SCHWAB INVESTMENTS, 485BPOS, 2000-11-13

SCHWAB INVESTMENTS
485BPOS, 2000-11-13

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<PAGE> 1
File Nos. 33-37459 and 811-6200
As filed with the Securities and Exchange Commission on

November 13, 2000
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-1A

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Post-Effective Amendment No. 34 [X]

and

REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 38 [X]

SCHWAB INVESTMENTS
(Exact Name of Registrant as Specified in Charter)

101 Montgomery Street, San Francisco, California 94104
(Address of Principal Executive Offices) (zip code)

Registrant's Telephone Number, including Area Code:
(415) 627-7000

Jeremiah H. Chafkin

101 Montgomery Street, San Francisco, California 94104
(Name and Address of Agent for Service)

Copies of communications to:

<TABLE>
<S> <C> <C>
John H. Grady, Jr. Esq. Martin E. Lybecker, Esq. Koji Felton, Esq.
Morgan Lewis & Bockius LLP Ropes & Gray Charles Schwab Investment
1701 Market Street One Franklin Square Management, Inc.
Philadelphia, PA 19103 1301 K Street, N.W., Suite 800 East 101 Montgomery Street
Washington, D.C. 20005 120K-14-109
San Francisco, CA 94104
</TABLE>

It is proposed that this filing will become effective (check appropriate box):

/ / Immediately upon filing pursuant to paragraph (b)
/X/ On November 15, 2000, pursuant to paragraph (b)
/ / 60 days after filing pursuant to paragraph (a)(i)
/ / On (date), pursuant to paragraph (a)(i)
/ / 75 days after filing pursuant to paragraph (a)(ii)
/ / On (date), pursuant to paragraph (a)(i) of Rule 485 if
appropriate, check appropriate box:

/ / This post-effective amendment designates a new effective date for a
previously filed post-effective amendment

<PAGE> 2
SCHWAB

TAX-FREE BOND FUNDS

PROSPECTUS
November 15, 2000

SCHWAB SHORT/INTERMEDIATE TAX-FREE
BOND FUND

SCHWAB LONG-TERM TAX-FREE BOND FUND

SCHWAB CALIFORNIA SHORT/INTERMEDIATE
TAX-FREE BOND FUND

SCHWAB CALIFORNIA LONG-TERM TAX-FREE
BOND FUND

As with all mutual funds, the Securities and Exchange Commission (SEC) has not
approved these securities or passed on whether the information in this
prospectus is adequate and accurate. Anyone who indicates otherwise is
committing a federal crime.

This prospectus does not offer for sale and is not a solicitation of offers to
purchase shares of certain funds described herein in those states and
jurisdictions where the funds are not registered and/or qualified for sale. In
particular, the California state-specific funds are offered for sale and are
available only to residents of California, Arizona, District of Columbia,
Florida, South Carolina, New Jersey and the U.S. Virgin Islands.

[CHARLES SCHWAB LOGO]
<PAGE> 3
SCHWAB

TAX-FREE BOND FUNDS

ABOUT THE FUNDS

4 Schwab Short/Intermediate
Tax-Free Bond Fund

8 Schwab Long-Term Tax-Free
Bond Fund

12 Schwab California
Short/Intermediate Tax-Free
Bond Fund

16 Schwab California Long-Term
Tax-Free Bond Fund

20 Fund Management

INVESTING IN THE FUNDS

22 Buying Shares

23 Selling/Exchanging Shares

24 Transaction Policies

25 Distributions and Taxes

<PAGE> 4
ABOUT THE FUNDS

The Schwab Tax-Free Bond Funds seek to provide HIGH CURRENT INCOME free from
federal income tax and, in the case of the California funds, California personal
income tax. Each fund has a similar investment goal but uses a DIFFERENT
STRATEGY.

Because these funds invest in municipal bonds, their dividends generally are
free from federal income tax. Dividends from the California funds generally are
free from California personal income tax as well. Each fund also seeks to lower
risks by investing across different sectors of the INVESTMENT-GRADE municipal
bond market.

The funds are designed for LONG-TERM INVESTING. Their performance will fluctuate
over time and, as with all investments, future performance may differ from past
performance.
<PAGE> 5
SCHWAB TICKER SYMBOL

SHORT/INTERMEDIATE TAX-FREE SWITX
BOND FUND

THE FUND SEEKS HIGH CURRENT INCOME THAT IS EXEMPT FROM FEDERAL INCOME TAX,
CONSISTENT WITH CAPITAL PRESERVATION.

STRATEGY

TO PURSUE ITS GOAL, THE FUND INVESTS IN INVESTMENT-GRADE MUNICIPAL SECURITIES --
THOSE IN THE FOUR HIGHEST CREDIT RATING CATEGORIES (AAA TO BBB-). The fund
normally invests at least 80% of total assets in these securities, and typically
far more. Interest income from these securities is free from federal income tax
and generally federal alternative minimum tax. To help preserve investors'
capital, the fund seeks to keep the average maturity of its overall portfolio
between two and five years.

The fund may invest in fixed-, variable- or floating-rate securities from state
issuers around the country and from municipal agencies, U.S. territories and
possessions. These may include general obligation issues, which typically are
backed by the issuer's ability to levy taxes, and revenue issues, which
typically are backed by a stream of revenue from a given source, such as an
electric utility or a public water system. The fund may invest more than 25% of
total assets in municipal securities financing similar projects, and may also
invest in municipal notes. Many of the fund's securities carry credit
enhancements (such as bond insurance) or liquidity enhancements (such as a
letter of credit), which are designed to provide incremental levels of
creditworthiness or liquidity.

In choosing securities, the fund's manager seeks to maximize current income
within the limits of the fund's credit and average maturity standards. The
investment adviser's credit research department analyzes and monitors the
securities that the fund owns or is considering buying. If a portfolio security
falls below investment-grade, the fund may continue to hold it if the investment
adviser believes it would benefit the fund. The manager may adjust the fund's
holdings or its average maturity based on actual or anticipated changes in
interest rates or credit quality.

During unusual market conditions, the fund may invest in taxable securities as a
temporary defensive measure. In this case, the fund would not be pursuing its
goal.

SHORTER MATURITIES
----------------------

As a bond approaches maturity, its market value typically moves closer to its
par value (the amount of the bond's principal value, which a bondholder receives
when the bond matures).

Investing in short- and intermediate-term bonds is a common strategy for
reducing price volatility and other risks. In exchange for these lower risks,
short- and intermediate-term bonds typically (though not always) offer lower
yields than longer term bonds.

SHORT/INTERMEDIATE TAX-FREE BOND FUND 4
<PAGE> 6
Individuals in higher tax brackets who are seeking TAX-FREE INCOME along with
the potential for LOWER VOLATILITY may want to consider this fund.

MAIN RISKS

BOND MARKETS RISE AND FALL DAILY. As with any investment whose performance is
tied to these markets, the value of your investment in the fund will fluctuate,
which means that you could lose money.

WHEN INTEREST RATES RISE, BOND PRICES USUALLY FALL, and with them the fund's
share price. The fund's short-to-intermediate maturity is designed to reduce
this risk, but will not eliminate it. A fall in interest rates could hurt the
fund as well, by lowering its yield. This is because issuers tend to pay off
their bonds when interest rates fall, often forcing the fund to reinvest in
lower-yielding securities.

STATE AND REGIONAL FACTORS COULD AFFECT THE FUND'S PERFORMANCE. To the extent
that the fund invests in securities from a given state or geographic region, its
share price and performance could be affected by local, state and regional
factors, including erosion of the tax base and changes in the economic climate.
National governmental actions, such as the elimination of tax-free status, also
could affect performance. Because the fund is non-diversified, it may divide its
assets among fewer issuers than a diversified fund. This means that the fund
could increase its exposure to the risks of a given issuer.

THE FUND COULD LOSE MONEY OR UNDERPERFORM AS A RESULT OF DEFAULT. Although the
risk of default generally is considered unlikely with investment-grade municipal
securities, any default on the part of a portfolio investment could cause the
fund's share price or yield to fall. The fund's emphasis on quality and
preservation of capital also could cause it to underperform certain other types
of bond investments, particularly those that take greater maturity and credit
risks. At the same time, some of the fund's investments may have greater risks
than securities in taxable bond funds.

THE MANAGER'S MATURITY DECISIONS ALSO WILL AFFECT THE FUND'S PERFORMANCE.
To the extent that the manager anticipates interest rate trends imprecisely, the
fund could miss yield opportunities or its share price could fall.

IF CERTAIN TYPES OF INVESTMENTS THE FUND BUYS AS TAX EXEMPT ARE LATER RULED TO
BE TAXABLE, A PORTION OF THE FUND'S INCOME COULD BE TAXABLE. Any defensive
investments in taxable securities could generate taxable income. Also, some
types of municipal securities produce income that is subject to the federal
alternative minimum tax (AMT).

THE FUND IS NOT DESIGNED TO OFFER SUBSTANTIAL CAPITAL APPRECIATION. In exchange
for its goal of capital preservation, the fund may offer lower long-term
performance than stock investments or certain other types of bond investments.

5 SHORT/INTERMEDIATE TAX-FREE BOND FUND
<PAGE> 7
PERFORMANCE

Below are a chart and a table showing the fund's performance, as well as data on
an unmanaged market index. These figures assume that all distributions were
reinvested. Keep in mind that future performance may differ from past
performance, and that the index does not include any costs of investment.

ANNUAL TOTAL RETURNS (%) as of 12/31

[BAR CHART]
<TABLE>
<S> <C>
94 (1.12)

95 9.28

96 3.54

97 5.17

98 4.78

99 0.51
</TABLE>

BEST QUARTER: 3.00% Q1 1995
WORST QUARTER: -2.33% Q1 1994
YEAR-TO-DATE PERFORMANCE AS OF 9/30/2000: 4.22%

AVERAGE ANNUAL TOTAL RETURNS (%) as of 12/31/1999

<TABLE>
<CAPTION>
SINCE
1 YEAR 5 YEARS INCEPTION
---------------------------------------------------------------
<S> <C> <C> <C>
Fund 0.51 4.62 3.95 1

Lehman Brothers Three-
Year Municipal Bond Index 1.96 5.17 4.47 2
</TABLE>

1 Inception: 4/21/1993.
2 From 4/21/1993.

FUND FEES AND EXPENSES

The following table describes what you could expect to pay as a fund investor.
"Shareholder fees" are one-time expenses charged to you directly by the fund.
"Annual operating expenses" are paid out of fund assets, so their effect is
included in the fund's total return.

FEE TABLE (%)

<TABLE>
<CAPTION>
SHAREHOLDER FEES
-----------------------------------------------------------
None

ANNUAL OPERATING EXPENSES (% of average net assets)
-----------------------------------------------------------
<S> <C>
Management fees* 0.30
Distribution (12b-1) fees None
Other expenses* 0.42
----
Total annual operating expenses 0.72

EXPENSE REDUCTION (0.23)
----
NET OPERATING EXPENSES** 0.49
====
</TABLE>

* Restated to reflect current fees and expenses.

** Guaranteed by Schwab and the investment adviser through 11/15/2001, excluding
interest, taxes and certain non-routine expenses.

EXPENSES ON A $10,000 INVESTMENT

Designed to help you compare expenses, this example uses the same assumptions as
other mutual fund prospectuses: a $10,000 investment and 5% return each year.
One-year figures are based on net operating expenses. The expenses would be the
same whether you stayed in the fund or sold your shares at the end of each
period. Your actual costs may be higher or lower.

<TABLE>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------------------------------------------------
<S> <C> <C> <C>
$50 $207 $378 $873
</TABLE>

The performance information above shows you how the fund's PERFORMANCE compares
to its index, which VARIES OVER TIME.

SHORT/INTERMEDIATE TAX-FREE BOND FUND 6
<PAGE> 8
FINANCIAL HIGHLIGHTS

This section provides further details about the fund's financial history. "Total
return" shows the percentage that an investor in the fund would have earned or
lost during a given period, assuming all distributions were reinvested. The
fund's independent accountants, PricewaterhouseCoopers LLP, audited these
figures. Their full report is included in the fund's annual report (see back
cover).

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------
9/1/99- 9/1/98- 9/1/97- 9/1/96- 9/1/95-
8/31/00 8/31/99 8/31/98 8/31/97 8/31/96
---------------------------------------------------------------------------------------------------------

PER-SHARE DATA ($)
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value at beginning of period 10.05 10.26 10.16 10.04 10.12
-----------------------------------------------------
Income from investment operations:
Net investment income 0.41 0.40 0.42 0.41 0.41
Net realized and unrealized gains or losses 0.03 (0.21) 0.10 0.12 (0.08)
-----------------------------------------------------
Total income from investment operations 0.44 0.19 0.52 0.53 0.33
Less distributions:
Dividends from net investment income (0.41) (0.40) (0.42) (0.41) (0.41)
-----------------------------------------------------
Net asset value at end of period 10.08 10.05 10.26 10.16 10.04
=====================================================
Total return (%) 4.50 1.86 5.17 5.40 3.32

RATIOS/SUPPLEMENTAL DATA (%)
---------------------------------------------------------------------------------------------------------
Ratio of net operating expenses to
average net assets 0.49 1 0.49 0.49 0.49 0.49
Expense reductions reflected in above ratio 0.25 0.32 0.36 0.47 0.41
Ratio of net investment income to
average net assets 4.11 3.87 3.99 4.08 4.06
Portfolio turnover rate 11 8 22 20 44
Net assets, end of period ($ x 1,000,000) 76 87 68 54 54
</TABLE>

1 Would have been 0.50% if certain non-routine expenses (proxy fees) had been
included.

7 SHORT/INTERMEDIATE TAX-FREE BOND FUND
<PAGE> 9
SCHWAB TICKER SYMBOL

LONG-TERM TAX-FREE SWNTX
BOND FUND

THE FUND SEEKS HIGH CURRENT INCOME THAT IS EXEMPT FROM FEDERAL INCOME TAX,
CONSISTENT WITH CAPITAL PRESERVATION.

STRATEGY

TO PURSUE ITS GOAL, THE FUND INVESTS IN INVESTMENT-GRADE MUNICIPAL SECURITIES --
THOSE IN THE FOUR HIGHEST CREDIT RATING CATEGORIES (AAA TO BBB-). The fund
normally invests at least 80% of total assets in these securities, and typically
far more. Interest income from these securities is free from federal income tax
and generally federal alternative minimum tax. The fund seeks to maintain an
average maturity in its overall portfolio of at least ten years.

During unusual market conditions, the fund may invest in taxable securities as a
temporary defensive measure. In this case, the fund would not be pursuing its
goal.

MATURITY AND YIELD
----------------------

Bond yields typically are higher the longer the bond's maturity. By investing in
longer term bonds, the fund seeks to earn higher yields over time than the
Schwab Short/Intermediate Tax-Free Bond Fund.

Maintaining a longer average maturity does carry certain risks, and investors
should expect this fund's share price to fluctuate more than that of the Schwab
Short/Intermediate Tax-Free Bond Fund.

LONG-TERM TAX-FREE BOND FUND 8
<PAGE> 10
This fund is designed for individuals in higher tax brackets who are interested
in HIGH CURRENT TAX-FREE INCOME and can accept a higher degree of risk to their
investment.

MAIN RISKS

BOND MARKETS RISE AND FALL DAILY. As with any investment whose performance is
tied to these markets, the value of your investment in the fund will fluctuate,
which means that you could lose money.

WHEN INTEREST RATES RISE, BOND PRICES USUALLY FALL, and with them the fund's
share price. The fund's comparatively long maturity will tend to make it more
sensitive to this risk than funds with shorter average maturities.

9 LONG-TERM TAX-FREE BOND FUND
<PAGE> 11
PERFORMANCE

ANNUAL TOTAL RETURNS (%) as of 12/31

[BAR CHART]
<TABLE>
<S> <C>
93 13.61

94 (7.04)

95 18.14

96 4.18

97 9.83

98 6.14

99 (7.31)
</TABLE>

BEST QUARTER: 8.03% Q1 1995
WORST QUARTER: -5.88% Q1 1994
YEAR-TO-DATE PERFORMANCE AS OF 9/30/2000: 8.48%

AVERAGE ANNUAL TOTAL RETURNS (%) as of 12/31/1999

<TABLE>
<CAPTION>
SINCE
1 YEAR 5 YEARS INCEPTION
---------------------------------------------------------------
<S> <C> <C> <C>
Fund (7.31) 5.88 4.90 1

Lehman Brothers General
Municipal Bond Index (2.06) 6.91 5.74 2
</TABLE>

1 Inception: 9/11/1992.
2 From 9/11/1992.

FUND FEES AND EXPENSES

FEE TABLE (%)

<TABLE>
<CAPTION>
SHAREHOLDER FEES
-----------------------------------------------------------
None

EXPENSE REDUCTION (0.24)
----
NET OPERATING EXPENSES** 0.49
====
</TABLE>

* Restated to reflect current fees and expenses.

** Guaranteed by Schwab and the investment adviser through 11/15/2001, excluding
interest, taxes and certain non-routine expenses.

EXPENSES ON A $10,000 INVESTMENT

<TABLE>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------------------------------------------------
<S> <C> <C> <C>
$50 $209 $382 $884
</TABLE>

The performance information above shows you how the fund's PERFORMANCE compares
to its index, which VARIES OVER TIME.

LONG-TERM TAX-FREE BOND FUND 10
<PAGE> 12
FINANCIAL HIGHLIGHTS

PER-SHARE DATA ($)
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value at beginning of period 10.11 11.01 10.53 10.13 10.16
-----------------------------------------------------
Income from investment operations:
Net investment income 0.50 0.50 0.53 0.53 0.52
Net realized and unrealized gains or losses 0.13 (0.85) 0.48 0.40 (0.03)
-----------------------------------------------------
Total income from investment operations 0.63 (0.35) 1.01 0.93 0.49
Less distributions:
Dividends from net investment income (0.50) (0.50) (0.53) (0.53) (0.52)
Distributions from net realized gains -- (0.05) -- -- --
-----------------------------------------------------
Total distributions (0.50) (0.55) (0.53) (0.53) (0.52)
-----------------------------------------------------
Net asset value at end of period 10.24 10.11 11.01 10.53 10.13
=====================================================
Total return (%) 6.59 (3.34) 9.81 9.36 4.87

RATIOS/SUPPLEMENTAL DATA (%)
---------------------------------------------------------------------------------------------------------
Ratio of net operating expenses to
average net assets 0.49 1 0.49 0.49 0.49 0.49
Expense reductions reflected in above ratio 0.26 0.32 0.37 0.53 0.45
Ratio of net investment income to
average net assets 5.11 4.59 4.76 5.09 5.06
Portfolio turnover rate 25 35 39 61 50
Net assets, end of period ($ x 1,000,000) 76 90 70 47 44
</TABLE>

1 Would have been 0.50% if certain non-routine expenses (proxy fees) had been
included.

11 LONG-TERM TAX-FREE BOND FUND
<PAGE> 13
SCHWAB TICKER SYMBOL

CALIFORNIA SHORT/INTERMEDIATE SWCSX
TAX-FREE BOND FUND

THE FUND SEEKS HIGH CURRENT INCOME EXEMPT FROM FEDERAL AND CALIFORNIA
PERSONAL INCOME TAX THAT IS CONSISTENT WITH CAPITAL PRESERVATION.

STRATEGY

TO PURSUE ITS GOAL, THE FUND INVESTS IN INVESTMENT-GRADE MUNICIPAL SECURITIES --
THOSE IN THE FOUR HIGHEST CREDIT RATING CATEGORIES (AAA TO BBB-) -- FROM
CALIFORNIA ISSUERS. The fund normally invests at least 80% of total assets in
these securities, and typically far more. Interest income from these securities
is free from federal and California personal income tax and generally federal
alternative minimum tax. To help preserve investors' capital, the fund seeks to
keep the average maturity of its overall portfolio between two and five years.

The fund may invest in securities from municipal issuers in California and in
U.S. territories and possessions. These may include general obligation issues,
which typically are backed by the issuer's ability to levy taxes, and revenue
issues, which typically are backed by a stream of revenue from a given source,
such as an electric utility or a public water system. The fund may invest more
than 25% of total assets in municipal securities financing similar projects, and
may also invest in municipal notes. Many of the fund's securities carry credit
enhancements (such as bond insurance) or liquidity enhancements (such as a
letter of credit), which are designed to provide incremental levels of
creditworthiness or liquidity.

During unusual market conditions, the fund may invest in taxable securities as a
temporary defensive measure. In this case, the fund would not be pursuing its
goal.

SHORTER MATURITIES
-----------------------

As a bond approaches maturity, its market value typically moves closer to its
par value (the amount of the bond's principal, which a bondholder receives when
the bond matures).

CALIFORNIA SHORT/INTERMEDIATE TAX-FREE BOND FUND 12
<PAGE> 14
California taxpayers who are seeking DOUBLE TAX-FREE INCOME along with the
potential for LOWER VOLATILITY may want to consider this fund.

MAIN RISKS

BOND MARKETS RISE AND FALL DAILY. As with any investment whose performance is
tied to these markets, the value of your investment in the fund will fluctuate,
which means that you could lose money.

THIS FUND INVESTS PRIMARILY IN SECURITIES ISSUED BY THE STATE OF CALIFORNIA AND
ITS MUNICIPALITIES. The fund's share price and performance could be affected by
local, state and regional factors, including erosion of the tax base and changes
in the economic climate. National governmental actions, such as the elimination
of tax-free status, also could affect performance. Because the fund is
non-diversified, it may divide its assets among fewer issuers than a diversified
fund. This means that the fund could increase its exposure to the risks of a
given issuer.

13 CALIFORNIA SHORT/INTERMEDIATE TAX-FREE BOND FUND
<PAGE> 15
PERFORMANCE

ANNUAL TOTAL RETURNS (%) AS OF 12/31

[BAR CHART]
<TABLE>
<S> <C>
94 (2.08)

95 10.46

96 3.90

97 5.19

98 4.83

99 0.66
</TABLE>

BEST QUARTER: 3.62% Q1 1995
WORST QUARTER: -2.45% Q1 1994
YEAR-TO-DATE PERFORMANCE AS OF 9/30/2000: 5.01%

AVERAGE ANNUAL TOTAL RETURNS (%) AS OF 12/31/1999

<TABLE>
<CAPTION>
SINCE
1 YEAR 5 YEARS INCEPTION
---------------------------------------------------------------
<S> <C> <C> <C>
Fund 0.66 4.96 4.03 1

Lehman Brothers Three-
Year Municipal Bond Index 1.96 5.17 4.47 2
</TABLE>

1 Inception: 4/21/1993.
2 From 4/21/1993.

FUND FEES AND EXPENSES

FEE TABLE (%)

<TABLE>
<CAPTION>
SHAREHOLDER FEES
-----------------------------------------------------------
None

EXPENSE REDUCTION (0.19)
----
NET OPERATING EXPENSES** 0.49
====
</TABLE>

* Restated to reflect current fees and expenses.

** Guaranteed by Schwab and the investment adviser through 11/15/2001, excluding
interest, taxes and certain non-routine expenses.

EXPENSES ON A $10,000 INVESTMENT

<TABLE>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------------------------------------------------
<S> <C> <C> <C>
$50 $198 $360 $829
</TABLE>

The performance information above shows you how the fund's PERFORMANCE compares
to its index, which VARIES OVER TIME.

CALIFORNIA SHORT/INTERMEDIATE TAX-FREE BOND FUND 14
<PAGE> 16
FINANCIAL HIGHLIGHTS

Net investment income 0.39 0.39 0.41 0.43 0.43
Net realized and unrealized gains or losses 0.13 (0.17) 0.11 0.12 (0.02)
-----------------------------------------------------
Total income from investment operations 0.52 0.22 0.52 0.55 0.41
Less distributions:
Dividends from net investment income (0.39) (0.39) (0.42) (0.43) (0.43)
-----------------------------------------------------
Net asset value at end of period 10.22 10.09 10.26 10.16 10.04
=====================================================
Total return (%) 5.32 2.16 5.19 5.54 4.11

RATIOS/SUPPLEMENTAL DATA (%)
---------------------------------------------------------------------------------------------------------
Ratio of net operating expenses to
average net assets 0.49 1 0.49 0.49 0.49 0.49
Expense reductions reflected in above ratio 0.21 0.28 0.30 0.40 0.38
Ratio of net investment income to
average net assets 3.91 3.81 4.02 4.21 4.23
Portfolio turnover rate 42 7 8 23 20
Net assets, end of period ($ x 1,000,000) 124 126 96 59 46
</TABLE>

1 Would have been 0.50% if certain non-routine expenses (proxy fees) had been
included.

15 CALIFORNIA SHORT/INTERMEDIATE TAX-FREE BOND FUND
<PAGE> 17
SCHWAB TICKER SYMBOL

CALIFORNIA LONG-TERM TAX-FREE SWCAX
BOND FUND

THE FUND SEEKS HIGH CURRENT INCOME EXEMPT FROM FEDERAL AND CALIFORNIA
PERSONAL INCOME TAX THAT IS CONSISTENT WITH CAPITAL PRESERVATION.

STRATEGY

TO PURSUE ITS GOAL, THE FUND INVESTS IN INVESTMENT-GRADE MUNICIPAL SECURITIES --
THOSE IN THE FOUR HIGHEST CREDIT RATING CATEGORIES (AAA TO BBB-) -- FROM
CALIFORNIA ISSUERS. The fund normally invests at least 80% of total assets in
these securities, and typically far more. Interest income from these securities
is free from federal and California personal income tax and generally federal
alternative minimum tax. The fund seeks to maintain an average maturity in its
overall portfolio of at least ten years.

In choosing securities, the fund's manager seeks to maximize current income
within the limits of the fund's credit and average maturity standards. The
investment adviser's credit research department analyzes and monitors the
securities that the fund owns or is considering buying. If a portfolio security
falls below investment-grade, the fund may continue to hold it if the
investment adviser believes it would benefit the fund. The manager may adjust
the fund's holdings or its average maturity based on actual or anticipated
changes in interest rates or credit quality.

During unusual market conditions, the fund may invest in taxable securities as a
temporary defensive measure. In this case, the fund would not be pursuing its
goal.

MATURITY AND YIELD
-----------------------

Bond yields typically are higher the longer the bond's maturity. By investing in
longer term bonds, the fund seeks to earn higher yields over time than the
Schwab California Short/Intermediate Tax-Free Bond Fund.

Maintaining a longer average maturity does carry certain risks, however:
investors should expect this fund's share price to be more volatile than that of
the Schwab California Short/Intermediate Tax-Free Bond Fund.

CALIFORNIA LONG-TERM TAX-FREE BOND FUND 16
<PAGE> 18
This fund is designed for California taxpayers who want DOUBLE TAX-FREE INCOME
and can accept higher risk in exchange for potentially higher LONG-TERM RETURNS.

MAIN RISKS

BOND MARKETS RISE AND FALL DAILY. As with any investment whose performance is
tied to these markets, the value of your investment in the fund will fluctuate,
which means that you could lose money.

WHEN INTEREST RATES RISE, BOND PRICES USUALLY FALL, and with them the fund's
share price. The fund's comparatively long average maturity will tend to make it
more sensitive to this risk than funds with shorter average maturities.

17 CALIFORNIA LONG-TERM TAX-FREE BOND FUND
<PAGE> 19
PERFORMANCE

ANNUAL TOTAL RETURNS (%) as of 12/31

[BAR CHART]
<TABLE>
<S> <C>

93 12.88

94 (8.75)

95 19.63

96 4.33

97 10.04

98 6.43

99 (6.14)
</TABLE>

BEST QUARTER: 8.47% Q1 1995
WORST QUARTER: -6.74% Q1 1994
YEAR-TO-DATE PERFORMANCE AS OF 9/30/2000: 10.26%

AVERAGE ANNUAL TOTAL RETURNS (%) as of 12/31/1999

<TABLE>
<CAPTION>
SINCE
1 YEAR 5 YEARS INCEPTION
---------------------------------------------------------------
<S> <C> <C> <C>
Fund (6.14) 6.53 5.91 1

Lehman Brothers General
Municipal Bond Index (2.06) 6.91 6.29 2
</TABLE>

1 Inception: 2/24/1992.
2 From 2/24/1992.

FUND FEES AND EXPENSES

FEE TABLE (%)

<TABLE>
<CAPTION>
SHAREHOLDER FEES
-----------------------------------------------------------
None

EXPENSE REDUCTION (0.17)
-----
NET OPERATING EXPENSES** 0.49
=====
</TABLE>

* Restated to reflect current fees and expenses.

** Guaranteed by Schwab and the investment adviser through 11/15/2001, excluding
interest, taxes and certain non-routine expenses.

EXPENSES ON A $10,000 INVESTMENT

<TABLE>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------------------------------------------------
<S> <C> <C> <C>
$50 $194 $351 $806
</TABLE>

The performance information above shows you how the fund's PERFORMANCE compares
to its index, which VARIES OVER TIME.

CALIFORNIA LONG-TERM TAX-FREE BOND FUND 18
<PAGE> 20
FINANCIAL HIGHLIGHTS

PER-SHARE DATA ($)
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value at beginning of period 10.82 11.52 11.10 10.63 10.53
-----------------------------------------------------
Income from investment operations:
Net investment income 0.55 0.54 0.54 0.56 0.57
Net realized and unrealized gains or losses 0.24 (0.70) 0.43 0.47 0.10
-----------------------------------------------------
Total income from investment operations 0.79 (0.16) 0.97 1.03 0.67
Less distributions:
Dividends from net investment income (0.55) (0.54) (0.55) (0.56) (0.57)
-----------------------------------------------------
Net asset value at end of period 11.06 10.82 11.52 11.10 10.63
=====================================================
Total return (%) 7.67 (1.57) 8.96 9.95 6.43

RATIOS/SUPPLEMENTAL DATA (%)
---------------------------------------------------------------------------------------------------------
Ratio of net operating expenses to
average net assets 0.49 1 0.49 0.49 0.49 0.49
Expense reductions reflected in above ratio 0.19 0.26 0.27 0.33 0.33
Ratio of net investment income to
average net assets 5.19 4.69 4.79 5.17 5.30
Portfolio turnover rate 36 55 28 35 36
Net assets, end of period ($ x 1,000,000) 179 202 190 125 102
</TABLE>

1 Would have been 0.50% if certain non-routine expenses (proxy fees) had been
included.

19 CALIFORNIA LONG-TERM TAX-FREE BOND FUND
<PAGE> 21
FUND MANAGEMENT

The funds' INVESTMENT ADVISER, Charles Schwab Investment Management, Inc., has
more than $120 billion under management.

THE INVESTMENT ADVISER for the funds is Charles Schwab Investment Management,
Inc., 101 Montgomery Street, San Francisco, CA 94104. Founded in 1989, the firm
today serves as investment adviser for all of the SchwabFunds(R). The firm
manages assets for more than 5 million accounts. (All figures on this page are
as of 8/31/2000.)

As the investment adviser, the firm oversees the asset management and
administration of the funds. As compensation for these services, the firm
receives a management fee from each fund. For the 12 months ended 8/31/2000,
these fees were 0.07% for the Schwab Short/Intermediate Tax-Free Bond Fund,
0.06% for the Schwab Long-Term Tax-Free Bond Fund, 0.11% for the Schwab
California Short/Intermediate Tax-Free Bond Fund and 0.13% for the Schwab
California Long-Term Tax-Free Bond Fund. These figures, which are expressed as a
percentage of each fund's average daily net assets, represent the actual amounts
paid, including the effects of reductions.

JOANNE LARKIN, a vice president of the investment adviser, has had overall
responsibility for management of each fund since its inception. Prior to joining
the firm in February 1992, she worked for more than eight years in research and
asset management at another firm.

FUND MANAGEMENT 20
<PAGE> 22
INVESTING IN THE FUNDS

As a SchwabFunds(R) investor, you have a number of WAYS TO DO BUSINESS with us.

On the following pages, you will find information on BUYING, SELLING AND
EXCHANGING shares using the method that is most CONVENIENT for you. You also
will see how to choose a distribution option for your investment. Helpful
information on TAXES is included as well.

21 INVESTING IN THE FUNDS
<PAGE> 23
BUYING SHARES

Shares of the funds may be purchased through a Schwab brokerage account or
through certain third-party investment providers, such as other financial
institutions, investment professionals and workplace retirement plans.

The information on these pages outlines how Schwab brokerage account investors
can place "good orders," which are orders made in accordance with the funds'
policies, to buy, sell and exchange shares of the funds. If you are investing
through a third-party investment provider, some of the instructions, minimums
and policies may be different. Some investment providers may charge transaction
or other fees. Contact your investment provider for more information.

SCHWAB ACCOUNTS
---------------------

Different types of Schwab brokerage accounts are available, with varying account
opening and balance requirements. Some Schwab brokerage account features can
work in tandem with features offered by the funds.

For example, when you sell shares in a fund, the proceeds automatically are paid
to your Schwab brokerage account. From your account, you can use features such
as MoneyLink(R), which lets you move money between your brokerage accounts and
bank accounts, and Automatic Investment Plan (AIP), which lets you set up
periodic investments.

For more information on Schwab brokerage accounts, call 800-435-4000 or visit
the Schwab web site at www.schwab.com.

STEP 1

CHOOSE A FUND, then decide how much you want to invest.

<TABLE>
<CAPTION>
MINIMUM INITIAL MINIMUM ADDITIONAL
INVESTMENT INVESTMENTS MINIMUM BALANCE
--------------------------------------------------------------------------------
<S> <C> <C>
$2,500 $500 $1,000
($1,000 for custodial ($100 for Automatic ($500 for custodial
accounts) Investment Plan) accounts)
</TABLE>

STEP 2

CHOOSE AN OPTION FOR FUND DISTRIBUTIONS. The three options are described below.
If you don't indicate a choice, you will receive the first option.

<TABLE>
<CAPTION>
OPTION FEATURES
--------------------------------------------------------------------------------
<S> <C>
Reinvestment All dividends and capital gain distributions are
invested automatically in shares of your fund.
--------------------------------------------------------------------------------
Cash/reinvestment mix You receive payment for dividends, while any capital
gain distributions are invested in shares of your
fund.
--------------------------------------------------------------------------------
Cash You receive payment for all dividends and capital gain
distributions.
</TABLE>

STEP 3

PLACE YOUR ORDER. Use any of the methods described at right. Make checks payable
to Charles Schwab and Co., Inc.

INVESTING IN THE FUNDS 22
<PAGE> 24
SELLING/EXCHANGING SHARES

USE ANY OF THE METHODS DESCRIBED BELOW TO SELL SHARES OF A FUND.

When selling or exchanging shares, please be aware of the following policies:

- A fund may take up to seven days to pay sale proceeds.

- If you are selling shares that were recently purchased by check, the proceeds
may be delayed until the check for purchase clears; this may take up to 15
days from the date of purchase.

- These funds reserve the right to honor redemptions in portfolio securities
instead of cash when your redemptions over a 90-day period exceed $250,000 or
1% of a fund's assets.

- Exchange orders are limited to other Schwab funds that are not Sweep
Investments as well as variable NAV funds and must meet the minimum
investment and other requirements for the fund and share class into which you
are exchanging.

- You must obtain and read the prospectus for the fund into which you are
exchanging prior to placing your ORDER.

METHODS FOR PLACING DIRECT ORDERS

PHONE

Call 800-435-4000, day or night (for TDD service, call 800-345-2550).

INTERNET

www.schwab.com/schwabfunds

SCHWABLINK

Investment professionals should follow the transaction instructions in the
SchwabLink manual; for technical assistance, call 800-367-5198.

MAIL

Write to SchwabFunds(R) at:
P.O. Box 7575
San Francisco, CA 94120-7575

When selling or exchanging shares, be sure to include the signature of at least
one of the persons whose name is on the account.

IN PERSON

Visit the nearest Charles Schwab branch office.

WHEN PLACING ORDERS
-------------------------

With every order to buy, sell or exchange shares, you will need to include the
following information:

- Your name or, for internet orders, your account number/"Login ID."

- Your account number (for SchwabLink transactions, include the master account
and subaccount numbers) or, for internet orders, your password.

- The name and share class (if applicable) of the fund whose shares you want to
buy or sell.

- The dollar amount or number of shares you would like to buy, sell or
exchange.

- For exchanges, the name and share class of the fund into which you want to
exchange and the distribution option you prefer.

- When selling shares, how you would like to receive the proceeds.

Please note that orders to buy, sell or exchange become irrevocable at the time
you mail them.

23 INVESTING IN THE FUNDS
<PAGE> 25
TRANSACTION POLICIES

THE FUNDS ARE OPEN FOR BUSINESS EACH DAY THAT THE NEW YORK STOCK EXCHANGE (NYSE)
IS OPEN. The funds calculate their share prices each business day after the
close of the NYSE (generally 4 p.m. Eastern time). A fund's share price is its
net asset value per share, or NAV, which is the fund's net assets divided by the
number of its shares outstanding.

Orders that are received in good order are executed at the next NAV to be
calculated. Orders to buy shares that are accepted prior to the close of the
fund generally will receive the next day's dividend. Orders to sell or exchange
shares that are accepted and executed prior to the close of the fund on a given
day generally will receive that day's dividend.

In valuing their securities, the funds use market quotes if they are readily
available. In cases where quotes are not readily available, a fund may value
securities based on fair values developed using methods approved by the fund's
Board of Trustees.

THE FUNDS AND SCHWAB RESERVE CERTAIN RIGHTS, including the following:

- To automatically redeem your shares if the account they are held in is closed
for any reason or your balance falls below the minimum as a result of selling
or exchanging your shares.

- To modify or terminate the exchange privilege upon 60 days' written notice to
shareholders.

- To refuse any purchase or exchange order, including large purchase orders
that may negatively affect a fund's operations or orders that appear to be
associated with short-term trading activities.

- To change or waive a fund's investment minimums.

- To suspend the right to sell shares back to the fund, and delay sending
proceeds, during times when trading on the NYSE is restricted or halted, or
otherwise as permitted by the SEC.

- To withdraw or suspend any part of the offering made by this prospectus.

INVESTING IN THE FUNDS 24
<PAGE> 26
DISTRIBUTIONS AND TAXES

ANY INVESTMENT IN THE FUNDS TYPICALLY INVOLVES SEVERAL TAX CONSIDERATIONS. The
information below is meant as a general summary for U.S. citizens and residents.
Because each person's tax situation is different, you should consult your tax
advisor about the tax implications of your investment in the fund. You also can
visit the Internal Revenue Service (IRS) web site at www.irs.gov.

AS A SHAREHOLDER, YOU ARE ENTITLED TO YOUR SHARE OF THE DIVIDENDS AND GAINS YOUR
FUND EARNS. Each fund distributes to its shareholders substantially all of its
net investment income and net capital gains, if any. Each fund declares a
dividend every business day, based on its determination of its net investment
income. Each fund pays its dividends on the 25th of every month (or next
business day, if the 25th is not a business day), except that in December
dividends are paid on the last business day of the month. The funds expect to
pay any capital gain distributions every year, typically in December, to all
shareholders of record.

THE FUNDS' DISTRIBUTIONS MAY HAVE TAX CONSEQUENCES. Schwab Short/Intermediate
Tax-Free Bond Fund's and Schwab Long-Term Tax-Free Bond Fund's dividends
typically are free from federal income tax, but are subject to state and local
income taxes. A portion of each of these fund's dividends may be free from state
or local income taxes, depending on the extent to which a fund invests in bonds
that are tax-exempt in your state. Dividends from Schwab California
Short/Intermediate Tax-Free Bond Fund and Schwab California Long-Term Tax-Free
Bond Fund typically are free from federal and California personal income taxes.
Each fund's capital gain distributions, if any, generally are taxable in the tax
year in which they are declared, whether you reinvest them or take them in cash.

While interest from municipal securities generally is free from federal income
tax, some types of securities produce income that is subject to the federal
alternative minimum tax (AMT). To the extent that a fund invests in these
securities, shareholders who are subject to the AMT may have to pay this tax on
some or all dividends received from that fund.

GENERALLY, ANY SALE OF YOUR SHARES IS A TAXABLE EVENT. A sale may result in a
capital gain or loss for you. The gain or loss generally will be treated as
short-term if you held the shares for 12 months or less, long-term if you held
the shares longer.

AT THE BEGINNING OF EVERY YEAR, THE FUNDS PROVIDE SHAREHOLDERS WITH INFORMATION
DETAILING THE TAX STATUS OF ANY DISTRIBUTIONS a fund paid during the previous
calendar year, including a breakdown of the fund's income from each state.
Schwab brokerage account customers also receive information on distributions and
transactions in their monthly account statements.

SCHWAB BROKERAGE ACCOUNT CUSTOMERS WHO SELL FUND SHARES typically will receive a
report that calculates their gain or loss using the "average cost"
single-category method. This information is not reported to the IRS, and you
still have the option of calculating gains or losses using any other methods
permitted by the IRS.

25 INVESTING IN THE FUNDS
<PAGE> 27
NOTES
<PAGE> 28
NOTES
<PAGE> 29
TO LEARN MORE

This prospectus contains important information on the funds and should be read
and kept for reference. You also can obtain more information from the following
sources.

SHAREHOLDER REPORTS, which are mailed to current fund investors, discuss recent
performance and portfolio holdings.

The STATEMENT OF ADDITIONAL INFORMATION (SAI) includes a more detailed
discussion of investment policies and the risks associated with various
investments. The SAI is incorporated by reference into the prospectus, making it
legally part of the prospectus.

