGE SHARES. You may exchange some or all of your Class Y shares for
shares of the same Class in the other Evergreen Keystone Funds through your
financial intermediary, by calling or writing to EKSC or by using the Evergreen
Keystone Express Line as described above. Once an exchange request has been
telephoned or mailed, it is irrevocable and may not be modified or canceled.
Exchanges will be made on the basis of the relative net asset values of the
shares exchanged next determined after an exchange request is received. An
exchange which represents an initial investment in another Evergreen Keystone
Fund is subject to the minimum investment and suitability requirements of each
Fund.
Each of the Evergreen Keystone Funds has different investment objectives
and policies. For complete information, a prospectus of the fund into which an
exchange will be made should be read prior to the exchange. An exchange order
must comply with the requirement for a redemption or repurchase order and must
specify the dollar value or number of shares to be exchanged. An exchange is
treated for federal income tax purposes as a redemption and purchase of shares
and may result in the realization of a capital gain or loss. Shareholders are
limited to five exchanges per calendar year, with a maximum of three per
calendar quarter. This exchange privilege may be modified or discontinued at any
time by the Fund upon sixty days' notice to shareholders and is only available
in states in which shares of the fund being acquired may lawfully be sold.
EXCHANGES THROUGH YOUR FINANCIAL INTERMEDIARY. The Fund must receive exchange
instructions from your financial intermediary before 4:00 p.m. (Eastern time)
for you to receive that day's net asset value. Your financial intermediary is
responsible for furnishing all necessary documentation to the Fund and may
charge you for this service.
EXCHANGES BY TELEPHONE AND MAIL. Exchange requests received by the Fund after
4:00 p.m. (Eastern time) will be processed using the net asset value determined
at the close of the next business day. During periods of drastic economic or
market changes, shareholders may experience difficulty in effecting telephone
exchanges. You should follow the procedures outlined below for exchanges by mail
if you are unable to reach EKSC by telephone. If you wish to use the telephone
exchange service you should indicate this on the Application. As noted above,
each Fund will employ reasonable procedures to confirm that instructions for the
redemption or exchange of shares communicated by telephone are genuine. A
telephone exchange may be refused by the Fund or EKSC if it is believed
advisable to do so. Procedures for exchanging Fund shares may be modified,
including the right to charge
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for exchanges, or terminated at any time. Written requests for exchanges should
follow the same procedures outlined for written redemption requests in the
section entitled "How to Redeem Shares," however, no signature guarantee is
required.
SHAREHOLDER SERVICES
The Fund offers the following shareholder services. For more information
about these services or your account, contact your financial intermediary, EKSC
or call the toll-free number on the front page of this Prospectus. Some services
are described in more detail in the Application.
SYSTEMATIC INVESTMENT PLAN. Under a Systematic Investment Plan, you may invest
as little as $25 per month to purchase shares of a fund with no minimum initial
investment required.
TELEPHONE INVESTMENT PLAN. You may make investments into an existing account
electronically in amounts of not less than $50 or more than $10,000 per
investment. Telephone investment requests received by 3:00 p.m. (Eastern time)
will be credited to a shareholder's account the day the request is received.
Shares purchased under the Funds Systematic Investment Plan or Telephone
Investment Plan may not be redeemed for ten days from the date of investment.
SYSTEMATIC WITHDRAWAL PLAN. When an account of $10,000 or more is opened or when
an existing account reaches that size, you may participate in the Fund's
Systematic Withdrawal Plan by filling out the appropriate part of the
Application. Under this Plan, you may receive (or designate a third party to
receive) a monthly or quarterly fixed-withdrawal payment in a stated amount of
at least $75, or a maximum of 1.00% per month or 3.00% per quarter of the total
net asset value of the Fund shares in your account when the Plan was
established. Fund shares will be redeemed as necessary to meet withdrawal
payments. All participants must elect to have their dividends and capital gain
distributions reinvested automatically.
AUTOMATIC REINVESTMENT PLAN. For the convenience of investors, all dividends and
distributions are automatically reinvested in full and fractional shares of the
Fund at the net asset value per share at the close of business on the record
date, unless otherwise requested by a shareholder in writing. If the transfer
agent does not receive a written request for subsequent dividends and/or
distributions to be paid in cash at least three full business days prior to a
given record date, the dividends and/or distributions to be paid to a
shareholder will be reinvested.
DOLLAR COST AVERAGING. Through dollar cost averaging you can invest a fixed
dollar amount each month or each quarter in any Evergreen Keystone Fund. This
results in more shares being purchased when the selected fund's net asset value
is relatively low and fewer shares being purchased when the fund's net asset
value is relatively high and may result in a lower average cost per share than a
less systematic investment approach.
Prior to participating in dollar cost averaging, you must establish an
account in an Evergreen Keystone Fund. You should designate on the Application
(1) the dollar amount of each monthly or quarterly investment you wish to make
and (2) the fund in which the investment is to be made. Thereafter, on the first
day of the designated month, an amount equal to the specified monthly or
quarterly investment will automatically be redeemed from your initial account
and invested in shares of the designated fund.
TWO DIMENSIONAL INVESTING. You may elect to have income and capital gains
distributions from any class of Evergreen Keystone Fund shares you own
automatically invested to purchase the same class of shares of any other
Evergreen Keystone Fund. You may select this service on your Application and
indicate the Evergreen Keystone Fund(s) into which distributions are to be
invested.
EFFECT OF BANKING LAWS
The Glass-Steagall Act and other banking laws and regulations presently
prohibit member banks of the Federal Reserve System ("Member Banks") or their
non-bank affiliates from sponsoring, organizing, controlling, or distributing
the shares of registered open-end investment companies such as the Fund. Such
laws and regulations also prohibit banks from issuing, underwriting or
distributing securities in general. However, under the Glass-Steagall Act and
such other laws and regulations, a Member Bank or an affiliate thereof may act
as investment adviser, transfer agent or custodian to a registered open-end
investment company and may also act as agent in connection with the purchase of
shares of such an investment company upon the order of its customer. Keystone
and its affiliates, since they are direct or indirect subsidiaries of FUNB, are
subject to and in compliance with the aforementioned laws and regulations.
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Changes to applicable laws and regulations or future judicial or
administrative decisions could result in Keystone being prevented from
continuing to perform the services required under the investment advisory
agreement or FUNB from acting as agent in connection with the purchase of shares
of the Fund by its customers. If Keystone or its affiliates were prevented from
continuing to provide the services called for under the investment advisory
agreement, it is expected that the Trustees would identify, and call upon the
Fund's shareholders to approve, a new investment adviser. If this were to occur,
it is not anticipated that the shareholders of the Fund would suffer any adverse
financial consequences.