You can obtain free copies of these documents by contacting SchwabFunds(R). You
can also review and copy them in person at the SEC's Public Reference Room,
access them online at www.sec.gov or obtain paper copies by sending an
electronic request to [email protected]. You will need to pay a duplicating fee
before receiving paper copies from the SEC.

SEC FILE NUMBER
Schwab Tax-Free Bond Funds 811-6200

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-0102
202-942-8090 (Public Reference Section)
www.sec.gov
[email protected]

SCHWABFUNDS
P.O. Box 7575
San Francisco, CA 94120-7575
800-435-4000
WWW.SCHWAB.COM/SCHWABFUNDS

SCHWAB

TAX-FREE BOND FUNDS

PROSPECTUS
November 15, 2000

[CHARLES SCHWAB LOGO]

MKT4272FLT-2

<PAGE> 30
STATEMENT OF ADDITIONAL INFORMATION

SCHWAB INVESTMENTS

SCHWAB SHORT/INTERMEDIATE TAX-FREE BOND FUND
SCHWAB LONG-TERM TAX-FREE BOND FUND
SCHWAB CALIFORNIA SHORT/INTERMEDIATE TAX-FREE BOND FUND
SCHWAB CALIFORNIA LONG-TERM TAX-FREE BOND FUND

NOVEMBER 15, 2000

The Statement of Additional Information (SAI) is not a prospectus. It should be
read in conjunction with a fund's prospectus dated November 15, 2000 (as amended
from time to time).

To obtain a copy of the prospectus, please contact SchwabFunds(R) at
800-435-4000, day or night, or write to the fund at P.O. Box 7575, San
Francisco, CA 94120-7575. For TDD service call 800-345-2550, day or night. The
prospectus also may be available on the Internet at:
http://www.schwab.com/schwabfunds.

The funds are a series of Schwab Investments (the trust).

The funds' most recent annual report is a separate document supplied with the
SAI and includes the funds' audited financial statements, which are incorporated
by reference into this SAI.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE, STRATEGIES,
SECURITIES, RISKS AND LIMITATIONS ....................................... 2
MANAGEMENT OF THE FUNDS ................................................. 13
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES ..................... 17
INVESTMENT ADVISORY AND OTHER SERVICES .................................. 18
BROKERAGE ALLOCATION AND OTHER PRACTICES ................................ 19
DESCRIPTION OF THE TRUST ................................................ 20
PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER REPORTS
AND PRICING OF SHARES ................................................... 22
TAXATION ................................................................ 23
CALCULATION OF PERFORMANCE DATA ......................................... 25
APPENDIX - RATINGS OF INVESTMENT SECURITIES ............................. 29
</TABLE>

1
<PAGE> 31

INVESTMENT OBJECTIVES, STRATEGIES, SECURITIES,
RISKS AND LIMITATIONS

INVESTMENT OBJECTIVES

Schwab Short/Intermediate Tax-Free Bond Fund and Schwab Long-Term Tax-Free Bond
Fund's investment objective is to seek a high level of current income that is
exempt from federal income tax, consistent with preservation of capital. There
is no guarantee a fund will achieve its investment objective.

Schwab California Short/Intermediate Tax-Free Bond Fund and Schwab California
Long-Term Tax-Free Bond Fund's investment objective is to seek a high level of
current income that is exempt from federal income and State of California
personal income taxes, consistent with preservation of capital. There is no
guarantee a fund will achieve its investment objective.

Each fund's investment objective may be changed by vote of a majority of its
shareholders. A majority vote of outstanding securities of a fund means the
vote, at an annual or a special meeting of shareholders of a fund where (a) of
67% or more of the voting securities present at the meeting, if the shareholders
of more than 50% of the outstanding securities of a fund are present or
represented by proxy, or (b) of more than 50% of the outstanding voting
securities of a fund, whichever is less.

The following descriptions of investment securities, risks and limitations
supplement those set forth in the prospectus and may be changed without
shareholder approval unless otherwise noted. Also, policies and limitations that
state a maximum percentage of assets that may be invested in a security or other
asset, or that set forth a quality standard, shall be measured immediately after
and as a result of a fund's acquisition of such security or asset unless
otherwise noted. Any subsequent change in values, net assets or other
circumstances will not be considered when determining whether the investment
complies with a fund's investment policies and limitations. Not all investment
securities or techniques discussed below are eligible investments for each fund.
Each fund will invest in securities or engage in techniques that are intended to
help achieve its investment objective.

These funds are not suitable for investors who would not benefit from the
tax-exempt character of each fund's investments, such as holders of IRAs,
qualified retirement plans or other tax-exempt entities.

INVESTMENT STRATEGIES

Each fund will normally invest at least 80% of its total assets in municipal
securities the interest of which is free from federal income tax including
federal alternative minimum tax. This policy may be changed only by
shareholders. Each fund may invest more than 25% in municipal securities
financing similar projects.

INVESTMENT SECURITIES AND RISKS

BORROWING may subject a fund to interest costs, which may exceed the interest
received on the securities purchased with the borrowed funds. A fund normally
may borrow at times to meet redemption requests rather than sell portfolio
securities to raise the necessary cash. Borrowing can involve leveraging when
securities are purchased with the borrowed money. Each fund may borrow money
from banks and make other investments or engage in other transactions
permissible under the 1940 Act which may be considered a borrowing. However,
each fund may not purchase securities when bank borrowings exceed 5% of a fund's
total assets.

Each fund may establish lines-of-credit (lines) with certain banks by which it
may borrow funds for temporary or emergency purposes. A borrowing is presumed to
be for temporary or emergency purposes

2
<PAGE> 32
if it is repaid by a fund within 60 days and is not extended or renewed. Each
fund intends to use the lines to meet large or unexpected redemptions that would
otherwise force a fund to liquidate securities under circumstances which are
unfavorable to the fund's remaining shareholders. Each fund will pay a fee to
the bank for using the lines.

CREDIT AND LIQUIDITY SUPPORTS may be employed by issuers to reduce the credit
risk of their securities. Credit supports include letters of credit, insurance
and guarantees provided by foreign and domestic entities. Liquidity supports
include puts, demand features, and lines of credit. Most of these arrangements
move the credit risk of an investment from the issuer of the security to the
support provider. Changes in the credit quality of a support provider could
cause losses to a fund.

DEBT SECURITIES are obligations issued by domestic and foreign entities,
including governments and corporations, in order to raise money. They are
basically "IOUs," but are commonly referred to as bonds or money market
securities. These securities normally require the issuer to pay a fixed,
variable or floating rate of interest on the amount of money borrowed (the
"principal") until it is paid back upon maturity.

Debt securities experience price changes when interest rates change. For
example, when interest rates fall, the prices of debt securities generally rise.
Also, issuers tend to pre-pay their outstanding debts and issue new ones paying
lower interest rates. This is especially true for bonds with sinking fund
provisions, which commit the issuer to set aside a certain amount of money to
cover timely repayment of principal and typically allow the issuer to annually
repurchase certain of its outstanding bonds from the open market or at a pre-set
call price.

Conversely, in a rising interest rate environment, prepayment on outstanding
debt securities generally will not occur. This is known as extension risk and
may cause the value of debt securities to depreciate as a result of the higher
market interest rates. Typically, longer-maturity securities react to interest
rate changes more severely than shorter-term securities (all things being
equal), but generally offer greater rates of interest.

Debt securities also are subject to the risk that the issuers will not make
timely interest and/or principal payments or fail to make them at all. This is
called credit risk. Corporate debt securities (bonds) tend to have higher credit
risk generally than U.S. government debt securities. Debt securities also may be
subject to price volatility due to market perception of future interest rates,
the creditworthiness of the issuer and general market liquidity (market risk).
Investment-grade debt securities are considered medium- and high-quality
securities, although some still possess varying degrees of speculative
characteristics and risks. Debt securities rated below investment-grade are
riskier, but may offer higher yields. These securities are sometimes referred to
as high yield securities or "junk bonds."

The funds invest in higher-quality investment-grade securities. In the event a
debt security held by a fund were downgraded below BBB-, a fund could continue
to hold it if the investment adviser believed it would benefit a fund.

See the Appendix for a full description of the various ratings assigned to debt
securities by various nationally recognized statistical rating organizations
(NRSROs).

3
<PAGE> 33
cover its delayed-delivery purchase obligations. When a fund sells a security on
a delayed-delivery basis, a fund does not participate in further gains or losses
with respect to that security. If the other party to a delayed-delivery
transaction fails to deliver or pay for the securities, a fund could suffer
losses.

DEMAND FEATURES, which may include guarantees, are used to shorten a security's
effective maturity and/or enhance its creditworthiness. If a demand feature
provider were to refuse to permit the feature's exercise or otherwise terminate
its obligations with respect to such feature, however, the security's effective
maturity may be lengthened substantially, and/or its credit quality may be
adversely impacted. In either event, a fund may experience an increase in share
price volatility. This also could lengthen a fund's overall average effective
maturity.

DIVERSIFICATION involves investing in a wide range of securities and thereby
spreading and reducing the risks of investment. Each fund is a non-diversified
mutual fund, which means that a fund may invest in the securities of a limited
number of issuers. As a result, the performance of a particular investment or
small group of investments may affect a fund's performance more than if a fund
were diversified.

DURATION was developed as a more precise alternative to the concept of
"maturity." Traditionally, a debt obligation's maturity has been used as a proxy
for the sensitivity of the security's price to changes in interest rates (which
is the "interest rate risk" or "volatility" of the security). However, maturity
measures only the time until a debt obligation provides its final payment,
taking no account of the pattern of the security's payments prior to maturity.
In contrast, duration incorporates a bond's yield, coupon interest payments,
final maturity and call features into one measure. Duration management is one of
the fundamental tools used by the investment adviser.

Duration is a measure of the expected life of a debt obligation on a present
value basis. Duration takes the length of the time intervals between the present
time and the time that the interest and principal payments are scheduled or, in
the case of a callable bond, the time the principal payments are expected to be
received, and weights them by the present values of the cash to be received at
each future point in time. For debt obligations with interest payments occurring
prior to the payment of principal, duration will usually be less than maturity.
In general, all others being equal, the lower the stated or coupon rate of the
interest of a fixed income security, the longer the duration of the security;
conversely, the higher the stated or coupon rate of a fixed income security, the
shorter the duration of the security.

HIGH YIELD SECURITIES are frequently issued by companies without long track
records of sales and earnings, or by those of questionable credit strength, and
are more speculative and volatile (though typically higher yielding) than
investment grade bonds. In addition, the high yield market is relatively new and
its growth has paralleled a long period of economic expansion and an increase in
merger, acquisition and leveraged buyout activity. Adverse economic developments
could disrupt the market for high yield securities, and severely affect the
ability of issuers, especially highly-leveraged issuers, to service their debt
obligations or to repay their obligations upon maturity.

Also, the secondary market for high yield securities at times may not be as
liquid as the secondary market for higher-quality debt securities. As a result,
the investment adviser could find it difficult to sell these securities or
experience difficulty in valuing certain high yield securities at certain times.
Prices realized upon the sale of such lower rated securities, under these
circumstances, may be less than the prices at which a fund purchased them.

4
<PAGE> 34
Thus, high yield securities are more likely to react to developments affecting
interest rates and market and credit risk than are more highly rated securities,
which primarily react to movements in the general level of interest rates. When
economic conditions appear to be deteriorating, medium to lower quality debt
securities may decline in value more than higher-quality debt securities due to
heightened concern over credit quality, regardless of prevailing interest rates.
Prices for high yield securities also could be affected by legislative and
regulatory developments. These laws could adversely affect a fund's net asset
value and investment practices, the secondary market value for high yield
securities, the financial condition of issuers of these securities and the value
of outstanding high yield securities.

ILLIQUID SECURITIES generally are any securities that cannot be disposed of
promptly and in the ordinary course of business at approximately the amount at
which a fund has valued the instruments. The liquidity of a fund's investments
is monitored on an on-going basis under the supervision and direction of the
board of trustees. Investments currently not considered liquid include
repurchase agreements not maturing within seven days and certain restricted
securities.

LENDING of portfolio securities is a common practice in the securities industry.
A fund may engage in security lending arrangements with the primary objective of
increasing its income. For example, a fund may receive cash collateral and it
may invest it in short-term, interest-bearing obligations, but will do so only
to the extent that it will not lose the tax treatment available to mutual funds.
Lending portfolio securities involves risks that the borrower may fail to return
the securities or provide additional collateral.

A fund may loan portfolio securities to qualified broker-dealers or other
institutional investors provided: (1) the loan is secured continuously by
collateral consisting of U.S. government securities, letters of credit, cash or
cash-equivalents or other appropriate instruments maintained on a daily
marked-to-market basis in an amount at least equal to the current market value
of the securities loaned; (2) a fund may at any time call the loan and obtain
the return of the securities loaned; (3) a fund will receive any interest or
dividends paid on the loaned securities; and (4) an aggregate market value of
securities loaned will not at any time exceed one-third of the total assets of a
fund including collateral received from the loan (at market value computed at
the time of the loan).

Although voting rights with respect to loaned securities pass to the borrower,
the lender retains the right to recall a security (or terminate a loan) for the
purpose of exercising the security's voting rights. Efforts to recall such
securities promptly may be unsuccessful, especially for foreign securities or
thinly traded securities such as small-cap stocks. In addition, because
recalling a security may involve expenses to a fund, it is expected that a fund
will do so only where the items being voted upon are, in the judgment of the
investment adviser, either material to the economic value of the security or
threaten to materially impact the issuer's corporate governance policies or
structure.

MATURITY OF INVESTMENTS will generally be determined using the portfolio
securities' final maturity dates. However for certain securities, maturity will
be determined using the security's effective maturity date. The effective
maturity date for a security subject to a put or demand feature is the demand
date, unless the security is a variable- or floating-rate security. If it is a
variable-rate security, its effective maturity date is the later of its demand
date or next interest rate change date. For variable-rate securities not subject
to a put or demand feature and floating-rate securities, the effective maturity
date is the next interest rate change date. The effective maturity of
mortgage-backed and certain other asset-backed securities is determined on an
"expected life" basis by the investment adviser and securities being hedged with
futures contracts may be deemed to have a longer maturity, in the case of
purchases of future contracts, and a shorter maturity, in the case of sales of
futures contracts, than they would otherwise be deemed to have. In addition, a
security that is subject to redemption at the option of the issuer on a
particular date ("call date"), which is prior to the security's stated maturity,
may be deemed to mature on the call date rather than on its stated maturity
date. The call date of a security will be used to calculate average portfolio

5
<PAGE> 35
maturity when the investment adviser reasonably anticipates, based upon
information available to it, that the issuer will exercise its right to redeem
the security. The average portfolio maturity of a fund is dollar-weighted based
upon the market value of a fund's securities at the time of the calculation. A
fund may invest in securities with final or effective maturities of any length.

MONEY MARKET SECURITIES are high-quality, short-term debt securities that may be
issued by entities such as the U.S. government, corporations and financial
institutions (like banks). Money market securities include commercial paper,
certificates of deposit, bankers' acceptances, notes and time deposits.

Money market securities pay fixed, variable or floating rates of interest and
are generally subject to credit and interest rate risks. The maturity date or
price of and financial assets collateralizing a security may be structured in
order to make it qualify as or act like a money market security. These
securities may be subject to greater credit and interest rate risks than other
money market securities because of their structure. Money market securities may
be issued with puts or these can be sold separately.

Restriction: Each fund will invest only in certificates of deposit and bankers'
acceptances of banks that have capital, surplus and undivided profits in excess
of $100 million.

MORTGAGE-BACKED SECURITIES ("MBS") and other ASSET-BACKED SECURITIES may be
purchased by a fund. MBS represent participations in mortgage loans, and include
pass-through securities and collateralized mortgage obligations. MBS may be
issued or guaranteed by U.S. government agencies or instrumentalities, such as
the Government National Mortgage Association (GNMA or Ginnie Mae) and Fannie Mae
or the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), or by
private issuers, generally originators and investors in mortgage loans,
including savings associations, mortgage banks, commercial banks, and special
purpose entities (collectively, "private lenders"). MBS issued by private
lenders may be supported by pools of mortgage loans or other mortgage-backed
securities that are guaranteed, directly or indirectly, by the U.S. government
or one of its agencies or instrumentalities, or they may be issued without any
governmental guarantee of the underlying mortgage assets but with some form of
credit enhancement.

Asset-backed securities ("ABS") have structural characteristics similar to MBS.
Asset-backed debt obligations represent direct or indirect participation in
assets such as automobile loans, credit card receivables, trade receivables,
home equity loans (which sometimes are categorized as MBS) or other financial
assets. Therefore, repayment depends largely on the cash flows generated by the
assets backing the securities. The credit quality of most ABS depends primarily
on the credit quality of the assets underlying such securities, how well the
entity issuing the security is insulated from the credit risk of the originator
or any other affiliated entities, and the amount and quality of any credit
enhancement of the securities. Payments or distributions of principal and
interest on asset-backed debt obligations may be supported by credit
enhancements including letters of credit, an insurance guarantee, reserve funds
and overcollateralization.

The rate of principal payment on MBS and ABS generally depends on the rate of
principal payments received on the underlying assets which in turn may be
affected by a variety of economic and other factors. As a result, the price and
yield on any MBS or ABS is difficult to predict with precision and price and
yield to maturity may be more or less than the anticipated yield to maturity. If
a fund purchases these securities at a premium, a prepayment rate that is faster
than expected will reduce yield to maturity, while a prepayment rate that is
slower than expected will have the opposite effect of increasing the yield to
maturity. Conversely, if a fund purchases these securities at a discount, a
prepayment rate that is faster than expected will increase yield to maturity,
while a prepayment rate that is slower than expected will reduce yield to
maturity. Amounts available for reinvestment by a fund are likely to be greater
during a period of declining interest rates and, as a result, are likely to be
reinvested at lower interest rates than during a period of rising interest
rates.

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<PAGE> 36
While many MBS and ABS are issued with only one class of security, many are
issued in more than one class, each with different payment terms. Multiple class
MBS and ABS are issued as a method of providing credit support, typically
through creation of one or more classes whose right to payments on the security
is made subordinate to the right to such payments of the remaining class or
classes. In addition, multiple classes may permit the issuance of securities
with payment terms, interest rates, or other characteristics differing both from
those of each other and from those of the underlying assets. Examples include
stripped securities, which are MBS and ABS entitling the holder to
disproportionate interest or principal compared with the assets backing the
security, and securities with classes having characteristics different from the
assets backing the securities, such as a security with floating interest rates
with assets backing the securities having fixed interest rates. The market value
of such securities generally is more or less sensitive to changes in prepayment
and interest rates than is the case with traditional MBS and ABS, and in some
cases such market value may be extremely volatile.

MUNICIPAL LEASES are obligations issued to finance the construction or
acquisition of equipment or facilities. These obligations may take the form of a
lease, an installment purchase contract, a conditional sales contract or a
participation interest in any of these obligations. Municipal leases may be
considered illiquid investments. Additionally, municipal leases are subject to
"non-appropriation risk," which is the risk that the municipality may terminate
the lease because funds have not been allocated to make the necessary lease
payments. Further, if there is a non-appropriation but principal and/or interest
is paid by a credit enhancer, such principal and/or interest payments may not be
tax-exempt. The lessor would then be entitled to repossess the property, but the
value of the property may be less to private sector entities than it would be to
the municipality.

MUNICIPAL SECURITIES are debt securities issued by a state, its counties,
municipalities, authorities and other subdivisions, or the territories and
possessions of the United States and the District of Columbia, including their
subdivisions, agencies and instrumentalities and corporations. These securities
may be issued to obtain money for various public purposes, including the
construction of a wide range of public facilities such as airports, bridges,
highways, housing, hospitals, mass transportation, public utilities, schools,
streets, and water and sewer works. Other public purposes include refunding
outstanding obligations, obtaining funds for general operating expenses and
obtaining funds to loan to other public institutions and facilities.

Municipal securities also may be issued to finance various private activities,
including certain types of private activity bonds ("industrial development
bonds" under prior law). These securities may be issued by or on behalf of
public authorities to obtain funds to provide certain privately owned or
operated facilities. The funds may not be desirable investments for "substantial
users" of facilities financed by private activity bonds or industrial
development bonds or for "related persons" of substantial users because
distributions from the funds attributable to interest on such bonds may not be
tax exempt. The funds intend to limit investments in these securities to 20% of
their total assets. Shareholders should consult their own tax advisors regarding
the potential effect on them (if any) of any investments in these funds.

Municipal securities may be owned directly or through participation interests,
and include general obligation or revenue securities, tax-exempt commercial
paper, notes and leases. Municipal securities generally are classified as
"general obligation" or "revenue" and may be purchased directly or through
participation interests. General obligation securities typically are secured by
the issuer's pledge of its full faith and credit and most often its taxing power
for the payment of principal and interest. Revenue securities typically are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special tax or other
specific revenue source. Private activity bonds and industrial development bonds
are, in most cases, revenue bonds and generally do not constitute the pledge of
the credit of the issuer of such bonds. The credit quality of private activity
bonds

7
<PAGE> 37
is frequently related to the credit standing of private corporations or other
entities.

In addition to bonds, municipalities issue short-term securities such as tax
anticipation notes, bond anticipation notes, revenue anticipation notes,
construction loan notes and tax-free commercial paper. Tax anticipation notes
typically are sold to finance working capital needs of municipalities in
anticipation of the receipt of property taxes on a future date. Bond
anticipation notes are sold on an interim basis in anticipation of a
municipality's issuance of a longer-term bond in the future. Revenue
anticipation notes are issued in expectation of the receipt of other types of
revenue, such as that available under the Federal Revenue Sharing Program.
Construction loan notes are instruments insured by the Federal Housing
Administration with permanent financing by Fannie Mae or Ginnie Mae at the end
of the project construction period. Tax-free commercial paper is an unsecured
promissory obligation issued or guaranteed by a municipal issuer. A fund may
purchase other municipal securities similar to the foregoing that are or may
become available, including securities issued to pre-refund other outstanding
obligations of municipal issuers.

A fund also may invest in moral obligation securities, which are normally issued
by special purpose public authorities. If the issuer of a moral obligation
security is unable to meet its obligation from current revenues, it may draw on
a reserve fund. The state or municipality that created the entity has only a
moral commitment, not a legal obligation, to restore the reserve fund.

The value of municipal securities may be affected by uncertainties with respect
to the rights of holders of municipal securities in the event of bankruptcy or
the taxation of municipal securities as a result of legislation or litigation.
For example, under federal law, certain issuers of municipal securities may be
authorized in certain circumstances to initiate bankruptcy proceedings without
prior notice to or the consent of creditors. Such action could result in
material adverse changes in the rights of holders of the securities. In
addition, litigation challenging the validity under the state constitutions of
present systems of financing public education has been initiated or adjudicated
in a number of states, and legislation has been introduced to effect changes in
public school finances in some states. In other instances, there has been
litigation challenging the issuance of pollution control revenue bonds or the
validity of their issuance under state or federal law, which ultimately could
affect the validity of those municipal securities or the tax-free nature of the
interest thereon.

Municipal securities pay fixed, variable or floating rates of interest, which
may be exempt from federal income tax and, typically, personal income tax of a
state or locality.

The investment adviser relies on the opinion of the issuer's counsel, which is
rendered at the time the security is issued, to determine whether the security
is fit, with respect to its validity and tax status, to be purchased by a fund.

PUTS are agreements that allow the buyer to sell a security at a specified price
and time to the seller or "put provider." When a fund buys a security with a put
feature, losses could occur if the put provider does not perform as agreed. If a
put provider fails to honor its commitment upon a fund's attempt to exercise the
put, a fund may have to treat the security's final maturity as its effective
maturity. If that occurs, the security's price may be negatively impacted, and
its sensitivity to interest rate changes may be increased, possibly contributing
to increased share price volatility for a fund. This also could lengthen a
fund's overall average effective maturity. Standby commitments are types of
puts.

QUALITY OF INVESTMENTS will be in investment grade for at least 80% of each
fund's assets. Investment-grade quality securities are rated by at least one
NRSRO in one of the four highest rating categories (within which there may be
sub-categories or gradations indicating relative standing) or have been
determined to be of equivalent quality by the investment adviser pursuant to
procedures adopted by the board of trustees. Sometimes an investment grade
quality security may be downgraded to a below

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<PAGE> 38
investment grade quality rating. If a security no longer has at least one
investment quality rating from an NRSRO, the investment adviser would reanalyze
the security in light of the downgrade and determine whether a fund should
continue to hold the security. Each fund will limit its investments in unrated
securities to no more than 20% of its net assets.

REPURCHASE AGREEMENTS involve a fund buying securities (usually U.S. government
securities) from a seller and simultaneously agreeing to sell them back at an
agreed-upon price (usually higher) and time. There are risks that losses will
result if the seller does not perform as agreed. Under certain circumstances,
repurchase agreements that are fully collateralized by U.S. government
securities may be deemed to be investments in U.S. government securities.

STATE-SPECIFIC MUNICIPAL MUTUAL FUNDS are municipal funds that invest primarily
in municipal securities issued by or on behalf of one state or one state's
counties, municipalities, authorities or other subdivisions.

These funds' securities are subject to the same general risks associated with
other municipal funds' securities. In addition, their values will be
particularly affected by economic, political, geographic and demographic
conditions and developments within the affected state. A fund that invests
primarily in securities issued by a single state and its political subdivisions
provides a greater level of risk than a fund that is diversified across numerous
states and municipal entities. The ability of the state or its municipalities to
meet their obligations will depend on the availability of tax and other
revenues; economic, political and demographic conditions within the state; and
the underlying fiscal condition of the state and its municipalities. The risks
of investing in mutual funds generally reflect the risks of the securities in
which the mutual funds invest and the investment techniques they may employ.
Also, mutual funds charge fees and incur operating expenses, so the fund will
bear its proportionate share of the expenses of the mutual fund it invests in,
in addition to its own expenses.

CALIFORNIA MUNICIPAL SECURITIES. These funds are state-specific municipal funds
that invest substantially all of their assets in municipal securities issued by
or on behalf of, the State of California, or its counties, municipalities,
authorities or other subdivisions.

A fund that invests primarily in securities issued by a single state and its
political subdivisions entails a greater level of risk than a fund that is
diversified across numerous states and their municipal entities. The ability of
the State or its municipalities to meet their obligations will depend on the
availability of tax and other revenues; economic, political and other conditions
within the State; and the underlying fiscal condition of the State and its
municipalities.

In recent years, the State of California has derived a significant portion of
its revenues from personal income and sales taxes. Because the amount collected
from these taxes is sensitive to economic conditions, the State's revenues have
been volatile. In addition, a number of political developments, voter
initiatives, state constitutional amendments and legislative actions in
California in recent years have subjected the State government to spending
obligations and limitations and have constrained the fiscal condition of local
governments by subjecting them to annual appropriation limits, by reducing and
limiting the future growth of property taxes, and by limiting the ability of
local governments to impose special taxes without two-thirds voter approval.

In response to the fiscal constraints on local governments, the State
legislature in the past has provided varying levels of aid to local governments
from the State general fund and other sources. Consequently, the budgets of
California counties and other local governments have been significantly affected
by State budget decisions beyond their control and have been subject to revenue
volatility which reflects that of the State. Whether legislation will be enacted
in the future to either reduce or increase the redistribution of State revenues
to local governments, or to make them less dependent on State budget decisions,
cannot

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<PAGE> 39
be predicted.

From mid-1990 to late 1993, California suffered the worst recession in the State
since the 1930s. The recession reduced State revenues while its health and
welfare costs were increasing. Consequently, the State had a lengthy period of
budget imbalance. During the recession, the State legislature eliminated
significant components of its aid to local governments. With the end of the
recession, the State's financial condition has improved, with a combination of
better than expected revenues, slowdown in growth of social welfare programs,
and continued spending restraint. The accumulated budget deficit from the
recession years has been eliminated and no deficit borrowing has occurred at the
end of the last several fiscal years. The State has also increased aid to local
governments and reduced certain mandates for local services.

It is not possible to predict the future impact of the voter initiatives, State
constitutional amendments, legislation or economic considerations described
above, or of such initiatives, amendments or legislation that may be enacted in
the future, on the long-term ability of the State of California or its municipal
issuers to pay interest or repay principal on their obligations. There is no
assurance that any California issuer will make full or timely payments of
principal or interest or remain solvent. For example, in December 1994, Orange
County filed for bankruptcy.

Certain tax exempt securities in which these funds may invest may be obligations
payable solely from the revenues of specific institutions, or may be secured by
specific properties, which are subject to provisions of California law that
could adversely affect the holders of such obligations. For example, the
revenues of California health care institutions may be adversely affected by
state laws, and California law limits the remedies of a creditor secured by a
mortgage or deed of trust on real property. Debt obligations payable solely from
revenues of health care institutions may also be insured by the State but no
guarantee exists that adequate reserve funds will be appropriated by the State
legislature for such insurance.

California is subject to seismic risks and it is impossible to predict the time,
magnitude or location of a major earthquake or its effect on the California
economy. In January 1994, a major earthquake struck Los Angeles, causing
significant damage to structures and facilities in a four county area. The
possibility exists that another such earthquake could cause a major dislocation
of the California economy.

SECURITIES OF OTHER INVESTMENT COMPANIES may be purchased and sold by a fund,
and those issued by foreign investment companies. Mutual funds are registered
investment companies, which may issue and redeem their shares on a continuous
basis (open-end mutual funds) or may offer a fixed number of shares usually
listed on an exchange (closed-end mutual funds). Mutual funds generally offer
investors the advantages of diversification and professional investment
management, by combining shareholders' money and investing it in various types
of securities, such as stocks, bonds and money market securities. Mutual funds
also make various investments and use certain techniques in order to enhance
their performance. These may include entering into delayed-delivery and
when-issued securities transactions or swap agreements; buying and selling
futures contracts, illiquid and restricted securities and repurchase agreements
and borrowing or lending money and/or portfolio securities. The risks of
investing in mutual funds generally reflect the risks of the securities in which
the mutual funds invest and the investment techniques they may employ. Also,
mutual funds charge fees and incur operating expenses.

If a fund decides to purchase securities of other investment companies, a fund
intends to purchase shares of mutual funds in compliance with the requirements
of federal law or any applicable exemptive relief received from the Securities
and Exchange Commission (SEC). Mutual fund investments for a fund are currently
restricted under federal regulations, and therefore, the extent to which a fund
may invest in another mutual fund may be limited. In addition, a fund intends to
vote any proxies of underlying mutual funds in accordance with the instructions
received, or in the same proportion as the vote of all other shareholders of the
underlying mutual fund.

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<PAGE> 40
TAXABLE SECURITIES. Under normal conditions, the funds do not intend to invest
in securities in which interest is subject to federal income and/or state and
local personal income taxes. However, from time to time, as a defensive measure
or under abnormal market conditions, the funds may make temporary investments in
securities, the interest on which is subject to federal income and/or state and
local personal income taxes.

U.S. GOVERNMENT SECURITIES are issued by the U.S. Treasury or issued or
guaranteed by the U.S. government or any of its agencies or instrumentalities.
Not all U.S. government securities are backed by the full faith and credit of
the United States. Some U.S. government securities, such as those issued by
Fannie Mae, the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac),
the Student Loan Marketing Association (SLMA or Sallie Mae), and the Federal
Home Loan Banks (FHLB), are supported by a line of credit the issuing entity has
with the U.S. Treasury. Others are supported solely by the credit of the issuing
agency or instrumentality such as obligations issued by the Federal Farm Credit
Banks Funding Corporation (FFCB). There can be no assurance that the U.S.
government will provide financial support to U.S. government securities of its
agencies and instrumentalities if it is not obligated to do so under law. Of
course U.S. government securities, including U.S. Treasury securities, are among
the safest securities, however, not unlike other debt securities, they are still
sensitive to interest rate changes, which will cause their yields to fluctuate.

VARIABLE- AND FLOATING-RATE DEBT SECURITIES pay an interest rate, which is
adjusted either periodically or at specific intervals or which floats
continuously according to a formula or benchmark. Although these structures
generally are intended to minimize the fluctuations in value that occur when
interest rates rise and fall, some structures may be linked to a benchmark in
such a way as to cause greater volatility to the security's value.

Some variable-rate securities may be combined with a put or demand feature
(variable-rate demand securities) that entitles the holder to the right to
demand repayment in full or to resell at a specific price and/or time. While the
demand feature is intended to reduce credit risks, it is not always
unconditional, and may make the securities more difficult to sell quickly
without losses. There are risks involved with these securities because there may
be no active secondary market for a particular variable-rate demand security
purchased by a fund. In addition, a fund may exercise its demand rights only at
certain times. A fund could also suffer losses in the event that the issuer
defaults on its obligation.

INVESTMENT LIMITATIONS

The following investment limitations may be changed only by vote of a majority
of each fund's shareholders.

EACH FUND MAY NOT:

1) Concentrate investments in a particular industry or group of industries,
as concentration is defined under the 1940 Act, the rules or regulations
thereunder or any exemption therefrom, as such statute, rules or
regulations may be amended or interpreted from time to time.

2) Purchase or sell commodities or real estate, except to the extent
permitted under the 1940 Act, the rules or regulations thereunder or any
exemption therefrom, as such statute, rules or regulations may be amended
or interpreted from time to time.

3) Purchase securities of other investment companies, except as permitted by
the 1940 Act.

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<PAGE> 41
4) Make loans to other persons, except to the extent permitted under the 1940
Act, the rules or regulations thereunder or any exemption therefrom, as
such statute, rules or regulations may be amended or interpreted from time
to time.

5) Borrow money, except to the extent permitted under the 1940 Act, the rules
or regulations thereunder or any exemption therefrom, as such statute,
rules or regulations may be amended or interpreted from time to time.

6) Issue senior securities, except to the extent permitted under the 1940
Act, the rules or regulations thereunder or any exemption therefrom, as
such statute, rules or regulations may be amended or interpreted from time
to time.

7) Underwrite securities issued by other persons, except to the extent
permitted under the 1940 Act, the rules or regulations thereunder or any
exemption therefrom, as such statute, rules or regulations may be amended
or interpreted from time to time.

The following investment policies and restrictions are non-fundamental and may
be changed by the trust's board of trustees. Each fund may not:

1) As to 75% of its assets, purchase securities of any issuer (other than
obligations of, or guaranteed by, the U.S. government, its agencies or
instrumentalities) if, as a result, more than 5% of the value of its total
assets would be invested in the securities of such issuer, except that
provided that no more than 25% of a fund's total assets would be invested
in the securities of a single issuer, up to 50% of a fund's total assets
may be invested without regard to this 5% limitation.

2) Purchase more than 10% of any class of securities of any issuer if, as a
result of such purchase, it would own more than 10% of such issuer's
outstanding voting securities.

3) Invest more than 5% of its total assets in securities of issuers (other
than obligations of, or guaranteed by the U.S. government, its agencies or
instrumentalities) that with their predecessors have a record of less than
three years continuous operation.

4) Purchase securities that would cause more than 5% of its net assets to be
invested in restricted securities, excluding restricted securities
eligible for resale pursuant to Rule 144A under the Securities Act of 1933
that have been determined to be liquid under procedures adopted by the
trust's board of trustees based upon the trading markets for the
securities.

5) Invest more than 5% of its net assets in warrants, valued at the lower of
cost or market, and no more than 40% of this 5% may be invested in
warrants that are not listed on the New York Stock Exchange or the
American Stock Exchange, provided, however, that for purposes of this
restriction, warrants acquired by a fund in units or attached to other
securities are deemed to be without value.

6) Purchase puts, calls, straddles, spreads or any combination thereof if by
reason of such purchase the value of its aggregate investment in such
securities would exceed 5% of a fund's total assets.

7) Make short sales, except for short sales against the box.

8) Purchase or sell interests in oil, gas or other mineral development
programs or leases, although it may invest in companies that own or invest
in such interests or leases.

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<PAGE> 42
9) Purchase securities on margin, except such short-term credits as may be
necessary for the clearance of purchases and sales of securities.

10) Purchase securities the income of which is subject to federal alternative
minimum tax if, by reason of such purchase, the total income earned by
such securities would exceed 20% of all income earned by a fund.

11) Purchase an unrated security, if, as a result, more than 20% of its net
assets would be invested in unrated securities.

12) Invest more than 25% of its total assets in when-issued and
delayed-delivery securities, or purchase such securities for speculative
purposes.

13) Each fund will normally invest at least 65% of its total assets in
securities deemed by the investment adviser to be bonds.

14) Borrow money except that a fund may (i) borrow money from banks and (ii)
engage in reverse repurchase agreements with any party; provided that (i)
and (ii) in combination do not exceed 33 1/3% of its total assets (any
borrowings that come to exceed this amount will be reduced to the extent
necessary to comply with the limitation with three business days) and a
fund will not purchase securities while borrowings represent more than 5%
of its total assets.

15) Lend any security or make any other loan if, as a result, more than 33
1/3% of its total assets would be lent to other parties (this
restriction does not apply to purchases of debt securities or
repurchase agreements).

16) Invest more than 15% of its net assets in illiquid securities.

17) Purchase securities (other than securities issued or guaranteed by the
U.S. government, its agencies or instrumentalities) if, as a result of
such purchase, 25% or more of the value of its total assets would be
invested in any industry. Securities issued by governments or political
subdivisions or authorities of governments are not considered to be
securities subject to this industry concentration restriction.

18) Purchase or sell commodities or real estate, including interests in real
estate limited partnerships, provided that a fund may (i) purchase
securities of companies that deal in real estate or interests therein, and
(ii) purchase or sell futures contracts, options contracts, equity index
participations and index participation contracts.

19) Invest for the purpose of exercising control or management of another
issuer.

Note that with respect to non-fundamental restriction (4), each fund does not
currently intend to invest more than 5% of its total assets in restricted
securities eligible for resale pursuant to Rule 144A under the Securities Act of
1933 that have been determined to be liquid under procedures adopted by the
trust's board of trustees based upon the trading markets for the securities.

MANAGEMENT OF THE FUNDS

The officers and trustees, their principal occupations during the past five
years and their affiliations, if any, with The Charles Schwab Corporation,
Charles Schwab & Co., Inc. (Schwab) and Charles Schwab Investment Management,
Inc. (CSIM or the investment adviser), are as follows:

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<PAGE> 43
<TABLE>
<CAPTION>
POSITION(S) WITH PRINCIPAL OCCUPATIONS & AFFILIATIONS
NAME/DATE OF BIRTH THE TRUST
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CHARLES R. SCHWAB* Chairman, Chief Chairman and Co-Chief Executive Officer,
July 29, 1937 Executive Officer and Director, The Charles Schwab Corporation; Chief
Trustee Executive Officer, Director, Charles Schwab
Holdings, Inc.; Chairman, Director, Charles
Schwab & Co., Inc., Charles Schwab Investment
Management, Inc.; Director, The Charles Schwab
Trust Company; Chairman, Schwab Retirement Plan
Services, Inc.; Chairman and Director until
January 1999, Mayer & Schweitzer, Inc. (a
securities brokerage subsidiary of The Charles
Schwab Corporation); Director, The Gap, Inc. (a
clothing retailer), Audiobase, Inc.
(full-service audio solutions for the internet),
Vodaphone AirTouch PLC (a telecommunications
company) and Siebel Systems (a software company).

STEVEN L. SCHEID* President and Trustee Vice Chairman and Executive Vice President, The
June 28, 1953 Charles Schwab Corporation; Vice Chairman and
Enterprise President - Financial Products and
Services, Director, Charles Schwab & Co., Inc.;
Chief Executive Officer and Chief Financial
Officer and Director, Charles Schwab Investment
Management, Inc.; Director, Depository Trust
Company (a securities depository company) and
Requisite Technology (a technology company).
From 1994 to 1996, Mr. Scheid was Executive Vice
President of Finance for First Interstate
Bancorp and Principal Financial Officer from
1995 to 1996.

DONALD F. DORWARD Trustee Chief Executive Officer, Dorward & Associates
September 23, 1931 (corporate management, marketing and
communications consulting firm). From 1996 to
1999, Executive Vice President and Managing
Director, Grey Advertising. From 1990 to 1996,
Mr. Dorward was President and Chief Executive
Officer, Dorward & Associates (advertising and
marketing/consulting firm).

ROBERT G. HOLMES Trustee Chairman, Chief Executive Officer and Director,
May 15, 1931 Semloh Financial, Inc. (international financial
services and investment advisory firm).

DONALD R. STEPHENS Trustee Managing Partner, D.R. Stephens & Company
June 28, 1938 (investments). Prior to 1996, Chairman and
Chief
</TABLE>

--------

* This trustee is an "interested person" of the trusts.

<PAGE> 44

<TABLE>
<S> <C> <C>
Executive Officer of North American Trust
(real estate investment trust).

MICHAEL W. WILSEY Trustee Chairman and Chief Executive Officer, Wilsey
August 18, 1943 Bennett, Inc. (truck and air transportation,
real estate investment and management, and
investments).

JEREMIAH H. CHAFKIN* Executive Vice Executive Vice President, Asset Management
May 9, 1959 President, Chief Products and Services, Charles Schwab & Co.,
Operating Officer and Inc.; President and Chief Operating Officer,
Trustee Charles Schwab Investment Management, Inc.
Prior to September 1999, Mr. Chafkin was Senior
Managing Director, Bankers Trust Company.

MARIANN BYERWALTER Trustee Vice President for Business Affairs and Chief
August 13, 1960 Financial Officer, Stanford University (higher
education). Prior to February 1996, Ms.
Byerwalter was Chief Financial Officer of Eureka
Bank (savings and loans) and Chief Financial
Officer and Chief Operating Officer of America
First Eureka Holdings, Inc. (holding company).
Ms. Byerwalter also is on the Board of Directors
of America First Companies, Omaha, NE (venture
capital/fund management) and Redwood Trust, Inc.
(mortgage finance), and is Director of Stanford
Hospitals and Clinics, SRI International
(research) and LookSmart, Ltd. (an Internet
infrastructure company).

WILLIAM A. HASLER Trustee Co-Chief Executive Officer, Aphton Corporation
November 22, 1941 (bio-pharmaceuticals). Prior to August 1998,
Mr. Hasler was Dean of the Haas School of
Business at the University of California,
Berkeley (higher education). Mr. Hasler also is
on the Board of Directors of Solectron
Corporation (manufacturing), Tenera, Inc.
(services and software), Airlease Ltd. (aircraft
leasing) and Mission West Properties (commercial
real estate).

GERALD B. SMITH Trustee Chairman and Chief Executive Officer and founder
September 28, 1950 of Smith Graham & Co. (investment advisors).
Mr. Smith is also on the Board of Directors of
Pennzoil-Quaker State Company (oil and gas) and
Rorento N.V. (investments - Netherlands), and is
a member of the audit committee of Northern
Border Partners, L.P., a subsidiary of Enron
Corp. (energy).
</TABLE>

--------

* This trustee is an "interested person" of the trusts.

<PAGE> 45

<TABLE>
<S> <C> <C>
TAI-CHIN TUNG Treasurer and Principal Senior Vice President, Treasurer and Controller,
March 7, 1951 Financial Officer Charles Schwab Investment Management, Inc. From
1994 to 1996, Ms. Tung was Controller for
Robertson Stephens Investment Management, Inc.

STEPHEN B. WARD Senior Vice President Senior Vice President and Chief Investment
April 5, 1955 and Chief Investment Officer, Charles Schwab Investment Management,
Officer Inc.

KOJI E. FELTON Secretary Vice President, Chief Counsel and Assistant
March 13, 1961 Corporate Secretary, Charles Schwab Investment
Management, Inc. Prior to June 1998, Mr. Felton
was a Branch Chief in Enforcement at the U.S.
Securities and Exchange Commission in San
Francisco.
</TABLE>

Each of the above-referenced officers and/or trustees also serves in the same
capacity as described for the trust, for The Charles Schwab Family of Funds,
Schwab Capital Trust and Schwab Annuity Portfolios. The address of each
individual listed above is 101 Montgomery Street, San Francisco, California
94104.

Each fund is overseen by a board of trustees. The board of trustees meets
regularly to review a fund's activities, contractual arrangements and
performance. The board of trustees is responsible for protecting the interests
of a fund's shareholders. The following table provides information concerning
compensation of the trustees.

<TABLE>
<CAPTION>
($) Pension or ($)
Aggregate Compensation from each Fund Retirement Total
Name of Trustee Benefits Compensation
Accrued as from Fund
Part of Complex 1
Fund
Expenses
Short/Inter California California
-mediate Long-Term Short/Inter Long-Term
Tax-Free Tax-Free -mediate Tax-Free
Bond Fund Bond Fund Tax-Free Bond Fund
Bond Fund
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Charles R. Schwab 0 0 0 0 N/A 0
Steven L. Scheid 0 0 0 0 N/A 0
William J. Klipp 2 0 0 0 0 N/A 0
Jeremiah H. Chafkin 3 0 0 0 0 N/A 0
Mariann Byerwalter 3 338 337 349 364 N/A 38,870
Donald F. Dorward 1,670 1,670 1,719 1,807 N/A 134,600
William A. Hasler 3 338 337 349 364 N/A 38,870
Robert G. Holmes 1,670 1,670 1,719 1,807 N/A 134,600
</TABLE>

16
<PAGE> 46

<TABLE>
<CAPTION>
($) Pension or ($)
Aggregate Compensation from each Fund Retirement Total
Name of Trustee Benefits Compensation
Accrued as from Fund
Part of Complex 1
Fund
Expenses
Short/Inter California California
-mediate Long-Term Short/Inter Long-Term
Tax-Free Tax-Free -mediate Tax-Free
Bond Fund Bond Fund Tax-Free Bond Fund
Bond Fund
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Gerald B. Smith 3 338 337 349 364 N/A 38,870
Donald R. Stephens 1,670 1,670 1,719 1,807 N/A 134,600
Michael W. Wilsey 1,575 1,575 1,622 1,704 N/A 124,600
</TABLE>

1 Unless otherwise stated, information is for the fund complex, which
included 44 funds as of August 31, 2000.

2 Mr. Klipp departed Charles Schwab & Co., Inc. in 1999 and resigned from
the Board of Trustees effective April 30, 2000.

3 This trustee was first elected by shareholders on June 1, 2000.

DEFERRED COMPENSATION PLAN

Trustees who are not "interested persons" of a trust ("independent trustees")
may enter into a fee deferral plan. Under this plan, deferred fees will be
credited to an account established by the trust as of the date that such fees
would have been paid to the trustee. The value of this account will equal the
value that the account would be if the fees credited to the account had been
invested in the shares of SchwabFunds selected by the trustee. Currently, none
of the independent trustees has elected to participate in this plan.

CODE OF ETHICS

The funds, their investment adviser and Schwab have adopted a Code of Ethics
(Code) as required under the 1940 Act. Subject to certain conditions or
restrictions, the Code permits the trustees, directors, officers or advisory
representatives of the funds or the investment adviser or the directors or
officers of Schwab to buy or sell securities for their own accounts. This
includes securities that may be purchased or held by the funds. Securities
transactions by some of these individuals may be subject to prior approval of
the investment adviser's Chief Compliance Officer or alternate. Most securities
transactions are subject to quarterly reporting and review requirements.

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of October 16, 2000, the officers and trustees of Schwab Short/Intermediate
Tax-Free Bond Fund, Schwab Long-Term Tax-Free Bond Fund, Schwab California
Short/Intermediate Tax-Free Bond Fund and Schwab California Long-Term Tax-Free
Bond Fund as a group owned of record or beneficially less than 1% of the
outstanding voting securities of the funds.

As of October 16, 2000, Andrew & Nancy Kessler, JT TEN, 75 Catalpa Drive,
Atherton, CA 94027, directly or beneficially owned 6.02% of the shares of the
Schwab California Short/Intermediate Tax-Free Bond Fund. As of the same date,
William & Nancy Thompson TTEE, The Thompson Revocable Trust,

17
<PAGE> 47

2431 Riviera Drive, Laguna Beach, CA 92651, directly or beneficially owned 5.07%
of the Schwab California Short/Intermediate Tax-Free Bond Fund.

INVESTMENT ADVISORY AND OTHER SERVICES

INVESTMENT ADVISER

Charles Schwab Investment Management, Inc. (CSIM or the investment adviser), a
wholly owned subsidiary of The Charles Schwab Corporation, 101 Montgomery
Street, San Francisco CA 94104, serves as each fund's investment adviser and
administrator pursuant to Investment Advisory and Administration Agreements
(Advisory Agreements) between it and the trust. Charles Schwab & Co., Inc.
(Schwab) is an affiliate of the investment adviser and is the trust's
distributor, shareholder services agent and transfer agent. Charles R. Schwab is
the founder, Chairman, Co-Chief Executive Officer and Director of The Charles
Schwab Corporation. As a result of his ownership of and interests in The Charles
Schwab Corporation, Mr. Schwab may be deemed to be a controlling person of the
investment adviser and Schwab.

For its advisory and administrative services to each fund, the investment
adviser is entitled to receive a graduated annual fee payable monthly based on
each fund's average daily net assets as described below.

First $500 million - 0.30%
More than $500 million - 0.22%

Prior to November 15, 1999 for its advisory and administrative services for each
fund, the investment adviser was entitled to receive an annual fee, payable
monthly from each fund of 0.41% of each fund's average daily net assets.

For the fiscal years ended August 31, 1998, 1999 and 2000, the investment
advisory fees incurred by the Schwab Short/Intermediate Tax-Free Bond Fund were
$28,000 (fees were reduced by $212,000), $69,000 (fees were reduced by
$257,000), and $55,000 (fees were reduced by $209,000), respectively.

For the fiscal years ended August 31, 1998, 1999 and 2000, the investment
advisory fees incurred by the Schwab Long-Term Tax-Free Bond Fund were $19,000
(fees were reduced by $209,000), $80,000 (fees were reduced by $286,000), and
$47,000 (fees were reduced by $208,000), respectively.

For the fiscal years ended August 31, 1998, 1999 and 2000, the investment
advisory fees incurred by the Schwab California Short/Intermediate Tax-Free Bond
Fund were $77,000 (fees were reduced by $215,000), $149,000 (fees were reduced
by $318,000), and $128,000 (fees were reduced by $253,000), respectively.

For the fiscal years ended August 31, 1998, 1999 and 2000, the investment
advisory fees incurred by the Schwab California Long-Term Tax-Free Bond Fund
were $209,000 (fees were reduced by $409,000), $307,000 (fees were reduced by
$533,000), and $232,000 (fees were reduced by $336,000), respectively.

The investment adviser and Schwab have contractually guaranteed that, through at
least November 15, 2001 that total operating expenses (excluding interest, taxes
and certain non-routine expenses) will not exceed 0.49% of each fund's average
net assets.

DISTRIBUTOR

18
<PAGE> 48

prospectuses and shareholder reports to be prepared and delivered to existing
shareholders. Schwab pays such costs when the described materials are used in
connection with the offering of shares to prospective investors and for
supplemental sales literature and advertising. Schwab receives no fee under the
Distribution Agreement. At its own expense, Schwab may engage third party
entities, as appropriate, to perform some or all of these services.

SHAREHOLDER SERVICES AND TRANSFER AGENT

Schwab provides fund information to shareholders, including share price,
reporting shareholder ownership and account activities and distributing a fund's
prospectuses, financial reports and other informational literature about a fund.
Schwab maintains the office space, equipment and personnel necessary to provide
these services. Schwab also distributes and markets SchwabFunds and provides
other services. At its own expense, Schwab may engage third party entities, as
appropriate, to perform some or all of these services.

For the services performed as transfer agent under the contract with a fund,
Schwab is entitled to receive an annual fee, payable monthly from each fund, in
the amount of 0.05% of a fund's average daily net assets. For the services
performed as shareholder services agent under its contract with a fund, Schwab
is entitled to receive an annual fee, payable monthly from the funds, in the
amount of 0.20% of the average daily net assets of each fund.

CUSTODIAN AND FUND ACCOUNTANT

PFPC Trust Company, 8800 Tinicum Blvd. Third Floor Suite 200, Philadelphia, PA
19153, serves as custodian for the funds and PFPC, Inc., 400 Bellevue Parkway,
Wilmington, DE 19809, serves as fund accountant.

The custodian is responsible for the daily safekeeping of securities and cash
held or sold by the funds. The accountant maintains all books and records
related to each fund's transactions.

INDEPENDENT ACCOUNTANT

The funds' independent accountant, PricewaterhouseCoopers LLP, audits and
reports on the annual financial statements of each series of the trust and
reviews certain regulatory reports and each fund's federal income tax return.
They also perform other professional accounting, auditing, tax and advisory
services when the trust engages them to do so. Their address is 333 Market
Street, San Francisco, CA 94105. Each fund's audited financial statements for
the fiscal year ending August 31, 2000, will be included in the fund's annual
report that is supplied with the SAI.

BROKERAGE ALLOCATION AND OTHER PRACTICES

PORTFOLIO TURNOVER

For reporting purposes, a fund's turnover rate is calculated by dividing the
value of purchases or sales of portfolio securities for the fiscal year,
whichever is less, by the monthly average value of portfolio securities a fund
owned during the fiscal year. When making the calculation, all securities whose
maturities at the time of acquisition were one year or less ("short-term
securities") are excluded.

The portfolio turnover rates for the Schwab Short/Intermediate Tax-Free Bond
Fund for the fiscal years ended August 31, 1999 and 2000 were 8% and 11%,
respectively. The portfolio turnover rates for the Schwab Long-Term Tax-Free
Bond Fund for the fiscal years ended August 31, 1999 and 2000 were 35% and 25%,
respectively.

19
<PAGE> 49

The portfolio turnover rates for the Schwab California Short/Intermediate
Tax-Free Bond Fund for the fiscal years ended August 31, 1999 and 2000 were 7%
and 42%, respectively. The portfolio turnover rates for the Schwab California
Long-Term Tax-Free Bond Fund for the fiscal years ended August 31, 1999 and 2000
were 55% and 36%, respectively.

PORTFOLIO TRANSACTIONS

The funds paid no brokerage commissions in the last three fiscal years.

In effecting securities transactions for a fund, the investment adviser seeks to
obtain best execution. Subject to the supervision of the board of trustees, the
investment adviser will select brokers and dealers for a fund on the basis of a
number of factors, including, for example, price paid for securities, clearance,
settlement, reputation, financial strength and stability, efficiency of
execution and error resolution, block trading and block positioning
capabilities, willingness to execute related or unrelated difficult transactions
in the future, and order of call.

When the execution capability and price offered by two or more broker-dealers
are comparable, the investment adviser may, in its discretion, in agency
transactions (and not principal transactions) utilize the services of
broker-dealers that provide it with investment information and other research
resources. Such resources also may be used by the investment adviser when
providing advisory services to its clients.

A fund expects that purchases and sales of portfolio securities will usually be
principal transactions. Securities will normally be purchased directly from the
issuer or from an underwriter or market maker for the securities. Purchases from
underwriters will include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers serving as market makers will include
the spread between the bid and asked prices.

The investment decisions for a fund are reached independently from those for
other accounts managed by the investment adviser. Such other accounts also may
make investments in instruments or securities at the same time as a fund. When
two or more accounts managed by the investment adviser have funds available for
investment in similar instruments, available instruments are allocated as to
amount in a manner considered equitable to each account. In some cases, this
procedure may affect the size or price of the position obtainable for a fund.
However, it is the opinion of the board of trustees that the benefits conferred
by the investment adviser outweigh any disadvantages that may arise from
exposure to simultaneous transactions.

In an attempt to obtain best execution for a fund, the investment adviser may
place orders directly with market makers or with third market brokers such as
Instinet, which is a computer subscriber service, or brokers on an agency basis.
Placing orders with third market brokers or through Instinet may enable a fund
to trade directly with other institutional holders on a net basis. At times,
this may allow a fund to trade larger blocks than would be possible trading
through a single market maker.

DESCRIPTION OF THE TRUST

Each fund is a series of Schwab Investments. Schwab Investments was organized
under Massachusetts law on October 26, 1990.

The Declaration of Trust provides that shares may be automatically redeemed if
held by a shareholder in an amount less than the minimum required by a fund or
share class. Each fund's initial and subsequent minimum investment and balance
requirements are set forth in the prospectus. These minimums may be

20
<PAGE> 50
waived for certain investors, including trustees, officers and employees of
Schwab, or changed without prior notice.

Each fund may hold special meetings, which may cause the funds to incur
non-routine expenses. These meetings may be called for purposes such as
electing trustees, changing fundamental policies and amending management
contracts. Shareholders are entitled to one vote for each share owned and may
vote by proxy or in person. Proxy materials will be mailed to shareholders prior
to any meetings, and will include a voting card and information explaining the
matters to be voted upon.

The bylaws of the trust provides that a majority of shares entitled to vote
shall be a quorum for the transaction of business at a shareholders' meeting,
except that where any provision of law, or of the Declaration of Trust or of the
bylaws permits or requires that (1) holders of any series shall vote as a
series, then a majority of the aggregate number of shares of that series
entitled to vote shall be necessary to constitute a quorum for the transaction
of business by that series, or (2) holders of any class shall vote as a class,
then a majority of the aggregate number of shares of that class entitled to vote
shall be necessary to constitute a quorum for the transaction of business by
that class. Any lesser number shall be sufficient for adjournments. Any
adjourned session or sessions may be held, within a reasonable time after the
date set for the original meeting, without the necessity of further notice. The
Declaration of Trust specifically authorizes the board of trustees to terminate
the trust (or any of its investment portfolios) by notice to the shareholders
without shareholder approval.

Under Massachusetts law, shareholders of a Massachusetts business trust could,
under certain circumstances, be held personally liable for the trust's
obligations. The Declaration of Trust, however, disclaims shareholder liability
for the trust's acts or obligations and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the trust or the trustees. In addition, the Declaration of Trust provides for
indemnification out of the property of an investment portfolio in which a
shareholder owns or owned shares for all losses and expenses of such shareholder
or former shareholder if he or she is held personally liable for the obligations
of the trust solely by reason of being or having been a shareholder. Moreover,
the trust will be covered by insurance which the trustees consider adequate to
cover foreseeable tort claims. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is considered remote, because
it is limited to circumstances in which a disclaimer is inoperative and the
trust itself is unable to meet its obligations. There is a remote possibility
that a fund could become liable for a misstatement in the prospectus or SAI
about another fund.

As more fully described in the Declaration of Trust, the trustees may each year,
or more frequently, distribute to the shareholders of each series accrued income
less accrued expenses and any net realized capital gains less accrued expenses.
Distributions of each year's income of each series shall be distributed pro rata
to shareholders in proportion to the number of shares of each series held by
each of them. Distributions will be paid in cash or shares or a combination
thereof as determined by the trustees. Distributions paid in shares will be paid
at the net asset value as determined in accordance with the bylaws.

21
<PAGE> 51
PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER REPORTS AND
PRICING OF SHARES

PURCHASING AND REDEEMING SHARES OF THE FUNDS

As long as a fund or Schwab follow reasonable procedures to confirm that your
telephone or internet order is genuine, they will not be liable for any losses
an investor may experience due to unauthorized or fraudulent instructions. These
procedures may include requiring a form of personal identification or other
confirmation before acting upon any telephone or internet order, providing
written confirmation of telephone or internet orders and tape recording all
telephone orders.

Share certificates will not be issued in order to avoid additional
administrative costs, however, share ownership records are maintained by Schwab.

EXCHANGING SHARES OF THE FUNDS

Shares of any Schwab Fund, including any class of shares, may be sold and shares
of any other Schwab Fund or class purchased, provided the minimum investment and
any other requirements of the fund or class purchased are satisfied. Without
limiting this privilege, "an exchange order," which is a simultaneous order to
sell shares of one fund or class and automatically invest the proceeds in
another fund or class, may not be executed between shares of Sweep
Investments(TM) and shares of non-Sweep Investments. Shares of Sweep
Investments may be bought and sold automatically pursuant to the terms and
conditions of your account agreement or by direct order as long as you meet the
minimums for direct investments.

DELIVERY OF SHAREHOLDER DOCUMENTS

Typically once a year, an updated prospectus will be mailed to shareholders
describing each fund's investment strategies, risks and shareholder policies.
Twice a year, financial reports will be mailed to shareholders describing each
fund's performance and investment holdings. In order to eliminate duplicate
mailings of shareholder documents, each household may receive one copy of these
documents, under certain conditions. This practice is commonly called
"householding." If you want to receive multiple copies, you may write or call
your fund at the address or telephone number on the front of this SAI. Your
instructions will be effective within 30 days of receipt by Schwab.

PRICING OF SHARES

Securities traded on stock exchanges are valued at the last-quoted sales price
on the exchange on which such securities are primarily traded, or, lacking any
sales, at the mean between the bid and ask prices. Securities traded in the
over-the-counter market are valued at the last sales price that day, or if no
sales that day, at the mean between the bid and ask prices. Securities for which
market quotations or closing values are not readily available (including
restricted securities that are subject to limitations on their sale and illiquid
securities) are valued at fair value as determined in good faith pursuant to
guidelines and procedures adopted by the board of trustees. These procedures
require that securities be valued on the basis of prices provided by approved
pricing services, except when a price appears manifestly incorrect or events
occurring between the time a price is furnished by a service and the time a fund
calculates its share price materially affect the furnished price. The board of
trustees regularly reviews fair values assigned to portfolio securities under
these circumstances and also when no prices from approved pricing services are
available.

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<PAGE> 52
TAXATION

FEDERAL TAX INFORMATION FOR THE FUNDS

It is each fund's policy to qualify for taxation as a "regulated investment
company" (RIC) by meeting the requirements of Subchapter M of the Internal
Revenue Code of 1986, as amended (the Code). By qualifying as a RIC, a fund
expects to eliminate or reduce to a nominal amount the federal income tax to
which it is subject. If a fund does not qualify as a RIC under the Code, it will
be subject to federal income tax, at regular corporate rates, on its net income,
including any net realized capital gains.

The Code imposes a non-deductible excise tax on RICs that do not distribute in a
calendar year (regardless of whether they otherwise have a non-calendar taxable
year) an amount equal to 98% of their "ordinary income" (as defined in the Code)
for the calendar year plus 98% of their net capital gain for the one-year period
ending on October 31 of such calendar year, plus any undistributed amounts from
prior years. The non-deductible excise tax is equal to 4% of the deficiency. For
the foregoing purposes, a fund is treated as having distributed any amount on
which it is subject to income tax for any taxable year ending in such calendar
year.

A fund's transactions in futures contracts, options and certain other investment
activities may be restricted by the Code and are subject to special tax rules.
In a given case, these rules may accelerate income to a fund, defer its losses,
cause adjustments in the holding periods of a fund's assets, convert short-term
capital losses into long-term capital losses or otherwise affect the character
of a fund's income. These rules could therefore affect the amount, timing and
character of distributions to shareholders. A fund will endeavor to make any
available elections pertaining to these transactions in a manner believed to be
in the best interest of a fund and its shareholders.

FEDERAL INCOME TAX INFORMATION FOR SHAREHOLDERS

The discussion of federal income taxation presented below supplements the
discussion in a fund's prospectus and only summarizes some of the important
federal tax considerations generally affecting shareholders of a fund.
Accordingly, prospective investors (particularly those not residing or domiciled
in the United States) should consult their own tax advisers regarding the
consequences of investing in a fund.

Any dividends declared by a fund in October, November or December and paid the
following January are treated, for tax purposes, as if they were received by
shareholders on December 31 of the year in which they were declared. Long-term
capital gains distributions are taxable as long-term capital gains, regardless
of how long you have held your shares. However, if you receive a long-term
capital gains distribution with respect to fund shares held for six months or
less, any loss on the sale or exchange of those shares shall, to the extent of
the long-term capital gains distribution, be treated as a long-term capital
loss. Distributions by a fund also may be subject to state, local and foreign
taxes, and its treatment under applicable tax laws may differ from the federal
income tax treatment.

Each fund will be required in certain cases to withhold and remit to the U.S.
Treasury 31% of taxable dividends paid to any shareholder who (1) fails to
provide a correct taxpayer identification number certified under penalty of
perjury; (2) is subject to withholding by the Internal Revenue Service for
failure to properly report all payments of interest or dividends; or (3) fails
to provide a certified statement that he or she is not subject to "backup
withholding." Backup withholding is not an additional tax and any amounts
withheld may be credited against the shareholder's ultimate U.S. tax liability.

23
<PAGE> 53
distributions derived from net investment income and short-term capital gains.
Distributions to foreign shareholders of long-term capital gains and any gains
from the sale or other disposition of shares of the funds generally are not
subject to U.S. taxation, unless the recipient is an individual who either (1)
meets the Code's definition of "resident alien" or (2) who is physically present
in the U.S. for 183 days or more. Different tax consequences may result if the
foreign shareholder is engaged in a trade or business within the United States.
In addition, the tax consequences to a foreign shareholder entitled to claim the
benefits of a tax treaty may be different than those described above.

If, at the close of each quarter of its taxable year, at least 50% of the value
of a fund's assets consist of obligations the interest on which is excludable
from gross income, a fund may pay "exempt-interest dividends" to its
shareholders. Those dividends constitute the portion of the aggregate dividends
as designated by a fund, equal to the excess of the excludable interest over
certain amounts disallowed as deductions. Exempt-interest dividends are
excludable from a shareholder's gross income for federal income tax purposes.

Exempt-interest dividends may nevertheless be subject to the federal alternative
minimum tax (AMT) imposed by Section 55 of the Code and are also taken into
account when determining the taxable portion of social security or railroad
retirement benefits. The AMT is imposed at rates of 26% and 28%, in the case of
non-corporate taxpayers, and at the rate of 20%, in the case of corporate
taxpayers, to the extent it exceeds the taxpayer's federal income tax liability.
The AMT may be imposed in the following two circumstances. First,
exempt-interest dividends derived from certain private activity bonds issued
after August 7, 1986, will generally be an item of tax preference (and,
therefore, potentially subject to AMT) for both corporate and non-corporate
taxpayers. Second, in the case of exempt-interest dividends received by
corporate shareholders, all exempt-interest dividends, regardless of when the
bonds from which they are derived were issued or whether they are derived from
private activity bonds, will be included in the corporation's "adjusted current
earnings," as defined in Section 56(g) of the Code, in calculating the
corporations' alternative minimum taxable income for purposes of determining the
AMT.

The funds may realize capital gains or taxable income from the sale of municipal
bonds and may make taxable distributions. For federal tax purposes, each fund's
distributions of short-term capital gains and gains on the sale of bonds
characterized as market discount are taxable to shareholders as ordinary income.
Distributions of long-term capital gains are taxable to the shareholder as
long-term capital gain, no matter how long the shareholder has held shares in a
fund.

Current federal law limits the types and volume of bonds qualifying for the
federal income tax exemption of interest that may have an effect on the ability
of a fund to purchase sufficient amounts of tax-exempt securities to satisfy the
Code's requirements for the payment of "exempt-interest dividends."

Interest on indebtedness incurred or continued by a shareholder in order to
purchase or carry shares of the funds is not deductible for federal income tax
purposes. Furthermore, these funds may not be an appropriate investment for
persons (including corporations and other business entities) who are
"substantial users" (or persons related to "substantial users") of facilities
financed by industrial development private activity bonds. Such persons should
consult their tax advisors before purchasing shares. A "substantial user" is
defined generally to include "certain persons" who regularly use in their trade
or business a part of a facility financed from the proceeds of such bonds.

CALIFORNIA TAX CONSIDERATIONS

Both the Schwab California Short/Intermediate Tax-Free Bond Fund and Schwab
California Long-Term Tax Free Bond Fund intend to qualify to pay dividends to
shareholders that are exempt from California personal income tax ("California
exempt-interest dividends"). A fund will qualify to pay California
exempt-interest dividends if (1) at the close of each quarter of a fund's
taxable year, at least 50% of the

24
<PAGE> 54
value of a fund's total assets consists of obligations the interest on which
would be exempt from California personal income tax if the obligations were held
by an individual ("California Tax Exempt Obligations") and (2) a fund continues
to qualify as a regulated investment company.

If a fund qualifies to pay California exempt-interest dividends, dividends
distributed to shareholders will be considered California exempt-interest
dividends if they meet certain requirements. A fund will notify its shareholders
of the amount of exempt-interest dividends each year.

Corporations subject to California franchise tax that invest in a fund may not
be entitled to exclude California exempt-interest dividends from income.

Dividend distributions that do not qualify for treatment as California
exempt-interest dividends (including those dividend distributions to
shareholders taxable as long-term capital gains for federal income tax purposes)
will be taxable to shareholders at ordinary income tax rates for California
personal income tax purposes to the extent of a fund's earnings and profits.

Interest on indebtedness incurred or continued by a shareholder in connection
with the purchase of shares of a fund will not be deductible for California
personal income tax purposes if a fund distributes California exempt-interest
dividends.

If a fund qualifies to pay dividends to shareholders that are California
exempt-interest dividends, dividends distributed to shareholders will be
considered California exempt-interest dividends if (1) they are designated as
exempt-interest dividends by a fund in a written notice to shareholders mailed
within 60 days of the close of a fund's taxable year and (2) to the extent the
interest received by a fund during the year on California Tax-Exempt Obligations
exceeds expenses of a fund that would be disallowed under California personal
income tax law as allocable to tax-exempt interest if a fund were an individual.
If the aggregate dividends so designated exceed the amount that may be treated
as California exempt-interest dividends, only that percentage of each dividend
distribution equal to the ratio of aggregate California exempt-interest
dividends to aggregate dividends so designated will be treated as a California
exempt-interest dividend.

CALCULATION OF PERFORMANCE DATA

Average annual total return is a standardized measure of performance calculated
using methods prescribed by SEC rules. It is calculated by determining the
ending value of a hypothetical initial investment of $1,000 made at the
beginning of a specified period. The ending value is then divided by the initial
investment, which is annualized and expressed as a percentage. It is reported
for periods of one, five and 10 years or since commencement of operations for
periods not falling on those intervals. In computing average annual total
return, a fund assumes reinvestment of all distributions at net asset value on
applicable reinvestment dates.

25
<PAGE> 55
Standardized Total Return

<TABLE>
<CAPTION>
Average Annual Total Average Annual Total Average Annual Total
Return for 1 year ended Return for 5 years ended Return from commencement
August 31, 2000 August 31, 2000 of operations to
August 31, 2000*

Fund
<S> <C> <C> <C>
Schwab Short/Intermediate 4.50% 4.04% 4.17%
Tax-Free Bond Fund

Schwab Long-Term Tax-Free 6.59% 5.34% 5.67%
Bond Fund

Schwab California 5.32% 4.46% 4.38%
Short/Intermediate
Tax-Free Bond Fund

Schwab California 7.67% 6.20% 6.70%
Long-Term Tax-Free Bond
Fund
</TABLE>

* April 21, 1993 for the Schwab Short/Intermediate Tax-Free Bond Fund and
Schwab California Short/Intermediate Tax-Free Bond Fund; September 11,
1992 for the Schwab Long-Term Tax-Free Bond Fund; and February 24, 1992
for the Schwab California Long-Term Tax-Free Bond Fund.

Nonstandardized Cumulative Total Return

<TABLE>
<CAPTION>
Fund Cumulative Total Return as of
August 31, 2000*
<S> <C>
Schwab Short/Intermediate Tax-Free 35.07%
Bond Fund

Schwab Long-Term Tax-Free Bond Fund 55.27%

Schwab California Short/Intermediate 37.17%
Tax-Free Bond Fund

Schwab California Long-Term Tax-Free 73.82%
Bond Fund
</TABLE>

Each fund also may advertise its cumulative total return since inception. This
number is calculated using the same formula that is used for average annual
total return except that, rather than calculating the total return based on a
one-year period, cumulative total return is calculated from commencement of
operations to the end of the fiscal year.

30-Day Yield

<TABLE>
<CAPTION>
Fund 30-day period ended August 31, 2000
<S> <C>
Schwab Short/Intermediate Tax-Free 4.20%
Bond Fund
</TABLE>

26
<PAGE> 56

<TABLE>
<S> <C>
Schwab Long-Term Tax-Free Bond Fund 5.01%

Schwab California Short/Intermediate 3.80%
Tax-Free Bond Fund

Schwab California Long-Term Tax-Free 5.06%
Bond Fund
</TABLE>

A 30-day yield is calculated by dividing the net investment per share earned
during a 30-day period by a fund's share price on the last day of the period.

27
<PAGE> 57
30-Day Tax-Equivalent Yield

<TABLE>
<CAPTION>
Fund 30-day period ended August 31, 2000
<S> <C>
Schwab Short/Intermediate Tax-Free 6.95%
Bond Fund

Schwab Long-Term Tax-Free Bond Fund 8.29%

Schwab California Short/Intermediate 6.94%
Tax-Free Bond Fund

Schwab California Long-Term Tax-Free 9.24%
Bond Fund
</TABLE>

The tax equivalent yield of the funds is calculated by dividing that portion of
the applicable fund's yield (computed as described above) that is tax-exempt by
an amount equal to 1 minus the applicable effective tax rate, and adding the
result to that portion, if any, of the yield of a fund that is not tax-exempt.
For the Schwab Short/Intermediate Tax-Free Bond Fund and Schwab Long-Term
Tax-Free Bond Fund, the maximum federal marginal rate of 39.6% is normally used.
For the Schwab California Short/Intermediate Tax-Free Bond Fund and Schwab
California Long-Term Tax-Free Bond Fund, a maximum combined federal and State of
California marginal rate of 45.22% is normally used.

Tax equivalent effective yields are computed in the same manner as tax
equivalent yields, except that effective yield is substituted for yield in the
calculation.

The performance of a fund may be compared with the performance of other mutual
funds by comparing the ratings of mutual fund rating services, various indices,
U.S. government obligations, bank certificates of deposit, the consumer price
index and other investments for which reliable data is available. An index's
performance data assumes the reinvestment of dividends but does not reflect
deductions for administrative, management and trading expenses. A fund will be
subject to these costs and expenses, while an index does not have these
expenses. In addition, various factors, such as holding a cash balance, may
cause a fund's performance to be higher or lower than that of an index.

28
<PAGE> 58
APPENDIX - RATINGS OF INVESTMENT SECURITIES

From time to time, a fund may report the percentage of its assets that fall into
the rating categories set forth below.

BONDS

MOODY'S INVESTORS SERVICE

Aaa Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.

Aa Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than the Aaa securities.

A Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.

Baa Bonds which are rated Baa are considered as medium-grade obligations (i.e.,
they are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.

Ba Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.

B Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.

STANDARD & POOR'S CORPORATION

INVESTMENT GRADE

AAA Debt rated 'AAA' has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.

AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated debt only in small degree.

29
<PAGE> 59
A Debt rated 'A' has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.

BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.

SPECULATIVE GRADE

Debt rated 'BB' and 'B' is regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to adverse
conditions.

BB Debt rated 'BB' has less near-term vulnerability to default than other
speculative grade debt. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions that could lead
to inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.

B Debt rate 'B' has greater vulnerability to default but presently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions would likely impair capacity or willingness to
pay interest and repay principal. The 'B' rating category also is used for debt
subordinated to senior debt that is assigned an actual or implied 'BB' or 'BB-'
rating.

FITCH, INC.

INVESTMENT GRADE BOND

AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably
foreseeable events.

AA Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds rated in
the 'AAA' and 'AA' categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is
generally rated 'F-1+'.

A Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.

BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than
for bonds with higher ratings.

30
<PAGE> 60
SPECULATIVE GRADE BOND

BB Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic
changes. However, business and financial alternatives can be identified
which could assist the obligor in satisfying its debt service
requirements.

B Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued
timely payment of principal and interest reflects the obligor's limited
margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.

DESCRIPTION OF THOMSON BANKWATCH'S LONG-TERM DEBT RATINGS

INVESTMENT GRADE

AAA The highest category; indicates that the ability to repay principal and
interest on a timely basis is very high.

AA The second-highest category; indicates a superior ability to repay
principal and interest on a timely basis, with limited incremental risk
compared to issues rated in the highest category.

A The third-highest category; indicates the ability to repay principal and
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher
ratings.

BBB The lowest investment-grade category; indicates an acceptable capacity to
repay principal and interest. Issues rated "BBB" are, however, more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.

NON-INVESTMENT GRADE

BB While not investment grade, the "BB" rating suggests that the likelihood
of default is considerably less than for lower-rated issues. However,
there are significant uncertainties that could affect the ability to
adequately service debt obligations.

B Issues rated "B" show a higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse
developments could well negatively affect the payment of interest and
principal on a timely basis.

SHORT-TERM NOTES AND VARIABLE RATE DEMAND OBLIGATIONS

MOODY'S INVESTORS SERVICE

Short-term notes/variable rate demand obligations bearing the designations
MIG-1/VMIG-1 are considered to be of the best quality, enjoying strong
protection from established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing. Obligations rated
MIG-2/VMIG-3 are of high quality and enjoy ample margins of protection although
not as large as those of the top rated securities.

31
<PAGE> 61
STANDARD & POOR'S CORPORATION

An S&P SP-1 rating indicates that the subject securities' issuer has a strong
capacity to pay principal and interest. Issues determined to possess very strong
safety characteristics are given a plus (+) designation. S&P's determination
that an issuer has a satisfactory capacity to pay principal and interest is
denoted by an SP-2 rating.

FITCH, INC.

Obligations supported by the highest capacity for timely repayment are rated
F1+. An F1 rating indicates that the obligation is supported by a very strong
capacity for timely repayment. Obligations rated F2 are supported by a good
capacity for timely repayment, although adverse changes in business, economic,
or financial conditions may affect this capacity.

COMMERCIAL PAPER

MOODY'S INVESTORS SERVICE

Prime-1 is the highest commercial paper rating assigned by Moody's. Issuers (or
related supporting institutions) of commercial paper with this rating are
considered to have a superior ability to repay short-term promissory
obligations. Issuers (or related supporting institutions) of securities rated
Prime-2 are viewed as having a strong capacity to repay short-term promissory
obligations. This capacity will normally be evidenced by many of the
characteristics of issuers whose commercial paper is rated Prime-1 but to a
lesser degree.

STANDARD & POOR'S CORPORATION

A Standard & Poor's Corporation ("S&P") A-1 commercial paper rating indicates a
strong degree of safety regarding timely payment of principal and interest.
Issues determined to possess overwhelming safety characteristics are denoted
A-1+. Capacity for timely payment on commercial paper rated A-2 is satisfactory,
but the relative degree of safety is not as high as for issues designated A-1.

FITCH, INC.

F-1+ is the highest category, and indicates the strongest degree of assurance
for timely payment. Issues rated F-1 reflect an assurance of timely payment only
slightly less than issues rated F-1+. Issues assigned an F-2 rating have a
satisfactory degree of assurance for timely payment, but the margin of safety is
not as great as for issues in the first two rating categories.

COMMERCIAL PAPER, SHORT-TERM OBLIGATIONS
AND DEPOSIT OBLIGATIONS ISSUED BY BANKS

THOMSON BANKWATCH (TBW)

TBW-1 is the highest category and indicates the degree of safety regarding
timely repayment of principal and interest is very high. TBW-2 is the second
highest category and while the degree of safety regarding timely repayment of
principal and interest is strong, the relative degree of safety is not as high
as for issues rated "TBW-1."

<PAGE> 62
SCHWAB
BOND INDEX FUNDS

Prospectus
November 15, 2000

SCHWAB SHORT-TERM BOND MARKET INDEX FUND

SCHWAB TOTAL BOND MARKET INDEX FUND

[CHARLES SCHWAB LOGO]
<PAGE> 63
SCHWAB
BOND INDEX FUNDS

ABOUT THE FUNDS

4 Schwab Short-Term Bond
Market Index Fund

8 Schwab Total Bond Market
Index Fund

12 Fund Management

INVESTING IN THE FUNDS

14 Buying Shares

15 Selling/Exchanging Shares

16 Transaction Policies

17 Distributions and Taxes
<PAGE> 64
ABOUT THE FUNDS

The funds in this prospectus share the same basic INVESTMENT STRATEGY: They are
designed to track the price and yield performance of a bond index. Each fund
tracks a different index.

This strategy distinguishes an index fund from an "actively managed" fund.
Instead of choosing investments based on judgments about future market or
interest rate movements, a portfolio manager LOOKS TO AN INDEX to determine
which securities the fund should own.

By investing in bonds, the funds seek to provide CURRENT INCOME to shareholders.
Each fund also seeks to lower risk by DIVERSIFYING BROADLY across the various
sectors of the bond market represented in its index.

The funds are designed FOR LONG-TERM INVESTING. Their performance will fluctuate
over time and, as with all investments, future performance may differ from past
performance.
<PAGE> 65
SCHWAB

SHORT-TERM BOND MARKET INDEX FUND

TICKER SYMBOL
SWBDX

THE FUND SEEKS CURRENT INCOME BY TRACKING THE PERFORMANCE OF THE LEHMAN BROTHERS
MUTUAL FUND SHORT (1 - 5 YEAR) U.S. GOVERNMENT/CREDIT INDEX.

INDEX

THE LEHMAN BROTHERS MUTUAL FUND SHORT (1 - 5 YEAR) U.S. GOVERNMENT/CREDIT INDEX
INCLUDES INVESTMENT-GRADE GOVERNMENT AND CORPORATE BONDS that are denominated in
U.S. dollars and have maturities of one to five years. Investment-grade
securities are rated in the four highest credit rating categories (AAA to BBB-).
Bonds are represented in the index in proportion to their market value.

STRATEGY

TO PURSUE ITS GOAL, THE FUND INVESTS IN BONDS THAT ARE INCLUDED IN THE INDEX.
The fund normally invests at least 65% of total assets in these securities, and
typically far more. If a portfolio security falls below investment-grade, the
fund may continue to hold it if the investment adviser believes it would benefit
the fund.

Because it would be impractical to invest in every bond in the index, the fund
uses quantitative techniques to assemble a portfolio whose performance is
expected to track that of the index. The fund seeks to remain close to the index
in its dollar-weighted average maturity by investing primarily in bonds that are
included in the index.

Like many index funds, the fund may enter into swap agreements, in which the
payment or investment performance of one security or asset is exchanged for
another. The fund may also invest in convertible, preferred, variable and
floating rate securities, collateralized mortgage obligations and futures
contracts, and may lend securities. The fund would use these securities and
techniques in seeking to enhance total return and minimize the gap between its
performance and that of the index. However, because of fund expenses, the fund's
performance normally is somewhat below that of the index.