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OTHER INFORMATION
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DIVIDENDS, DISTRIBUTIONS AND TAXES
The Fund intends to declare dividends from net investment income daily
and distribute to its shareholders such dividends monthly. The Fund intends to
declare and distribute all net realized long-term capital gains at least
annually. Shareholders receive Fund distributions in the form of additional
shares of that class of shares upon which the distribution is based or, at the
shareholder's option, in cash. Shareholders of the Fund who have not opted to
receive cash prior to the payable date for any dividend from net investment
income or the record date for any capital gains distribution will have the
number of such shares determined on the basis of the Fund's net asset value per
share computed at the end of that day after adjustment for the distribution. Net
asset value is used in computing the number of shares in both capital gains and
income distribution reinvestments. There is a possibility that shareholders may
lose the tax-exempt status on accrued income on municipal bonds if shares of the
Fund are redeemed before a dividend has been declared.
Account statements and/or checks, as appropriate, will be mailed within
seven days after the Fund pays a distribution. Unless the Fund receives
instructions to the contrary before the record or payable date, as the case may
be, it will assume that a shareholder wishes to receive that distribution and
future capital gains and income distributions in shares. Instructions continue
in effect until changed in writing.
The Fund has qualified and intends to continue to qualify as a RIC under
the Code. The Fund is a separate taxable entity for purposes of Code provisions
applicable to RICs. The Fund qualifies if, among other things, it distributes to
its shareholders at least 90% of its net investment income for its fiscal year.
The Fund also intends to make timely distributions, if necessary, sufficient in
amount to avoid the nondeductible 4% excise tax imposed on a RIC to the extent
that it fails to distribute, with respect to each calendar year, at least 98% of
its ordinary income for such calendar year and 98% of its net capital gains for
the one-year period ending on October 31 of such calendar year.
If the Fund qualifies as a RIC and if it distributes substantially all of
its net investment income and net capital gains, if any, to shareholders, it
will be relieved of any federal income tax liability.
Any taxable dividend declared in October, November or December to
shareholders of record in such a month and paid by the following January 31 will
be includable in the taxable income of shareholders as if paid on December 31 of
the year in which the dividend was declared.
The Fund expects that substantially all of its dividends will be "exempt
interest dividends," which should be treated as excludable from federal gross
income. In order to pay exempt interest dividends, at least 50% of the value of
the Fund's assets must consist of federally tax-exempt obligations at the close
of each quarter. An exempt interest dividend is any dividend or part thereof
(other than a capital gain dividend) paid by the Fund with respect to its net
federally excludable municipal obligation interest and designated as an exempt
interest dividend in a written notice mailed to each shareholder not later than
60 days after the close of its taxable year. The percentage of the total
dividends paid by the Fund with respect to any taxable year that qualifies as
exempt interest dividends will be the same for all shareholders of the Fund
receiving dividends with respect to such year. If a shareholder receives an
exempt interest dividend with respect to any share and such share has been held
for six months or less, any loss on the sale or exchange of such share will be
disallowed to the extent of the exempt interest dividend amount.
Any shareholder of the Fund who may be a "substantial user" of a facility
financed with an issue of tax-exempt obligations or a "related person" to such a
user should consult his tax adviser concerning his qualification to receive
exempt interest dividends should the Fund hold obligations financing such
facility.
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Under regulations to be promulgated, to the extent attributable to
interest paid on certain private activity bonds, the Fund's exempt interest
dividends, while otherwise tax-exempt, will be treated as a tax preference item
for alternative minimum tax purposes. Corporate shareholders should also be
aware that the receipt of exempt interest dividends could subject them to
alternative minimum tax under the provisions of Section 56(g) of the Code
(relating to "adjusted current earnings").
Under particularly unusual circumstances, such as when the Fund is in a
prolonged defensive investment position, it is possible that no portion of the
Fund's distributions of income to its shareholders for a fiscal year would be
exempt from federal income tax. The Trust does not presently anticipate,
however, that such unusual circumstances will occur.
Since none of the Fund's income will consist of corporate dividends, no
distributions will qualify for the 70% corporate dividends received deduction.
The Fund intends to distribute its net capital gains as capital gains
dividends. Shareholders should treat such dividends as long-term capital gains.
The Fund will designate capital gains distributions as such by a written notice
mailed to each shareholder no later than 60 days after the close of the Fund's
taxable year. If a shareholder receives a capital gain dividend and holds his
shares for six months or less, then any allowable loss on disposition of such
shares will be treated as a long-term capital loss to the extent of such capital
gain dividend.
Interest on indebtedness incurred or continued by shareholders to
purchase or carry shares of the Fund will not be deductible for federal income
tax purposes to the extent of the portion of the interest expense relating to
exempt interest dividends. Such portion is determined by multiplying the total
amount of interest paid or accrued on the indebtedness by a fraction, the
numerator of which is the exempt interest dividends received by a shareholder in
his taxable year and the denominator of which is the sum of the exempt interest
dividends and the taxable distributions out of the Fund's investment income and
long-term capital gains received by the shareholder.
The Fund may acquire options to "put" specified securities to municipal
bond dealers or issuers from whom the securities are purchased. It is expected
that the Fund will be treated for federal income tax purposes as the owner of
the municipal bonds acquired subject to the put. The interest on the municipal
bonds will be tax-exempt to the Fund, and the purchase price must be allocated
between such securities and the puts based upon their respective fair market
values. The Internal Revenue Service has not issued a published ruling on this
matter and could reach a different conclusion.
STATE INCOME TAXES
The exemption of interest on municipal bonds for federal income tax
purposes does not necessarily result in exemption under the income, corporate or
personal property tax laws of any state or city. Generally, individual
shareholders of the Fund receive tax-exempt treatment at the state level for
distributions derived from municipal securities of their state of residency. The
Fund will report to shareholders on a state by state basis the sources of its
exempt interest dividends. For a further discussion of Pennsylvania tax
treatment relating to the Fund, see Appendix A to this Prospectus.
The foregoing is only a summary of some of the important tax
considerations generally affecting the Fund and its shareholders. No attempt is
made to present a detailed explanation of the federal or state income or other
tax treatment of the Fund or its shareholders, and this discussion is not
intended as a substitute for careful tax planning. Accordingly, shareholders are
urged to consult their tax advisers with specific reference to their tax
situations.
GENERAL INFORMATION
PORTFOLIO TRANSACTIONS. Consistent with the Conduct Rules of the National
Association of Securities Dealers, Inc., and subject to seeking best price and
execution, the Fund may consider sales of its shares as a factor in the
selection of dealers to enter into portfolio transactions with the Fund.
ORGANIZATION. The Fund is a separate investment series of Keystone State Tax
Free Fund, a Massachusetts business trust organized in 1990.