SHORT-TERM BONDS
--------------------------------------------------------------------------------

As a bond approaches maturity, its market value typically approaches its par
value (the amount a bondholder receives when the bond matures). Because of this,
short-term bond prices typically do not react as strongly to interest rate
changes.

In exchange for this lower volatility, short-term bonds typically (though not
always) offer lower yields than longer term bonds.

The index focuses on three bond market sectors, in this proportion:

<TABLE>
<CAPTION>
BOND TYPE
-------------------------------------
<S> <C>
U.S. government 67.5%

U.S. corporate 24.8%

Dollar-denominated
foreign issues 7.7%
</TABLE>

The index has approximately 1,983 bonds and a dollar-weighted average maturity
of 2.80 years. (All figures as of 8/31/2000.)

SHORT-TERM BOND MARKET INDEX FUND 4

<PAGE> 66
Investors who are seeking a DIVERSIFIED source of current income and want
potentially LOWER VOLATILITY and lower returns, compared to a long-term fund,
may want to consider this fund.

MAIN RISKS

BOND MARKETS RISE AND FALL DAILY. As with any investment whose performance is
tied to these markets, the value of your investment in the fund will fluctuate,
which means that you could lose money.

YOUR INVESTMENT FOLLOWS THE SHORT-TERM BOND MARKET, AS MEASURED BY THE INDEX.
The fund is designed to follow the index during upturns as well as downturns.
Because of its indexing strategy, the fund will not take steps to reduce market
exposure or to lessen the effects of a declining market.

WHEN INTEREST RATES RISE, BOND PRICES USUALLY FALL, and with them the fund's
share price. The fund's short average maturity is designed to reduce this risk,
but will not eliminate it. A fall in interest rates could hurt the fund as well,
by lowering its yield. This is because issuers tend to pay off their bonds when
interest rates fall, often forcing the fund to reinvest in lower-yielding
securities.

DIFFERENT TYPES OF BONDS CARRY DIFFERENT TYPES OF RISKS. To the extent that the
fund is exposed to a given sector of the bond market, it takes on the risks of
that sector. Prices of foreign bonds may be more volatile than those of
comparable bonds from U.S. issuers, for reasons ranging from lack of reliable
issuer information to the risk of political upheaval. Although the risk of
default is generally considered unlikely, any default on the part of a portfolio
investment could cause the fund's share price or yield to fall.

OTHER MAIN RISK FACTORS
--------------------------------------------------------------------------------

Although the fund's main risks are those associated with its bond investments,
its other investment strategies also involve risks.

For example, the fund's use of quantitative techniques may increase the gap
between the performance of the fund and that of the index.

Futures contracts, which the fund uses to gain exposure to bonds for its cash
balances or to enhance total return, also could cause the fund to track the
index less closely if they don't perform as expected.

The fund also may lend a portion of its securities to certain financial
institutions in order to earn income. The fund's loans are fully collateralized.
However, if the institution defaults, the fund's performance could be reduced.

The fund also could lose money if a swap agreement doesn't perform as expected
or if the counterparty to a swap agreement fails to honor the agreement.

Additionally, the fund may have a relatively high portfolio turnover rate, which
could increase transaction costs and the likelihood of capital gain
distributions.

5 SHORT-TERM BOND MARKET INDEX FUND
<PAGE> 67
PERFORMANCE

The fund adopted its current goal and strategies on 11/1/1997; performance
before that time may have been different had its current goal and strategy been
in place.

ANNUAL TOTAL RETURNS (%) AS OF 12/31

BEST QUARTER: 4.32% Q3 1992
WORST QUARTER: -2.09% Q1 1994
YEAR-TO-DATE PERFORMANCE AS OF 9/30/2000: 5.85%

AVERAGE ANNUAL TOTAL RETURNS (%) AS OF 12/31/1999

<TABLE>
<CAPTION>
SINCE
1 YEAR 5 YEARS INCEPTION
-------------------------------------------------------------------------------
<S> <C> <C> <C>
Fund 1.54 6.01 5.48 1
Lehman Brothers Mutual
Fund Short (1-5 Year) U.S.
Government/Credit Index 2.09 6.82 6.15 2
</TABLE>

1 Inception: 11/5/1991.

2 From 11/5/1991.

FUND FEES AND EXPENSES

FEE TABLE (%)

<TABLE>
<CAPTION>
SHAREHOLDER FEES
--------------------------------------------------------------------------------
<S> <C>
None
ANNUAL OPERATING EXPENSES (% OF AVERAGE NET ASSETS)
--------------------------------------------------------------------------------
Management fees* 0.30
Distribution (12b-1) fees None
Other expenses* 0.35
Total annual operating expenses 0.65

EXPENSE REDUCTION (0.30)
NET OPERATING EXPENSES** 0.35
</TABLE>

* Restated to reflect current fees and expenses.

** Guaranteed by Schwab and the investment adviser through 11/15/2001, excluding
interest, taxes and certain non-routine expenses.

EXPENSES ON A $10,000 INVESTMENT

<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
--------------------------------------------------------------------------------
<S> <C> <C> <C>
$36 $178 $332 $782
</TABLE>

The performance information above shows you how the fund's PERFORMANCE compares
to its index, which VARIES OVER TIME.

SHORT-TERM BOND MARKET INDEX FUND 6
<PAGE> 68
FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
9/1/99 - 9/1/98 - 9/1/97 - 9/1/96 - 9/1/95 -
8/31/00 8/31/99 8/31/98 8/31/97 8/31/96
<S> <C> <C> <C> <C> <C>
---------------------------------------------------------------------------------------------------------------
PER-SHARE DATA ($)
Net asset value at beginning of period 9.66 9.90 9.74 9.67 9.84
--------------------------------------------------------
Income from investment operations:
Net investment income 0.57 0.50 0.56 0.59 0.59
Net realized and unrealized gains or losses (0.01) (0.24) 0.17 0.07 (0.17)
--------------------------------------------------------
Total income from investment operations 0.56 0.26 0.73 0.66 0.42
Less distributions:
Dividends from net investment income (0.57) (0.50) (0.57) (0.59) (0.59)
--------------------------------------------------------
Net asset value at end of period 9.65 9.66 9.90 9.74 9.67
========================================================
Total return (%) 5.97 2.66 7.64 6.96 4.39

RATIOS/SUPPLEMENTAL DATA (%)
---------------------------------------------------------------------------------------------------------------
Ratio of net operating expenses to
average net assets 0.35 1 0.35 0.46 0.49 0.49
Expense reductions reflected in above ratio 0.32 0.42 0.39 0.33 0.31
Ratio of net investment income to
average net assets 5.91 5.11 5.58 6.02 6.03
Portfolio turnover rate 129 195 128 71 80
Net assets, end of period ($ x 1,000,000) 219 218 157 127 134
</TABLE>

1 Would have been 0.36% if certain non-routine expenses (proxy fees) had been
included.

7 SHORT-TERM BOND MARKET INDEX FUND
<PAGE> 69
SCHWAB
TOTAL BOND MARKET
INDEX FUND

TICKER SYMBOL
SWLBX

THE FUND SEEKS CURRENT INCOME BY TRACKING THE PERFORMANCE OF THE LEHMAN BROTHERS
U.S. AGGREGATE BOND INDEX.

INDEX

THE LEHMAN BROTHERS U.S. AGGREGATE BOND INDEX INCLUDES INVESTMENT-GRADE
GOVERNMENT, CORPORATE, MORTGAGE-, COMMERCIAL MORTGAGE- AND ASSET-BACKED BONDS
that are denominated in U.S. dollars and have maturities longer than one year.
Investment-grade securities are rated in the four highest rating categories (AAA
to BBB-). Bonds are represented in the index in proportion to their market
value.

STRATEGY

TO PURSUE ITS GOAL, THE FUND INVESTS IN BONDS THAT ARE INCLUDED IN THE INDEX.
The fund normally invests at least 65% of total assets in these securities. If a
portfolio security falls below investment-grade, the fund may continue to hold
it if the investment adviser believes it would benefit the fund.

Like many index funds, the fund may enter into swap agreements, in which
the payments or investment performance of one security or asset is exchanged for
another. The fund also may invest in mortgage dollar rolls, which involve the
fund selling mortgage-backed securities and simultaneously agreeing to later
repurchase nearly identical securities at a stated price. In addition, the fund
may invest in convertible, preferred, variable and floating rate securities,
collateralized mortgage obligations and futures contracts, and may lend
securities. The fund would use these securities and techniques in seeking to
enhance total return and minimize the gap between its performance and that of
the index. However, because of fund expenses, the fund's performance normally is
somewhat below that of the index.

THE BOND MARKET

The fund's index focuses on five main sectors of the bond market, in this
proportion:

<TABLE>
<CAPTION>
BOND TYPE
----------------------------------------------
<S> <C>
U.S. government 38.8%

Mortgage-backed 34.4%

U.S. corporate 18.0%

Dollar-denominated
foreign issues 5.7%

Asset-backed 1.6%

Commercial
mortgage-backed 1.5%
</TABLE>

The index has approximately 6,013 bonds and a dollar-weighted average maturity
of 8.77 years. (All figures as of 8/31/2000.)

By investing in longer term bonds, the fund seeks to earn higher yields over
time than the Schwab Short-Term Bond Market Index Fund, although with more share
price volatility than that fund.

TOTAL BOND MARKET INDEX FUND 8
<PAGE> 70
MAIN RISKS

This fund is designed for investors seeking to fill the fixed income component
to their ASSET ALLOCATION plan, and who can accept higher risk in exchange for
potentially higher LONG-TERM RETURNS compared to a short-term fund.

BOND MARKETS RISE AND FALL DAILY. As with any investment whose performance is
tied to these markets, the value of your investment in the fund will fluctuate,
which means that you could lose money.

YOUR INVESTMENT FOLLOWS THE BOND MARKET, AS MEASURED BY THE INDEX. The fund is
designed to follow the index during upturns as well as downturns. Because of its
indexing strategy, the fund will not take steps to reduce market exposure or to
lessen the effects of a declining market.

WHEN INTEREST RATES RISE, BOND PRICES USUALLY FALL, and with them the fund's
share price. The longer the fund's dollar-weighted average maturity,
the more sensitive to interest rate movements its share price is likely to be.
When interest rates fall, issuers tend to pay off their bonds, which may force
the fund to reinvest in lower-yielding securities.

DIFFERENT TYPES OF BONDS CARRY DIFFERENT TYPES OF RISKS. To the extent that the
fund is exposed to a given sector of the bond market, it takes on the risks of
that sector. With certain mortgage- and asset-backed bonds, a primary risk is
the possibility that the bonds may be paid off earlier or later than expected.
Either situation could hurt the fund's yield or share price. Prices of foreign
bonds may be more volatile than those of comparable bonds from U.S. issuers, for
reasons ranging from lack of reliable issuer information to the risk of
political upheaval. Although the risk of default is generally considered
unlikely, any default on the part of a portfolio investment could cause the
fund's share price or yield to fall.

OTHER MAIN RISK FACTORS
--------------------------------------------------------------------------------

Although the fund's main risks are those associated with its bond investments,
its other investment strategies also involve risks.

For example, the fund's use of quantitative techniques may increase the gap
between the performance of the fund and that of the index.

Futures contracts, which the fund may use to gain exposure to bonds for its cash
balances or to enhance total return, also could cause the fund to track the
index less closely if they don't perform as expected.

The fund also could lose money if a swap agreement doesn't perform as expected
or if the counterparty to a swap agreement fails to honor the agreement. The
fund's mortgage dollar rolls could lose money if the price of the
mortgage-backed securities falls below the agreed repurchase price, or if the
counterparty is unable to honor the agreement.

Additionally, the fund may have a relatively high portfolio turnover rate, which
could increase transaction costs and the likelihood of capital gain
distributions.

9 TOTAL BOND MARKET INDEX FUND
<PAGE> 71
PERFORMANCE

The fund adopted its current goal and strategies on 11/1/1997; performance
before that time may have been different had its current goal and strategy been
in place.

ANNUAL TOTAL RETURNS (%) AS OF 12/31

BEST QUARTER: 6.79% Q2 1995
WORST QUARTER: -4.83% Q1 1994
YEAR-TO-DATE PERFORMANCE AS OF 9/30/2000: 6.65%

AVERAGE ANNUAL TOTAL RETURNS (%) AS OF 12/31/1999

<TABLE>
<CAPTION>
SINCE
1 YEAR 5 YEARS INCEPTION
--------------------------------------------------------------------------------
<S> <C> <C> <C>
Fund (1.04) 7.87 5.89 1
Lehman Brothers U.S.
Aggregate Bond Index (0.82) 7.73 5.93 2
</TABLE>

1 Inception: 3/5/1993.

2 From 3/5/1993.

FUND FEES AND EXPENSES

FEE TABLE (%)

<S> <C>
SHAREHOLDER FEES
--------------------------------------------------------------------------------
None

ANNUAL OPERATING EXPENSES (% OF AVERAGE NET ASSETS)
--------------------------------------------------------------------------------
Management fees* 0.29
Distribution (12b-1) fees None
Other expenses* 0.31
-----
Total annual operating expenses 0.60

EXPENSE REDUCTION (0.25)
-----
NET OPERATING EXPENSES** 0.35
=====
</TABLE>

* Restated to reflect current fees and expenses.

** Guaranteed by Schwab and the investment adviser through 11/15/2001, excluding
interest, taxes and certain non-routine expenses.

EXPENSES ON A $10,000 INVESTMENT

<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
--------------------------------------------------------------------------------
<S> <C> <C> <C>
$36 $167 $310 $726
</TABLE>

The performance information above shows you how the fund's PERFORMANCE compares
to its index, which VARIES OVER TIME.

TOTAL BOND MARKET INDEX FUND 10
<PAGE> 72
FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
9/1/99 - 9/1/98 - 9/1/97 - 9/1/96 - 9/1/95 -
8/31/00 8/31/99 8/31/98 8/31/97 8/31/96
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER-SHARE DATA ($)
----------------------------------------------------------------------------------------------------------------------
Net asset value at beginning of period 9.58 10.18 9.75 9.38 9.80
------------------------------------------------------------
Income from investment operations:
Net investment income 0.61 0.55 0.60 0.65 0.65
Net realized and unrealized gains or losses 0.07 (0.53) 0.43 0.37 (0.42)
------------------------------------------------------------
Total income from investment operations 0.68 0.02 1.03 1.02 0.23
Less distributions:
Dividends from net investment income (0.61) (0.55) (0.60) (0.65) (0.65)
Distributions from net realized gains -- (0.07) -- -- --
------------------------------------------------------------
Total distributions (0.61) (0.62) (0.60) (0.65) (0.65)
------------------------------------------------------------
Net asset value at end of period 9.65 9.58 10.18 9.75 9.38
------------------------------------------------------------
Total return (%) 7.36 0.14 10.83 11.18 2.29

RATIOS/SUPPLEMENTAL DATA (%)
----------------------------------------------------------------------------------------------------------------------
Ratio of net operating expenses to
average net assets 0.35 1 0.35 0.31 0.20 --
Expense reductions reflected in above ratio 0.27 0.39 0.51 0.98 1.17
Ratio of net investment income to
average net assets 6.42 5.55 5.86 6.74 6.67
Portfolio turnover rate 135 174 285 51 66
Net assets, end of period ($ x 1,000,000) 647 480 294 25 23
</TABLE>

1 Would have been 0.36% if certain non-routine expenses (proxy fees) had been
included.

11 TOTAL BOND MARKET INDEX FUND
<PAGE> 73
FUND MANAGEMENT

The Funds' INVESTMENT ADVISER, Charles Schwab Investment Management, Inc., has
more than $120 billion under management.

As the investment adviser, the firm oversees the asset management and
administration of the Schwab Bond Index Funds. As compensation for these
services, the firm receives a management fee from each fund. For the 12 months
ended 8/31/2000, these fees were 0.00% for the Schwab Short-Term Bond Market
Index Fund and 0.04% for the Schwab Total Bond Market Index Fund. These figures,
which are expressed as a percentage of each fund's average daily net assets,
represent the actual amounts paid, including the effects of reductions.

KIMON DAIFOTIS, CFA, a vice president of the investment adviser, has overall
responsibility for management of the funds. Prior to joining the firm in
September 1997, he worked for more than 18 years in research and asset
management.

BIRGER NESTEBY, a portfolio manager, co-manages the funds' portfolio and has
over 10 years of experience in the fixed income securities markets. He joined
the firm in August, 1999.

FUND MANAGEMENT 12
<PAGE> 74
INVESTING IN THE FUNDS

As a SchwabFunds(R) investor, you have a number of WAYS TO DO BUSINESS with us.

13 INVESTING IN THE FUNDS
<PAGE> 75
BUYING SHARES

SCHWAB ACCOUNTS
--------------------------------------------------------------------------------

For more information on Schwab brokerage accounts, call 800-435-4000 or visit
the Schwab web site at www.schwab.com.

STEP 1

CHOOSE A FUND, then decide how much you want to invest.

<TABLE>
<CAPTION>
MINIMUM INITIAL MINIMUM ADDITIONAL
INVESTMENT INVESTMENTS MINIMUM BALANCE
--------------------------------------------------------------------------------
<S> <C> <C>
$2,500 $500 $1,000
($1,000 for retirement and ($100 for Automatic ($500 for retirement and
custodial accounts) Investment Plan) custodial accounts)
</TABLE>

STEP 2

CHOOSE AN OPTION FOR FUND DISTRIBUTIONS. The three options are described below.
If you don't indicate a choice, you will receive the first option.

<TABLE>
<CAPTION>
OPTION FEATURES
--------------------------------------------------------------------------------
<S> <C>
Reinvestment All dividends and capital gain distributions are invested
automatically in shares of your fund.
--------------------------------------------------------------------------------
Cash/reinvestment mix You receive payment for dividends, while any capital
gain distributions are invested in shares of your fund.
--------------------------------------------------------------------------------
Cash You receive payment for all dividends and capital gain
distributions.
</TABLE>

STEP 3

PLACE YOUR ORDER. Use any of the methods described at right. Make checks payable
to Charles Schwab and Co., Inc.

INVESTING IN THE FUNDS 14
<PAGE> 76
SELLING/EXCHANGING SHARES

USE ANY OF THE METHODS DESCRIBED BELOW TO SELL SHARES OF A FUND.

When selling or exchanging shares, please be aware of the following policies:

- A fund may take up to seven days to pay sale proceeds.

- If you are selling shares that were recently purchased by check, the
proceeds may be delayed until the check for purchase clears; this may take
up to 15 days from the date of purchase.

- These funds reserve the right to honor redemptions in portfolio securities
instead of cash when your redemptions over a 90-day period exceed $250,000
or 1% of a fund's assets.

- You must obtain and read the prospectus for the fund into which you are
exchanging prior to placing your order.

METHODS FOR PLACING DIRECT ORDERS

PHONE

Call 800-435-4000, day or night (for TDD service, call 800-345-2550).

INTERNET
www.schwab.com/schwabfunds

SCHWABLINK
Investment professionals should follow the transaction instructions in the
SchwabLink manual; for technical assistance, call 800-367-5198.

MAIL
Write to SchwabFunds(R) at:
P.O. Box 7575
San Francisco, CA 94120-7575

When selling or exchanging shares, be sure to include the signature of at least
one of the persons whose name is on the account.

IN PERSON
Visit the nearest Charles Schwab branch office.

WHEN PLACING ORDERS

With every order to buy, sell or exchange shares, you will need to include the
following information:

- Your name or, for internet orders, your account number/"Login ID."

- Your account number (for SchwabLink transactions, include the master account
and subaccount numbers) or, for internet orders, your password.

- The name and share class (if applicable) of the fund whose shares you want
to buy or sell.

- The dollar amount or number of shares you would like to buy, sell or
exchange.

- For exchanges, the name and share class of the fund into which you want to
exchange and the distribution option you prefer.

- When selling shares, how you would like to receive the proceeds.

Please note that orders to buy, sell or exchange become irrevocable at the time
you mail them.

15 INVESTING IN THE FUNDS
<PAGE> 77
TRANSACTION POLICIES

Shareholders of the funds should be aware that because foreign markets are often
open on weekends and other days when the fund is closed, the value of some of
the fund's portfolio may change on days when it is not possible to buy or sell
shares of the fund.

THE FUNDS AND SCHWAB RESERVE CERTAIN RIGHTS, including the following:

- To automatically redeem your shares if the account they are held in is
closed for any reason or your balance falls below the minimum as a result of
selling or exchanging your shares.

- To modify or terminate the exchange privilege upon 60 days' written notice
to shareholders.

- To refuse any purchase or exchange order, including large purchase orders
that may negatively affect a fund's operations or orders that appear to be
associated with short-term trading activities.

- To change or waive a fund's investment minimums.

- To suspend the right to sell shares back to the fund, and delay sending
proceeds, during times when trading on the NYSE is restricted or halted, or
otherwise as permitted by the SEC.

- To withdraw or suspend any part of the offering made by this prospectus.

INVESTING IN THE FUNDS 16
<PAGE> 78
DISTRIBUTIONS AND TAXES

ANY INVESTMENT IN THE FUNDS TYPICALLY INVOLVES SEVERAL TAX CONSIDERATIONS. The
information below is meant as a general summary for U.S. citizens and residents.
Because each person's tax situation is different, you should consult your tax
advisor about the tax implications of your investment in a fund. You also can
visit the Internal Revenue Service (IRS) web site at www.irs.gov.

UNLESS YOU ARE INVESTING THROUGH A TAX-DEFERRED OR ROTH RETIREMENT ACCOUNT, YOUR
FUND DISTRIBUTIONS GENERALLY HAVE TAX CONSEQUENCES. Each fund's net investment
income and short-term capital gains are distributed as dividends and are taxable
as ordinary income. Other capital gain distributions are taxable as long-term
capital gains, regardless of how long you have held your shares in the fund.
Distributions generally are taxable in the tax year in which they are declared,
whether you reinvest them or take them in cash.

Dividends derived from U.S. government securities are generally free from state
and local income taxes. However, some states may limit this benefit, and some
agency-backed securities may not qualify for tax-exempt status.

AT THE BEGINNING OF EVERY YEAR, THE FUNDS PROVIDE SHAREHOLDERS WITH INFORMATION
DETAILING THE TAX STATUS OF ANY DISTRIBUTIONS a fund paid during the previous
calendar year including the percentage of dividends paid that may qualify for
tax-exempt status. Schwab brokerage account customers also receive information
on distributions and transactions in their monthly account statements.

17 INVESTING IN THE FUNDS
<PAGE> 79
NOTES
<PAGE> 80
NOTES
<PAGE> 81
TO LEARN MORE

This prospectus contains important information on the funds and should be read
and kept for reference. You also can obtain more information from the following
sources.

SHAREHOLDER REPORTS, which are mailed to current fund investors, discuss recent
performance and portfolio holdings.

SEC FILE NUMBER
Schwab Bond Index Funds 811-6200

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-0102
202-942-8090 (Public Reference Section)
www.sec.gov
[email protected]

SCHWABFUNDS
P.O. Box 7575
San Francisco, CA 94120-7575
800-435-4000
www.schwab.com/schwabfunds

SCHWAB
BOND INDEX FUNDS

PROSPECTUS
November 15, 2000

MKT4271FLT-2 [CHARLES SCHWAB LOGO]

<PAGE> 82
STATEMENT OF ADDITIONAL INFORMATION

SCHWAB INVESTMENTS

SCHWAB SHORT-TERM BOND MARKET INDEX FUND
SCHWAB TOTAL BOND MARKET INDEX FUND

NOVEMBER 15, 2000

The Statement of Additional Information (SAI) is not a prospectus. It should be
read in conjunction with a fund's prospectus dated November 15, 2000 (as amended
from time to time).

The funds are a series of Schwab Investments (the trust).

The funds' most recent annual report is a separate document supplied with the
SAI and includes the funds' audited financial statements, which are incorporated
by reference into this SAI.

Prior to November 1, 1997, Schwab Short-Term Bond Market Index Fund was named
Schwab Short/Intermediate Government Bond Fund, and Schwab Total Bond Market
Index Fund was named Schwab Long-Term Government Bond Fund.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
<S> <C>
INVESTMENT OBJECTIVE, SECURITIES, RISKS AND LIMITATIONS......... 2
MANAGEMENT OF THE FUNDS......................................... 27
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES............. 31
INVESTMENT ADVISORY AND OTHER SERVICES.......................... 31
BROKERAGE ALLOCATION AND OTHER PRACTICES........................ 33
DESCRIPTION OF THE TRUST........................................ 34
PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER REPORTS
AND PRICING OF SHARES........................................... 35
TAXATION........................................................ 36
CALCULATION OF PERFORMANCE DATA................................. 37
APPENDIX - RATINGS OF INVESTMENT SECURITIES..................... 40
</TABLE>

1
<PAGE> 83
INVESTMENT OBJECTIVE, SECURITIES, RISKS AND LIMITATIONS

INVESTMENT OBJECTIVE

Each fund's investment objective is to attempt to provide a high level of
current income consistent with preservation of capital by seeking to track the
investment results of a particular bond index through the use of an indexing
strategy.

There is no guarantee a fund will achieve its investment objective.

The indexes are the Lehman Brothers Mutual Fund Short (1-5 Year) U.S.
Government/Credit Index for the Schwab Short-Term Bond Market Index Fund (the
Short-Term Index), and the Lehman Brothers U.S. Aggregate Bond Index for the
Schwab Total Bond Market Index Fund (the U.S. Aggregate Bond Index).

The Short-Term Index is a market-capitalization weighted index of
investment-grade debt securities with maturities between one and five years.

The U.S. Aggregate Bond Index is a market-weighted index of investment-grade
debt securities with maturities of greater than one year.

The securities in each index also are required to be publicly issued and have a
par amount outstanding of at least $150 million and a fixed interest rate.

Each fund's investment objective may be changed by vote of a majority of its
outstanding voting shares. A majority vote of outstanding securities of a fund
means the vote, at an annual or a special meeting of shareholders of a fund
where (a) of 67% or more of the voting securities present at the meeting, if the
shareholders of more than 50% of the outstanding securities of a fund are
present or represented by proxy, or (b) of more than 50% of the outstanding
voting securities of a fund, whichever is less.

INVESTMENT SECURITIES AND RISKS

BANKERS' ACCEPTANCES or notes are credit instruments evidencing a bank's
obligation to pay a draft drawn on it by a customer. These instruments reflect
the obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity. A fund will invest only in bankers' acceptances of
banks that have capital, surplus and undivided profits in excess of $100
million.

2
<PAGE> 84
BOND SUBSTITUTION is a strategy whereby a fund may, from time to time,
substitute one type of investment-grade bond for another. This means that, as an
example, a fund may have a higher weighting in corporate bonds and a lower
weighting in U.S. Treasury securities than its Index in order to increase
income. This particular substitution - a corporate bond substitution - may
increase a fund's credit risk, although this may be mitigated through increased
diversification in the corporate sector of the bond market.

BORROWING may subject a fund to interest costs, which may exceed the interest
received on the securities purchased with the borrowed funds. A fund normally
may borrow at times to meet redemption requests rather than sell portfolio
securities to raise the necessary cash. Borrowing can involve leveraging when
securities are purchased with the borrowed money. Each fund may borrow money
from banks and make other investments or engage in other transactions
permissible under the 1940 Act which may be considered a borrowing (such as
mortgage dollar rolls and reverse repurchase agreements). However, each fund may
not purchase securities when bank borrowings exceed 5% of a fund's total assets.

Each fund may establish lines-of-credit (lines) with certain banks by which it
may borrow funds for temporary or emergency purposes. A borrowing is presumed to
be for temporary or emergency purposes if it is repaid by a fund within 60 days
and is not extended or renewed. Each fund intends to use the lines to meet large
or unexpected redemptions that would otherwise force a fund to liquidate
securities under circumstances which are unfavorable to the fund's remaining
shareholders. Each fund will pay a fee to the bank for using the lines.

CERTIFICATES OF DEPOSIT or time deposits are issued against funds deposited in a
banking institution for a specified period of time at a specified interest rate.
A fund will invest only in certificates of deposit of banks that have capital,
surplus and undivided profits in excess of $100 million.

COMMERCIAL PAPER consists of short-term, promissory notes issued by banks,
corporations and other institutions to finance short-term credit needs. These
securities generally are discounted but sometimes may be interest bearing.
Commercial paper, which also may be unsecured, is subject to credit risk.

CONCENTRATION means that substantial amounts of assets are invested in a
particular industry or group of industries. Concentration increases investment
exposure. For example, the automobile industry may have a greater exposure to a
single risk factor, such as an increase in the price of oil, which may adversely
affect the sale of automobiles and, as a result, the value of the industry's
securities. Based on the primary characteristics of non-U.S. (foreign) banks,
each fund has identified each foreign country as a separate bank industry for
purposes of a fund's concentration policy. Each fund will limit its investments
in securities issued by foreign banks in each country to less than 25% of its
net assets.

Based on the primary characteristics of the various types of asset-backed
securities, for purposes of a fund's concentration policy, the following
asset-backed securities industries have been selected: credit card receivables,
automobile receivables, trade receivables and diversified financial assets. Each
fund will limit its investments in each such industry to less than 25% of its
net assets.

3
<PAGE> 85
called for redemption would be required to tender it for redemption to the
issuer, convert it to the underlying common stock or sell it to a third party.
Convertible bonds typically pay a lower interest rate than nonconvertible bonds
of the same quality and maturity, because of the convertible feature. This
structure allows the holder of the convertible bond to participate in share
price movements in the company's common stock. The actual return on a
convertible bond may exceed its stated yield if the company's common stock
appreciates in value and the option to convert to common shares becomes more
valuable.

Convertible securities typically trade at prices above their conversion value,
which is the current market value of the common stock received upon conversion,
because of their higher yield potential than the underlying common stock. The
difference between the conversion value and the price of a convertible security
will vary depending on the value of the underlying common stock and interest
rates. When the underlying value of the common stocks decline, the price of the
issuer's convertible securities will tend not to fall as much because the
convertible security's income potential will act as a price support. While the
value of a convertible security also tends to rise when the underlying common
stock value rises, it will not rise as much because their conversion value is
more narrow. The value of convertible securities also is affected by changes in
interest rates. For example, when interest rates fall, the value of convertible
securities may rise because of their fixed income component.

CREDIT AND LIQUIDITY SUPPORTS may be employed by issuers or the fund to reduce
the credit risk of their securities. Credit supports include letters of credit,
insurance, total return and credit swap agreements and guarantees provided by
foreign and domestic entities. Liquidity supports include puts, demand features,
and lines of credit. Most of these arrangements move the credit risk of an
investment from the issuer of the security to the support provider. Changes in
the credit quality of a support provider could cause losses to a fund.

4
<PAGE> 86
grade debt securities are considered medium- or/and high-quality securities,
although some still possess varying degrees of speculative characteristics and
risks. Debt securities rated below investment-grade are riskier, but may offer
higher yields. These securities are sometimes referred to as high yield
securities or "junk bonds."

See the Appendix for a full description of the various ratings assigned to debt
securities by various nationally recognized statistical rating organizations
(NRSROs).

DELAYED-DELIVERY TRANSACTIONS include purchasing and selling securities on a
delayed-delivery or when-issued basis. These transactions involve a commitment
to buy or sell specific securities at a predetermined price or yield, with
payment and delivery taking place after the customary settlement period for that
type of security. When purchasing securities on a delayed-delivery basis, a fund
assumes the rights and risks of ownership, including the risk of price and yield
fluctuations. Typically, no interest will accrue to a fund until the security is
delivered. Each fund will segregate appropriate liquid assets to cover its
delayed-delivery purchase obligations. When a fund sells a security on a
delayed-delivery basis, the fund does not participate in further gains or losses
with respect to that security. If the other party to a delayed-delivery
transaction fails to deliver or pay for the securities, a fund could suffer
losses.

DEMAND FEATURES, which may include guarantees, are used to shorten a security's
effective maturity and/or enhance its creditworthiness. If a demand feature
provider were to refuse to permit the feature's exercise or otherwise terminate
its obligations with respect to such feature, however, the security's effective
maturity may be lengthened substantially, and/or its credit quality may be
adversely impacted. In either event, the fund may experience an increase in
share price volatility. This also could lengthen the fund's overall average
effective maturity.

DEPOSITARY RECEIPTS include American or European Depositary Receipts (ADRs or
EDRs), Global Depositary Receipts or Shares (GDRs or GDSs) or other similar
global instruments that are receipts representing ownership of shares of a
foreign-based issuer held in trust by a bank or similar financial institution.
These securities are designed for U.S. and European securities markets as
alternatives to purchasing underlying securities in their corresponding national
markets and currencies. Depositary receipts can be sponsored or unsponsored.
Sponsored depositary receipts are certificates in which a bank or financial
institution participates with a custodian. Issuers of unsponsored depositary
receipts are not contractually obligated to disclose material information in the
United States. Therefore, there may not be a correlation between such
information and the market value of an unsponsored depositary receipt.

DIVERSIFICATION involves investing in a wide range of securities and thereby
spreading and reducing the risks of investment. Each fund is a series of an
open-end investment management company. Each fund is a diversified mutual fund.

DURATION was developed as a more precise alternative to the concept of
"maturity." Traditionally, a debt obligation's maturity has been used as a proxy
for the sensitivity of the security's price to changes in interest rates (which
is the "interest rate risk" or "volatility" of the security). However, maturity
measures only the time until a debt obligation provides its final payment,
taking no account of the pattern of the security's payments prior to maturity.
In contrast, duration incorporates a bond's yield, coupon interest payments,
final maturity, call and put features and prepayment exposure into one measure.
Duration is the magnitude of the change in the price of a bond relative to a
given change in market interest rates. Duration management is one of the
fundamental tools used by the investment adviser.

5
<PAGE> 87
Duration is a measure of the expected life of a debt obligation on a present
value basis. Duration takes the length of the time intervals between the present
time and the time that the interest and principal payments are scheduled or, in
the case of a callable bond, the time the principal payments are expected to be
received, and weights them by the present values of the cash to be received at
each future point in time. For debt obligations with interest payments occurring
prior to the payment of principal, duration will usually be less than maturity.
In general, all else being equal, the lower the stated or coupon rate of the
interest of a fixed income security, the longer the duration of the security;
conversely, the higher the stated or coupon rate of a fixed income security, the
shorter the duration of the security.

Holding long futures or call option positions will lengthen the duration of a
fund's portfolio. Holding short futures or put options will shorten the duration
of a fund's portfolio.

A swap agreement on an asset or group of assets may affect the duration of the
portfolio depending on the attributes of the swap. For example, if the swap
agreement provides the fund with a floating rate of return in exchange for a
fixed rate of return, the duration of the fund would be modified to reflect the
duration attributes of a similar security that the fund is permitted to buy.

There are some situations where even the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example,
floating- and variable-rate securities often have final maturities of ten or
more years; however, their interest rate exposure corresponds to the frequency
of the coupon reset. Another example where the interest rate exposure is not
properly captured by maturity is mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but current prepayment
rates are more critical in determining the securities' interest rate exposure.
Finally, the duration of the debt obligation may vary over time in response to
changes in interest rates and other market factors.

FOREIGN SECURITIES involve additional risks, including foreign currency exchange
rate risks, because they are issued by foreign entities, including foreign
governments, banks, corporations or because they are traded principally
overseas. Foreign securities in which a fund may invest include foreign entities
that are not subject to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those applicable to U.S.
corporations. In addition, there may be less publicly available information
about foreign entities. Foreign economic, political and legal developments, as
well as fluctuating foreign currency exchange rates and withholding taxes, could
have more dramatic effects on the value of foreign securities. For example,
conditions within and around foreign countries, such as the possibility of
expropriation or confiscatory taxation, political or social instability,
diplomatic developments, change of government or war could affect the value of
foreign investments. Moreover, individual foreign economies may differ favorably
or unfavorably from the U.S. economy in such respects as growth of gross
national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position.

Foreign securities typically have less volume and are generally less liquid and
more volatile than securities of U.S. companies. Fixed commissions on foreign
securities exchanges are generally higher than negotiated commissions on U.S.
exchanges, although a fund will endeavor to achieve the most favorable overall
results on portfolio transactions. There is generally less government
supervision and regulation of foreign securities exchanges, brokers, dealers and
listed companies than in the United States, thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities. There may be difficulties in obtaining or enforcing judgments
against foreign issuers as well. These factors and others may increase the risks
with

6
<PAGE> 88
respect to the liquidity of a fund, and its ability to meet a large number of
shareholder redemption requests.

Foreign markets also have different clearance and settlement procedures and, in
certain markets, there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Such delays in settlement could result in temporary periods
when a portion of the assets of a fund is uninvested and no return is earned
thereon. The inability to make intended security purchases due to settlement
problems could cause a fund to miss attractive investment opportunities. Losses
to a fund arising out of the inability to fulfill a contract to sell such
securities also could result in potential liability for a fund.

Investments in the securities of foreign issuers may be made and held in foreign
currencies. In addition, a fund may hold cash in foreign currencies. These
investments may be affected favorably or unfavorably by changes in currency
rates and in exchange control regulations, and may cause a fund to incur costs
in connection with conversions between various currencies. The rate of exchange
between the U.S. dollar and other currencies is determined by the forces of
supply and demand in the foreign exchange market as well as by political and
economic factors. Changes in the 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 a fund.

On January 1, 1999, 11 of the 15 member states of the European union introduced
the "euro" as a common currency. During a three-year transitional period, the
euro will coexist with each member state's currency. By July 1, 2002, the euro
will have replaced the national currencies of the following member countries:
Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the
Netherlands, Portugal and Spain. During the transition period, each fund will
treat the euro as a separate currency from that of any member state.

Currently, the exchange rate of the currencies of each of these countries is
fixed to the euro. The euro trades on currency exchange and is available for
non-cash transactions. The participating countries currently issue sovereign
debt exclusively in euro. By July 1, 2002, euro-denominated bills and coins will
replace the bills and coins of the participating countries.

The new European Central Bank has control over each country's monetary policies.
Therefore, the participating countries no longer control their own monetary
policies by directing independent interest rates for their currencies. The
national governments of the participating countries, however, have retained the
authority to set tax and spending policies and public debt levels.

The conversion may impact the trading in securities of issuers located in, or
denominated in the currencies of, the member states, as well as foreign
exchanges, payments, the settlement process, custody of assets and accounting.
The introduction of the euro is also expected to affect derivative and other
financial contracts in which the funds may invest in so far as price sources
such as day-count fractions or settlement dates applicable to underlying
instruments may be changed to conform to the conventions applicable to euro
currency.

The overall impact of the transition of the member states' currencies to the
euro cannot be determined with certainty at this time. In addition to the
effects described above, it is likely that more general short and long-term
consequences can be expected, such as changes in economic environment and change
in behavior of investors, all of which will impact a fund's euro-denominated
investments.

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FORWARD CONTRACTS are sales contracts between a buyer (holding the "long",
position and the seller (holding the "short" position) for an asset with
delivery deferred to a future date. The buyer agrees to pay a fixed price at the
agreed future date and the seller agrees to deliver the asset. The seller hopes
that the market price on the delivery date is less than the agreed upon price,
while the buyer hopes for the contrary. The change in value of a forward-based
derivative generally is roughly proportional to the change in value of the
underlying asset.

FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS involve the purchase or sale of
foreign currency at an established exchange rate, but with payment and delivery
at a specified future time. Many foreign securities markets do not settle trades
within a time frame that would be considered customary in the U.S. stock market.
Therefore, a fund may engage in forward foreign currency exchange contracts in
order to secure exchange rates for portfolio securities purchased or sold, but
waiting settlement. These transactions do not seek to eliminate any fluctuations
in the underlying prices of the securities involved. Instead, the transactions
simply establish a rate of exchange that can be expected when a fund settles its
securities transactions in the future.

A fund also may engage in forward foreign currency exchange contracts to protect
the value of specific portfolio positions, which is called "position hedging."
When engaging in position hedging, a fund may enter into forward foreign
currency exchange transactions to protect against a decline in the values of the
foreign currencies in which portfolio securities are denominated (or against an
increase in the value of currency for securities that a fund expects to
purchase).

Buying and selling foreign currency exchange contracts involve costs and may
result in losses. The ability of a fund to engage in these transactions may be
limited by tax considerations. Although these techniques tend to minimize the
risk of loss due to decline in the value of the hedged currency, they tend to
limit any potential gain that might result from an increase in the value of such
currency. Transactions in these contracts involve certain other risks.
Unanticipated fluctuations in currency prices may result in a poorer overall
performance for a fund than if it had not engaged in any such transactions.
Moreover, there may be imperfect correlation between a fund's holdings of
securities denominated in a particular currency and forward contracts into which
a fund enters. Such imperfect correlation may cause a fund to sustain losses,
which will prevent it from achieving a complete hedge or expose it to risk of
foreign exchange loss. Losses to a fund will affect its performance.

FUTURES CONTRACTS are securities that represent an agreement between two parties
that obligates one party to buy and the other party to sell specific securities
at an agreed-upon price on a stipulated future date. In the case of futures
contracts relating to an index or otherwise not calling for physical delivery at
the close of the transaction, the parties usually agree to deliver the final
cash settlement price of the contract. Each fund may purchase and sell futures
contracts based on securities, securities indices and foreign currencies,
interest rates or any other futures contracts traded on U.S. exchanges or boards
of trade that the Commodities Future Trading Commission (the "CFTC") licenses
and regulates on foreign exchanges.

Each fund must maintain a small portion of its assets in cash to process
shareholder transactions in and out of it to pay its expenses. In order to
reduce the effect this otherwise uninvested cash would have on its performance a
fund may purchase futures contracts. Such transactions allow a fund's cash
balance to produce a return similar to that of the underlying security or index
on which the futures contract is based. Also, each fund may purchase or sell
futures contracts on a specified foreign currency to "fix" the price in U.S.
dollars of the foreign security it has acquired

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<PAGE> 90
or sold or expects to acquire or sell. Each fund may enter into futures
contracts for these or other reasons.

When buying or selling futures contracts, each fund must place a deposit with
its broker equal to a fraction of the contract amount. This amount is known as
"initial margin" and must be in the form of liquid debt instruments, including
cash, cash-equivalents and U.S. government securities. Subsequent payments to
and from the broker, known as "variation margin" may be made daily, if
necessary, as the value of the futures contracts fluctuate. This process is
known as "marking-to-market." The margin amount will be returned to a fund upon
termination of the futures contracts assuming all contractual obligations are
satisfied. Each fund's aggregate initial and variation margin payments required
to establish its futures positions may not exceed 5% of its net assets. Because
margin requirements are normally only a fraction of the amount of the futures
contracts in a given transaction, futures trading can involve a great deal of
leverage. In order to avoid this, a fund will segregate assets for any
outstanding futures contracts as may be required by the federal securities laws.

While each fund may purchase and sell futures contracts in order to simulate
full investment, there are risks associated with these transactions. Adverse
market movements could cause a fund to experience substantial losses when buying
and selling futures contracts. Of course, barring significant market
distortions, similar results would have been expected if a fund had instead
transacted in the underlying securities directly. There also is the risk of
losing any margin payments held by a broker in the event of its bankruptcy.
Additionally, a fund incurs transaction costs (i.e. brokerage fees) when
engaging in futures trading.

When interest rates are rising or securities prices are falling, a fund may
seek, through the sale of futures contracts, to offset a decline in the value of
its current portfolio securities. When rates are falling or prices are rising, a
fund, through the purchase of futures contracts, may attempt to secure better
rates or prices than might later be available in the market when they effect
anticipated purchases. Similarly, a fund may sell futures contracts on a
specified currency to protect against a decline in the value of that currency
and its portfolio securities that are denominated in that currency. Each fund
may purchase futures contracts on a foreign currency to fix the price in U.S.
dollars of a security denominated in that currency that a fund has acquired or
expects to acquire.

Futures contracts normally require actual delivery or acquisition of an
underlying security or cash value of an index on the expiration date of the
contract. In most cases, however, the contractual obligation is fulfilled before
the date of the contract by buying or selling, as the case may be, identical
futures contracts. Such offsetting transactions terminate the original contracts
and cancel the obligation to take or make delivery of the underlying securities
or cash. There may not always be a liquid secondary market at the time a fund
seeks to close out a futures position. If a fund is unable to close out its
position and prices move adversely, a fund would have to continue to make daily
cash payments to maintain its margin requirements. If a fund had insufficient
cash to meet these requirements it may have to sell portfolio securities at a
disadvantageous time or incur extra costs by borrowing the cash. Also, a fund
may be required to make or take delivery and incur extra transaction costs
buying or selling the underlying securities. Each fund would seek to reduce the
risks associated with futures transactions by buying and selling futures
contracts that are traded on national exchanges or for which there appears to be
a liquid secondary market.

HIGH YIELD SECURITIES, also called lower quality bonds ("junk bonds"), are
frequently issued by companies without long track records of sales and earnings,
or by those of questionable credit

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strength, and are more speculative and volatile (though typically higher
yielding) than investment grade bonds. Adverse economic developments could
disrupt the market for high yield securities, and severely affect the ability of
issuers, especially highly-leveraged issuers, to service their debt obligations
or to repay their obligations upon maturity.

Thus, high yield securities are more likely to react to developments affecting
interest rates and market and credit risk than are more highly rated securities,
which primarily react to movements in the general level of interest rates. When
economic conditions appear to be deteriorating, medium- to lower-quality debt
securities may decline in value more than higher-quality debt securities due to
heightened concern over credit quality, regardless of prevailing interest rates.
Prices for high yield securities also could be affected by legislative and
regulatory developments. These laws could adversely affect a fund's net asset
value and investment practices, the secondary market value for high yield
securities, the financial condition of issuers of these securities and the value
of outstanding high yield securities.

ILLIQUID SECURITIES generally are any securities that cannot be disposed of
promptly and in the ordinary course of business at approximately the amount at
which a fund has valued the instruments. The liquidity of a fund's investments
is monitored under the supervision and direction of the board of trustees.
Investments currently not considered liquid include repurchase agreements not
maturing within seven days and certain restricted securities.

INDEX PARTICIPATIONS and index participation contracts provide the equivalent of
a position in the securities comprising an index, with each security's
representation equaling its index weighting. Moreover, their holders are
entitled to payments equal to the dividends paid by the underlying index
securities. Generally, the value of an index participation or index
participation contract will rise and fall along with the value of the related
index. A fund will invest in index participation contracts only if a liquid
market for them appears to exist.

INDEXING STRATEGIES involve tracking the investments and, therefore, performance
of an index. Each fund normally will invest 65% of its total assets in the
securities of its index. Moreover, each fund will invest so that its portfolio
performs similarly to that of its index. Each fund tries to generally match its
holdings in a particular security to its weight in the index. Each fund will
seek a correlation between its performance and that of its index of 0.90 or
better. A perfect correlation of 1.0 is unlikely as the funds incur operating
and trading expenses unlike their indices. A fund may rebalance its holdings in
order to track its index more closely. In the event its intended correlation is
not achieved, the board of trustees will consider alternative arrangements for a
fund.

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<PAGE> 92
purchased on foreign securities exchanges, may subject a fund to additional
investment risks, such as adverse political and economic developments, possible
seizure, nationalization or expropriation of foreign investments, less stringent
disclosure requirements, non-U.S. withholding taxes and the adoption of other
foreign governmental restrictions.

Additional risks include less publicly available information, the risk that
companies may not be subject to the accounting, auditing and financial reporting
standards and requirements of U.S. companies, the risk that foreign securities
markets may have less volume and therefore may be less liquid and their prices
more volatile than U.S. securities, and the risk that custodian and transaction
costs may be higher. Foreign issuers of securities or obligations are often
subject to accounting requirements and engage in business practices different
from those respecting domestic issuers of similar securities or obligations.
Foreign branches of U.S. banks and foreign banks may be subject to less
stringent reserve requirements than those applicable to domestic branches of
U.S. banks.

A fund may loan portfolio securities to qualified broker-dealers or other
institutional investors provided: (1) the loan is secured continuously by
collateral consisting of U.S. government securities, letters of credit, cash or
cash-equivalents or other appropriate instruments maintained on a daily
marked-to-market basis in an amount at least equal to the current market value
of the securities loaned; (2) a fund may at any time call the loan and obtain
the return of the securities loaned; (3) a fund will receive any interest or
dividends paid on the loaned securities; and (4) an aggregate market value of
securities loaned will not at any time exceed one-third of the total assets of a
fund, including collateral received from the loan (at market value computed at
the time of the loan).

LOAN INTERESTS, and other direct debt instruments or interests therein, may be
acquired by a fund. A loan interest is typically originated, negotiated, and
structured by a U.S. or foreign commercial bank, insurance company, finance
company, or other financial institution ("Agent") for a lending syndicate of
financial institutions. The Agent typically administers and enforces the loan on
behalf of the other lenders in the syndicate. In addition, an institution
typically but not always the Agent ("Collateral Bank"), holds collateral (if
any) on behalf of the lenders. When a Collateral Bank holds collateral, such
collateral typically consists of one or more of the following asset types:
inventory, accounts receivable, property, plant and equipment, intangibles,
common

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stock of subsidiaries or other investments. These loan interests may take the
form of participation interests in, assignments of or novations of a loan during
its second distribution, or direct interests during a primary distribution. Such
loan interests may be acquired from U.S. or foreign banks, insurance companies,
finance companies, or other financial institutions who have made loans or are
members of a lending syndicate or from other holders of loan interests. A fund
may also acquire loan interests under which a fund derives its rights directly
from the borrower. Such loan interests are separately enforceable by a fund
against the borrower and all payments of interest and principal are typically
made directly to a fund from the borrower. In the event that a fund and other
lenders become entitled to take possession of shared collateral, it is
anticipated that such collateral would be held in the custody of Collateral Bank
for their mutual benefit. A fund may not act as an Agent, a Collateral Bank, a
guarantor or sole negotiator or structurer with respect to a loan.

The investment adviser will analyze and evaluate the financial condition of the
borrower in connection with the acquisition of any Loan Interest. Credit ratings
are typically assigned to Loan Interests in the same manner as with other fixed
income debt securities, and the investment adviser analyzes and evaluates these
ratings, if any, in deciding whether to purchase a Loan Interest. The investment
adviser also analyzes and evaluates the financial condition of the Agent and, in
the case of Loan Interests in which a fund does not have privity with the
borrower, those institutions from or through whom a fund derives its rights in a
loan ("Intermediate Participants").

In a typical loan, the Agent administers the terms of the loan agreement. In
such cases, the Agent is normally responsible for the collection of principal
and interest payments from the borrower and the apportionment of these payments
to the credit of all the institutions which are parties to the loan agreement. A
fund will generally rely upon the Agent or Intermediate Participant to receive
and forward to a fund its portion of the principal and interest payments on the
loan. Furthermore, unless under the terms of a participation agreement a fund
has direct recourse against the borrower, a fund will rely on the Agent and the
other members of the lending syndicate to use appropriate credit remedies
against the borrower. The Agent is typically responsible for monitoring
compliance with covenants contained in the loan agreement based upon reports
prepared by the borrower. The seller of the Loan Interest usually does, but is
often not obligated to, notify holders of Loan Interests of any failures of
compliance. The Agent may monitor the value of the collateral and, if the value
of the collateral declines, may accelerate the loan, may give the borrower an
opportunity to provide additional collateral or may seek other protection for
the benefit of the participants in the loan. The Agent is compensated by the
borrower for providing these services under a loan agreement, and such
compensation may include special fees paid upon structuring and funding the loan
and other fees paid on a continuing basis. With respect to Loan Interests for
which the Agent does not perform such administrative and enforcement functions,
a fund will perform such tasks on its own behalf, although a Collateral Bank
will typically hold any collateral on behalf of a fund and the other holders
pursuant to the applicable loan agreement.

A financial institution's appointment as Agent may usually be terminated in the
event that it fails to observe the requisite standard of care or becomes
insolvent, enters Federal Deposit Insurance Corporation ("FDIC") receivership,
or, if not FDIC insured, enters into bankruptcy proceedings. A successor agent
generally would be appointed to replace the terminated Agent, and assets held by
the Agent under the loan agreement should remain available to holders of Loan
Interests. However, if assets held by the Agent for the benefit of a fund were
determined to be subject to the claims of the Agent's general creditors, a fund
might incur certain costs and delays in

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realizing payment on a loan interest, or suffer a loss of principal and/or
interest. In situations involving Intermediate Participants, similar risks may
arise.

Purchasers of Loan Interests depend primarily upon the creditworthiness of the
borrower for payment of principal and interest. If a fund does not receive a
scheduled interest or principal payment on such indebtedness, a fund's share
price and yield could be adversely affected. Loans that are fully secured offer
a fund more protections than an unsecured loan in the event of non-payment of
scheduled interest or principal. However, there is no assurance that the
liquidation of collateral from a secured loan would satisfy the borrower's
obligation, or that the collateral can be liquidated. Indebtedness of borrowers
whose creditworthiness is poor involves substantially greater risks, and may be
highly speculative. Borrowers that are in bankruptcy or restructuring may never
pay off their indebtedness, or may pay only a small fraction of the amount owed.
Direct indebtedness of developing countries also will involve a risk that the
governmental entities responsible for the repayment of the debt may be unable,
or unwilling, to pay interest and repay principal when due.

The Loan Interests market is in a developing phase with increased participation
among several investor types. The dealer community has become increasingly
involved in this secondary market. If, however, a particular Loan Interest is
deemed to be illiquid, it would be valued using procedures adopted by the board
of Trustees. In such a situation, there is no guarantee that the fund will be
able to sell such Loan Interests, which could lead to a decline in the value of
the Loan Interests and the value of the fund's shares.

MATURITY OF INVESTMENTS will generally be determined using the portfolio
securities' final maturity dates. However for certain securities, maturity will
be determined using the security's effective maturity date. The effective
maturity date for a security subject to a put or demand feature is the demand
date, unless the security is a variable- or floating-rate security. If it is a
variable-rate security, its effective maturity date is the earlier of its demand
date or next interest rate change date. For variable-rate securities not subject
to a put or demand feature and floating-rate securities, the effective maturity
date is the next interest rate change date. The effective maturity of
mortgage-backed and certain other asset-backed securities is determined on an
"expected life" basis by the investment adviser. For an interest rate swap
agreement, its effective maturity would be equal to the difference in the
effective maturity of the interest rates "swapped." Securities being hedged with
futures contracts may be deemed to have a longer maturity, in the case of
purchases of future contracts, and a shorter maturity, in the case of sales of
futures contracts, than they would otherwise be deemed to have. In addition, a
security that is subject to redemption at the option of the issuer on a
particular date ("call date"), which is prior to, or in lieu of, the security's
stated maturity, may be deemed to mature on the call date rather than on its
stated maturity date. The call date of a security will be used to calculate
average portfolio maturity when the investment adviser reasonably anticipates,
based upon information available to it, that the issuer will exercise its right
to redeem the security. The average portfolio maturity of a fund is
dollar-weighted based upon the market value of a fund's securities at the time
of the calculation. A fund may invest in securities with final or effective
maturities of any length.

Money market securities pay fixed, variable or floating rates of interest and
are generally subject

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to credit and interest rate risks. The maturity date or price of and financial
assets collateralizing a security may be structured in order to make it qualify
as or act like a money market security. These securities may be subject to
greater credit and interest rate risks than other money market securities
because of their structure. Money market securities may be issued with puts or
these can be sold separately.

MORTGAGE-BACKED SECURITIES ("MBS") and other ASSET-BACKED SECURITIES may be
purchased by a fund. MBS represent participations in mortgage loans, and include
pass-through securities, collateralized mortgage obligations and stripped
mortgage-backed securities. MBS may be issued or guaranteed by U.S. government
agencies or instrumentalities, such as the Government National Mortgage
Association (GNMA or Ginnie Mae) and Fannie Mae or the Federal National Home
Loan Mortgage Corporation (FHLMC or Freddie Mac), or by private issuers,
generally originators and investors in mortgage loans, including savings
associations, mortgage banks, commercial banks, and special purpose entities
(collectively, "private lenders"). MBS are based on different types of mortgages
including those on commercial real estate and residential property. MBS issued
by private lenders may be supported by pools of mortgage loans or other MBS that
are guaranteed, directly or indirectly, by the U.S. government or one of its
agencies or instrumentalities, or they may be issued without any governmental
guarantee of the underlying mortgage assets but with some form of credit
enhancement.

COMMERCIAL MORTGAGE-BACKED SECURITIES include securities that reflect an
interest in, and are secured by, mortgage loans on commercial real property. The
market for commercial mortgage-backed securities developed more recently and in
terms of total outstanding principal amount of issues is relatively small
compared to the market for residential single-family MBS. Many of the risks of
investing in commercial mortgage-backed securities reflect the risks of
investing in the real estate securing the underlying mortgage loans. These risks
reflect the effects of local and other economic conditions on real estate
markets, the ability of tenants to make loan payments, and the ability of a
property to attract and retain tenants. Commercial mortgage-backed securities
may be less liquid and exhibit greater price volatility than other types of
mortgage- or asset-backed securities.

A COLLATERALIZED MORTGAGE OBLIGATIONS ("CMO") is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, on a monthly basis. CMOs
may be collateralized by whole mortgage loans, but are more typically
collateralized by portfolios of mortgage pass-through securities guaranteed by
the Government National Mortgage Association (GNMA or Ginnie Mae), Federal Home
Loan Mortgage Corporation (FHLMC or Freddie Mac), Fannie Mae, and their income
streams.

CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs

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provide for a modified form of call protection through a de facto breakdown of
the underlying pool of mortgages according to how quickly the loans are repaid.
Monthly payment of principal received from the pool of underlying mortgages,
including prepayments, is first returned to investors holding the shortest
maturity class. Investors holding the longer maturity classes receive principal
only after the first class has been retired. An investor is partially guarded
against a sooner than desired return of principal because of the sequential
payments.

In a typical CMO transaction, a corporation ("issuer") issues multiple series
(e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering are
used to purchase mortgages or mortgage pass-through certificates ("Collateral").
The Collateral is pledged to a third party trustee as security for the Bonds.
Principal and interest payments from the Collateral are used to pay principal on
the Bonds in the order A, B, C, Z. The Series A, B, and C Bonds all bear current
interest. Interest on the Series Z Bond is accrued and added to principal and a
like amount is paid as principal on the Series A, B, or C Bond currently being
paid off. When the Series A, B, and C Bonds are paid in full, interest and
principal on the Series Z Bond begins to be paid currently. With some CMOs, the
issuer serves as a conduit to allow loan originators (primarily builders or
savings and loan associations) to borrow against their loan portfolios.

While many MBS and ABS are issued with only one class of security, many are
issued in more than one class, each with different payment terms. Multiple class
MBS and ABS are issued as a method of providing credit support, typically
through creation of one or more classes whose right to payments on the security
is made subordinate to the right to such payments of the remaining class or
classes. In addition, multiple classes may permit the issuance of securities
with payment terms, interest rates, or other characteristics differing both from
those of each other and from those of the underlying assets. Examples include
stripped securities, which are MBS and ABS entitling the holder to
disproportionate interest or principal compared with the assets backing the
security, and securities with classes having characteristics different from the
assets backing the securities, such as a security with floating interest rates
with assets backing the securities having fixed interest rates. The market value
of such securities and CMOs generally is more or less sensitive to changes in
prepayment and interest rates than is the case with traditional MBS and ABS, and
in some cases such market value may be extremely volatile.

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entitled to repossess the property, but the value of the property may be less to
private sector entities than it would be to the municipality.

Municipal securities may be owned directly or through participation interests,
and include general obligation or revenue securities, tax-exempt commercial
paper, notes and leases.

Municipal securities generally are classified as "general obligation" or
"revenue" and may be purchased directly or through participation interests.
General obligation securities typically are secured by the issuer's pledge of
its full faith and credit and taxing power for the payment of principal and
interest. Revenue securities typically are payable only from the revenues
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special tax or other specific revenue source. Private
activity bonds and industrial development bonds are, in most cases, revenue
bonds and generally do not constitute the pledge of the credit of the issuer of
such bonds. The credit quality of private activity bonds is frequently related
to the credit standing of private corporations or other entities.

Examples of municipal securities that are issued with original maturities of 397
days or less are short-term tax anticipation notes, bond anticipation notes,
revenue anticipation notes, construction loan notes, pre-refunded municipal
bonds and tax-free commercial paper. Tax anticipation notes typically are sold
to finance working capital needs of municipalities in anticipation of the
receipt of property taxes on a future date. Bond anticipation notes are sold on
an interim basis in anticipation of a municipality's issuance of a longer-term
bond in the future. Revenue anticipation notes are issued in expectation of the
receipt of other types of revenue, such as that available under the Federal
Revenue Sharing Program. Construction loan notes are instruments insured by the
Federal Housing Administration with permanent financing by Fannie Mae or Ginnie
Mae at the end of the project construction period. Pre-refunded municipal bonds
are bonds that are not yet refundable, but for which securities have been placed
in escrow to refund an original municipal bond issue when it becomes refundable.
Tax-free commercial paper is an unsecured promissory obligation issued or
guaranteed by a municipal issuer. A fund may purchase other municipal securities
similar to the foregoing that are or may become available, including securities
issued to pre-refund other outstanding obligations of municipal issuers.

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The value of municipal securities may be affected by uncertainties with respect
to the rights of holders of municipal securities in the event of bankruptcy or
the taxation of municipal securities as a result of legislation or litigation.
For example, under federal law, certain issuers of municipal securities may be
authorized in certain circumstances to initiate bankruptcy proceedings without
prior notice to or the consent of creditors. Such action could result in
material adverse changes in the rights of holders of the securities. In
addition, litigation challenging the validity under the state constitutions of
present systems of financing public education has been initiated or adjudicated
in a number of states, and legislation has been introduced to effect changes in
public school finances in some states. In other instances, there has been
litigation challenging the issuance of pollution control revenue bonds or the
validity of their issuance under state or federal law, which ultimately could
affect the validity of those municipal securities or the tax-free nature of the
interest thereon.

Municipal securities pay fixed, variable or floating rates of interest, which
may be exempt from federal income tax and, typically, personal income tax of a
state or locality. Some municipal securities are taxable. These securities are
issued by state and local governments and instrumentalities thereof that pay
interest that is not exempt from federal income tax. States and municipalities
issue taxable instruments for various reasons, relating in some cases to the
nature of the project being financed and to various specific ceilings on debt
issuance in others. The rate of interest payable on such instruments typically
reflects its taxable nature.

OPTIONS CONTRACTS generally provide the right to buy or sell a security,
commodity, futures contract or foreign currency in exchange for an agreed upon
price. If the right is not exercised after a specified period, the option
expires and the option buyer forfeits the money paid to the option seller.

A call option gives the buyer the right to buy a specified number of shares of a
security at a fixed price on or before a specified date in the future. For this
right, the call option buyer pays the call option seller, commonly called the
call option writer, a fee called a premium. Call option buyers are usually
anticipating that the price of the underlying security will rise above the price
fixed with the call writer, thereby allowing them to profit. If the price of the
underlying security does not rise, the call option buyer's losses are limited to
the premium paid to the call option writer. For call option writers, a rise in
the price of the underlying security will be offset by the premium received from
the call option buyer. If the call option writer does not own the underlying
security, however, the losses that may ensue if the price rises could be
potentially unlimited. If the call option writer owns the underlying security or
commodity, this is called writing a covered call. All call options written by
the funds will be covered, which means that the funds will own the securities
subject to the option so long as the option is outstanding.

A put option is the opposite of a call option. It gives the buyer the right to
sell a specified number of shares of a security at a fixed price on or before a
specified date in the future. Put option buyers are usually anticipating a
decline in the price of the underlying security, and wish to offset those losses
when selling the security at a later date. All put options a fund writes will be
covered, which means that a fund will deposit with its custodian cash, U.S.
government securities or other high-grade debt securities (i.e., securities
rated in one of the top three categories by Moody's Investor Service ("Moody's")
or Standard & Poor's ("S&P") or, if unrated, determined by the investment
adviser to be of comparable credit quality) with a value at least equal to the
exercise price of the put option. The purpose of writing such options is to
generate additional income for a fund. However, in return for the option
premium, a fund accepts the risk that it may be required to purchase the
underlying securities at a price in excess of the securities market value at the
time of purchase.

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A fund may purchase and write put and call options on any securities in which it
may invest or any securities index based on securities in which it may invest. A
fund may purchase and write such options on securities that are listed on
domestic or foreign securities exchanges or traded in the over-the-counter
market. Like futures contracts, option contracts are rarely exercised. Option
buyers usually sell the option before it expires. Option writers may terminate
their obligations under a written call or put option by purchasing an option
identical to the one it has written. Such purchases are referred to as "closing
purchase transactions." A fund may enter into closing sale transactions in order
to realize gains or minimize losses on options it has purchased or written.

An exchange-traded currency option position may be closed out only on an options
exchange that provides a secondary market for an option of the same series.
Although a fund generally will purchase or 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 or at any
particular time. If a fund is unable to effect a closing purchase transaction
with respect to options it has written, it will not be able to sell the
underlying securities or dispose of assets held in a segregated account until
the options expire or are exercised. Similarly, if a fund is unable to effect a
closing sale transaction with respect to options it has purchased, it would have
to exercise the options in order to realize any profit and will incur
transaction costs upon the purchase or sale of underlying securities.

Reasons for the absence of a liquid secondary market on an exchange include the
following: (1) there may be insufficient trading interest in certain options;
(2) an exchange may impose restrictions on opening transactions or closing
transactions or both; (3) trading halts, suspensions or other restrictions may
be imposed with respect to particular classes or series of options; (4) unusual
or unforeseen circumstances may interrupt normal operations on an exchange; (5)
the facilities of an exchange or the Options Clearing Corporation (the "OCC")
may not at all times be adequate to handle current trading volume; or (6) one or
more exchanges could, for economic or other reasons, decide or be compelled at
some future date to discontinue the trading of options (or a particular class or
series of options), although outstanding options on that exchange that had been
issued by the OCC as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.

The ability to terminate over-the-counter options is more limited than with
exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations. Until
such time as the staff of the Securities and Exchange Commission (the "SEC")
changes its position, a fund will treat purchased over-the-counter options and
all assets used to cover written over-the-counter options as illiquid
securities, except that with respect to options written with primary dealers in
U.S. government securities pursuant to an agreement requiring a closing purchase
transaction at a formula price, the amount of illiquid securities may be
calculated with reference to a formula the staff of the SEC approves.

Additional risks are involved with options trading because of the low margin
deposits required and the extremely high degree of leverage that may be involved
in options trading. There may be imperfect correlation between the change in
market value of the securities held by a fund and the prices of the options,
possible lack of a liquid secondary markets, and the resulting inability to
close such positions prior to their maturity dates.

A fund may write or purchase an option only when the market value of that
option, when aggregated with the market value of all other options transactions
made on behalf of a fund, does not exceed 5% of its total assets.

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<PAGE> 100
PREFERRED STOCKS are nonvoting equity securities that pay a stated fixed or
variable rate dividend. Although the preferred shareholders generally have no
right to receive discretionary dividends, they must receive the preferred
dividend at the stated rate prior to any dividends being paid on the common
stock. Since the preferred stockholder receives a fixed dividend payment, the
holder's position is much like that of the bondholder. Due to their fixed income
features, preferred stocks provide higher income potential than issuers' common
stocks, but typically are more sensitive to interest rate changes than an
underlying common stock. In the event of liquidation, bondholders have claims on
company assets senior to those of stockholders; preferred stockholders have
claims senior to those of common stockholders. Preferred stocks are rated like
fixed income securities and a fund will only invest in investment-grade
preferred stock that has a call feature that the investment manager expects to
be exercised by the issuer on the call date or that has a specified redemption
date.

PROMISSORY NOTES are written agreements committing the maker or issuer to pay
the payee a specified amount either on demand or at a fixed date in the future,
with or without interest. These are sometimes called negotiable notes or
instruments and are subject to credit risk. Bank notes are notes used to
represent obligations issued by banks in large denominations.

QUALITY OF INVESTMENTS will be principally investment-grade for each fund's
assets. Investment-grade quality securities are rated by at least one NRSRO in
one of the four highest rating categories (within which there may be
sub-categories or gradations indicating relative standing) or have been
determined to be of equivalent quality by the investment adviser pursuant to
procedures adopted by the board of trustees. Sometimes an investment-grade
quality security may be down-graded to a below investment-grade quality rating.
If a security no longer has at least one investment-quality rating from an
NRSRO, the investment adviser would reanalyze the security in light of the
downgrade and determine whether a fund should continue to hold the security.
However, such downgrade would not require the investment adviser to sell the
security on behalf of a fund. Sometimes lower-quality securities may be
downgraded to an even lower quality. If any of a fund's lower-quality securities
were down-graded to below the sixth rating category, the investment adviser will
promptly sell the security on behalf of a fund.

The investment adviser may also elect to purchase high-yield securities for
either fund, subject to an aggregate limit of 5% of the investing fund's assets
and only in circumstances where the investment adviser believes that the credit
quality of the security (or issuer thereof) is reasonably likely to be upgraded
to investment-grade in the foreseeable future. If such an upgrade were to occur
under these circumstances, the value of the security would likely increase,
thereby raising the potential for the investing fund to realize a gain on its
investment and/or track the performance of its index. There is no guarantee that
any such upgrade will occur, however, and all such high-yield securities are
subject to the risks associated with non-investment grade instruments. In order
to limit a funds' exposure in this regard, the investment manager will not
purchase for a fund's high-yield securities that are rated (at the time of
purchase) below B or the equivalent by Moody's or S&P. In addition, if a
high-yield security that is held by either fund is

19
<PAGE> 101
downgraded to below B or the equivalent by Moody's or S&P, the investment
adviser will promptly dispose of the security.

RESTRICTED SECURITIES are securities that are subject to legal restrictions on
their sale. Restricted securities may be considered to be liquid if an
institutional or other market exists for these securities. In making this
determination, a fund, under the direction and supervision of the board of
trustees, will take into account the following factors: (1) the frequency of
trades and quotes for the security; (2) the number of dealers willing to
purchase or sell the security and the number of potential purchasers; (3) dealer
undertakings to make a market in the security; and (4) the nature of the
security and marketplace trades (e.g., the time needed to dispose of the
security, the method of soliciting offers and the mechanics of transfer). To the
extent a fund invests in restricted securities that are deemed liquid, the
general level of illiquidity in a fund's portfolios may be increased if
qualified institutional buyers become uninterested in purchasing these
securities.

REVERSE REPURCHASE AGREEMENTS AND MORTGAGE DOLLAR ROLLS may be used by a fund. A
fund may engage in reverse repurchase agreements to facilitate portfolio
liquidity, a practice common in the mutual fund industry, or for arbitrage
transactions as discussed below. In a reverse repurchase agreement, a fund would
sell a security and enter into an agreement to repurchase the security at a
specified future date and price. A fund generally retains the right to interest
and principal payments on the security. Because a fund receives cash upon
entering into a reverse repurchase agreement, it may be considered a borrowing.
When required by guidelines of the SEC, a fund will set aside permissible liquid
assets in a segregated account to secure its obligations to repurchase the
security.

A fund also may enter into mortgage dollar rolls, in which a fund would sell MBS
for delivery in the current month and simultaneously contract to purchase
substantially similar securities on a specified future date. While a fund would
forego principal and interest paid on the MBS during the roll period, a fund
would be compensated by the difference between the current sales price and the
lower price for the future purchase as well as by any interest earned on the
proceeds of the initial sale. A fund also could be compensated through the
receipt of fee income equivalent to a lower forward price. At the time a fund
would enter into a mortgage dollar roll, it would set aside permissible liquid
assets in a segregated account to secure its obligation for the forward
commitment to buy MBS. Mortgage dollar roll transactions may be considered a
borrowing by a fund.

The mortgage dollar rolls and reverse repurchase agreements entered into by a
fund may be used as arbitrage transactions in which a fund will maintain an
offsetting position in short duration investment grade debt obligations. Since a
fund will receive interest on the securities or repurchase agreements in which
it invests the transaction proceeds, such transactions may involve leverage.
However, since such securities or repurchase agreements will be high quality and
short duration, the investment adviser believes that such arbitrage transactions
present lower risks to a fund than those associated with other types of
leverage. There can be no assurance that a fund's use of the cash it receives
from a mortgage dollar roll will provide a positive return.

RISK MANAGEMENT TECHNIQUES used by a fund may include buying and selling futures
and options contracts, entering into total return, asset and credit swaps,
credit-linked notes and wrap agreements

20
<PAGE> 102
and investing in various types of derivative instruments. A fund may use risk
management techniques, including derivative instruments, for any lawful purpose
consistent with its investment objective, such as hedging or managing risk.
Derivative instruments are commonly defined to include securities or contracts
whose values depend on (or "derive" from) the value of one or more other assets
such as securities, currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."

A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, as well as
exchange-traded futures. Option-based derivatives include privately negotiated,
over-the-counter ("OTC") options (including caps, floors, collars, and options
on forward and swap contracts) and exchange-traded options on futures. Diverse
types of derivatives may be created by combining options or forward contracts in
different ways, and applying these structures to a wide range of underlying
assets.

Risk management strategies include investment techniques designed to facilitate
the sale of portfolio securities, manage the average duration of the portfolio
or create or alter exposure to certain asset classes, such as equity, other debt
or foreign securities.

In addition to the derivative instruments and strategies described in the SAI,
the investment adviser expects to discover additional derivative instruments and
other hedging or risk management techniques. The investment adviser may utilize
these new derivative instruments and techniques to the extent that they are
consistent with a fund's investment objective and permitted by a fund's
investment limitations, operating policies, and applicable regulatory
authorities.

SECURITIES OF OTHER INVESTMENT COMPANIES may be purchased and sold by a fund and
those issued by foreign investment companies. Mutual funds are registered
investment companies, which may issue and redeem their shares on a continuous
basis (open-end mutual funds) or may offer a fixed number of shares usually
listed on an exchange (closed-end mutual funds). Mutual funds generally offer
investors the advantages of diversification and professional investment
management, by combining shareholders' money and investing it in various types
of securities, such as stocks, bonds and money market securities. Mutual funds
also make various investments and use certain techniques in order to enhance
their performance. These may include entering into delayed-delivery and
when-issued securities transactions or swap agreements; buying and selling
futures contracts, illiquid and restricted securities and repurchase agreements
and borrowing or lending money and/or portfolio securities. The risks of
investing in mutual funds generally reflect the risks of the securities in which
the mutual funds invest and the investment techniques they may employ. Also,
mutual funds charge fees and incur operating expenses.

If a fund decides to purchase securities of other investment companies, a fund
intends to purchase shares of mutual funds in compliance with the requirements
of federal law or any applicable exemptive relief received from the SEC. Mutual
fund investments for a fund are currently restricted under federal regulations,
and therefore, the extent to which a fund may invest in another mutual fund may
be limited. In addition, a fund intends to vote any proxies of underlying mutual
funds in accordance with the instructions received, or in the same proportion as
the vote of all other shareholders of the underlying mutual fund.

Funds in which a fund also may invest include unregistered or privately-placed
funds, such as hedge funds and off-shore funds, and unit investment trusts.
Hedge funds and off-shore funds are

21
<PAGE> 103
not registered with the SEC, and therefore are largely exempt from the
regulatory requirements that apply to registered investment companies (mutual
funds). As a result, these funds may have greater ability to make investments or
use investment techniques that offer a higher degree of investment return, such
as leveraging, which also may subject fund assets to substantial risk to the
investment principal. These funds, while not regulated by the SEC like mutual
funds, may be indirectly supervised by the sources of their assets, which tend
to be commercial and investment banks and other financial institutions.
Investments in these funds also may be more difficult to sell, which could cause
losses to a fund. For example, hedge funds typically require investors to keep
their investment in a hedge fund for some period of time, such as one month.
This means investors would not be able to sell their shares of a hedge fund
until such time had past.

SHORT SALES may be used by a fund to hedge unrealized gains on portfolio
securities. Selling securities short against the box involves selling a security
that a fund owns or has the right to acquire, for the delivery at a specified
date in the future. If a fund sells securities short against the box, it may
protect unrealized gains, but will lose the opportunity to profit on such
securities if the price rises.

SINKING FUNDS may be established by bond issuers to set aside a certain amount
of money to cover timely repayment of bondholders' principal raised through a
bond issuance. By creating a sinking fund, the issuer is able to spread
repayment of principal to numerous bondholders while reducing reliance on its
then current cash flows. A sinking fund also may allow the issuer to annually
repurchase certain of its outstanding bonds from the open market or repurchase
certain of its bonds at a call price named in a bond's sinking fund provision.
This call provision will allow bonds to be prepaid or called prior to a bond's
maturity. The likelihood of this occurring is substantial during periods of
falling interest rates.

SPREAD TRANSACTIONS may be used for hedging or managing risk. A fund may
purchase covered spread options from securities dealers. Such covered spread
options are not presently exchange-listed or exchange-traded. The purchase of a
spread option gives a fund the right to put, or sell, a security that it owns at
a fixed dollar spread or fixed yield spread in relation to another security that
a fund does not own, but which is used as a benchmark. The risk to a fund in
purchasing covered spread options is the cost of the premium paid for the spread
option and any transaction costs. In addition, there is no assurance that
closing transactions will be available. The purchase of spread options will be
used to protect a fund against adverse changes in prevailing credit quality
spreads, i.e., the yield spread between high quality and lower quality
securities. Such protection is only provided during the life of the spread
option.

STRIPPED SECURITIES are securities whose income and principal components are
detached and sold separately. While risks associated with stripped securities
are similar to other fixed income securities, stripped securities are typically
subject to greater changes in value. U.S. Treasury securities that have been
stripped by a Federal Reserve Bank are obligations of the U.S. Treasury.

SWAP AGREEMENTS can be structured to increase or decrease a fund's exposure to
long- or short-term interest rates, corporate borrowing rates and other
conditions, such as changing security prices and inflation rates. They also can
be structured to increase or decrease a fund's exposure to specific issuers or
specific sectors of the bond market such as mortgage securities. For example, if
a fund agreed to pay a longer-term fixed rate in exchange for a shorter-term
floating rate while holding longer-term fixed-rate bonds, the swap would tend to
decrease a fund's exposure to longer-term interest rates. Swap agreements tend
to increase or decrease the overall volatility of a fund's investments and its
share price and yield. Changes in interest rates, or other factors determining
the amount of payments due to and from a fund, can be the most significant
factors in the performance

22
<PAGE> 104
of a swap agreement. If a swap agreement calls for payments from a fund, a fund
must be prepared to make such payments when they are due. In order to help
minimize risks, a fund will segregate appropriate assets for any accrued but
unpaid net amounts owed under the terms of a swap agreement entered into on a
net basis. All other swap agreements will require a fund to segregate
appropriate assets in the amount of the accrued amounts owed under the swap. A
fund could sustain losses if a counterparty does not perform as agreed under the
terms of the swap. A fund will enter into swap agreements with counterparties
deemed creditworthy by the investment adviser.

WARRANTS are a type of security usually issued with bonds and preferred stock
that entitles the holder to a proportionate amount of common stock at specified
price for a specific period of time. The prices of warrants do not necessarily
move parallel to the prices of the underlying common stock. Warrants have no
voting rights, receive no dividends and have no rights with respect to the
assets of the issuer. If a warrant is not exercised within the specified time
period, it will become worthless and a fund will lose the purchase price it paid
for the warrant and the right to purchase the underlying security.

WRAP AGREEMENTS may be entered into by a fund with insurance companies, banks or
other financial institutions (wrapper providers). A wrap agreement typically
obligates the wrapper provider to maintain the value of the assets covered under
the agreement (covered assets) up to a specified maximum dollar amount upon the
occurrence of certain specified events. The value is pre-determined using the
purchase price of the securities plus interest at a specified rate minus an
adjustment for any defaulted securities. The specified interest rate may be
adjusted periodically

23
<PAGE> 105
under the terms of the agreement. While the rate typically will reflect
movements in the market rates of interest, it may at times be less or more than
the actual rate of income earned on the covered assets. The rate also can be
impacted by defaulted securities and by purchase and redemption levels in a
fund. A fund also pays a fee under the agreement, which reduces the rate as
well.

Wrap agreements may be used as a risk management technique intended to help
minimize fluctuations in a fund's NAV. However, a fund's NAV will typically
fluctuate at least minimally, and may fluctuate more at times when interest
rates are fluctuating. Additionally, wrap agreements do not protect against
losses a fund may incur if the issuers of portfolio securities do not make
timely payments of interest and/or principal. A wrap agreement provider also
could default on its obligations under the agreement. Therefore, the funds will
only invest in a wrap provider with an investment-grade credit rating. There is
no active trading market for wrap agreements and none is expected to develop.
Therefore, wrap agreements are considered illiquid investments. There is no
guarantee that a fund will be able to purchase any wrap agreements or replace
ones that defaulted. Wrap agreements are valued using procedures adopted by the
board of trustees. There are risks that the value of a wrap agreement may not be
sufficient to minimize the fluctuations in a fund's NAV. All of these factors
might result in a decline in the value of a fund's shares.

ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES are debt securities that do
not make regular cash interest payments. Zero-coupon and step-coupon securities
are sold at a deep discount to their face value. Pay-in-kind securities pay
interest through the issuance of additional securities. Because such securities
do not pay current cash income, the price of these securities can be volatile
when interest rates fluctuate. While these securities do not pay current cash
income, federal income tax law requires the holders of zero-coupon, step-coupon,
and pay-in-kind securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash income on such
securities accruing that year. In order to continue to qualify as a "regulated
investment company" or "RIC" under the Internal Revenue Code and avoid a certain
excise tax, a fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.

INVESTMENT LIMITATIONS

The following investment limitations are fundamental investment polices and
restrictions and may be changed only by vote of a majority of a fund's
outstanding voting shares.

EACH FUND MAY:

1) Lend or borrow money to the extent permitted by the Investment Company Act
of 1940 or rule or regulations thereunder, as such statute, rules or
regulations may be amended from time to time.

2) Pledge, mortgage or hypothecate any of its assets to the extent permitted
by the Investment Company Act of 1940 or the rules or regulations
thereunder, as such statute, rules or regulations may be amended from time
to time.

3) Not concentrate investments in a particular industry or group of
industries, or within one state (except to the extent that the index which
each fund seeks to track is also so

24
<PAGE> 106
concentrated) as concentration is defined under the Investment Company Act
of 1940 or the rules or regulations thereunder, as such statute, rules or
regulations may be amended from time to time.