A shareholder in each Class of the Fund will be entitled to his or her
share of all dividends and distributions from the Fund's assets, based upon the
relative value of such shares to those of other Classes of the Fund, and, upon
redeeming shares, will receive the then current net asset value of the Class of
shares of the Fund
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represented by the redeemed shares less any applicable contingent deferred sales
charge. The Trust is empowered to establish, without shareholder approval,
additional investment series, which may have different investment objectives,
and additional Classes of shares for any existing or future series. If an
additional series or Class were established in the Fund, each share of the
series or Class would normally be entitled to one vote for all purposes.
Generally, shares of each series and Class would vote together as a single Class
on matters, such as the election of Trustees, that affect each series and Class
in substantially the same manner. Class A, Class B, Class C and Class Y shares
have identical voting, dividend, liquidation and other rights, except that each
Class bears, to the extent applicable, its own distribution, shareholder service
and transfer agency expenses as well as any other expenses applicable only to a
specific Class. Each Class of shares votes separately with respect to Rule 12b-1
distribution plans and other matters for which separate Class voting is
appropriate under applicable law. Shares are entitled to dividends as determined
by the Trustees and, in liquidation of the Fund, are entitled to receive the net
assets of the Fund.
TRANSFER AGENT AND DIVIDEND DISBURSING AGENT. Evergreen Keystone Service
Company, 200 Berkeley Street, Boston, Massachusetts 02116, acts as the Fund's
transfer agent and dividend disbursing agent. EKSC is an indirect, wholly-owned
subsidiary of FUNB.
CUSTODIAN. State Street Bank and Trust Company, P.O. Box 9021, Boston,
Massachusetts 02205-9827, acts as the Fund's custodian.
PRINCIPAL UNDERWRITER. EKD, an affiliate of BISYS, located at 125 West 55th
Street, New York, New York 10019, is the principal underwriter of the Fund.
BISYS also acts as sub-administrator to the Fund.
OTHER CLASSES OF SHARES. The Fund currently offers four classes of shares, Class
A, Class B, Class C and Class Y, and may in the future offer additional classes.
Class Y shares are the only class of shares offered by this Prospectus and are
only available to (i) persons who at or prior to December 31, 1994, owned shares
in a mutual fund advised by Evergreen Asset, (ii) certain institutional
investors and (iii) investment advisory clients of FUNB or its affiliates. The
dividends payable with respect to Class A, Class B and Class C shares will be
less than those payable with respect to Class Y shares due to the distribution
and distribution related expenses borne by Class A, Class B and Class C shares
and the fact that such expenses are not borne by Class Y shares.
PERFORMANCE INFORMATION. The Fund's performance may be quoted in advertising in
terms of yield or total return. Both types of performance are based on SEC
formulas and are not intended to indicate future performance.
Yield is a way of showing the rate of income the Fund earns on its
investments as a percentage of the Fund's share price. The Fund's yield is
calculated according to accounting methods that are standardized by the SEC for
all stock and bond funds. Because yield accounting methods differ from the
method used for other accounting purposes, the Fund's yield may not equal its
distribution rate, the income paid to your account or the income reported in the
Fund's financial statements. To calculate yield, the Fund takes the interest
income it earned from its portfolio of investments (as defined by the SEC
formula) for a 30-day period (net of expenses), divides it by the average number
of shares entitled to receive dividends, and expresses the result as an
annualized percentage rate based on the Fund's share price at the end of the
30-day period. This yield does not reflect gains or losses from selling
securities.
Total returns are based on the overall dollar or percentage change in the
value of a hypothetical investment in the Fund. The Fund's total return shows
its overall change in value including changes in share prices and assumes all
the Fund's distributions are reinvested. A cumulative total return reflects the
Fund's performance over a stated period of time. An average annual total return
reflects the hypothetical annually compounded return that would have produced
the same cumulative total return if the Fund's performance had been constant
over the entire period. Because average annual total returns tend to smooth out
variations in the Fund's return, you should recognize that they are not the same
as actual year-by-year results. To illustrate the components of overall
performance, the Fund may separate its cumulative and average annual total
returns into income results and realized and unrealized gain or loss.
The Fund may also quote tax-equivalent yields, which show the taxable
yields an investor would have to earn before taxes to equal the Fund's tax-free
yields. A tax-equivalent yield is calculated by dividing the Fund's tax-exempt
yield by the result of one minus a stated federal tax rate. If only a portion of
the Fund's income was tax-exempt, only that portion is adjusted in the
calculation.
Comparative performance information may also be used from time to time in
advertising or marketing the Fund's shares, including data from Lipper
Analytical Services, Inc., Morningstar and other industry publications. The Fund
may also advertise in items of sales literature an "actual distribution rate"
which is computed by dividing the total ordinary income distributed (which may
include the excess of short-term capital gains over losses) to
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shareholders for the latest twelve month period by the maximum public offering
price per share on the last day of the period. Investors should be aware that
past performance may not be reflective of future results.
In marketing the Fund's shares, information may be provided that is
designed to help individuals understand their investment goals and explore
various financial strategies. Such information may include: publications
describing general principles of investing, such as asset allocation,
diversification, risk tolerance, and goal setting; a questionnaire designed to
help create a personal financial profile; and an action plan offering investment
alternatives. The information provided to investors may also include discussions
of other Evergreen Keystone mutual funds, products, and services, which may
include: retirement investing; brokerage products and services; the effects of
periodic investment plans and dollar cost averaging; saving for college; and
charitable giving. In addition, the information provided to investors may quote
financial or business publications and periodicals, including model portfolios
or allocations, as they relate to fund management, investment philosophy, and
investment techniques. The Principal Underwriter may also reprint, and use as
advertising and sales literature, articles from EVERGREEN KEYSTONE EVENTS, a
quarterly magazine provided to Evergreen Keystone Fund shareholders.
LIABILITY UNDER MASSACHUSETTS LAW. Under Massachusetts law, trustees and
shareholders of a business trust may, in certain circumstances, be held
personally liable for its obligations. The Declaration of Trust under which the
Fund operates provides that no Trustee or shareholder will be personally liable
for the obligations of the Trust and that every written contract made by the
Trust contain a provision to that effect. If any Trustee or shareholder were
required to pay any liability of the Trust, that person would be entitled to
reimbursement from the general assets of the Trust.
ADDITIONAL INFORMATION. This Prospectus and the Statement of Additional
Information, which has been incorporated by reference herein, do not contain all
the information set forth in the Registration Statement filed by the Trust with
the SEC under the Securities Act of 1933, as amended. Copies of the Registration
Statement may be obtained at a reasonable charge from the SEC or may be
examined, without charge, at the offices of the SEC in Washington, D.C.