4) Underwrite securities to the extent permitted by the Investment Company
Act of 1940 or the rules or regulations thereunder, as such statute, rules
or regulations may be amended from time to time.

5) Not purchase securities of an issuer, except as consistent with the
maintenance of its status as an open-end diversified company under the
1940 Act, the rules or regulations thereunder or any exemption therefrom,
as such statute, rules or regulations may be amended or interpreted from
time to time.

6) Not purchase securities of other investment companies, except as permitted
by the Investment Company Act of 1940.

7) Issue senior securities to the extent permitted by the Investment Company
Act of 1940 or the rules or regulations thereunder, as such statute, rules
or regulations may be amended from time to time.

8) Purchase or sell commodities, commodities contracts, futures contracts, or
real estate to the extent permitted by the Investment Company Act of 1940
or rules or regulations thereunder, as such statute, rules or regulations
may be amended from time to time.

THE FOLLOWING DESCRIPTIONS OF THE 1940 ACT MAY ASSIST INVESTORS IN UNDERSTANDING
THE ABOVE POLICIES AND RESTRICTIONS.

Concentration. The SEC has presently defined concentration as investing 25% or
more of an investment company's net assets in an industry or group of
industries, with certain exceptions.

Borrowing. The 1940 Act presently allows a fund to borrow from any bank
(including pledging, mortgaging or hypothecating assets) in an amount up to 33
1/3% of its total assets (not including temporary borrowings not in excess of 5%
of its total assets).

Lending. Under the 1940 Act, a fund may only make loans if expressly permitted
by its investment policies. Each fund's non-fundamental investment policy on
lending is set forth below.

Underwriting. Under the 1940 Act, underwriting securities involves a fund
purchasing securities directly from an issuer for the purpose of selling
(distributing) them or participating in any such activity either directly or
indirectly. Under the 1940 Act, a diversified fund may not make any commitment
as underwriter, if immediately thereafter the amount of its outstanding
underwriting commitments, plus the value of its investments in securities of
issuers (other than investment companies) of which it owns more than 10% of the
outstanding voting securities, exceeds 25% of the value of its total assets.

Senior Securities. Senior securities may include any obligation or instrument
issued by a fund evidencing indebtedness. The 1940 Act generally prohibits funds
from issuing senior securities, although it provides allowances for certain
borrowings and certain other investments, such as short sales, reverse
repurchase agreements, firm commitment agreements and standby commitments, with
appropriate segregation of assets.

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<PAGE> 107
The following are non-fundamental investment policies and restrictions and may
be changed by the board of trustees.

EACH FUND MAY NOT:

1) Purchase more than 10% of any class of securities of any issuer if, as a
result of such purchase, it would own more than 10% of such issuer's
outstanding voting securities.

2) Invest more than 5% of its total assets in securities of issuers (other
than obligations of, or guaranteed by the U.S. government, its agencies or
instrumentalities) that with their predecessors have a record of less than
three years continuous operation.

3) Purchase securities that would cause more than 5% of its net assets to be
invested in restricted securities, excluding restricted securities
eligible for resale pursuant to Rule 144A under the Securities Act of 1933
that have been determined to be liquid under procedures adopted by the
trust's board of trustees based upon the trading markets for the
securities.

4) Invest more than 5% of its net assets in warrants, valued at the lower of
cost or market, and no more than 40% of this 5% may be invested in
warrants that are not listed on the New York Stock Exchange or the
American Stock Exchange, provided, however, that for purposes of this
restriction, warrants acquired by a fund in units or attached to other
securities are deemed to be without value.

5) Purchase puts, calls, straddles, spreads or any combination thereof if by
reason of such purchase the value of its aggregate investment in such
securities would exceed 5% of a fund's total assets.

6) Make short sales, except for short sales against the box.

7) Purchase or sell interests in oil, gas or other mineral development
programs or leases, although it may invest in companies that own or invest
in such interests or leases.

8) Purchase securities on margin, except such short-term credits as may be
necessary for the clearance of purchases and sales of securities.

9) Lend money to any person, except that each fund may (1) purchase a portion
of an issue of short-term debt securities or similar obligations
(including repurchase agreements) that are publicly distributed or
customarily purchased by institutional investors, and (2) lend its
portfolio securities.

10) Borrow money, except from banks for temporary purposes to satisfy
redemption requests or for extraordinary or emergency purposes and then
only in an amount not to exceed one-third of the value of its total assets
(including the amount borrowed), provided that each fund will not purchase
securities while borrowings represent more than 5% of its total assets.

11) Pledge, mortgage or hypothecate any of its assets, except that to secure
allowable borrowing, each fund may do so with respect to no more than
one-third of the value of its total assets.

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<PAGE> 108
12) Underwrite securities issued by others, except to the extent it may be
deemed to be an underwriter, under the federal securities laws, in
connection with the disposition of securities from its investment
portfolio.

13) Purchase securities of any other issuer (other than U.S. government
securities ) if, as a result, more than 25% of its total assets would be
invested in the securities if an issuer from a single industry or group of
industries.

14) Purchase the securities of any issuer if, as a result more than 15% of its
net assets would be invested in illiquid securities.

15) Purchase or sell commodities or real estate, including interests in real
estate limited partnerships, provided that each fund may (1) purchase
securities of companies that deal in real estate or interests therein, and
(2) purchase or sell futures contracts, options contracts, equity index
participations and index participations contracts.

16) As to 75% of its assets, purchase securities of any issuer (other than
obligations of, or guaranteed by, the U.S. government, its agencies or
instrumentalities) if, as a result more than 5% of the value of its total
assets would be invested in the securities of such issuer.

17) Invest for the purpose of exercising control or management of another
issuer.

MANAGEMENT OF THE FUNDS

The officers and trustees, their principal occupations during the past five
years and their affiliations, if any, with The Charles Schwab Corporation,
Charles Schwab & Co., Inc. and Charles Schwab Investment Management, Inc.,
are as follows:

<TABLE>
<CAPTION>
POSITION(S) WITH PRINCIPAL OCCUPATIONS & AFFILIATIONS
NAME/DATE OF BIRTH THE TRUST
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CHARLES R. SCHWAB* Chairman, Chief Chairman and Co-Chief Executive Officer,
July 29, 1937 Executive Officer and Director, The Charles Schwab Corporation; Chief
Trustee Executive Officer, Director, Charles Schwab
Holdings, Inc.; Chairman, Director, Charles
Schwab & Co., Inc., Charles Schwab Investment
Management, Inc.; Director, The Charles Schwab
Trust Company; Chairman, Schwab Retirement Plan
Services, Inc.; Chairman and Director until
January 1999, Mayer & Schweitzer, Inc. (a
securities brokerage subsidiary of The Charles
Schwab Corporation); Director, The Gap, Inc. (a
clothing retailer), Audiobase, Inc.
(full-service audio solutions for the internet),
Vodaphone AirTouch PLC (a telecommunications
company) and Siebel Systems (a software company).

STEVEN L. SCHEID* President and Trustee Vice Chairman and Executive Vice President, The
Charles Schwab Corporation; Vice Chairman and
</TABLE>

--------

* This trustee is an "interested person" of the trusts.

27
<PAGE> 109
<TABLE>
<S> <C> <C>
June 28, 1953 Enterprise President - Financial Products and
Services, Director, Charles Schwab & Co., Inc.;
Chief Executive Officer and Chief Financial
Officer and Director, Charles Schwab Investment
Management, Inc.; Director, Depository Trust
Company (a securities depository company) and
Requisite Technology (a technology company).
From 1994 to 1996, Mr. Scheid was Executive Vice
President of Finance for First Interstate
Bancorp and Principal Financial Officer from
1995 to 1996.

ROBERT G. HOLMES Trustee Chairman, Chief Executive Officer and Director,
May 15, 1931 Semloh Financial, Inc. (international financial
services and investment advisory firm).

DONALD R. STEPHENS Trustee Managing Partner, D.R. Stephens & Company
June 28, 1938 (investments). Prior to 1996, Chairman and
Chief Executive Officer of North American Trust
(real estate investment trust).

MICHAEL W. WILSEY Trustee Chairman and Chief Executive Officer, Wilsey
August 18, 1943 Bennett, Inc. (truck and air transportation,
real estate investment and management, and
investments).

--------

* This trustee is an "interested person" of the trusts.

28
<PAGE> 110

<TABLE>
<S> <C> <C>
Officer and Chief Operating Officer of America
First Eureka Holdings, Inc. (holding company).
Ms. Byerwalter also is on the Board of Directors
of America First Companies, Omaha, NE (venture
capital/fund management) and Redwood Trust, Inc.
(mortgage finance), and is Director of Stanford
Hospitals and Clinics, SRI International
(research) and LookSmart, Ltd. (an Internet
infrastructure company).

TAI-CHIN TUNG Treasurer and Principal Senior Vice President, Treasurer and Controller,
March 7, 1951 Financial Officer Charles Schwab Investment Management, Inc. From
1994 to 1996, Ms. Tung was Controller for
Robertson Stephens Investment Management, Inc.

STEPHEN B. WARD Senior Vice President Senior Vice President and Chief Investment
April 5, 1955 and Chief Investment Officer, Charles Schwab Investment Management,
Officer Inc.

29
<PAGE> 111
Each fund is overseen by a board of trustees. The board of trustees meets
regularly to review a fund's activities, contractual arrangements and
performance. The board of trustees is responsible for protecting the interests
of a fund's shareholders. The following table provides information concerning
compensation of the trustees.

<TABLE>
<CAPTION>
Pension or Retirement ($)
($) Benefits Accrued as Total
Name of Trustee Aggregate Compensation Part of Fund Expenses Compensation from
from each Fund 1 Fund Complex 2
Short-Term Total Bond
Bond Market
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Charles R. Schwab 0 0 N/A 0
Steven L. Scheid 0 0 N/A 0
William J. Klipp 3 0 0 N/A 0
Jeremiah H. Chafkin 4 0 0 N/A 0
Mariann Byerwalter 4 376 487 N/A 38,870
Donald F. Dorward 1,854 2,299 N/A 134,600
William A. Hasler 4 376 487 N/A 38,870
Robert G. Holmes 1,854 2,299 N/A 134,600
Gerald B. Smith 4 376 487 N/A 38,870
Donald R. Stephens 1,854 2,299 N/A 134,600
Michael W. Wilsey 1,748 2,170 N/A 124,600
</TABLE>

1 For the fiscal year ended August 31, 2000.

2 Unless otherwise stated, information is for the fund complex, which
included 44 funds as of August 31, 2000.

3 Mr. Klipp departed Charles Schwab & Co., Inc. in 1999 and resigned from the
Board of Trustees effective April 30, 2000.

4 This trustee was first elected by shareholders on June 1, 2000.

DEFERRED COMPENSATION PLAN

CODE OF ETHICS

30
<PAGE> 112

securities that may be purchased or held by the funds. Securities transactions
by some of these individuals may be subject to prior approval of the investment
adviser's Chief Compliance Officer or alternate. Most securities transactions
are subject to quarterly reporting and review requirements.

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of October 16, 2000, the officers and trustees of Schwab Total Bond Market
Index Fund, as a group, owned of record or beneficially less than 1% of the
outstanding voting securities of the fund.

As of October 16, 2000, the officers and trustees of Schwab Short-Term Bond
Market Index Fund, as a group, owned of record or beneficially less than 1% of
the outstanding voting securities of the fund, excluding Charles R. Schwab as
reported below.

As of October 16, 2000, Charles R. Schwab, 101 Montgomery Street, San Francisco,
CA 94119, directly or beneficially owned 13.20% of shares of the Schwab
Short-Term Bond Market Index Fund.

As of the same date, Charles Schwab & Co., Inc. -- Retirement Plan Services,
MarketTrack Growth II Portfolio, MarketTrack Balanced Portfolio, MarketTrack
Conservative Portfolio and MarketTrack Growth Portfolio in the aggregate,
directly or beneficially owned 65.41% of the shares of Schwab Total Bond Market
Index Fund.

INVESTMENT ADVISORY AND OTHER SERVICES

INVESTMENT ADVISER

First $500 million - 0.30%
More than $500 million - 0.22%

31
<PAGE> 113

For the fiscal years ended August 31, 1998, 1999 and 2000, the investment
advisory fees incurred by the Schwab Short-Term Bond Market Index Fund were
$25,000 (fees were reduced by $561,000), $0 (fees were reduced by $760,000), and
$0 (fees were reduced by $705,000) respectively.

For the fiscal years ended August 31, 1998, 1999 and 2000, the investment
advisory fees incurred by the Schwab Total Bond Market Index Fund, were $0 (fees
were reduced by $580,000), $76,000 (fees were reduced by $1,498,000), and
$221,000 (fees were reduced by $1,525,000) respectively.

The investment adviser and Schwab have contractually guaranteed that, through at
least November 15, 2001, total operating expenses (excluding interest, taxes and
certain non-routine expenses) of the Schwab Short-Term Bond Market Index Fund
and Schwab Total Bond Market Index Fund will not exceed 0.35%, of each fund's
average daily net assets.

DISTRIBUTOR

Pursuant to a Distribution Agreement, Schwab is the principal underwriter for
shares of a fund and is the trust's agent for the purpose of the continuous
offering of a fund's shares. Each fund pays the cost of the prospectuses and
shareholder reports to be prepared and delivered to existing shareholders.
Schwab pays such costs when the described materials are used in connection with
the offering of shares to prospective investors and for supplemental sales
literature and advertising. Schwab receives no fee under the Distribution
Agreement.

SHAREHOLDER SERVICES AND TRANSFER AGENT

Schwab provides fund information to shareholders, including share price,
reporting shareholder ownership and account activities and distributing a fund's
prospectuses, financial reports and other informational literature about the
fund. Schwab maintains the office space, equipment and personnel necessary to
provide these services. Schwab also distributes and markets SchwabFunds and
provides other services. At its own expense, Schwab may engage third party
entities, as appropriate, to perform some or all of these services.

CUSTODIAN AND FUND ACCOUNTANT

PFPC Trust Company, 8800 Tinicum Blvd., Third Floor Suite 200, Philadelphia, PA
19153, serves as custodian for the funds and PFPC, Inc., 400 Bellevue Parkway,
Wilmington, DE 19809, serves as fund accountant.

The custodian is responsible for the daily safekeeping of securities and cash
held or sold by the funds. The accountant maintains all books and records
related to each fund's transactions.

INDEPENDENT ACCOUNTANT

The funds' independent accountant, PricewaterhouseCoopers LLP, audits and
reports on the annual financial statements of each series of the trust and
reviews certain regulatory reports and each fund's

32
<PAGE> 114

federal income tax return. They also perform other professional accounting,
auditing, tax and advisory services when the trust engages them to do so. Their
address is 333 Market Street, San Francisco, CA 94105. Each fund's audited
financial statements for the fiscal year ending August 31, 2000, will be
included in the fund's annual report that is supplied with the SAI.

BROKERAGE ALLOCATION AND OTHER PRACTICES

PORTFOLIO TURNOVER

The portfolio turnover rates for the Schwab Total Bond Market Index Fund for the
fiscal years ended August 31, 1999 and 2000 were 174% and 135%, respectively.
The portfolio turnover rates for the Schwab Short-Term Bond Index Fund for the
fiscal years ended August 31, 1999 and 2000 were 195% and 129%, respectively.

PORTFOLIO TRANSACTIONS

The funds paid no brokerage commissions in the last three fiscal years.

33
<PAGE> 115
However, it is the opinion of the board of trustees that the benefits conferred
by the investment adviser outweigh any disadvantages that may arise from
exposure to simultaneous transactions.

DESCRIPTION OF THE TRUST

Each fund is a series of Schwab Investments. Schwab Investments was organized
under Massachusetts law on October 26, 1990.

Each fund may hold special meetings, which may cause the funds to incur
non-routine expenses. These meetings may be called for purposes such as electing
trustees, changing fundamental policies and amending management contracts.
Shareholders are entitled to one vote for each share owned and may vote by proxy
or in person. Proxy materials will be mailed to shareholders prior to any
meetings, and will include a voting card and information explaining the matters
to be voted upon.

34
<PAGE> 116
the trust itself is unable to meet its obligations. There is a remote
possibility that a fund could become liable for a misstatement in the prospectus
or SAI about another fund.

PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER REPORTS AND PRICING OF SHARES

PURCHASING AND REDEEMING SHARES OF THE FUNDS

Share certificates will not be issued in order to avoid additional
administrative costs, however, share ownership records are maintained by Schwab.

EXCHANGING SHARES OF THE FUNDS

DELIVERY OF SHAREHOLDER DOCUMENTS

35
<PAGE> 117
PRICING OF SHARES

TAXATION

FEDERAL TAX INFORMATION FOR THE FUNDS

It is each fund's policy to qualify for taxation as a "regulated investment
company" (RIC) by meeting the requirements of Subchapter M of the Internal
Revenue Code of 1986, as amended (the Code). By qualifying as a RIC, a fund
expects to eliminate or reduce to a nominal amount the federal income tax to
which it is subject. If a fund does not qualify as a RIC under the Code, it will
be subject to federal income tax, at regular corporate rates on its net income,
including any net realized capital gains.

FEDERAL INCOME TAX INFORMATION FOR SHAREHOLDERS

36
<PAGE> 118

Any dividends declared by a fund in October, November or December and paid the
following January are treated, for tax purposes, as if they were received by
shareholders on December 31 of the year in which they were declared. Long-term
capital gains distributions are taxable as long-term capital gains, regardless
of how long you have held your shares. However, if you receive a long-term
capital gains distribution with respect to fund shares held for six months or
less, any loss on the sale or exchange of those shares shall, to the extent of
the long-term capital gains distribution, be treated as a long-term capital
loss. Because a fund's income is expected to consist of interest rather than
dividends, it is anticipated that no portion of its distributions will generally
be eligible for the dividends-received deduction. Distributions by a fund also
may be subject to state, local and foreign taxes, and its treatment under
applicable tax laws may differ from the federal income tax treatment.

Foreign shareholders (i.e., nonresident alien individuals and foreign
corporations, partnerships, trusts and estates) are generally subject to U.S.
withholding tax at the rate of 30% (or a lower tax treaty rate) on distributions
derived from net investment income and short-term capital gains. Distributions
to foreign shareholders of long-term capital gains and any gains from the sale
or other disposition of shares of the funds generally are not subject to U.S.
taxation, unless the recipient is an individual who either (1) meets the Code's
definition of "resident alien" or (2) who is physically present in the U.S. for
183 days or more. Different tax consequences may result if the foreign
shareholder is engaged in a trade or business within the United States. In
addition, the tax consequences to a foreign shareholder entitled to claim the
benefits of a tax treaty may be different than those described above.

GENERAL STATE AND LOCAL TAX INFORMATION

Many states grant tax-free status to dividends paid to you from interest earned
on direct obligations of the U.S. government, subject in some states to minimum
investment requirements that must be met by a fund. Investment in Ginnie Mae or
Fannie Mae securities, banker's acceptances, commercial paper and repurchase
agreements collateralized by U.S. government securities do not generally qualify
for such tax-free treatment. The rules on exclusion of this income are different
for corporate shareholders. Shareholders are urged to consult their tax advisors
as to the consequences of these and other state and local tax rules affecting
investments in the funds.

CALCULATION OF PERFORMANCE DATA

37
<PAGE> 119
those intervals. In computing average annual total return, a fund assumes
reinvestment of all distributions at net asset value on applicable reinvestment
dates.

Standardized Total Return

Schwab Total Bond Market 7.36% 6.25% 6.17%
Index Fund
</TABLE>

* November 5, 1991 for Schwab Short-Term Bond Market Index Fund and March 5,
1993 for the Schwab Total Bond Market Index Fund.

Nonstandardized Cumulative Total Return

<TABLE>
<CAPTION>
Fund Cumulative Total Return as of
August 31, 2000*
<S> <C>
Schwab Short-Term Bond Market Index Fund 62.02%

Schwab Total Bond Market Index Fund 56.66%
</TABLE>

* November 5, 1991 for Schwab Short-Term Bond Market Index Fund and March 5,
1993 for the Schwab Total Bond Market Index Fund.

A 30-day yield is calculated by dividing the net investment income per share
earned during a 30-day period by a fund's share price on the last day of the
period.

30-Day Yield

<TABLE>
<CAPTION>
Fund 30-day period ended August 31, 2000
<S> <C>
Schwab Short-Term Bond Market Index Fund 6.65%

Schwab Total Bond Market Index Fund 6.87%
</TABLE>

The performance of a fund may be compared with the performance of other mutual
funds by comparing the ratings of mutual fund rating services, various indices,
U.S. government

<PAGE> 120
obligations, bank certificates of deposit, the consumer price index and other
investments and measures for which reliable data is available. An index's
performance data assumes the reinvestment of dividends but does not reflect
deductions for administrative, management and trading expenses. A fund will be
subject to these costs and expenses, while an index does not have these
expenses. In addition, various factors, such as holding a cash balance, may
cause a fund's performance to be higher or lower than that of an index.

COMPARATIVE INDEX PERFORMANCE

Each fund's performance may be compared to various unmanaged bond indexes in
addition to the Lehman Brothers Mutual Fund Short (1-5 Year) U.S.
Government/Credit Index and the unmanaged Lehman Brothers U.S. Aggregate Bond
Index, including but not limited to, Salomon Smith Barney Broad Investment-Grade
Bond Index, the Lehman Brothers Government/Credit Bond Index, the Merrill Lynch
Domestic Master Index and to Lipper, Inc. averages and Morningstar, Inc.
rankings.

The following tables illustrate the historical total return of securities
comprising the indexes beginning calendar year end December 31, 1989 through
calendar year end December 30, 1999. This historical information is not
indicative of any future trend of the funds or the particular market sectors
that the Indexes represent.

<TABLE>
<CAPTION>
DATE U.S. AGGREGATE BOND SHORT (1-5 Year)
INDEX GOVERNMENT/CREDIT INDEX
<S> <C> <C>
Dec. 31, 1989 14.53 11.70
Dec. 31, 1990 8.96 9.69
Dec. 31, 1991 16.00 13.14
Dec. 31, 1992 7.40 6.83
Dec. 31, 1993 9.75 7.10
Dec. 31, 1994 -2.92 -0.72
Dec. 31, 1995 18.47 12.88
Dec. 31, 1996 3.63 4.67
Dec. 31, 1997 9.65 7.13
Dec. 31, 1998 8.67 7.64
Dec. 31, 1999 -0.82 2.09
</TABLE>

39
<PAGE> 121
APPENDIX - RATINGS OF INVESTMENT SECURITIES

From time to time, a fund may report the percentage of its assets that fall into
the rating categories set forth below.

BONDS

MOODY'S INVESTORS SERVICE

STANDARD & POOR'S CORPORATION

INVESTMENT GRADE

AAA Debt rated 'AAA' has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.

AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated debt only in small degree.

40
<PAGE> 122
A Debt rated 'A' has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.

SPECULATIVE GRADE

FITCH, INC.

INVESTMENT GRADE BOND

41
<PAGE> 123
ratings of these bonds will fall below investment grade is higher than
for bonds with higher ratings.

SPECULATIVE GRADE BOND

DESCRIPTION OF THOMSON BANKWATCH'S LONG-TERM DEBT RATINGS

INVESTMENT GRADE

AAA The highest category; indicates that the ability to repay principal and
interest on a timely basis is very high.

AA The second-highest category; indicates a superior ability to repay
principal and interest on a timely basis, with limited incremental risk
compared to issues rated in the highest category.

NON-INVESTMENT GRADE

SHORT-TERM NOTES AND VARIABLE RATE DEMAND OBLIGATIONS

MOODY'S INVESTORS SERVICE

Short-term notes/variable rate demand obligations bearing the designations
MIG-1/VMIG-1 are considered to be of the best quality, enjoying strong
protection from established cash flows,

42
<PAGE> 124
superior liquidity support or demonstrated broad-based access to the market for
refinancing. Obligations rated MIG-2/VMIG-3 are of high quality and enjoy ample
margins of protection although not as large as those of the top rated
securities.

STANDARD & POOR'S CORPORATION

FITCH, INC.

COMMERCIAL PAPER

MOODY'S INVESTORS SERVICE

STANDARD & POOR'S CORPORATION

FITCH, INC.

COMMERCIAL PAPER, SHORT-TERM OBLIGATIONS
AND DEPOSIT OBLIGATIONS ISSUED BY BANKS

THOMSON BANKWATCH (TBW)

TBW-1 is the highest category and indicates the degree of safety regarding
timely repayment of principal and interest is very high. TBW-2 is the second
highest category and while

<PAGE> 125
the degree of safety regarding timely repayment of principal and interest is
strong, the relative degree of safety is not as high as for issues rated
"TBW-1."

<PAGE> 126
SCHWAB

YIELDPLUS FUND(TM)

PROSPECTUS
November 15, 2000

[CHARLES SCHWAB LOGO]
<PAGE> 127
SCHWAB

YIELDPLUS FUND(TM)

ABOUT THE FUND

4 Strategy

5 Main Risks

6 Performance

6 Fees and Expenses

8 Fund Management

INVESTING IN THE FUND

10 Buying Shares

10 Schwab Accounts

11 Selling/Exchanging Shares

12 Transaction Policies

13 Distributions and Taxes

<PAGE> 128
ABOUT THE FUND
<PAGE> 129
SCHWAB TICKER SYMBOL
INVESTOR SHARES: SWYPX
YIELDPLUS FUND(TM) SELECT SHARES(R): SWYSX

THE FUND SEEKS HIGH CURRENT INCOME WITH MINIMAL CHANGES IN SHARE PRICE.

STRATEGY

TO PURSUE ITS GOAL, THE FUND INVESTS IN INVESTMENT-GRADE (HIGH AND CERTAIN
MEDIUM QUALITY, AAA TO BBB-) BONDS. These may include fixed-, variable- or
floating-rate corporate, mortgage-backed, asset-backed debt securities, and
collateralized mortgage obligations from U.S. and foreign issuers.

In choosing securities, the fund's manager seeks to maximize current income
within the limits of the fund's credit and maturity policies. To help maintain a
very high degree of share price stability and preserve investors' capital, the
fund seeks to keep the average duration of its overall portfolio at one year or
less. Duration is a tool to measure interest rate risk. For any bonds with
interest payments occurring before principal is repaid, duration is ordinarily
less than the maturity. Historically, the fund's average maturity measurement
and average duration have closely followed each other. However, in seeking to
enhance its potential yields, the fund may invest in bonds, convertible and
preferred securities with effective or final maturities of any length and may
invest up to 25% of assets in lower quality bonds (sometimes called junk bonds)
that are rated as low as BB or Ba by at least one nationally recognized rating
service or are the unrated equivalent.

The investment adviser's credit research department analyzes and monitors the
securities that the fund owns or is considering buying. The manager may adjust
the fund's holdings or its average duration based on actual or anticipated
changes in interest rates or credit quality. In the event a portfolio security
was downgraded below B, the manager would promptly sell the security. The
manager also may use risk management techniques, including short sales, futures
contracts, swap agreements and other derivatives, in seeking to reduce share
price volatility, increase income and otherwise manage the fund's exposure to
investment risks.

The fund's investment strategy is designed to offer the potential for somewhat
higher yields than a money market fund, although unlike a money market fund, its
share price will fluctuate. In exchange for seeking minimal fluctuation in share
price, the fund may offer lower long-term performance than stock investments or
certain other bond investments.

RISK MANAGEMENT
--------------------------------------------------------------------------------
The fund may use a variety of techniques to manage risk and increase income.
Certain types of derivatives (investments whose value is based on one or more
securities, rates or indices) can be cost-effective risk management tools.

For example, the fund may buy and sell futures contracts to manage interest rate
changes. By doing this, the fund has the potential to reduce the share price
volatility that tends to be a characteristic of bond funds.

These investments, such as swap agreements, also may produce additional income
for the fund.

YIELDPLUS FUND 4
<PAGE> 130
MAIN RISKS

INTEREST RATES RISE AND FALL OVER TIME. As with any investment whose yield
reflects current interest rates, the fund's yield will change over time. During
periods when interest rates are low, the fund's yield (and total return) also
may be low. Changes in interest rates also may affect the fund's share price: a
sharp rise in interest rates could cause the fund's share price to fall.
Assuming a 1 year duration for the fund, a 2% increase/decrease in interest
rates would be approximately a 2% decrease/increase in the fund's share price.
This risk is greater when the fund holds bonds with longer maturities.

THE FUND IS NOT A MONEY MARKET FUND OR A BANK DEPOSIT. Its shares are not
insured or guaranteed. Because the fund's share price may move up and down, the
value of your investment in the fund will fluctuate, which means you could lose
money.

THE FUND COULD LOSE MONEY OR UNDERPERFORM AS A RESULT OF DEFAULT. Although the
risk of default is generally considered unlikely, any default on the part of a
portfolio investment could cause the fund's share price or yield to fall. This
risk is greater with lower-quality bonds.

SOME INVESTMENTS CARRY ADDITIONAL RISKS. To the extent that the manager decides
to invest in foreign or lower quality bonds, the fund takes on a greater
exposure to certain risks. Prices of foreign bonds may be more volatile than
those of comparable bonds from U.S. issuers, for reasons ranging from lack of
reliable issuer information to the risk of political upheaval. Prices of
lower-quality bonds tend to be more volatile than those of investment-grade
bonds, and may fall based on bad news about an issuer, an industry or the
overall economy. With certain mortgage- and asset-backed bonds, a primary risk
is the possibility that the bonds may be paid off earlier or later than
expected. Either situation could cause the fund to hold securities paying lower
than market rates of interest, which could hurt the fund's yield or share price.

THE MANAGER'S MATURITY DECISIONS ALSO WILL AFFECT THE FUND'S PERFORMANCE. To the
extent that the manager anticipates interest rate trends imprecisely, the fund
could miss yield opportunities or its share price could fall.

Investors with investment horizons of one year or more who are seeking an
ALTERNATIVE to a money fund or other fixed-income fund may want to consider this
fund.

OTHER MAIN RISK FACTORS
--------------------------------------------------------------------------------
While the fund intends to use techniques to manage risk, they could hurt the
fund's performance if they don't perform as expected.

For example, if the fund uses a technique involving a derivative, such as a
futures contract, for the purpose of offsetting price changes in the fund's
portfolio, but the technique does not precisely offset the price changes, the
fund's share price could fall. The fund's performance also could be hurt if the
counterparty to a derivative does not honor its contractual obligations to the
fund.

The fund could lose money if the price of securities sold short increase.

The cost of derivatives may have the effect of increasing fund expenses. While
the decision to use or not use a given risk management technique depends on
market conditions, these costs could at times outweigh the benefits the fund
realizes from these techniques.

5 YIELDPLUS FUND
<PAGE> 131
PERFORMANCE

Because this is a new fund, no performance figures are given. Information will
appear in a future version of the fund's prospectus.

FUND FEES AND EXPENSES

FEE TABLE (%)

<TABLE>
<CAPTION>
INVESTOR SELECT
SHARES SHARES(R)
------------------------------------------------------------------------------
<S> <C> <C>
SHAREHOLDER FEES (% of transaction amount)
------------------------------------------------------------------------------
Redemption fee, charged only on shares
you sell within 90 days of buying them,
and paid directly to the fund 0.25 0.25

ANNUAL OPERATING EXPENSES (% of average net assets)
------------------------------------------------------------------------------
Management fees 0.35 0.35
Distribution (12b-1) fees None None
Other expenses* 0.44 0.29
----- -----
Total annual operating expenses 0.79 0.64

Expense reduction (0.24) (0.24)
----- -----
Net operating expenses** 0.55 0.40
===== =====
</TABLE>

* Restated to reflect current fees and expenses.

** Guaranteed by Schwab and the investment adviser through 11/15/2001, excluding
interest, taxes and certain non-routine expenses.

EXPENSES ON A $10,000 INVESTMENT

Designed to help you compare expenses, this example uses the same assumptions as
all mutual fund prospectuses: a $10,000 investment and 5% return each year.
One-year figures are based on net operating expenses. The expenses would be the
same whether you stayed in the fund or sold your shares at the end of each
period. Your actual costs may be higher or lower.

<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investor Shares $56 $228 $415 $956
Select Shares $41 $181 $333 $776
</TABLE>

YIELDPLUS FUND 6
<PAGE> 132

FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
---------------------------------------------------------------------
10/1/99 1 -
INVESTOR SHARES 8/31/00
---------------------------------------------------------------------
<S> <C>
PER-SHARE DATA ($)
Net asset value at beginning of period 10.00
-----
Income from investment operations:
Net investment income 0.61
Net realized and unrealized losses (0.08)
-----
Total income from investment operations 0.53
Less distributions:
Dividends from net investment income (0.61)
-----
Net asset value at end of period 9.92
=====
Total return (%) 5.44 2

RATIOS/SUPPLEMENTAL DATA (%)
Ratio of net operating expenses to
average net assets 0.55 3,4
Expense reductions reflected in above ratio 0.24 3
Ratio of net investment income to
average net assets 6.72 3
Portfolio turnover rate 81
Net assets, end of period ($ x 1,000,000) 53
</TABLE>

<TABLE>
<CAPTION>
---------------------------------------------------------------------
10/1/99 1 -
SELECT SHARES(R) 8/31/00
---------------------------------------------------------------------
<S> <C>
PER-SHARE DATA ($)
Net asset value at beginning of period 10.00
-----
Income from investment operations:
Net investment income 0.62
Net realized and unrealized losses (0.08)
-----
Total income from investment operations 0.54
Less distributions:
Dividends from net investment income (0.62)
-----
Net asset value at end of period 9.92
=====
Total return (%) 5.58 2

RATIOS/SUPPLEMENTAL DATA (%)
Ratio of net operating expenses to
average net assets 0.40 3,5
Expense reductions reflected in above ratio 0.24 3
Ratio of net investment income to
average net assets 6.88 3
Portfolio turnover rate 81
Net assets, end of period ($ x 1,000,000) 219
</TABLE>

1 Commencement of operations.
2 Not annualized.
3 Annualized.
4 Would have been 0.56% if certain non-routine expenses (proxy fees) had been
included.
5 Would have been 0.41% if certain non-routine expenses (proxy fees) had been
included.

7 YIELDPLUS FUND
<PAGE> 133
FUND MANAGEMENT

THE INVESTMENT ADVISER for the fund is Charles Schwab Investment Management,
Inc., 101 Montgomery Street, San Francisco, CA 94104. Founded in 1989, the firm
today serves as investment adviser for all of the SchwabFunds(R). The firm
manages assets for more than 5 million accounts. (All figures on this page are
as of 8/31/2000.)

As the investment adviser, the firm oversees the asset management and
administration of the Schwab YieldPlus Fund(TM). As compensation for these
services, the firm receives a management fee from the fund. This fee is
calculated as follows: 0.35% of the fund's assets up to $500 million, and 0.30%
of the fund's assets over $500 million.

KIMON DAIFOTIS, CFA, a vice president of the investment adviser, has overall
responsibility for fund management. Prior to joining the firm in September 1997,
he worked for more than 18 years in research and asset management.

BIRGER NESTEBY, a portfolio manager, co-manages the fund's portfolio and has
nearly 10 years of experience in the fixed income securities markets. He joined
the firm in August, 1999.

The funds' INVESTMENT ADVISER, Charles Schwab Investment Management, Inc., has
more than $120 billion under management.

FUND MANAGEMENT 8
<PAGE> 134
INVESTING IN THE FUND

AS A SCHWABFUNDS(R) INVESTOR, YOU HAVE A NUMBER OF WAYS TO DO BUSINESS WITH US.

On the following pages, you will find information on BUYING, SELLING AND
EXCHANGING shares using the method that is most CONVENIENT for you. You also
will see how to choose a share class and a distribution option for your
investment. Helpful information on TAXES is included as well.

9 INVESTING IN THE FUND
<PAGE> 135
BUYING SHARES

Shares of the fund may be purchased through a Schwab brokerage account or
through certain third-party investment providers, such as other financial
institutions, investment professionals and workplace retirement plans.

The information on these pages outlines how Schwab brokerage account investors
can place "good orders," which are orders made in accordance with the fund's
policies, to buy, sell and exchange shares of the fund. If you are investing
through a third-party investment provider, some of the instructions, minimums
and policies may be different. Some investment providers may charge transaction
or other fees. Contact your investment provider for more information.

SCHWAB ACCOUNTS

For example, when you sell shares in the fund, the proceeds automatically are
paid to your Schwab brokerage account. From your account, you can use features
such as MoneyLink(R), which lets you move money between your brokerage accounts
and bank accounts, and Automatic Investment Plan (AIP), which lets you set up
periodic investments.

For more information on Schwab brokerage accounts, call 800-435-4000 or visit
the Schwab web site at www.schwab.com.

-------------------------------------------------------------------------------
STEP 1
-------------------------------------------------------------------------------
CHOOSE A SHARE CLASS. Your choice may depend on the amount of your investment.
The minimums shown below are for each share class.

<TABLE>
<CAPTION>
MINIMUM INITIAL MINIMUM ADDITIONAL
SHARE CLASS INVESTMENT INVESTMENTS MINIMUM BALANCE
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Investor Shares $2,500 ($1,000 for $500 ($100 for $1,000 ($500 for
retirement and Automatic Investment retirement and
custodial accounts) Plan) custodial accounts)

Select Shares(R) $50,000 $1,000 $40,000
</TABLE>

-------------------------------------------------------------------------------
STEP 2
-------------------------------------------------------------------------------
CHOOSE AN OPTION FOR FUND DISTRIBUTIONS. The three options are described below.
If you don't indicate a choice, you will receive the first option.

Cash/reinvestment mix You receive payment for dividends, while any capital
gain distributions are invested in shares of your share
class.

Cash You receive payment for all dividends and capital gain
distributions.
</TABLE>

--------------------------------------------------------------------------------
STEP 3
--------------------------------------------------------------------------------

PLACE YOUR ORDER. Use any of the methods described at right. Make checks payable
to Charles Schwab and Co., Inc.

INVESTING IN THE FUND 10
<PAGE> 136
SELLING/EXCHANGING SHARES

USE ANY OF THE METHODS DESCRIBED BELOW TO SELL SHARES OF THE FUND.

When selling or exchanging shares, please be aware of the following policies:

- The fund may take up to seven days to pay sale proceeds.

- If you are selling shares that were recently purchased by check, the proceeds
may be delayed until the check for purchase clears; this may take up to 15
days from the date of purchase.

- The fund reserves the right to honor redemptions in portfolio securities
instead of cash if they exceed 1% of the fund's assets or $250,000 in any 90
day period.

- As indicated in the fund's fee table, the fund charges a redemption fee,
payable to the fund, on shares you sell or exchange within 90 days of buying
them; in attempting to minimize this fee, the fund will first sell any shares
in your account that aren't subject to the fee (including shares acquired
through reinvestment or exchange).

- There is no redemption fee when you exchange between share classes within
this fund.

- You must obtain and read the prospectus for the fund into which you are
exchanging prior to placing your order.

-------------------------------------------------------------------------------
METHODS FOR PLACING ORDERS
-------------------------------------------------------------------------------
PHONE
Call 800-435-4000, day or night (for TDD service, call 800-345-2550).

INTERNET
www.schwab.com/schwabfunds

SCHWABLINK
Investment professionals should follow the transaction instructions in the
SchwabLink manual; for technical assistance, call 800-367-5198.

MAIL
Write to SchwabFunds(R) at:
P.O. Box 7575
San Francisco, CA 94120-7575

When selling or exchanging shares, be sure to include the signature of at least
one of the persons whose name is on the account.

IN PERSON
Visit the nearest Charles Schwab branch office.

WHEN PLACING ORDERS

With every order to buy, sell or exchange shares, you will need to include the
following information:

- Your name or, for internet orders, your account number/"Login ID."

- Your account number (for SchwabLink transactions, include the master account
and subaccount numbers) or, for internet orders, your password.

- The name and share class (if applicable) of the fund whose shares you want to
buy or sell.

- The dollar amount you would like to buy, sell or exchange.

- For exchanges, the name and share class of the fund into which you want to
exchange and the distribution option you prefer.

- When selling shares, how you would like to receive the proceeds.

Please note that orders to buy, sell or exchange become irrevocable at the time
you mail them.

11 INVESTING IN THE FUND
<PAGE> 137
TRANSACTION POLICIES

THE FUND IS OPEN FOR BUSINESS EACH DAY THAT THE NEW YORK STOCK EXCHANGE (NYSE)
IS OPEN. The fund calculates its share price each business day, for each share
class, after the close of the NYSE (generally 4 p.m. Eastern time). The fund's
share price is its net asset value per share, or NAV, which is the fund's net
assets divided by the number of its shares outstanding.

In valuing its securities, the fund uses market quotes if they are readily
available. In cases where quotes are not readily available, the fund may value
securities based on fair values developed using methods approved by the fund's
Board of Trustees.

Because foreign markets are often open on weekends and other days when the fund
is closed, the value of the fund's portfolio may change on days when it is not
possible to buy or sell shares of the fund.

THE FUND AND SCHWAB RESERVE CERTAIN RIGHTS, including the following:

- To automatically redeem your shares if the account they are held in is closed
for any reason or your balance falls below the minimum for your share class
as a result of selling or exchanging your shares.

- To modify or terminate the exchange privilege upon 60 days' written notice to
shareholders.

- To refuse any purchase or exchange order, including large purchase orders
that may negatively affect the fund's operations or orders that appear to be
associated with short-term trading activities.

- To change or waive the fund's investment minimums.

- To suspend the right to sell shares back to the fund, and delay sending
proceeds, during times when trading on the NYSE is restricted or halted, or
otherwise as permitted by the SEC.

- To withdraw or suspend any part of the offering made by this prospectus.

INVESTING IN THE FUND 12
<PAGE> 138
DISTRIBUTIONS AND TAXES

ANY INVESTMENT IN THE FUND TYPICALLY INVOLVES SEVERAL TAX CONSIDERATIONS. The
information below is meant as a general summary for U.S. citizens and residents.
Because each person's tax situation is different, you should consult your tax
advisor about the tax implications of your investment in the fund. You also can
visit the Internal Revenue Service (IRS) web site at www.irs.gov.

AS A SHAREHOLDER, YOU ARE ENTITLED TO YOUR SHARE OF THE DIVIDENDS AND GAINS YOUR
FUND EARNS. The fund distributes to its shareholders substantially all of its
net investment income and net capital gains, if any. The fund declares a
dividend every business day, based on its determination of its net investment
income. The fund pays its dividends on the 25th of every month (or next business
day, if the 25th is not a business day), except that in December dividends are
paid on the last business day of the month. The fund expects to pay any capital
gain distributions every year, typically in December, to all shareholders of
record.

UNLESS YOU ARE INVESTING THROUGH A TAX-DEFERRED OR ROTH RETIREMENT ACCOUNT, YOUR
FUND DISTRIBUTIONS GENERALLY HAVE TAX CONSEQUENCES. The fund's net investment
income and short-term capital gains are distributed as dividends and are taxable
as ordinary income. Other capital gain distributions are taxable as long-term
capital gains, regardless of how long you have held your shares in the fund.
Distributions generally are taxable in the tax year in which they are declared,
whether you reinvest them or take them in cash.

FOR TAX PURPOSES, AN EXCHANGE BETWEEN FUNDS IS DIFFERENT FROM AN EXCHANGE
BETWEEN CLASSES. An exchange between funds is considered a sale. An exchange
between classes within the fund is not reported as a taxable sale.

AT THE BEGINNING OF EVERY YEAR, THE FUND PROVIDES SHAREHOLDERS WITH INFORMATION
DETAILING THE TAX STATUS OF ANY DISTRIBUTIONS the fund declared during the
previous calendar year. Schwab brokerage account customers also receive
information on distributions and transactions in their monthly account
statements.

13 INVESTING IN THE FUND
<PAGE> 139
NOTES
<PAGE> 140
NOTES
<PAGE> 141
TO LEARN MORE

This prospectus contains important information on the fund and should be read
and kept for reference. You also can obtain more information from the following
sources.

SHAREHOLDER REPORTS, which are mailed to current fund investors, discuss recent
performance and portfolio holdings.

SEC FILE NUMBER
Schwab YieldPlus Fund(TM) 811-6200

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-0102
202-942-8090 (Public Reference Section)
www.sec.gov
[email protected]

SCHWABFUNDS
P.O. Box 7575
San Francisco, CA 94120-7575
800-435-4000
WWW.SCHWAB.COM/SCHWABFUNDS

MKT4087FLT-2

SCHWAB

YIELDPLUS FUND(TM)

PROSPECTUS
November 15, 2000

[CHARLES SCHWAB LOGO]
<PAGE> 142
STATEMENT OF ADDITIONAL INFORMATION

SCHWAB INVESTMENTS

SCHWAB YIELDPLUS FUND(TM)

NOVEMBER 15, 2000

The Statement of Additional Information (SAI) is not a prospectus. It should be
read in conjunction with the fund's prospectus dated November 15, 2000 (as
amended from time to time).

The Schwab YieldPlus Fund is a series of Schwab Investments (the trust).

The fund's most recent annual report is a separate document supplied with the
SAI and includes the fund's audited financial statements, which are incorporated
by reference into this SAI.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE, SECURITIES, RISKS AND LIMITATIONS........................................ 2
MANAGEMENT OF THE FUND......................................................................... 26
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES............................................ 29
INVESTMENT ADVISORY AND OTHER SERVICES......................................................... 30
BROKERAGE ALLOCATION AND OTHER PRACTICES....................................................... 31
DESCRIPTION OF THE TRUST....................................................................... 32
PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER REPORTS
AND PRICING OF SHARES.......................................................................... 33
TAXATION....................................................................................... 34
CALCULATION OF PERFORMANCE DATA................................................................ 36
APPENDIX - RATINGS OF INVESTMENT SECURITIES.................................................... 38
</TABLE>

1
<PAGE> 143
INVESTMENT OBJECTIVE, SECURITIES, RISKS AND LIMITATIONS

INVESTMENT OBJECTIVE

The fund's investment objective is to seek high current income with minimal
changes in share price.

The fund's investment objective may be changed by vote of a majority of its
outstanding voting shares. A majority vote of outstanding securities of the fund
means the vote, at an annual or a special meeting of shareholders of the fund
where (a) of 67% or more of the voting securities present at the meeting, if the
shareholders of more than 50% of the outstanding securities of the fund are
present or represented by proxy, or (b) of more than 50% of the outstanding
voting securities of the fund, whichever is less.

There is no guarantee the fund will achieve its objective.

The following descriptions of investment securities, risks and limitations
supplement those set forth in the prospectus and may be changed without
shareholder approval unless otherwise noted. Also, policies and limitations that
state a maximum percentage of assets that may be invested in a security or other
asset, or that set forth a quality standard, shall be measured immediately after
and as a result of the fund's acquisition of such security or asset unless
otherwise noted. Any subsequent change in values, net assets or other
circumstances will not be considered when determining whether the investment
complies with the fund's investment policies and limitations. The fund will
invest in securities or engage in techniques that are intended to help achieve
its investment objective.

INVESTMENT SECURITIES AND RISKS

BANKERS' ACCEPTANCES or notes are credit instruments evidencing a bank's
obligation to pay a draft drawn on it by a customer. These instruments reflect
the obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity. The fund will invest only in bankers' acceptances of
banks that have capital, surplus and undivided profits in excess of $100
million.

BORROWING may subject the fund to interest costs, which may exceed the interest
received on the securities purchased with the borrowed funds. The fund normally
may borrow at times to meet redemption requests rather than sell portfolio
securities to raise the necessary cash. Borrowing can involve leveraging when
securities are purchased with the borrowed money. The fund may borrow money from
banks and make other investments or engage in other transactions permissible
under the 1940 Act which may be considered a borrowing (such as mortgage dollar
rolls and reverse repurchase agreements). However, the fund may not purchase
securities when bank borrowings exceed 5% of the fund's total assets.

The fund may establish lines-of-credit (lines) with certain banks by which it
may borrow funds for temporary or emergency purposes. A borrowing is presumed to
be for temporary or emergency purposes if it is repaid by the fund within 60
days and is not extended or renewed. The fund intends to use the lines to meet
large or unexpected redemptions that would otherwise force the fund to liquidate
securities under circumstances which are unfavorable to the fund's remaining
shareholders. The fund will pay a fee to the bank for using the lines.

CERTIFICATES OF DEPOSIT or time deposits are issued against funds deposited in a
banking

2
<PAGE> 144
institution for a specified period of time at a specified interest rate. The
fund will invest only in certificates of deposit of banks that have capital,
surplus and undivided profits in excess of $100 million.

CONCENTRATION means that substantial amounts of assets are invested in a
particular industry or group of industries. Concentration increases investment
exposure. For example, the automobile industry may have a greater exposure to a
single factor, such as an increase in the price of oil, which may adversely
affect the sale of automobiles and, as a result, the value of the industry's
securities. Based on the primary characteristics of non-U.S. (foreign) banks,
the fund has identified each foreign country as a separate bank industry for
purposes of the fund's concentration policy. The fund will limit its investments
in securities issued by foreign banks in each country to less than 25% of its
net assets.

Based on the primary characteristics of the various types of asset-backed
securities, for purposes of the fund's concentration policy, the following
asset-backed securities industries have been selected: credit card receivables,
automobile receivables, trade receivables and diversified financial assets. The
fund will limit its investments in each such industry to less than 25% of its
net assets.

CONVERTIBLE SECURITIES are typically preferred stock or bonds that are
exchangeable for a specific number of another form of security (usually the
issuer's common stock) at a specified price or ratio. A corporation may issue a
convertible security that is subject to redemption after a specified date and
usually under certain circumstances. A holder of a convertible security that is
called for redemption would be required to tender it for redemption to the
issuer, convert it to the underlying common stock or sell it to a third party.
Convertible bonds typically pay a lower interest rate than nonconvertible bonds
of the same quality and maturity, because of the convertible feature. This
structure allows the holder of the convertible bond to participate in share
price movements in the company's common stock. The actual return on a
convertible bond may exceed its stated yield if the company's common stock
appreciates in value and the option to convert to common shares becomes more
valuable.

CREDIT AND LIQUIDITY SUPPORTS may be employed by issuers or the fund to reduce
the credit risk of securities. Credit supports include letters of credit,
insurance, total return and credit swap agreements and guarantees provided by
foreign and domestic entities. Liquidity supports include puts, demand features,
and lines of credit. Most of these arrangements move the credit risk of an

3
<PAGE> 145
investment from the issuer of the security to the support provider. Changes in
the credit quality of a support provider could cause losses to the fund.

Debt securities also are subject to the risk that the issuers will not make
timely interest and/or principal payments or fail to make them at all. This is
called credit risk. Corporate debt securities (bonds) tend to have higher credit
risk generally than U.S. government debt securities. Debt securities also may be
subject to price volatility due to market perception of future interest rates,
the creditworthiness of the issuer and general market liquidity (market risk).
Investment-grade debt securities are considered medium- and/or high-quality
securities, although some still possess varying degrees of speculative
characteristics and risks. Debt securities rated below investment-grade are
riskier, but may offer higher yields. These securities are sometimes referred to
as high yield securities or "junk bonds."

See the Appendix for a full description of the various ratings assigned to debt
securities by various nationally recognized statistical rating organizations
(NRSROs).

DELAYED-DELIVERY TRANSACTIONS include purchasing and selling securities on a
delayed-delivery or when-issued basis. These transactions involve a commitment
to buy or sell specific securities at a predetermined price or yield, with
payment and delivery taking place after the customary settlement period for that
type of security. When purchasing securities on a delayed-delivery basis, the
fund assumes the rights and risks of ownership, including the risk of price and
yield fluctuations. Typically, no interest will accrue to the fund until the
security is delivered. The fund will segregate appropriate liquid assets to
cover its delayed-delivery purchase obligations. When the fund sells a security
on a delayed-delivery basis, the fund does not participate in further gains or
losses with respect to that security. If the other party to a delayed-delivery
transaction fails to deliver or pay for the securities, the fund could suffer
losses.

4
<PAGE> 146
quality may be adversely impacted. In either event, the fund may experience an
increase in share price volatility. This also could lengthen the fund's overall
average effective maturity.

DEPOSITARY RECEIPTS include American or European Depositary Receipts (ADRs or
EDRs), Global Depositary Receipts or Shares (GDRs or GSSs) or other similar
global instruments that are receipts representing ownership of shares of a
foreign-based issuer held in trust by a bank or similar financial institution.
These securities are designed for U.S. and European securities markets as
alternatives to purchasing underlying securities in their corresponding national
markets and currencies. Depositary receipts can be sponsored or unsponsored.
Sponsored depositary receipts are certificates in which a bank or financial
institution participates with a custodian. Issuers of unsponsored depositary
receipts are not contractually obligated to disclose material information in the
United States. Therefore, there may not be a correlation between such
information and the market value of an unsponsored depositary receipt.

DIVERSIFICATION involves investing in a wide range of securities and thereby
spreading and reducing the risks of investment. The fund is a series of an
open-end investment management company. The fund is a diversified mutual fund.

DURATION was developed as a more precise alternative to the concept of
"maturity." Traditionally, a debt obligations' maturity has been used as a proxy
for the sensitivity of the security's price to changes in interest rates (which
is the "interest rate risk" or "volatility" of the security). However, maturity
measures only the time until a debt obligation provides its final payment,
taking no account of the pattern of the security's payments prior to maturity.
In contrast, duration incorporates a bond's yield, coupon interest payments,
final maturity, call and put features and prepayment exposure into one measure.
Duration is the magnitude of the change in the price of a bond relative to a
given change in market interest rates. Duration management is one of the
fundamental tools used by the investment adviser. The fund seeks to keep the
average duration of its overall portfolio at one year or less. There may be
times when the portfolio's average duration is more than one year.

Duration is a measure of the expected life of a debt obligation on a present
value basis. Duration takes the length of the time intervals between the present
time and the time that the interest and principal payments are scheduled or, in
the case of a callable bond, the time the principal payments are expected to be
received, and weights them by the present values of the cash to be received at
each future point in time. For debt obligations with interest payments occurring
prior to the payment of principal, duration will usually be less than maturity.
In general, all else being equal, the lower the stated or coupon rate of the
interest of a fixed income security, the longer the duration of the security;
conversely, the higher the stated or coupon rate of a fixed income security, the
shorter the duration of the security.

Holding long futures or call option positions will lengthen the duration of the
fund's portfolio. Holding short futures or put options will shorten the duration
of the fund's portfolio.

There are some situations where even the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example, floating
and variable rate securities often

5
<PAGE> 147
have final maturities of ten or more years; however, their interest rate
exposure corresponds to the frequency of the coupon reset. Another example where
the interest rate exposure is not properly captured by maturity is mortgage
pass-through securities. The stated final maturity of such securities is
generally 30 years, but current prepayment rates are more critical in
determining the securities' interest rate exposure. Finally, the duration of the
debt obligation may vary over time in response to changes in interest rates and
other market factors.

FOREIGN SECURITIES involve additional risks, including foreign currency exchange
rate risks, because they are issued by foreign entities, including foreign
governments, banks, corporations or because they are traded principally
overseas. Foreign securities in which the fund may invest include foreign
entities that are not subject to uniform accounting, auditing and financial
reporting standards, practices and requirements comparable to those applicable
to U.S. corporations. In addition, there may be less publicly available
information about foreign entities. Foreign economic, political and legal
developments, as well as fluctuating foreign currency exchange rates and
withholding taxes, could have more dramatic effects on the value of foreign
securities. For example, conditions within and around foreign countries, such as
the possibility of expropriation or confiscatory taxation, political or social
instability, diplomatic developments, change of government or war could affect
the value of foreign investments. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as growth
of gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position.

Foreign securities typically have less volume and are generally less liquid and
more volatile than securities of U.S. companies. Fixed commissions on foreign
securities exchanges are generally higher than negotiated commissions on U.S.
exchanges, although the fund will endeavor to achieve the most favorable overall
results on portfolio transactions. There is generally less government
supervision and regulation of foreign securities exchanges, brokers, dealers and
listed companies than in the United States, thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities. There may be difficulties in obtaining or enforcing judgments
against foreign issuers as well. These factors and others may increase the risks
with respect to the liquidity of the fund, and its ability to meet a large
number of shareholder redemption requests.

Foreign markets also have different clearance and settlement procedures and, in
certain markets, there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to conduct
such transactions. Such delays in settlement could result in temporary periods
when a portion of the assets of the fund is uninvested and no return is earned
thereon. The inability to make intended security purchases due to settlement
problems could cause the fund to miss attractive investment opportunities.
Losses to the fund arising out of the inability to fulfill a contract to sell
such securities also could result in potential liability for the fund.

Investments in the securities of foreign issuers may be made and held in foreign
currencies. In addition, the fund may hold cash in foreign currencies. These
investments may be affected favorably or unfavorably by changes in currency
rates and in exchange control regulations, and may cause the fund to incur costs
in connection with conversions between various currencies. The rate of exchange
between the U.S. dollar and other currencies is determined by the forces of
supply and demand in the foreign exchange market as well as by political and
economic factors. Changes in the 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.

6
<PAGE> 148

On January 1, 1999, 11 of the 15 member states of the European union introduced
the "euro" as a common currency. During a three-year transitional period, the
euro will coexist with each member state's currency. By July 1, 2002, the euro
will have replaced the national currencies of the following member countries:
Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the
Netherlands, Portugal and Spain. During the transition period, the fund will
treat the euro as a separate currency from that of any member state.

The conversion may impact the trading in securities of issuers located in, or
denominated in the currencies of, the member states, as well as foreign
exchanges, payments, the settlement process, custody of assets and accounting.
The introduction of the euro is also expected to affect derivative and other
financial contracts in which the fund may invest in so far as price sources such
as day-count fractions or settlement dates applicable to underlying instruments
may be changed to conform to the conventions applicable to euro currency.

FORWARD CONTRACTS are sales contracts between a buyer (holding the "long"
position) and the seller (holding the "short" position) for an asset with
delivery deferred to a future date. The buyer agrees to pay a fixed price at the
agreed future date and the seller agrees to deliver the asset. The seller hopes
that the market price on the delivery date is less than the agreed upon price,
while the buyer hopes for the contrary. The change in value of a forward-based
derivative generally is roughly proportional to the change in value of the
underlying asset.

FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS involve the purchase or sale of
foreign currency at an established exchange rate, but with payment and delivery
at a specified future time. Many foreign securities markets do not settle trades
within a time frame that would be considered customary in the U.S. stock market.
Therefore, the fund may engage in forward foreign currency exchange contracts in
order to secure exchange rates for portfolio securities purchased or sold, but
waiting settlement. These transactions do not seek to eliminate any fluctuations
in the underlying prices of the securities involved. Instead, the transactions
simply establish a rate of exchange that can be expected when the fund settles
its securities transactions in the future.

The fund also may engage in forward foreign currency exchange contracts to
protect the value of specific portfolio positions, which is called "position
hedging." When engaging in position

7
<PAGE> 149
hedging, the fund may enter into forward foreign currency exchange transactions
to protect against a decline in the values of the foreign currencies in which
portfolio securities are denominated (or against an increase in the value of
currency for securities that the fund expects to purchase).

Buying and selling foreign currency exchange contracts involve costs and may
result in losses. The ability of the fund to engage in these transactions may be
limited by tax considerations. Although these techniques tend to minimize the
risk of loss due to decline in the value of the hedged currency, they tend to
limit any potential gain that might result from an increase in the value of such
currency. Transactions in these contracts involve certain other risks.
Unanticipated fluctuations in currency prices may result in a poorer overall
performance for the fund than if it had not engaged in any such transactions.
Moreover, there may be imperfect correlation between the fund's holdings of
securities denominated in a particular currency and forward contracts into which
the fund enters. Such imperfect correlation may cause the fund to sustain
losses, which will prevent it from achieving a complete hedge or expose it to
risk of foreign exchange loss. Losses to the fund will affect its performance.

FUTURES CONTRACTS are securities that represent an agreement between two parties
that obligates one party to buy and the other party to sell specific securities
at an agreed-upon price on a stipulated future date. In the case of futures
contracts relating to an index or otherwise not calling for physical delivery at
the close of the transaction, the parties usually agree to deliver the final
cash settlement price of the contract. The fund may purchase and sell futures
contracts based on securities, securities indices, foreign currencies, interest
rates or any other futures contracts traded on U.S. exchanges or boards of trade
that the Commodities Future Trading Commission (the "CFTC") licenses and
regulates on foreign exchanges.

The fund must maintain a small portion of its assets in cash to process
shareholder transactions and to pay its expenses. In order to reduce the effect
this otherwise uninvested cash would have on its performance, the fund may
purchase futures contracts. Such transactions allow the fund's cash balance to
produce a return similar to that of the underlying security or index on which
the futures contract is based. Also, the fund may purchase or sell futures
contracts on a specified foreign currency to "fix" the price in U.S. dollars of
the foreign security it has acquired or sold or expects to acquire or sell. The
fund may enter into futures contracts for these or other reasons.

When buying or selling futures contracts, the fund must place a deposit with its
broker equal to a fraction of the contract amount. This amount is known as
"initial margin" and must be in the form of liquid debt instruments, including
cash, cash-equivalents and U.S. government securities. Subsequent payments to
and from the broker, known as "variation margin" may be made daily, if
necessary, as the value of the futures contracts fluctuate. This process is
known as "marking-to-market." The margin amount will be returned to the fund
upon termination of the futures contracts assuming all contractual obligations
are satisfied. The fund's aggregate initial and variation margin payments
required to establish its futures positions may not exceed 5% of its net assets.
Because margin requirements are normally only a fraction of the amount of the
futures contracts in a given transaction, futures trading can involve a great
deal of leverage. In order to avoid this, the fund will segregate assets for any
outstanding futures contracts as may be required by the federal securities laws.

While the fund may purchase and sell futures contracts in order to simulate full
investment, there are risks associated with these transactions. Adverse market
movements could cause the fund to experience substantial losses when buying and
selling futures contracts. Of course, barring significant market distortions,
similar results would have been expected if the fund had instead transacted in
the underlying securities directly. There also is the risk of losing any margin

8
<PAGE> 150
payments held by a broker in the event of its bankruptcy. Additionally, the fund
incurs transaction costs (i.e. brokerage fees) when engaging in futures trading.

When interest rates are rising or securities prices are falling, the fund may
seek, through the sale of futures contracts, to offset a decline in the value of
its current portfolio securities. When rates are falling or prices are rising,
the fund, through the purchase of futures contracts, may attempt to secure
better rates or prices than might later be available in the market when they
effect anticipated purchases. Similarly, the fund may sell futures contracts on
a specified currency to protect against a decline in the value of that currency
and its portfolio securities that are denominated in that currency. The fund may
purchase futures contracts on a foreign currency to fix the price in U.S.
dollars of a security denominated in that currency that the fund has acquired or
expects to acquire.

Futures contracts normally require actual delivery or acquisition of an
underlying security or cash value of an index on the expiration date of the
contract. In most cases, however, the contractual obligation is fulfilled before
the date of the contract by buying or selling, as the case may be, identical
futures contracts. Such offsetting transactions terminate the original contracts
and cancel the obligation to take or make delivery of the underlying securities
or cash. There may not always be a liquid secondary market at the time the fund
seeks to close out a futures position. If the fund is unable to close out its
position and prices move adversely, the fund would have to continue to make
daily cash payments to maintain its margin requirements. If the fund had
insufficient cash to meet these requirements it may have to sell portfolio
securities at a disadvantageous time or incur extra costs by borrowing the cash.
Also, the fund may be required to make or take delivery and incur extra
transaction costs buying or selling the underlying securities. The fund seeks to
reduce the risks associated with futures transactions by buying and selling
futures contracts that are traded on national exchanges or for which there
appears to be a liquid secondary market.

HIGH YIELD SECURITIES, also called lower quality bonds ("junk bonds"), are
frequently issued by companies without long track records of sales and earnings,
or by those of questionable credit strength, and are more speculative and
volatile (though typically higher yielding) than investment grade bonds. Adverse
economic developments could disrupt the market for high yield securities, and
severely affect the ability of issuers, especially highly-leveraged issuers, to
service their debt obligations or to repay their obligations upon maturity.

Thus, high yield securities are more likely to react to developments affecting
interest rates and market and credit risk than are more highly rated securities,
which primarily react to movements in the general level of interest rates. When
economic conditions appear to be deteriorating, medium to lower quality debt
securities may decline in value more than higher-quality debt securities due to
heightened concern over credit quality, regardless of prevailing interest rates.
Prices for high yield securities also could be affected by legislative and
regulatory developments. These laws could adversely affect the fund's net asset
value and investment practices, the secondary market value for high yield
securities, the financial condition of issuers of these securities and the value
of outstanding high yield securities.

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ILLIQUID SECURITIES generally are any securities that cannot be disposed of
promptly and in the ordinary course of business at approximately the amount at
which the fund has valued the instruments. The liquidity of the fund's
investments is monitored under the supervision and direction of the board of
trustees. Investments currently not considered liquid include repurchase
agreements not maturing within seven days and certain restricted securities.

INDEX PARTICIPATIONS and index participation contracts provide the equivalent of
a position in the securities comprising an index, with each security's
representation equaling its index weighting. Moreover, their holders are
entitled to payments equal to the dividends paid by the underlying index
securities. Generally, the value of an index participation or index
participation contract will rise and fall along with the value of the related
index. The fund will invest in index participation contracts only if a liquid
market for them appears to exist.

INTERNATIONAL BONDS are certain obligations or securities of foreign issuers,
including Eurodollar Bonds, which are U.S. dollar denominated bonds issued by
foreign issuers payable in Eurodollars (U.S. dollars held in banks located
outside the United States, primarily Europe), Yankee Bonds, which are U.S.
dollar-denominated bonds issued in the U.S. by foreign banks and corporations,
and EuroBonds, which are bonds denominated in U.S. dollars and usually issued by
large underwriting groups composed of banks and issuing houses from many
countries. Investments in securities issued by foreign issuers, including
American Depositary Receipts and securities purchased on foreign securities
exchanges, may subject the fund to additional investment risks, such as adverse
political and economic developments, possible seizure, nationalization or
expropriation of foreign investments, less stringent disclosure requirements,
non-U.S. withholding taxes and the adoption of other foreign governmental
restrictions.

Additional risks include less publicly available information, the risk that
companies may not be subject to the accounting, auditing and financial reporting
standards and requirements of U.S. companies, the risk that foreign securities
markets may have less volume and therefore may be less liquid and their prices
more volatile than U.S. securities, and the risk that custodian and transaction
costs may be higher. Foreign issuers of securities or obligations are often
subject to accounting requirements, and engage in business practices, different
from those respecting domestic issuers of similar securities or obligations.
Foreign branches of U.S. banks and foreign banks may be subject to less
stringent reserve requirements than those applicable to domestic branches of
U.S. banks.

LENDING of portfolio securities is a common practice in the securities industry.
The fund may engage in security lending arrangements with the primary objective
of increasing its income. For example, the fund may receive cash collateral and
it may invest it in short-term, interest-bearing obligations, but will do so
only to the extent that it will not lose the tax treatment available to mutual
funds. Lending portfolio securities involves risks that the borrower may fail to
return the securities or provide additional collateral. Also, voting rights with
respect to the loaned securities may pass with the lending of the securities and
efforts to call such securities promptly may be unsuccessful, especially for
foreign securities. The fund may loan portfolio securities to qualified
broker-dealers or other institutional investors provided: (1) the loan is
secured continuously by collateral consisting of U.S. government securities,
letters of credit, cash or cash equivalents maintained on a daily
marked-to-market basis in an amount at least equal to the current market value
of the securities loaned; (2) the fund may at any time call the loan and obtain
or request the return of the securities loaned; (3) the fund will receive any
interest or dividends paid on the loaned securities; and (4) the aggregate
market value of securities loaned will not at any time exceed one-third of the
total assets of the fund, including collateral received from the loan (at market
value computed at the time of the loan).

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Although voting rights with respect to loaned securities pass to the borrower,
the lender retains the right to recall a security (or terminate a loan) for the
purpose of exercising the security's voting rights. Efforts to recall such
securities promptly may be unsuccessful, especially for foreign securities or
thinly traded securities such as small-cap stocks. In addition, because
recalling a security may involve expenses to the fund, it is expected that the
fund will do so only where the items being voted upon are, in the judgment of
the investment adviser, either material to the economic value of the security or
threaten to materially impact the issuer's corporate governance policies or
structure.

LOAN INTERESTS and other direct debt instruments or interests therein may be
acquired by the fund. A loan interest is typically originated, negotiated, and
structured by a U.S. or foreign commercial bank, insurance company, finance
company, or other financial institution ("Agent") for a lending syndicate of
financial institutions. The Agent typically administers and enforces the loan on
behalf of the other lenders in the syndicate. In addition, an institution
typically but not always the Agent ("Collateral Bank"), holds collateral (if
any) on behalf of the lenders. When a Collateral Bank holds collateral, such
collateral typically consists of one or more of the following asset types:
inventory, accounts receivable, property, plant and equipment, intangibles,
common stock of subsidiaries or other investments. These loan interests may take
the form of participation interests in, assignments of or novations of a loan
during its second distribution, or direct interests during a primary
distribution. Such loan interests may be acquired from U.S. or foreign banks,
insurance companies, finance companies, or other financial institutions who have
made loans or are members of a lending syndicate or from other holders of loan
interests. The fund may also acquire loan interests under which the fund derives
its rights directly from the borrower. Such loan interests are separately
enforceable by the fund against the borrower and all payments of interest and
principal are typically made directly to the fund from the borrower. In the
event that the fund and other lenders become entitled to take possession of
shared collateral, it is anticipated that such collateral would be held in the
custody of Collateral Bank for their mutual benefit. The fund may not act as an
Agent, a Collateral Bank, a guarantor or sole negotiator or structurer with
respect to a loan.

The investment adviser will analyze and evaluate the financial condition of the
borrower in connection with the acquisition of any Loan Interest. Credit ratings
are typically assigned to Loan Interests in the same manner as with other fixed
income debt securities, and the investment adviser analyzes and evaluates these
ratings, if any, in deciding whether to purchase a Loan Interest. The investment
adviser also analyzes and evaluates the financial condition of the Agent and, in
the case of Loan Interests in which the fund does not have privity with the
borrower, those institutions from or through whom the fund derives its rights in
a loan ("Intermediate Participants").

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monitor the value of the collateral and, if the value of the collateral
declines, may accelerate the loan, may give the borrower an opportunity to
provide additional collateral or may seek other protection for the benefit of
the participants in the loan. The Agent is compensated by the borrower for
providing these services under a loan agreement, and such compensation may
include special fees paid upon structuring and funding the loan and other fees
paid on a continuing basis. With respect to Loan Interests for which the Agent
does not perform such administrative and enforcement functions, the fund will
perform such tasks on its own behalf, although a Collateral Bank will typically
hold any collateral on behalf of the fund and the other holders pursuant to the
applicable loan agreement.

A financial institution's appointment as Agent may usually be terminated in the
event that it fails to observe the requisite standard of care or becomes
insolvent, enters Federal Deposit Insurance Corporation ("FDIC") receivership,
or, if not FDIC insured, enters into bankruptcy proceedings. A successor agent
generally would be appointed to replace the terminated Agent, and assets held by
the Agent under the loan agreement should remain available to holders of Loan
Interests. However, if assets held by the Agent for the benefit of the fund were
determined to be subject to the claims of the Agent's general creditors, the
fund might incur certain costs and delays in realizing payment on a loan
interest, or suffer a loss of principal and/or interest. In situations involving
Intermediate Participants, similar risks may arise.

Purchasers of Loan Interests depend primarily upon the creditworthiness of the
borrower for payment of principal and interest. If the fund does not receive a
scheduled interest or principal payments on such indebtedness, the fund's share
price and yield could be adversely affected. Loans that are fully secured offer
the fund more protections than an unsecured loan in the event of non-payment of
scheduled interest or principal. However, there is no assurance that the
liquidation of collateral from a secured loan would satisfy the borrower's
obligation, or that the collateral can be liquidated. Indebtedness of borrowers
whose creditworthiness is poor involves substantially greater risks, and may be
highly speculative. Borrowers that are in bankruptcy or restructuring may never
pay off their indebtedness, or may pay only a small fraction of the amount owed.
Direct indebtedness of developing countries also will involve a risk that the
governmental entities responsible for the repayment of the debt may be unable,
or unwilling, to pay interest and repay principal when due.

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deemed to have a longer maturity, in the case of purchases of future contracts,
and a shorter maturity, in the case of sales of futures contracts, than they
would otherwise be deemed to have. In addition, a security that is subject to
redemption at the option of the issuer on a particular date ("call date"), which
is prior to, or in lieu of, the security's stated maturity, may be deemed to
mature on the call date rather than on its stated maturity date. The call date
of a security will be used to calculate average portfolio maturity when the
investment adviser reasonably anticipates, based upon information available to
it, that the issuer will exercise its right to redeem the security. The average
portfolio maturity of the fund is dollar-weighted based upon the market value of
the fund's securities at the time of the calculation. The fund may invest in
securities with final or effective maturities of any length. There may be times
when the portfolio's overall average effective maturity, or duration, or overall
average weighted maturity is more than one year.

MORTGAGE-BACKED SECURITIES ("MBS") and other ASSET-BACKED SECURITIES may be
purchased by the fund. MBS represent participations in mortgage loans, and
include pass-through securities, collateralized mortgage obligations and
stripped mortgage-backed securities. MBS may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government National
Mortgage Association (GNMA or Ginnie Mae) and Fannie Mae or the Federal Home
Loan Mortgage Corporation (FHLMC or Freddie Mac), or by private issuers,
generally originators and investors in mortgage loans, including savings
associations, mortgage banks, commercial banks, and special purpose entities
(collectively, "private lenders"). MBS are based on different types of mortgages
including those on commercial real estate and residential property. MBS issued
by private lenders may be supported by pools of mortgage loans or other MBS that
are guaranteed, directly or indirectly, by the U.S. government or one of its
agencies or instrumentalities, or they may be issued without any governmental
guarantee of the underlying mortgage assets but with some form of credit
enhancement.

COMMERCIAL MORTGAGE-BACKED SECURITIES include securities that reflect an
interest in, and are

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secured by, mortgage loans on commercial real property. The market for
commercial mortgage-backed securities developed more recently and in terms of
total outstanding principal amount of issues is relatively small compared to the
market for residential single-family MBS. Many of the risks of investing in
commercial mortgage-backed securities reflect the risks of investing in the real
estate securing the underlying mortgage loans. These risks reflect the effects
of local and other economic conditions on real estate markets, the ability of
tenants to make loan payments, and the ability of a property to attract and
retain tenants. Commercial mortgage-backed securities may be less liquid and
exhibit greater price volatility than other types of mortgage- or asset-backed
securities.

A COLLATERALIZED MORTGAGE OBLIGATION ("CMO") is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, on a monthly basis. CMOs
may be collateralized by whole mortgage loans, but are more typically
collateralized by portfolios of mortgage pass-through securities guaranteed by
the Government National Mortgage Association (GNMA or Ginnie Mae), Federal Home
Loan Mortgage Corporation (FHLMC or Freddie Mac), Fannie Mae, and their income
streams.

CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.

The rate of principal payment on MBS and ABS generally depends on the rate of
principal payments received on the underlying assets which in turn may be
affected by a variety of economic and other factors. As a result, the price and
yield on any MBS or ABS is difficult to predict with precision and price and
yield to maturity may be more or less than the anticipated yield to maturity. If
the fund purchases these securities at a premium, a prepayment rate that is
faster than expected will reduce yield to maturity, while a prepayment rate that
is slower than expected will have the opposite effect of increasing the yield to
maturity. Conversely, if the fund purchases these securities at a discount, a
prepayment rate that is faster than expected will increase yield to maturity,
while a prepayment rate that is slower than expected will reduce yield to
maturity. Amounts available for reinvestment by the fund are likely to be
greater during a period of declining interest rates and, as a result, are likely
to be reinvested at lower interest rates than during a period of rising interest
rates.

While many MBS and ABS are issued with only one class of security, many are
issued in more

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than one class, each with different payment terms. Multiple class MBS and ABS
are issued as a method of providing credit support, typically through creation
of one or more classes whose right to payments on the security is made
subordinate to the right to such payments of the remaining class or classes. In
addition, multiple classes may permit the issuance of securities with payment
terms, interest rates, or other characteristics differing both from those of
each other and from those of the underlying assets. Examples include stripped
securities, which are MBS and ABS entitling the holder to disproportionate
interest or principal compared with the assets backing the security, and
securities with classes having characteristics different from the assets backing
the securities, such as a security with floating interest rates with assets
backing the securities having fixed interest rates. The market value of such
securities or CMOs generally is more or less sensitive to changes in prepayment
and interest rates than is the case with traditional MBS and ABS, and in some
cases such market value may be extremely volatile.

MUNICIPAL LEASES are obligations issued to finance the construction or
acquisition of equipment or facilities. These obligations may take the form of a
lease, an installment purchase contract, a conditional sales contract or a
participation interest in any of these obligations. Municipal leases may be
considered illiquid investments. Additionally, municipal leases are subject to
"nonappropriation risk," which is the risk that the municipality may terminate
the lease because funds have not been allocated to make the necessary lease
payments. The lessor would then be entitled to repossess the property, but the
value of the property may be less to private sector entities than it would be to
the municipality.

Municipal securities may be owned directly or through participation interests,
and include general obligation or revenue securities, tax-exempt commercial
paper, notes and leases.

Examples of municipal securities that are issued with original maturities of 397
days or less are short-term tax anticipation notes, bond anticipation notes,
revenue anticipation notes,

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construction loan notes, pre-refunded municipal bonds and tax-free commercial
paper. Tax anticipation notes typically are sold to finance working capital
needs of municipalities in anticipation of the receipt of property taxes on a
future date. Bond anticipation notes are sold on an interim basis in
anticipation of a municipality's issuance of a longer-term bond in the future.
Revenue anticipation notes are issued in expectation of the receipt of other
types of revenue, such as that available under the Federal Revenue Sharing
Program. Construction loan notes are instruments insured by the Federal Housing
Administration with permanent financing by Fannie Mae or Ginnie Mae at the end
of the project construction period. Pre-refunded municipal bonds are bonds that
are not yet refundable, but for which securities have been placed in escrow to
refund an original municipal bond issue when it becomes refundable. Tax-free
commercial paper is an unsecured promissory obligation issued or guaranteed by a
municipal issuer. The fund may purchase other municipal securities similar to
the foregoing that are or may become available, including securities issued to
pre-refund other outstanding obligations of municipal issuers.

The fund also may invest in moral obligation securities, which are normally
issued by special purpose public authorities. If the issuer of a moral
obligation security is unable to meet its obligation from current revenues, it
may draw on a reserve fund. The state or municipality that created the entity
has only a moral commitment, not a legal obligation, to restore the reserve
fund.

Municipal securities pay fixed, variable or floating rates of interest, which
may be exempt from federal income tax and, typically, personal income tax of a
state or locality. Some municipal securities are taxable. These securities are
issued by state and local governments and intrumentalities thereof that pay
interest that is not exempt from federal income tax. States and municipalities
issue taxable instruments for various reasons, relating in some cases to the
nature of the project being financed and to various specific ceilings on debt
issuance in others. The rate of interest payable on such instruments typically
reflects its taxable nature.

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option writers, a rise in the price of the underlying security will be offset by
the premium received from the call option buyer. If the call option writer does
not own the underlying security, however, the losses that may ensue if the price
rises could be potentially unlimited. If the call option writer owns the
underlying security or commodity, this is called writing a covered call. All
call options written by the fund will be covered, which means that the fund will
own the securities subject to the option so long as the option is outstanding.

A put option is the opposite of a call option. It gives the buyer the right to
sell a specified number of shares of a security at a fixed price on or before a
specified date in the future. Put option buyers are usually anticipating a
decline in the price of the underlying security, and wish to offset those losses
when selling the security at a later date. All put options the fund writes will
be covered, which means that the fund will deposit with its custodian cash, U.S.
government securities or other high-grade debt securities (i.e., securities
rated in one of the top three categories by Moody's Investor Service ("Moody's")
or Standard & Poor's ("S&P") or, if unrated, determined by the investment
adviser to be of comparable credit quality) with a value at least equal to the
exercise price of the put option. The purpose of writing such options is to
generate additional income for the fund. However, in return for the option
premium, the fund accepts the risk that it may be required to purchase the
underlying securities at a price in excess of the securities market value at the
time of purchase.

The fund may purchase and write put and call options on any securities in which
it may invest or any securities index based on securities in which it may
invest. The fund may purchase and write such options on securities that are
listed on domestic or foreign securities exchanges or traded in the
over-the-counter market. Like futures contracts, option contracts are rarely
exercised. Option buyers usually sell the option before it expires. Option
writers may terminate their obligations under a written call or put option by
purchasing an option identical to the one it has written. Such purchases are
referred to as "closing purchase transactions." The fund may enter into closing
sale transactions in order to realize gains or minimize losses on options it has
purchased or wrote.

An exchange-traded currency option position may be closed out only on an options
exchange that provides a secondary market for an option of the same series.
Although the fund generally will purchase or 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 or at any
particular time. If fund is unable to effect a closing purchase transaction with
respect to options it has written, it will not be able to sell the underlying
securities or dispose of assets held in a segregated account until the options
expire or are exercised. Similarly, if the fund is unable to effect a closing
sale transaction with respect to options it has purchased, it would have to
exercise the options in order to realize any profit and will incur transaction
costs upon the purchase or sale of underlying securities.

Reasons for the absence of a liquid secondary market on an exchange include the
following: (1) there may be insufficient trading interest in certain options;
(2) an exchange may impose restrictions on opening transactions or closing
transactions or both; (3) trading halts, suspensions or other restrictions may
be imposed with respect to particular classes or series of options; (4) unusual
or unforeseen circumstances may interrupt normal operations on an exchange; (5)
the facilities of an exchange or the Options Clearing Corporation (the OCC) may
not at all times be adequate to handle current trading volume; or (6) one or
more exchanges could, for economic or other reasons, decide or be compelled at
some future date to discontinue the trading of options (or a particular class or
series of options), although outstanding options on that exchange that had been
issued by the OCC as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.

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The ability to terminate over-the-counter options is more limited than with
exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations. Until
such time as the staff of the Securities and Exchange Commission (the SEC)
changes its position, the fund will treat purchased over-the-counter options and
all assets used to cover written over-the-counter options as illiquid
securities, except that with respect to options written with primary dealers in
U.S. government securities pursuant to an agreement requiring a closing purchase
transaction at a formula price, the amount of illiquid securities may be
calculated with reference to a formula the staff of the SEC approves.