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ADDITIONAL INVESTMENT INFORMATION
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CORPORATE AND MUNICIPAL BOND RATINGS
S&P CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES. An S&P note rating reflects the liquidity concerns and
market access risks unique to notes. Notes due in three years or less will
likely receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria are used in making that
assessment:
1. amortization schedule (the larger the final maturity relative to other
maturities the more likely it will be treated as a note); and
2. 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 ratings are as follows:
1. SP-1 -- Strong capacity to pay principal and interest. Those
issues determined to possess a very strong capacity to pay debt service are
given a plus (+) designation.
2. SP-2 -- Satisfactory capacity to pay principal and interest,
with some vulnerability to adverse financial and economic changes over the
terms of the notes.
3. SP-3 -- Speculative capacity to pay principal and interest.
B. TAX EXEMPT DEMAND BONDS. S&P assigns "dual" ratings to all long-term debt
issues that have as part of their provisions a demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, "AAA/A-1+"). For the newer "demand notes," S&P note rating
symbols, combined with the commercial paper symbols, are used (for example,
"SP-1+/A-1+").
C. CORPORATE AND MUNICIPAL BOND RATINGS. An S&P corporate or municipal bond
rating is a current assessment of the creditworthiness of an obligor, including
obligors outside the U.S., with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers or
lessees. Ratings of foreign obligors do not take into account currency exchange
and related uncertainties. The ratings are based on current information
furnished by the issuer or obtained by S&P from other sources it considers
reliable.
The ratings are based, in varying degrees, on the following
considerations:
1. 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;
2. nature of and provisions of the obligation; and
3. 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.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, 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.
A provisional rating is sometimes used by S&P. It assumes the successful
completion of the project being financed by the debt being rated and indicates
that payment of debt service requirements is largely or entirely dependent upon
the successful and timely completion of the project. This rating, however, while
addressing credit quality subsequent to completion of the project, makes no
comment on the likelihood of, or the risk of default upon failure of, such
completion.
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Bond ratings are as follows:
1. AAA -- Debt rated AAA has the highest rating assigned by S&P. Capacity
to pay interest and repay principal is extremely strong.
2. 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.
3. 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.
4. 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 in higher rated categories.
MOODY'S CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES. A Moody's rating for municipal short-term obligations will
be designated Moody's Investment Grade or ("MIG"). These ratings recognize the
difference between short-term credit risk and long-term risk. Factors affecting
the liquidity of the borrower and the short-term cyclical elements are critical
in short-term ratings.
A short-term rating may also be assigned on issues with a demand
feature -- variable rate demand obligation ("VRDO"). Such ratings will be
designated as VMIG. Short-term ratings on issues with demand features are
differentiated by the use of the VMIG symbol to reflect such characteristics as
payment upon periodic demand rather than fixed maturity dates and payment
relying on the external liquidity.
The note ratings are as follows:
1. MIG1/VMIG1 This designation denotes the best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broadbased access to the market for refinancing.
2. MIG2/VMIG2 This designation denotes high quality. Margins of
protection are ample although not so large as in the preceding group.
3. MIG3/VMIG3 This designation denotes favorable quality. All security
elements are accounted for but there is lacking the undeniable strength of the
preceding grades. Liquidity and cash flow protection may be narrow and market
access for refinancing is likely to be less well established.
4. MIG4/VMIG4 This designation denotes adequate quality. Protection
commonly regarded as required of an investment security is present and although
not distinctly or predominantly speculative, there is specific risk.
B. CORPORATE AND MUNICIPAL BOND RATINGS. 1. AAA -- Bonds rated AAA are judged to
be of the best quality. They carry the smallest degree of investment risk and
are generally referred to as "gilt-edge." 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.
2. AA -- Bonds rated AA are judged to be of high quality by all
standards. Together with the AAA group, they comprise what are generally known
as high grade bonds. 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 that
make the long term risks appear somewhat larger than in AAA securities.
3. A -- Bonds 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
that suggest a susceptibility to impairment sometime in the future.
4. BAA -- Bonds rated BAA are considered to be medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present, but certain
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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.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from AA through BAA in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
CON. ( -- ) -- Municipal bonds for which the security depends upon the
completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (1) earnings of projects under
construction, (2) earnings of projects unseasoned in operation experience, (3)
rentals that begin when facilities are completed, or (4) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon completion of construction or elimination of basis of condition.
Those municipal bonds in the AA, A, and BAA groups that Moody's believes
possess the strongest investment attributes are designated by the symbols AA 1,
A 1, and BAA 1.
FITCH CORPORATE AND MUNICIPAL RATINGS
A. MUNICIPAL NOTES. Fitch's short-term ratings apply to debt obligations that
are payable on demand or have original maturities of generally three years or
less. These include commercial paper, certificates of deposit, medium-term
notes, and municipal and investment notes. The short-term rating places greater
emphasis on the existence of liquidity necessary to meet the issuer's
obligations in a timely manner.
The note ratings are as follows:
1. F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating
are regarded as having the strongest degree of assurance for timely payment.
2. 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+.
3. 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 the two higher ratings.
4. 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.
B. CORPORATE AND MUNICIPAL BOND RATINGS. 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.
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 (-) 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.
A CONDITIONAL rating is premised on the successful completion of a
project or the occurrence of a specific event.
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Debt rated BB, B, CCC, CC and C by S&P is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
Debt rated C1 by S&P is debt (income bonds) on which no interest is being paid.
Debt rated D by S&P is in default and payment of interest and/or repayment of
principal is in arrears. Bonds that are rated CAA by Moody's are of poor
standing. Such issues may be in default or there may be present elements of
danger with respect to principal or interest. Bonds that are rated CA by Moody's
represent obligations that are speculative in a high degree. Such issues are
often in default or have other market shortcomings. Bonds that are rated C by
Moody's are the lowest rated bonds, and issues so rated can be regarded as
having extremely poor prospects of ever attaining any real investment standing.
Debt rated BB, B, CCC, CC, and C by Fitch is regarded as speculative with
respect to capacity to pay interest and repay principal in accordance with the
terms of the obligation. BB indicates the lowest degree of speculation and C
represents the highest degree of speculation. Debt rated DDD, DD, and D are in
default on interest and/or principal payments.
DESCRIPTIONS OF CERTAIN TYPES OF INVESTMENTS AND
INVESTMENT TECHNIQUES AVAILABLE TO THE FUND
The Fund may engage in the following investment practices to the extent
described in the Prospectus and the Statement of Additional Information.
OBLIGATIONS OF FOREIGN BRANCHES OF UNITED STATES BANKS
The obligations of foreign branches of U.S. banks may be general
obligations of the parent bank in addition to the issuing branch, or may be
limited by the terms of a specific obligation and by government regulation.
Payment of interest and principal upon these obligations may also be affected by
governmental action in the country of domicile of the branch (generally referred
to as sovereign risk). In addition, evidences of ownership of such securities
may be held outside the U.S., and the Fund may be subject to the risks
associated with the holding of such property overseas. Examples of governmental
actions would be the imposition of currency controls, interest limitations,
withholding taxes, seizure of assets or the declaration of a moratorium. Various
provisions of federal law governing domestic branches do not apply to foreign
branches of domestic banks.
OBLIGATIONS OF UNITED STATES BRANCHES OF FOREIGN BANKS
Obligations of U.S. branches of foreign banks may be general obligations
of the parent bank in addition to the issuing branch, or may be limited by the
terms of a specific obligation and by federal and state regulation as well as by
governmental action in the country in which the foreign bank has its head
office. In addition, there may be less publicly available information about a
U.S. branch of a foreign bank than about a domestic bank.
MASTER DEMAND NOTES
Master demand notes are unsecured obligations that permit the investment
of fluctuating amounts by the Fund at varying rates of interest pursuant to
direct arrangements between the Fund, as lender, and the issuer as borrower.
Master demand notes may permit daily fluctuations in the interest rate and daily
changes in the amounts borrowed. The Fund has the right to increase the amount
under the note at any time up to the full amount provided by the note agreement,
or to decrease the amount. The borrower may repay up to the full amount of the
note without penalty. Notes acquired by the Fund permit the Fund to demand
payment of principal and accrued interest at any time (on not more than seven
days' notice). Notes acquired by the Fund may have maturities of more than one
year, provided that (1) the Fund is entitled to payment of principal and accrued
interest upon not more than seven days notice, and (2) the rate of interest on
such notes is adjusted automatically at periodic intervals which normally will
not exceed 31 days, but may extend up to one year. The notes will be deemed to
have a maturity equal to the longer of the period remaining to the next interest
rate adjustment or the demand notice period. Because these types of notes are
direct lending arrangements between the lender and borrower, such instruments
are not normally traded and there is no secondary market for these notes,
although they are redeemable and thus repayable by the borrower at face value
plus accrued interest at any time. Accordingly, the Fund's right to redeem is
dependent on the ability of the borrower to pay principal and interest on
demand. In connection with master demand note arrangements, Keystone considers,
under standards established by the Board of Trustees, earning power, cash flow
and other liquidity ratios of the borrower and will monitor the ability of the
borrower to pay principal and interest on demand. These notes are not typically
rated by credit rating agencies. Unless rated, the
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Fund may invest in them only if at the time of an investment the issuer meets
the criteria established for commercial paper discussed in the Statement of
Additional Information.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the
Federal Reserve System having at least $1 billion in assets, primary dealers in
U.S. government securities or other financial institutions believed by Keystone
to be creditworthy. Such persons must be registered as U.S. government
securities dealers with appropriate regulatory organizations. Under such
agreements, the bank, primary dealer or other financial institution agrees upon
entering into the contract to repurchase the security at a mutually agreed upon
date 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. Under a repurchase agreement, the seller must maintain the value of
the securities subject to the agreement at not less than the repurchase price,
such value being determined on a daily basis by marking the underlying
securities to their market value. Although the securities subject to the
repurchase agreement might bear maturities exceeding a year, the Fund only
intends to enter into repurchase agreements that provide for settlement within a
year and usually within seven days. Securities subject to repurchase agreements
will be held by the Trust's custodian or in the Federal Reserve book entry
system. The Fund does not bear the risk of a decline in the value of the
underlying security unless the seller defaults under its repurchase obligation.
In the event of a bankruptcy or other default of a seller of a repurchase
agreement, the Fund could experience both delays in liquidating the underlying
securities and losses, including (1) possible declines in the value of the
underlying securities during the period while the Fund seeks to enforce its
rights thereto; (2) possible subnormal levels of income and lack of access to
income during this period; and (3) expenses of enforcing its rights. The Board
of Trustees has established procedures to evaluate the creditworthiness of each
party with whom the Fund enters into repurchase agreements by setting guidelines
and standards of review for Keystone and monitoring Keystone's actions with
regard to repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund would sell securities and
agree to repurchase them at a mutually agreed upon date and price. The Fund
intends to enter into reverse repurchase agreements to avoid otherwise having to
sell securities during unfavorable market conditions in order to meet
redemptions. At the time the Fund enters into a reverse repurchase agreement, it
will establish a segregated account with the Trust's custodian containing liquid
assets such as U.S. government securities or other high grade debt securities
having a value not less than the repurchase price (including accrued interest)
and will subsequently monitor the account to ensure such value is maintained.
Reverse repurchase agreements involve the risk that the market value of the
securities that the Fund is obligated to repurchase may decline below the
repurchase price. Reverse repurchase agreements magnify the potential for gain
or loss on the portfolio securities of the Fund and, therefore, increase the
possibility of fluctuation in the Fund's net asset value. In the event the buyer
of securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, such buyer or its trustee or receiver may receive an
extension of time to determine whether to enforce the Fund's obligation to
repurchase the securities and the Fund's use of the proceeds of the reverse
repurchase agreement may effectively be restricted pending such determination.
"WHEN ISSUED" SECURITIES
The Fund may also purchase and sell securities and currencies on a when
issued and delayed delivery basis. When issued or delayed delivery transactions
arise when securities or currencies are purchased or sold by the Fund with
payment and delivery taking place in the future in order to secure what is
considered to be an advantageous price and yield to the Fund at the time of
entering into the transaction. When the Fund engages in when issued and delayed
delivery transactions, the Fund relies on the buyer or seller, as the case may
be, to consummate the sale. Failure to do so may result in the Fund missing the
opportunity to obtain a price or yield considered to be advantageous. When
issued and delayed delivery transactions may be expected to occur a month or
more before delivery is due. However, no payment or delivery is made by the Fund
until it receives payment or delivery from the other party to the transaction. A
separate account of liquid assets equal to the value of such purchase
commitments will be maintained until payment is made. When issued and delayed
delivery agreements are subject to risks from changes in value based upon
changes in the level of interest rates, currency rates and other market factors,
both before and after delivery. The Fund does not accrue any income on such
securities or currencies prior to their delivery. To the extent the Fund engages
in when issued and delayed delivery
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transactions, it will do so consistent with its investment objective and
policies and not for the purpose of investment leverage.
LOANS OF SECURITIES TO BROKER-DEALERS
The Fund may lend securities to brokers and dealers pursuant to
agreements requiring that the loans be continuously secured by cash or
securities of the U.S. government, its agencies or instrumentalities, or any
combination of cash and such securities, as collateral equal at all times in
value to at least the market value of the securities loaned. Such securities
loans will not be made with respect to the Fund if as a result the aggregate of
all outstanding securities loans exceeds 15% of the value of the Fund's total
assets taken at their current value. The Fund continues to receive interest or
dividends on the securities loaned and simultaneously earns interest on the
investment of the cash loan collateral in U.S. Treasury notes, certificates of
deposit, other high-grade, short-term obligations or interest bearing cash
equivalents. Although voting rights attendant to securities loaned pass to the
borrower, such loans may be called at any time and will be called so that the
securities may be voted by the Fund if, in the opinion of the Fund, a material
event affecting the investment is to occur. There may be risks of delay in
receiving additional collateral or in recovering the securities loaned or even
loss of rights in the collateral should the borrower of the securities fail
financially. Loans may only be made to borrowers deemed to be of good standing,
under standards approved by the Trust's Board of Trustees, when the income to be
earned from the loan justifies the attendant risks.
DERIVATIVES
The Fund may use derivatives in furtherance of its investment objective.
Derivatives are financial contracts whose value depends on, or is derived from,
the value of an underlying asset, reference rate or index. These assets, rates,
and indices may include bonds, stocks, mortgages, commodities, interest rates,
currency exchange rates, bond indices and stock indices. Derivatives can be used
to earn income or protect against risk, or both. For example, one party with
unwanted risk may agree to pass that risk to another party who is willing to
accept the risk, the second party being motivated, for example, by the desire
either to earn income in the form of a fee or premium from the first party, or
to reduce its own unwanted risk by attempting to pass all or part of that risk
to the first party.
Derivatives can be used by investors such as the Fund to earn income and
enhance returns, to hedge or adjust the risk profile of the portfolio, and
either in place of more traditional direct investments or to obtain exposure to
otherwise inaccessible markets. The Fund is permitted to use derivatives for one
or more of these purposes. Each of these uses entails greater risk than if
derivatives were used solely for hedging purposes. The Fund uses futures
contracts and related options for hedging purposes. Derivatives are a valuable
tool which, when used properly, can provide significant benefit to the Fund's
shareholders. Keystone is not an aggressive user of derivatives with respect to
the Fund. However, the Fund may take positions in those derivatives that are
within its investment policies if, in Keystone's judgment, this represents an
effective response to current or anticipated market conditions. Keystone's use
of derivatives is subject to continuous risk assessment and control from the
standpoint of the Fund's investment objective and policies.
Derivatives may be (1) standardized, exchange-traded contracts or (2)
customized, privately negotiated contracts. Exchange-traded derivatives tend to
be more liquid and subject to less credit risk than those that are privately
negotiated.
There are four principal types of derivative instruments -- options,
futures, forwards and swaps -- from which virtually any type of derivative
transaction can be created. Further information regarding options and futures,
is provided later in this section and is provided in the Statement of Additional
Information.
Debt instruments that incorporate one or more of these building blocks
for the purpose of determining the principal amount of and/or rate of interest
payable on the debt instruments are often referred to as "structured
securities." An example of this type of structured security is indexed
commercial paper. The term is also used to describe certain securities issued in
connection with the restructuring of certain foreign obligations. See
"Structured Securities" below. The term "derivative" is also sometimes used to
describe securities involving rights to a portion of the cash flows from an
underlying pool of mortgages or other assets from which payments are passed
through to the owner of, or that collateralize, the securities.
While the judicious use of derivatives by experienced investment managers
such as Keystone can be beneficial, derivatives also involve risks different
from, and, in certain cases, greater than, the risks presented by
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more traditional investments. Following is a general discussion of important
risk factors and issues concerning the use of derivatives that investors should
understand before investing in the Fund.
* MARKET RISK -- This is the general risk attendant to all investments
that the value of a particular investment will decline or otherwise change in a
way detrimental to the Fund's interest.
* MANAGEMENT RISK -- Derivative products are highly specialized
instruments that require investment techniques and risk analyses different from
those associated with stocks and bonds. The use of a derivative requires an
understanding not only of the underlying instrument, but also of the derivative
itself, without the benefit of observing the performance of the derivative under
all possible market conditions. In particular, the use and complexity of
derivatives require the maintenance of adequate controls to monitor the
transactions entered into, the ability to assess the risk that a derivative adds
to the Fund's portfolio and the ability to forecast price, interest rate or
currency exchange rate movements correctly.
* CREDIT RISK -- This is the risk that a loss may be sustained by the
Fund as a result of the failure of another party to a derivative (usually
referred to as a "counterparty") to comply with the terms of the derivative
contract. The credit risk for exchange traded derivatives is generally less than
for privately negotiated derivatives, since the clearing house, which is the
issuer or counterparty to each exchange-traded derivative, provides a guarantee
of performance. This guarantee is supported by a daily payment system (i.e.,
margin requirements) operated by the clearing house in order to reduce overall
credit risk. For privately negotiated derivatives, there is no similar clearing
agency guarantee. Therefore, the Fund considers the creditworthiness of each
counterparty to a privately negotiated derivative in evaluating potential credit
risk.
* LIQUIDITY RISK -- Liquidity risk exists when a particular instrument is
difficult to purchase or sell. If a derivative transaction is particularly large
or if the relevant market is illiquid (as is the case with many privately
negotiated derivatives), it may not be possible to initiate a transaction or
liquidate a position at an advantageous price.
* LEVERAGE RISK -- Since many derivatives have a leverage component,
adverse changes in the value or level of the underlying asset, rate or index can
result in a loss substantially greater than the amount invested in the
derivative itself. In the case of swaps, the risk of loss generally is related
to a notional principal amount, even if the parties have not made any initial
investment. Certain derivatives have the potential for unlimited loss,
regardless of the size of the initial investment.
* OTHER RISKS -- Other risks in using derivatives include the risk of
mispricing or improper valuation and the inability of derivatives to correlate
perfectly with underlying assets, rates and indices. Many derivatives, in
particular privately negotiated derivatives, are complex and often valued
subjectively. Improper valuations can result in increased cash payment
requirements to counterparties or a loss of value to the Fund. Derivatives do
not always perfectly or even highly correlate or track the value of the assets,
rates or indices they are designed to closely track. Consequently, the Fund's
use of derivatives may not always be an effective means of, and sometimes could
be counterproductive to, furthering the Fund's investment objective.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. The Fund may write (i.e., sell) covered call and put
options. By writing a call option, the Fund becomes obligated during the term of
the option to deliver the securities underlying the option upon payment of the
exercise price. By writing a put option, the Fund becomes obligated during the
term of the option to purchase the securities underlying the option at the
exercise price if the option is exercised. The Fund also may write straddles
(combinations of covered puts and calls on the same underlying security).
The Fund may only write "covered" options. This means that so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option or, in the case of call options on U.S.
Treasury bills, the Fund might own substantially similar U.S. Treasury bills. If
the Fund has written options against all of its securities which are available
for writing options, the Fund may be unable to write additional options unless
it sells a portion of its portfolio holdings to obtain new securities against
which it can write options. If this were to occur, higher portfolio turnover and
correspondingly greater brokerage commissions and other transaction costs may
result. However, the Fund does not expect that this will occur.
The Fund will be considered "covered" with respect to a put option it
writes if, so long as it is obligated as the writer of the put option, it
deposits and maintains with its custodian in a segregated account liquid assets
having a value equal to or greater than the exercise price of the option.
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The principal reason for writing call or put options is to obtain,
through a receipt of premiums, a greater current return than would be realized
on the underlying securities alone. The Fund receives a premium from writing a
call or put option, which it retains whether or not the option is exercised. By
writing a call option, the Fund might lose the potential for gain on the
underlying security while the option is open, and by writing a put option the
Fund might become obligated to purchase the underlying security for more than
its current market price upon exercise.
PURCHASING OPTIONS. The Fund may purchase put or call options, including
purchasing put or call options for the purpose of offsetting previously written
put or call options of the same series.
If the Fund is unable to effect a closing purchase transaction with
respect to covered options it has written, the Fund will not be able to sell the
underlying security or dispose of assets held in a segregated account until the
options expire or are exercised.
An option position may be closed out only in a secondary market for an
option of the same series. Although the Fund generally will write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular option at
any particular time, and for some options no secondary market may exist. In such
event, it might not be possible to effect a closing transaction in a particular
option.
Options on some securities are relatively new, and it is impossible to
predict the amount of trading interest that will exist in such options. There
can be no assurance that viable markets will develop or continue. The failure of
such markets to develop or continue could significantly impair the Fund's
ability to use such options to achieve its investment objective.
OPTIONS TRADING MARKETS. Options in which the Fund will trade generally are
listed on national securities exchanges. Exchanges on which such options
currently are traded include the Chicago Board Options Exchange and the New
York, American, Pacific and Philadelphia Stock Exchanges. Options on some
securities may not be listed on any Exchange, but traded in the over-the-counter
market. Options traded in the over-the-counter market involve the additional
risk that securities dealers participating in such transactions could fail to
meet their obligations to the Fund. In addition to the limits on its use of
options discussed herein, the Fund is subject to the investment restrictions
described in this Prospectus and in the Statement of Additional Information.
The staff of the Commission is of the view that the premiums that the
Fund pays for the purchase of unlisted options, and the value of securities used
to cover unlisted options written by the Fund, are considered to be invested in
illiquid securities or assets for the purpose of calculating whether the Fund is
in compliance with its investment restriction relating to illiquid investments.
FUTURES TRANSACTIONS
The Fund may enter into currency and other financial futures contracts
and write options on such contracts. The Fund intends to enter into such
contracts and related options for hedging purposes. The Fund will enter into
futures on securities or currencies or index-based futures contracts in order to
hedge against changes in interest or exchange rates or securities prices. A
futures contract on securities or currencies is an agreement to buy or sell
securities or currencies at a specified price during a designated month. A
futures contract on a securities index does not involve the actual delivery of
securities, but merely requires the payment of a cash settlement based on
changes in the securities index. The Fund does not make payment or deliver
securities upon entering into a futures contract. Instead, it puts down a margin
deposit, which is adjusted to reflect changes in the value of the contract and
which continues until the contract is terminated.
The Fund may sell or purchase futures contracts. When a futures contract
is sold by the Fund, the value of the contract will tend to rise when the value
of the underlying securities or currencies declines and to fall when the value
of such securities or currencies increases. Thus, the Fund sells futures
contracts in order to offset a possible decline in the value of its securities
or currencies. If a futures contract is purchased by the Fund, the value of the
contract will tend to rise when the value of the underlying securities or
currencies increases and to fall when the value of such securities or currencies
declines. The Fund intends to purchase futures contracts in order to establish
what is believed by Keystone to be a favorable price and rate of return for
securities or favorable exchange rate for currencies the Fund intends to
purchase.
The Fund also intends to purchase put and call options on futures
contracts for hedging purposes. A put option purchased by the Fund would give it
the right to assume a position as the seller of a futures contract. A call
option purchased by the Fund would give it the right to assume a position as the
purchaser of a futures contract. The purchase of an option on a futures contract
requires the Fund to pay a premium. In exchange for the premium, the Fund
becomes entitled to exercise the benefits, if any, provided by the futures
contract, but is not required to
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take any action under the contract. If the option cannot be exercised profitably
before it expires, the Fund's loss will be limited to the amount of the premium
and any transaction costs.
The Fund may enter into closing purchase and sale transactions in order
to terminate a futures contract and may sell put and call options for the
purpose of closing out its options positions. The Fund's ability to enter into
closing transactions depends on the development and maintenance of a liquid
secondary market. There is no assurance that a liquid secondary market will
exist for any particular contract or at any particular time. As a result, there
can be no assurance that the Fund will be able to enter into an offsetting
transaction with respect to a particular contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the contract and to complete
the contract according to its terms, in which case it would continue to bear
market risk on the transaction.
Although futures and options transactions are intended to enable the Fund
to manage market, interest rate or exchange rate risk, unanticipated changes in
interest rates, exchange rates or market prices could result in poorer
performance than if it had not entered into these transactions. Even if Keystone
correctly predicts interest or exchange rate movements, a hedge could be
unsuccessful if changes in the value of the Fund's futures position did not
correspond to changes in the value of its investments. This lack of correlation
between the Fund's futures and securities or currencies positions may be caused
by differences between the futures and securities or currencies markets or by
differences between the securities or currencies underlying the Fund's futures
position and the securities or currencies held by or to be purchased for the
Fund. Keystone will attempt to minimize these risks through careful selection
and monitoring of the Fund's futures and options positions.
The Fund does not intend to use futures transactions for speculation or
leverage. The Fund has the ability to write options on futures, but currently
intends to write such options only to close out options purchased by the Fund.
The Fund will not change these policies without supplementing the information in
the Fund's Prospectus and Statement of Additional Information.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, the Fund may invest in securities denominated in
foreign currencies, and the Fund temporarily may hold funds in foreign
currencies. Thus, the value of Fund shares will be affected by changes in
exchange rates.
As one way of managing exchange rate risk, in addition to entering into
currency futures contracts, the Fund may enter into forward currency exchange
contracts (agreements to purchase or sell currencies at a specified price and
date). The exchange rate for the transaction (the amount of currency the Fund
will deliver or receive when the contract is completed) is fixed when the Fund
enters into the contract. The Fund usually will enter into these contracts to
stabilize the U.S. dollar value of a security it has agreed to buy or sell. The
Fund intends to use these contracts to hedge the U.S. dollar value of a security
it already owns, particularly if the Fund expects a decrease in the value of the
currency in which the foreign security is denominated. Although the Fund will
attempt to benefit from using forward contracts, the success of its hedging
strategy will depend on Keystone's ability to predict accurately the future
exchange rates between foreign currencies and the U.S. dollar. The value of the
Fund's investments denominated in foreign currencies will depend on the relative
strength of those currencies and the U.S. dollar, and the Fund may be affected
favorably or unfavorably by changes in the exchange rates or exchange control
regulations between foreign currencies and the dollar. Changes in foreign
currency exchange rates also may affect the value of dividends and interest
earned, gains and losses realized on the sale of securities and net investment
income and gains, if any, to be distributed to shareholders by the Fund. The
Fund may also purchase and sell options related to foreign currencies in
connection with hedging strategies.
STRUCTURED SECURITIES. Structured securities generally represent interests in
entities organized and operated solely for the purpose of restructuring the
investment characteristics of debt obligations. This type of restructuring
involves the deposit with or purchase by an entity, such as a corporation or
trust, of specified instruments (such as commercial bank loans) and the issuance
by that entity of one or more classes of structured securities backed by, or
representing interests in, the underlying instruments. The cash flow on the
underlying instruments may be apportioned among the newly issued structured
securities to create securities with different investment characteristics such
as varying maturities, payment priorities and interest rate provisions, and the
extent of the payments made with respect to structured securities is dependent
on the extent of the cash flow on the underlying instruments. Because structured
securities typically involve no credit enhancement, their credit risk generally
will be equivalent to that of the underlying instruments. Structured securities
of a given class may be either subordinated or unsubordinated to the right of
payment of another class. Subordinated structured securities typically have
higher yields and present greater risks than unsubordinated structured
securities.
ix
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APPENDIX A
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KEYSTONE PENNSYLVANIA TAX FREE FUND
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DESCRIPTION OF STATE AND LOCAL TAX TREATMENT
Individual shareholders of the Fund who are subject to the Pennsylvania
personal income tax, as either residents or non-residents of the Commonwealth of
Pennsylvania, will not be subject to Pennsylvania personal income tax on
distributions of interest made by the Fund that are attributable to (1)
obligations issued by the Commonwealth of Pennsylvania, any public authority,
commission, board or agency created by the Commonwealth of Pennsylvania, any
political subdivision of the Commonwealth of Pennsylvania or any public
authority created by any such political subdivision (collectively, "Pennsylvania
Obligations"); and (2) obligations of the United States and certain qualifying
agencies, instrumentalities, territories and possessions of the U.S., the
interest from which are statutorily free from state taxation in the Commonwealth
of Pennsylvania under the laws of the Commonwealth or the U.S. (collectively,
"U.S. Obligations"). Distributions attributable to most other sources will not
be exempt from Pennsylvania personal income tax. Distributions of gains
attributable to Pennsylvania Obligations and U.S. Obligations (collectively
"Exempt Obligations") will be subject to the Pennsylvania personal income tax.
Shares of the Fund that are held by individual shareholders who are
Pennsylvania residents subject to the Pennsylvania county personal property tax
will be exempt from such tax to the extent that the Fund's portfolio consists of
Exempt Obligations on the annual assessment date. Nonresidents of the
Commonwealth of Pennsylvania are not subject to the Pennsylvania county personal
property tax. Corporations are not subject to Pennsylvania personal property
taxes. For shareholders who are residents of the City of Philadelphia,
distributions of interest derived from Exempt Obligations are not taxable for
purposes of the Philadelphia School District investment income tax provided that
the Fund reports to its investors the percentage of Exempt Obligations held by
it for the year. The Fund will report such percentage to its shareholders.
Distributions of interest, but not gains, realized on Exempt Obligations
are not subject to the Pennsylvania corporate net income tax. The Pennsylvania
Department of Revenue also takes the position that shares of funds similar to
the Fund are not considered exempt assets of a corporation for the purpose of
determining its capital stock value subject to the Commonwealth's capital stock
and franchise taxes.
SPECIAL FACTORS AFFECTING THE FUND
Historically, Pennsylvania is among the leading states in manufacturing
and mining, and its steel and coal industries have been of national importance.
However, due in part to the decline in the steel and coal industries,
Pennsylvania's economy has become more diversified, with major new sources of
growth in the service and trade sectors. The Commonwealth's unemployment rate is
below the national average, and its per capita income is slightly above the
national average. The Commonwealth's General Fund, through which taxes are
received and debt service is made, had unappropriated balance surpluses for the
years ended June 30, 1995 and June 30, 1996.
The Fund's yield and share price stability are tied in part to conditions
within the Commonwealth. Changes in economic conditions in or governmental
policies of the Commonwealth could have a significant impact on the performance
of Pennsylvania Obligations held by the Fund. For example, the Commonwealth's
continued dependence on manufacturing, mining and steel has made the
Commonwealth vulnerable to cyclical industry fluctuations, foreign imports and
environmental concerns. Growth in the service and trade sectors, however, has
helped diversify the Commonwealth's economy and reduce its unemployment rate
below the national average. Changes in local economic conditions or local
governmental policies within the Commonwealth, which can vary substantially by
region, could also have a significant impact on the performance of municipal
obligations held by the Fund. Also, the Fund will invest in obligations that are
secured by obligors other than the Commonwealth or its political subdivisions
(such as hospitals, universities, corporate obligors and corporate credit and
liquidity providers) and obligations limited to specific revenue pledges (such
as sewer authority bonds). The creditworthiness of these obligors may be wholly
or partly independent of the creditworthiness of the Commonwealth or its
municipal authorities. The Trustees of the Trust have the power, however, to
eliminate unsafe investments.
An expanded discussion is contained in the Statement of Additional
Information.
A-1
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INVESTMENT ADVISER
Keystone Investment Management Company, 200 Berkeley Street, Boston,
Massachusetts 02116
CUSTODIAN
State Street Bank and Trust Company, Box 9021, Boston, Massachusetts
02205-9827
TRANSFER AGENT
Evergreen Keystone Service Company, Box 2121, Boston, Massachusetts,
02106-2121
LEGAL COUNSEL
Sullivan & Worcester LLP, 1025 Connecticut Avenue, N.W., Washington, D.C.
20036
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP, 99 High Street, Boston, Massachusetts 02110
DISTRIBUTOR
Evergreen Keystone Distributor, Inc., 125 West 55th Street, New York, New York
10019
61672 541689