Additional risks are involved with options trading because of the low margin
deposits required and the extremely high degree of leverage that may be involved
in options trading. There may be imperfect correlation between the change in
market value of the securities held by the fund and the prices of the options,
possible lack of a liquid secondary markets, and the resulting inability to
close such positions prior to their maturity dates.

The fund may write or purchase an option only when the market value of that
option, when aggregated with the market value of all other options transactions
made on behalf of the fund, does not exceed 5% of its total assets.

PREFERRED STOCKS are nonvoting equity securities that pay a stated fixed or
variable rate dividend. Although the preferred shareholders generally have no
right to receive discretionary dividends, they must receive the preferred
dividend at the stated rate prior to any dividends being paid on the common
stock. Since the preferred stockholder receives a fixed dividend payment, the
holder's position is much like that of the bondholder. Due to their fixed income
features, preferred stock provides higher income potential than the issuer's
common stock, but typically are more sensitive to interest rate changes than the
underlying common stock. In the event of liquidation, bondholders have claims on
company assets senior to those of stockholders; preferred stockholders have
claims senior to those of common stockholders. Preferred stock is rated like
fixed income securities and the fund will only invest in investment-grade
preferred stock that has a call feature that the investment manager expects to
be exercised by the issuer on the call date or that has a specified redemption
date.

PUTS are agreements that allow the buyer to sell a security at a specified price
and time to the seller or "put provider." When the fund buys a security with a
put feature, losses could occur if the put provider does not perform as agreed.
If a put provider fails to honor its commitment upon the fund's attempt to
exercise the put, the fund may have to treat the security's final maturity as
its effective maturity. If that occurs, the security's price may be negatively
impacted, and its sensitivity to interest rate changes may be increased,
possibly contributing to increased share price volatility for the fund. This
also could lengthen the fund's overall average effective maturity. Standby
commitments are types of puts.

QUALITY OF INVESTMENTS will be investment grade for at least 75% of the fund's
assets. Investment-grade quality securities are rated by at least one NRSRO in
one of the four highest rating categories (within which there may be
sub-categories or gradations indicating relative standing) or have been
determined to be of equivalent quality by the investment adviser pursuant

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to procedures adopted by the board of trustees. Sometimes an investment-grade
quality security may be downgraded to a below investment-grade quality rating.
If a security no longer had at least one investment-quality rating from an
NRSRO, the investment adviser would reanalyze the security in light of the
downgrade and determine whether the fund should continue to hold the security.
However, such a downgrade would not require the investment adviser to sell the
security on behalf of the fund.

The fund also may invest up to 25% of its assets in lower-quality securities
that are rated by at least one NRSRO in the fifth highest rating category
(within which there may be sub-categories or gradations indicating relative
standing) or have been determined to be of equivalent quality by the investment
adviser pursuant to procedures adopted by the board of trustees. Sometimes
lower-quality securities may be downgraded to an even lower quality rating. If
any of the fund's lower-quality securities were downgraded to below the sixth
rating category, the investment adviser will promptly sell the security on
behalf of the fund.

REPURCHASE AGREEMENTS. Repurchase agreements involve the fund buying securities
(usually U.S. government securities) from a seller and simultaneously agreeing
to sell them back at an agreed-upon price (usually higher) and time. There are
risks that losses will result if the seller does not perform as agreed. Under
certain circumstances, repurchase agreements that are fully collateralized by
U.S. government securities may be deemed to be investments in U.S. government
securities.

RESTRICTED SECURITIES are securities that are subject to legal restrictions on
their sale. Restricted securities may be considered to be liquid if an
institutional or other market exists for these securities. In making this
determination, the fund, under the direction and supervision of the board of
trustees, will take into account the following factors: (1) the frequency of
trades and quotes for the security; (2) the number of dealers willing to
purchase or sell the security and the number of potential purchasers; (3) dealer
undertakings to make a market in the security; and (4) the nature of the
security and marketplace trades (e.g., the time needed to dispose of the
security, the method of soliciting offers and the mechanics of transfer). To the
extent the fund invests in restricted securities that are deemed liquid, the
general level of illiquidity in the fund's portfolios may be increased if
qualified institutional buyers become uninterested in purchasing these
securities.

REVERSE REPURCHASE AGREEMENTS AND MORTGAGE DOLLAR ROLLS may be used by the fund.
The fund may engage in reverse repurchase agreements to facilitate portfolio
liquidity, a practice common in the mutual fund industry, or for arbitrage
transactions as discussed below. In a reverse repurchase agreement, the fund
would sell a security and enter into an agreement to repurchase the security at
a specified future date and price. The fund generally retains the right to
interest and principal payments on the security. Because the fund receives cash
upon entering into a reverse repurchase agreement, it may be considered a
borrowing. When required by guidelines of the SEC, the fund will set aside
permissible liquid assets in a segregated account to secure its obligations to
repurchase the security.

The fund also may enter into mortgage dollar rolls, in which the fund would sell
MBS for delivery in the current month and simultaneously contract to purchase
substantially similar securities on a specified future date. While the fund
would forego principal and interest paid on the MBS during the roll period, the
fund would be compensated by the difference between the current sales price and
the lower price for the future purchase as well as by any interest earned on the
proceeds of the initial sale. The fund also could be compensated through the
receipt of fee income equivalent to a lower forward price. At the time the fund
would enter into a mortgage dollar roll, it would set aside permissible liquid
assets in a segregated account to secure its obligation for the forward

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commitment to buy MBS. Mortgage dollar roll transactions may be considered a
borrowing by the fund.

The mortgage dollar rolls and reverse repurchase agreements entered into by the
fund may be used as arbitrage transactions in which the fund will maintain an
offsetting position in short duration investment grade debt obligations. Since
the fund will receive interest on the securities or repurchase agreements in
which it invests the transaction proceeds, such transactions may involve
leverage. However, since such securities or repurchase agreements will be high
quality and short duration, the investment adviser believes that such arbitrage
transactions present lower risks to the fund than those associated with other
types of leverage. There can be no assurance that the fund's use of the cash it
receives from a mortgage dollar roll will provide a positive return.

RISK MANAGEMENT TECHNIQUES used by the fund may include buying and selling
futures and options contracts, entering into total return, asset and credit
swaps, credit-linked notes and wrap agreements and investing in various types of
derivative instruments. The fund may use risk management techniques, including
derivative instruments, for any lawful purpose consistent with its investment
objective, such as hedging or managing risk. Derivative instruments are commonly
defined to include securities or contracts whose values depend on (or "derive"
from) the value of one or more other assets such as securities, currencies, or
commodities. These "other assets" are commonly referred to as "underlying
assets."

A derivative instrument generally consists of, is based upon, or exhibits
characteristics similar to options or forward contracts. Options and forward
contracts are considered to be the basic "building blocks" of derivatives. For
example, forward-based derivatives include forward contracts, as well as
exchange-traded futures. Option-based derivatives include privately negotiated,
over-the-counter (OTC) options (including caps, floors, collars, and options on
forward and swap contracts) and exchange-traded options on futures. Diverse
types of derivatives may be created by combining options or forward contracts in
different ways, and applying these structures to a wide range of underlying
assets.

In addition to the derivative instruments and strategies described in the SAI,
the investment adviser expects to discover additional derivative instruments and
other hedging or risk management techniques. The investment adviser may utilize
these new derivative instruments and techniques to the extent that they are
consistent with the fund's investment objective and permitted by the fund's
investment limitations, operating policies, and applicable regulatory
authorities.

SECURITIES OF OTHER INVESTMENT COMPANIES may be purchased and sold by the fund,
including those issued by foreign investment companies. Mutual funds are
registered investment companies, which may issue and redeem their shares on a
continuous basis (open-end mutual funds) or may offer a fixed number of shares
usually listed on an exchange (closed-end mutual funds). Mutual funds generally
offer investors the advantages of diversification and professional investment
management, by combining shareholders' money and investing it in various types
of securities, such as stocks, bonds and money market securities. Mutual funds
also make various investments and use certain techniques in order to enhance
their performance. These may include entering into delayed-delivery and
when-issued securities transactions or swap agreements; buying and selling
futures contracts, illiquid and restricted securities and repurchase agreements
and

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<PAGE> 162
borrowing or lending money and/or portfolio securities. The risks of investing
in mutual funds generally reflect the risks of the securities in which the
mutual funds invest and the investment techniques they may employ. Also, mutual
funds charge fees and incur operating expenses.

If the fund decides to purchase securities of other investment companies, the
fund intends to purchase shares of mutual funds in compliance with the
requirements of federal law or any applicable exemptive relief received from the
SEC. Mutual fund investments for the fund are currently restricted under federal
regulations, and therefore, the extent to which the fund may invest in another
mutual fund may be limited. In addition, the fund intends to vote any proxies of
underlying mutual funds in accordance with the instructions received, or in the
same proportion as the vote of all other shareholders of the underlying mutual
fund.

Funds in which the fund also may invest include unregistered or privately-placed
funds, such as hedge funds and off-shore funds, and unit investment trusts.
Hedge funds and off-shore funds are not registered with the SEC, and therefore
are largely exempt from the regulatory requirements that apply to registered
investment companies (mutual funds). As a result, these funds may have greater
ability to make investments or use investment techniques that offer a higher
degree of investment return, such as leveraging, which also may subject fund
assets to substantial risk to the investment principal. These funds, while not
regulated by the SEC like mutual funds, may be indirectly supervised by the
sources of their assets, which tend to be commercial and investment banks and
other financial institutions. Investments in these funds also may be more
difficult to sell, which could cause losses to the fund. For example, hedge
funds typically require investors to keep their investment in a hedge fund for
some period of time, such as one month. This means investors would not be able
to sell their shares of a hedge fund until such time had past.

SHORT SALES may be used by the fund (1) to hedge unrealized gains on portfolio
securities or (2) if it covers such short sales with liquid assets as required
by the current rules and positions of the SEC or its staff. Selling securities
short against the box involves selling a security that the fund owns or has the
right to acquire, for the delivery at a specified date in the future. If the
fund sells securities short against the box, it may protect unrealized gains,
but will lose the opportunity to profit on such securities if the price rises.
When the fund makes a short sale, it may borrow the security sold short and
deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon conclusion of the
sale. The fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any accrued interest and dividends on such borrowed
securities.

If the price of the security sold short increases between the time of the short
sale and the time and the fund replaces the borrowed security, the fund will
incur a loss; conversely, if the price declines, the fund will realize a capital
gain. Any gain will be decreased, and any loss increased, by the transaction
costs described above. The successful use of short selling may be adversely
affected by imperfect correlation between movements in the price of the security
sold short and the securities being hedged.

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<PAGE> 163
SPREAD TRANSACTIONS may be used for hedging or managing risk. The fund may
purchase covered spread options from securities dealers. Such covered spread
options are not presently exchange-listed or exchange-traded. The purchase of a
spread option gives the fund the right to put, or sell, a security that it owns
at a fixed dollar spread or fixed yield spread in relation to another security
that the fund does not own, but which is used as a benchmark. The risk to the
fund in purchasing covered spread options is the cost of the premium paid for
the spread option and any transaction costs. In addition, there is no assurance
that closing transactions will be available. The purchase of spread options will
be used to protect the fund against adverse changes in prevailing credit quality
spreads, i.e., the yield spread between high quality and lower quality
securities. Such protection is only provided during the life of the spread
option.

STRIPPED SECURITIES are securities whose income and principal components are
detached and sold separately. While the risks associated with stripped
securities are similar to other fixed income securities, stripped securities are
typically subject to greater changes in value. U.S. Treasury securities that
have been stripped by a Federal Reserve Bank are obligations of the U.S.
Treasury.

SWAP AGREEMENTS can be structured to increase or decrease the fund's exposure to
long- or short-term interest rates, corporate borrowing rates and other
conditions, such as changing security prices and inflation rates. They also can
be structured to increase or decrease the fund's exposure to specific issuers or
specific sectors of the bond market such as mortgage securities. For example, if
the fund agreed to pay a longer-term fixed rate in exchange for a shorter-term
floating rate while holding longer-term fixed-rate bonds, the swap would tend to
decrease the fund's exposure to longer-term interest rates. Swap agreements tend
to increase or decrease the overall volatility of the fund's investments and its
share price and yield. Changes in interest rates, or other factors determining
the amount of payments due to and from the fund, can be the most significant
factors in the performance of a swap agreement. If a swap agreement calls for
payments from the fund, the fund must be prepared to make such payments when
they are due. In order to help minimize risks, the fund will segregate
appropriate assets for any accrued but unpaid net amounts owed under the terms
of a swap agreement entered into on a net basis. All other swap agreements will
require the fund to segregate appropriate assets in the amount of the accrued
amounts owed under the swap. The fund could sustain losses if a counterparty
does not perform as agreed under the terms of the swap. The fund will enter into
swap agreements with counterparties deemed creditworthy by the investment
adviser.

VARIABLE AND FLOATING RATE DEBT SECURITIES pay an interest rate, which is
adjusted either

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<PAGE> 164
periodically or at specific intervals or which floats continuously according to
a formula or benchmark. Although these structures generally are intended to
minimize the fluctuations in value that occur when interest rates rise and fall,
some structures may be linked to a benchmark in such a way as to cause greater
volatility to the security's value.

Some variable rate securities may be combined with a put or demand feature
(variable rate demand securities) that entitles the holder to the right to
demand repayment in full or to resell at a specific price and/or time. While the
demand feature is intended to reduce credit risks, it is not always
unconditional, and may make the securities more difficult to sell quickly
without losses. There are risks involved with these securities because there may
be no active secondary market for a particular variable rate demand security
purchased by the fund. In addition, the fund may exercise only its demand rights
at certain times. The fund could suffer losses in the event that the issuer
defaults on its obligation.

WARRANTS are a type of security usually issued with bonds and preferred stock
that entitles the holder to a proportionate amount of common stock at specified
price for a specific period of time. The prices of warrants do not necessarily
move parallel to the prices of the underlying common stock. Warrants have no
voting rights, receive no dividends and have no rights with respect to the
assets of the issuer. If a warrant is not exercised within the specified time
period, it will become worthless and the fund will lose the purchase price it
paid for the warrant and the right to purchase the underlying security.

WRAP AGREEMENTS may be entered into by the fund with insurance companies, banks
or other financial institutions (wrapper providers). A wrap agreement typically
obligates the wrapper provider to maintain the value of the assets covered under
the agreement (covered assets) up to a specified maximum dollar amount upon the
occurrence of certain specified events. The value is pre-determined using the
purchase price of the securities plus interest at a specified rate minus an
adjustment for any defaulted securities. The specified interest rate may be
adjusted periodically under the terms of the agreement. While the rate typically
will reflect movements in the market rates of interest, it may at times be less
or more than the actual rate of income earned on the covered assets. The rate
also can be impacted by defaulted securities and by purchase and redemption
levels in the fund. The fund also pays a fee under the agreement, which reduces
the rate as well.

Wrap agreements may be used as a risk management technique intended to help
minimize fluctuations in the fund's NAV. However, the fund's NAV will typically
fluctuate at least minimally, and may fluctuate more at times when interest
rates are fluctuating. Additionally, wrap agreements do not protect against
losses the fund may incur if the issuers of portfolio securities do not make
timely payments of interest and/or principal. A wrapper provider also could
default on its obligations under the agreement. Therefore, the funds will only
invest in a wrap provider with an investment-grade credit rating. There is no
active trading market for wrap agreements and none is expected to develop.
Therefore, wrap agreements are considered illiquid investments. There is no
guarantee that the fund will be able to purchase any wrap agreements or replace
ones that defaulted. Wrap agreements are valued using procedures adopted by the
board of trustees. There are risks that the value of a wrap agreement may not be
sufficient to minimize the fluctuations in the fund's NAV. All of these factors
might result in a decline in the value of the fund's shares.

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<PAGE> 165
income, the price of these securities can be volatile when interest rates
fluctuate. While these securities do not pay current cash income, federal income
tax law requires the holders of zero-coupon, step-coupon, and pay-in-kind
securities to include in income each year the portion of the original issue
discount (or deemed discount) and other non-cash income on such securities
accruing that year. In order to continue to qualify as a "regulated investment
company" or "RIC" under the Internal Revenue Code and avoid a certain excise
tax, the fund may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio securities, which may
occur in periods of adverse market prices, in order to generate cash to meet
these distribution requirements.

INVESTMENT LIMITATIONS

The following investment limitations are fundamental investment polices and
restrictions and may be changed only by vote of a majority of the fund's
outstanding voting shares.

THE FUND MAY NOT:

1) Purchase securities of any issuer, unless consistent with the
maintenance of its status as a diversified investment management
company under the Investment Company Act of 1940 Act (the 1940 Act), or
the rules or regulations thereunder, as such statute, rules or
regulations may be amended from time to time;

2) Concentrate investments in a particular industry or group of
industries, as concentration is defined under the 1940 Act, or the
rules or regulations thereunder, as such statute, rules and regulations
may be amended from time to time; and

3) (i) Purchase or sell commodities, commodities contracts, futures
contracts or real estate, (ii) lend or borrow, (iii) issue senior
securities, (iv) underwrite securities or (v) pledge, mortgage or
hypothecate any of its assets, except as permitted by the 1940 Act, or
the rules or regulations thereunder, as such statute, rules and
regulations may be amended from time to time.

THE FOLLOWING DESCRIPTIONS OF THE 1940 ACT MAY ASSIST INVESTORS IN UNDERSTANDING
THE ABOVE POLICIES AND RESTRICTIONS.

Diversification. Under the 1940 Act, a diversified investment management
company, as to 75% of its total assets, may not purchase securities of any
issuer (other than U.S. government securities of other investment companies) if,
as a result, more than 5% of its total assets would be invested in the
securities of such issuer, or more than 10% of the issuer's outstanding voting
securities would be held by the fund.

Concentration. The SEC has presently defined concentration as investing 25% or
more of an investment company's total assets in an industry or group of
industries, with certain exceptions.

Borrowing. The 1940 Act presently allows the fund to borrow from any bank
(including pledging, mortgaging or hypothecating assets) in amount up to 33 1/3%
of its total assets. The 1940 Act presently excludes temporary borrowings not in
excess of 5% of the fund's total assets from this limitation on borrowings.

Lending. Under the 1940 Act, the fund may only make loans if expressly permitted
by its investment policies. The fund's non-fundamental investment policy on
lending is set forth below.

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<PAGE> 166
Underwriting. Under the 1940 Act, underwriting securities involves the fund
purchasing securities directly from an issuer for the purpose of selling
(distributing) them or participating in any such activity either directly or
indirectly. Under the 1940 Act, a diversified fund may not make any commitment
as underwriter, if immediately thereafter the amount of its outstanding
underwriting commitments, plus the value of its investments in securities of
issuers (other than investment companies) of which it owns more than 10% of the
outstanding voting securities, exceeds 25% of the value of its total assets.

Senior Securities. Senior securities may include any obligation or instrument
issued by the fund evidencing indebtedness. The 1940 Act generally prohibits
funds from issuing senior securities, although it provides allowances for
certain borrowings and certain other investments, such as short sales, reverse
repurchase agreements, firm commitment agreements and standby commitments, with
appropriate segregation of assets.

The following are non-fundamental investment policies and restrictions and may
be changed by the board of trustees. The fund may not:

1) Purchase securities of any issuer, if as a result, more than 15% of its
net assets would be invested in illiquid securities.

2) Invest for the purpose of exercising control or management of another
issuer.

3) Purchase securities of other investment companies, except as permitted
by the 1940 Act, including any exemptive relief granted by the SEC.

4) Sell securities short unless it owns the security or the right to
obtain the security or equivalent securities, or unless it covers such
short sale as required by current SEC rules and positions (transactions
in futures contracts, options and other derivative instruments are not
considered selling securities short).

5) Purchase securities on margin, except such short-term credits as may be
necessary for the clearance of purchases and sales of securities and
provided that margin payments in connection with futures contracts,
options on futures or other derivative instruments shall not constitute
purchasing securities on margin.

6) Borrow money except that the fund may (i) borrow money from banks and
(ii) engage in reverse repurchase agreements or mortgage dollar rolls
with any party; provided that (i) and (ii) in combination do not exceed
33 1/3% of its total assets (any borrowings that come to exceed this
amount will be reduced to the extent necessary to comply with the
limitation within three business days) and the fund will not purchase
securities while bank borrowings represent more than 5% of its total
assets.

7) Purchase securities of any issuer (other than U.S. government and
municipal securities) if, as a result, more than 25% of its net assets
would be invested in the securities of issuers in a single industry or
group of industries.

8) Lend any security or make any other loan if, as a result, more than
33 1/3% of its total assets would be lent to other parties (this
restriction does not apply to purchases of debt securities or
repurchase agreements).

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<PAGE> 167

Except with respect to non-fundamental limitations (1) illiquid securities and
(6) borrowing, any subsequent change in net assets or other circumstances will
not be considered when determining whether the investment complies with the
fund's investment policies and limitations.

MANAGEMENT OF THE FUND

The officers and trustees, their principal occupations during the past five
years and their affiliations, if any, with The Charles Schwab Corporation,
Charles Schwab & Co., Inc. and Charles Schwab Investment Management, Inc., are
as follows:

<TABLE>
<CAPTION>
POSITION(S) WITH
NAME/DATE OF BIRTH THE TRUST PRINCIPAL OCCUPATIONS & AFFILIATIONS
------------------ ---------------- ------------------------------------
<S> <C> <C>
CHARLES R. SCHWAB* Chairman, Chief Chairman and Co-Chief Executive Officer,
July 29, 1937 Executive Officer and Director, The Charles Schwab Corporation; Chief
Trustee Executive Officer, Director, Charles Schwab
Holdings, Inc.; Chairman, Director, Charles
Schwab & Co., Inc., Charles Schwab Investment
Management, Inc.; Director, The Charles Schwab
Trust Company; Chairman, Schwab Retirement Plan
Services, Inc.; Chairman and Director until
January 1999, Mayer & Schweitzer, Inc. (a
securities brokerage subsidiary of The Charles
Schwab Corporation); Director, The Gap, Inc. (a
clothing retailer), Audiobase, Inc.
(full-service audio solutions for the internet),
Vodaphone AirTouch PLC (a telecommunications
company) and Siebel Systems (a software company).

--------
* This trustee is an "interested person" of the trusts.

26
<PAGE> 168
<TABLE>

<S> <C> <C>
marketing/consulting firm).

ROBERT G. HOLMES Trustee Chairman, Chief Executive Officer and Director,
May 15, 1931 Semloh Financial, Inc. (international financial
services and investment advisory firm).

MICHAEL W. WILSEY Trustee Chairman and Chief Executive Officer, Wilsey
August 18, 1943 Bennett, Inc. (truck and air transportation,
real estate investment and management, and
investments).

MARIANN BYERWALTER Trustee Vice President for Business Affairs and Chief
August 13, 1960 Financial Officer, Stanford University (higher
education). Prior to February 1996, Ms.
Byerwalter was Chief Financial Officer of Eureka
Bank (savings and loans) and Chief Financial
Officer and Chief Operating Officer of America
First Eureka Holdings, Inc. (holding company).
Ms. Byerwalter also is on the Board of Directors
of America First Companies, Omaha, NE (venture
capital/fund management) and Redwood Trust, Inc.
(mortgage finance), and is Director of Stanford
Hospitals and Clinics. SRI International
(research) and LookSmart, Ltd. (an
infrastructure company).

--------
* This trustee is an "interested person" of the trusts.

27
<PAGE> 169

<TABLE>
<S> <C> <C>
GERALD B. SMITH Trustee Chairman and Chief Executive Officer and founder
September 28, 1950 of Smith Graham & Co. (investment advisors).
Mr. Smith is also on the Board of Directors of
Pennzoil-Quaker State Company (oil and gas) and
Rorento N.V. (investments - Netherlands), and is
a member of the audit committee of Northern
Border Partners, L.P., a subsidiary of Enron
Corp. (energy).

STEPHEN B. WARD Senior Vice President Senior Vice President and Chief Investment
April 5, 1955 and Chief Investment Officer, Charles Schwab Investment Management,
Officer Inc.

The fund is overseen by a board of trustees. The board of trustees meets
regularly to review the fund's activities, contractual arrangements and
performance. The board of trustees is responsible for protecting the interests
of the fund's shareholders. The following table provides information concerning
compensation of the trustees.

<TABLE>
<CAPTION>
($) Pension or ($)
Aggregate Retirement Total
Name of Trustee Compensation Benefits Accrued Compensation
from the Fund (1) as Part of Fund from Fund
Expenses Complex (2)
--------------- ----------------- ---------------- ------------
<S> <C> <C> <C>
Charles R. Schwab 0 N/A 0
Steven L. Scheid 0 N/A 0
William J. Klipp (3) 0 N/A 0
Jeremiah H. Chafkin (4) 0 N/A 0
Mariann Byerwalter (4) 385 N/A 38,870
Donald F. Dorward 1,320 N/A 134,600
</TABLE>

28
<PAGE> 170

<TABLE>
<CAPTION>
($) Pension or ($)
Aggregate Retirement Total
Name of Trustee Compensation Benefits Accrued Compensation
from the Fund (1) as Part of Fund from Fund
Expenses Complex (2)
--------------- ----------------- ---------------- ------------
<S> <C> <C> <C>
William A. Hasler (4) 385 N/A 38,870
Robert G. Holmes 1,320 N/A 134,600
Gerald B. Smith (4) 385 N/A 38,870
Donald R. Stephens 1,320 N/A 134,600
Michael W. Wilsey 1,223 N/A 124,600
</TABLE>

1 Estimated compensation for the fiscal year ended August 31, 2000.

2 Unless otherwise stated, information is for the fund complex, which included
44 funds as of August 31, 2000.

3 Mr. Klipp departed Charles Schwab & Co., Inc. in 1999 and resigned from the
Board of Trustees on April 30, 2000.

4 This trustee was first elected by shareholders on June 1, 2000.

DEFERRED COMPENSATION PLAN

CODE OF ETHICS

The fund, its investment adviser and Schwab have adopted a Code of Ethics (Code)
as required under the 1940 Act. Subject to certain conditions or restrictions,
the Code permits the trustees, directors, officers or advisory representatives
of the fund or the investment adviser or the directors or officers of Schwab to
buy or sell securities for their own accounts. This includes securities that may
be purchased or held by the fund. Securities transactions by some of these
individuals may be subject to prior approval of the investment adviser's Chief
Compliance Officer or alternate. Most securities transactions are subject to
quarterly reporting and review requirements.

CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES

As of October 16, 2000, the officers and trustees of Schwab YieldPlus
Fund-Select Shares, as a group, owned of record 1.72% of the outstanding voting
securities of the Schwab YieldPlus Fund-Select Shares.

As of October 16, 2000, no persons or entities owned, directly or beneficially,
more than 5% of the shares of the fund.

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<PAGE> 171
INVESTMENT ADVISORY AND OTHER SERVICES

INVESTMENT ADVISER

Charles Schwab Investment Management, Inc. (CSIM or the investment adviser), a
wholly owned subsidiary of The Charles Schwab Corporation, 101 Montgomery
Street, San Francisco CA 94104, serves as the fund's investment adviser and
administrator pursuant to Investment Advisory and Administration Agreements
(Advisory Agreements) between it and the trust. Charles Schwab & Co., Inc.
(Schwab) is an affiliate of the investment adviser and is the trust's
distributor, shareholder services agent and transfer agent. Charles R. Schwab is
the founder, Chairman, Co-Chief Executive Officer and Director of The Charles
Schwab Corporation. As a result of his ownership of and interests in The Charles
Schwab Corporation, Mr. Schwab may be deemed to be a controlling person of the
investment adviser and Schwab.

First $500 million - 0.35%
More than $500 million - 0.30%

For the fiscal year ended August 31, 2000, the fund paid investment advisory
fees of $194,000, (fees were reduced by $435,000).

The investment adviser and Schwab have contractually guaranteed that, through at
least November 15, 2001, the total operating expenses (excluding interest, taxes
and certain non-routine expenses) of the Investor Shares and Select Shares of
the fund will not exceed 0.55% and 0.40%, respectively, of average daily net
assets.

DISTRIBUTOR

Pursuant to a Distribution Agreement, Schwab is the principal underwriter for
shares of the fund and is the trust's agent for the purpose of the continuous
offering of the fund's shares. The fund pays the cost of the prospectuses and
shareholder reports to be prepared and delivered to existing shareholders.
Schwab pays such costs when the described materials are used in connection with
the offering of shares to prospective investors and for supplemental sales
literature and advertising. Schwab receives no fee under the Distribution
Agreement.

SHAREHOLDER SERVICES AND TRANSFER AGENT

Schwab provides fund information to shareholders, including share price,
reporting shareholder ownership and account activities and distributing the
fund's prospectuses, financial reports and other informational literature about
the fund. Schwab maintains the office space, equipment and personnel necessary
to provide these services. Schwab also distributes and markets SchwabFunds and
provides other services. At its own expense, Schwab may engage third party
entities, as appropriate, to perform some or all of these services.

For the services performed as transfer agent under the contract with the fund,
Schwab is entitled to receive an annual fee, payable monthly from the fund, in
the amount of 0.05% of the fund's average daily net assets. For the services
performed as shareholder services agent under its contract with the fund, Schwab
is entitled to receive an annual fee, payable monthly from each

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<PAGE> 172
class of shares of the fund, in the amount of 0.20% of the Investor Shares'
average daily net assets and 0.05% of the Select Shares' average daily net
assets.

CUSTODIAN AND FUND ACCOUNTANT

PFPC Trust Company, 8800 Tinicum Blvd., Third Floor Suite 200, Philadelphia PA
19153, serves as custodian for the funds and PFPC, Inc., 400 Bellevue Parkway,
Wilmington DE 19809, serves as fund accountant.

The custodians are responsible for the daily safekeeping of securities and cash
held or sold by the fund. The accountants maintain all books and records related
to the fund's transactions.

INDEPENDENT ACCOUNTANT

The fund's independent accountant, PricewaterhouseCoopers LLP, audits and
reports on the annual financial statements of each series of the trust and
reviews certain regulatory reports and the fund's federal income tax return.
They also perform other professional accounting, auditing, tax and advisory
services when the trust engages them to do so. Their address is 333 Market
Street, San Francisco, CA 94105. The fund's audited financial statements for the
fiscal year ending August 31, 2000, will be included in the fund's annual report
that is supplied with the SAI.

BROKERAGE ALLOCATION AND OTHER PRACTICES

PORTFOLIO TURNOVER

For reporting purposes, the fund's turnover rate is calculated by dividing the
value of purchases or sales of portfolio securities for the fiscal year,
whichever is less, by the monthly average value of portfolio securities the fund
owned during the fiscal year. When making the calculation, all securities whose
maturities at the time of acquisition were one year or less (short-term
securities) are excluded.

The portfolio turnover rate for the Schwab YieldPlus Fund for the fiscal year
ended August 31, 2000 was 81%.

PORTFOLIO TRANSACTIONS

The fund paid no brokerage commission in the last fiscal year.

In effecting securities transactions for the fund, the investment adviser seeks
to obtain best execution. Subject to the supervision of the board of trustees,
the investment adviser will select brokers and dealers for the fund on the basis
of a number of factors, including, for example, price paid for securities,
clearance, settlement, reputation, financial strength and stability, efficiency
of execution and error resolution, block trading and block positioning
capabilities, willingness to execute related or unrelated difficult transactions
in the future, and order of call.

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<PAGE> 173
The fund expects that purchases and sales of portfolio securities will usually
be principal transactions. Securities will normally be purchased directly from
the issuer or from an underwriter or market maker for the securities. Purchases
from underwriters will include a commission or concession paid by the issuer to
the underwriter, and purchases from dealers serving as market makers will
include the spread between the bid and asked prices.

The investment decisions for the fund are reached independently from those for
other accounts managed by the investment adviser. Such other accounts also may
make investments in instruments or securities at the same time as the fund. When
two or more accounts managed by the investment adviser have funds available for
investment in similar instruments, available instruments are allocated as to
amount in a manner considered equitable to each account. In some cases, this
procedure may affect the size or price of the position obtainable for the fund.
However, it is the opinion of the board of trustees that the benefits conferred
by the investment adviser outweigh any disadvantages that may arise from
exposure to simultaneous transactions.

In an attempt to obtain best execution for the fund, the investment adviser may
place orders directly with market makers or with third market brokers such as
Instinet, which is a computer subscriber service, or brokers on an agency basis.
Placing orders with third market brokers or through Instinet may enable the fund
to trade directly with other institutional holders on a net basis. At times,
this may allow the fund to trade larger blocks than would be possible trading
through a single market maker.

DESCRIPTION OF THE TRUST

The fund is a series of Schwab Investments. Schwab Investments was organized
under Massachusetts law on October 26, 1990.

The Declaration of Trust provides that shares may be automatically redeemed if
held by a shareholder in an amount less than the minimum required by the fund or
share class. The fund's initial and subsequent minimum investment and balance
requirements are set forth in the prospectus. These minimums may be waived for
certain investors, including trustees, officers and employees of Schwab, or
changed without prior notice.

The fund may hold special meetings, which may cause the funds to incur
non-routine expenses. These meetings may be called for purposes such as electing
trustees, changing fundamental policies and amending management contracts.
Shareholders are entitled to one vote for each share owned and may vote by proxy
or in person. Proxy materials will be mailed to shareholders prior to any
meetings, and will include a voting card and information explaining the matters
to be voted upon.

32
<PAGE> 174
Under Massachusetts law, shareholders of a Massachusetts business trust could,
under certain circumstances, be held personally liable for the trust's
obligations. The Declaration of Trust, however, disclaims shareholder liability
for the trust's acts or obligations and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the trust or the trustees. In addition, the Declaration of Trust provides for
indemnification out of the property of an investment portfolio in which a
shareholder owns or owned shares for all losses and expenses of such shareholder
or former shareholder if he or she is held personally liable for the obligations
of the trust solely by reason of being or having been a shareholder. Moreover,
the trust will be covered by insurance which the trustees consider adequate to
cover foreseeable tort claims. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is considered remote, because
it is limited to circumstances in which a disclaimer is inoperative and the
trust itself is unable to meet its obligations. There is a remote possibility
that the fund could become liable for a misstatement in the prospectus or SAI
about another fund.

PURCHASE, REDEMPTION, DELIVERY OF SHAREHOLDER REPORTS AND PRICING OF SHARES

PURCHASING AND REDEEMING SHARES OF THE FUND

As long as the fund or Schwab follows reasonable procedures to confirm that your
telephone or internet order is genuine, they will not be liable for any losses
an investor may experience due to unauthorized or fraudulent instructions. These
procedures may include requiring a form of personal identification or other
confirmation before acting upon any telephone or internet order, providing
written confirmation of telephone or internet orders and tape recording all
telephone orders.

Share certificates will not be issued in order to avoid additional
administrative costs, however, share ownership records are maintained by Schwab.

The fund reserves the right to waive the early redemption fee for certain
tax-advantaged retirement plans.

The fund has made an election with the SEC to pay in cash all redemptions
requested by any shareholder of record limited in amount during any 90-day
period to the lesser of $250,000 or 1% of its net assets at the beginning of
such period. This election is irrevocable without the SEC's prior approval.
Redemption requests in excess of these limits may be paid, in whole or in part,
in investment securities or in cash, as the board of trustees may deem
advisable. Payment will be made wholly in cash unless the board of trustees
believes that economic or market conditions exist that would make such payment a
detriment to the best interests of the fund. If redemption proceeds are paid in
investment securities, such securities will be valued as set forth in "Pricing

33
<PAGE> 175
of Shares". A redeeming shareholder would normally incur transaction costs if he
or she were to convert the securities to cash.

EXCHANGING SHARES OF THE FUNDS

DELIVERY OF SHAREHOLDER DOCUMENTS

PRICING OF SHARES

Securities traded on stock exchanges are valued at the last-quoted sales price
on the exchange on which such securities are primarily traded, or, lacking any
sales, at the mean between the bid and ask prices. Securities traded in the
over-the-counter market are valued at the last sales price that day, or if no
sales that day, at the mean between the bid and ask prices. Securities for which
market quotations or closing values are not readily available (including
restricted securities that are subject to limitations on their sale and illiquid
securities) are valued at fair value as determined in good faith pursuant to
guidelines and procedures adopted by the board of trustees. These procedures
require that securities be valued on the basis of prices provided by approved
pricing services, except when a price appears manifestly incorrect or events
occurring between the time a price is furnished by a service and the time the
fund calculates its share price materially affect the furnished price. The board
of trustees regularly reviews fair values assigned to portfolio securities under
these circumstances and also when no prices from approved pricing services are
available.

TAXATION

FEDERAL TAX INFORMATION FOR THE FUND

It is the fund's policy to qualify for taxation as a RIC by meeting the
requirements of Subchapter M of the Internal Revenue Code of 1986, as amended
(the Code). By qualifying as a RIC, the fund expects to eliminate or reduce to a
nominal amount the federal income tax to which it is subject. If the fund does
not qualify as a RIC under the Code, it will be subject to federal income tax,
at regular corporate rates, on its net income, including any net realized
capital gains.

<PAGE> 176
The Code imposes a non-deductible excise tax on RICs that do not distribute in a
calendar year (regardless of whether they otherwise have a non-calendar taxable
year) an amount equal to 98% of their "ordinary income" (as defined in the Code)
for the calendar year plus 98% of their net capital gain for the one-year period
ending on October 31 of such calendar year, plus any undistributed amounts from
prior years. The non-deductible excise tax is equal to 4% of the deficiency. For
the foregoing purposes, the fund is treated as having distributed any amount on
which it is subject to income tax for any taxable year ending in such calendar
year.

The fund's transactions in futures contracts, options and certain other
investment activities may be restricted by the Code and are subject to special
tax rules. In a given case, these rules may accelerate income to the fund, defer
its losses, cause adjustments in the holding periods of the fund's assets,
convert short-term capital losses into long-term capital losses or otherwise
affect the character of the fund's income. These rules could therefore affect
the amount, timing and character of distributions to shareholders. The fund will
endeavor to make any available elections pertaining to these transactions in a
manner believed to be in the best interest of the fund and its shareholders.

FEDERAL INCOME TAX INFORMATION FOR SHAREHOLDERS

The discussion of federal income taxation presented below supplements the
discussion in the fund's prospectus and only summarizes some of the important
federal tax considerations generally affecting shareholders of the fund.
Accordingly, prospective investors (particularly those not residing or domiciled
in the United States) should consult their own tax advisers regarding the
consequences of investing in the fund.

Any dividends declared by the fund in October, November or December and paid the
following January are treated, for tax purposes, as if they were received by
shareholders on December 31 of the year in which they were declared. Long-term
capital gains distributions are taxable as long-term capital gains, regardless
of how long you have held your shares. However, if you receive a long-term
capital gains distribution with respect to fund shares held for six months or
less, any loss on the sale or exchange of those shares shall, to the extent of
the long-term capital gains distribution, be treated as a long-term capital
loss. Because the fund's income is expected to consist of interest rather than
dividends, it is anticipated that no portion of its distributions will generally
be eligible for the dividends-received deduction. Distributions by the fund also
may be subject to state, local and foreign taxes, and its treatment under
applicable tax laws may differ from the federal income tax treatment.

The fund will be required in certain cases to withhold and remit to the U.S.
Treasury 31% of taxable dividends paid to any shareholder who (1) fails to
provide a correct taxpayer identification number certified under penalty of
perjury; (2) is subject to withholding by the Internal Revenue Service for
failure to properly report all payments of interest or dividends; or (3) fails
to provide a certified statement that he or she is not subject to "backup
withholding." Backup withholding is not an additional tax and any amounts
withheld may be credited against the shareholder's ultimate U.S. tax liability.

<PAGE> 177
recipient is an individual who either (1) meets the Code's definition of
"resident alien" or (2) who is physically present in the United States for 183
days or more. Different tax consequences may result if the foreign shareholder
is engaged in a trade or business within the United States. In addition, the tax
consequences to a foreign shareholder entitled to claim the benefits of a tax
treaty may be different than those described above.

GENERAL STATE AND LOCAL TAX INFORMATION

CALCULATION OF PERFORMANCE DATA

Average annual total return is a standardized measure of performance calculated
using methods prescribed by SEC rules. It is calculated by determining the
ending value of a hypothetical initial investment of $1,000 made at the
beginning of a specified period. The ending value is then divided by the initial
investment, which is annualized and expressed as a percentage. It is reported
for periods of one, five and 10 years or since commencement of operations for
periods not falling on those intervals. In computing average annual total
return, the fund assumes reinvestment of all distributions at net asset value on
applicable reinvestment dates.

Standardized Total Return

Average Annual Total Return from
commencement of operations to
August 31, 2000*

<TABLE>
<CAPTION>
Schwab YieldPlus Fund
<S> <C>
Investor Shares 5.44%+
Select Shares 5.58%+
</TABLE>

* October 1, 1999 for Schwab YieldPlus Fund.

+ Not annualized.

An after-tax total return for the fund may be calculated by taking that fund's
total return and subtracting applicable federal taxes from the portions of the
fund's total return attributable to capital gain and ordinary income
distributions. This after-tax total return may be compared to that of other
mutual funds with similar investment objectives as reported by independent
sources.

The fund may advertise the percentage of its total return that would be paid to
taxes annually (at the applicable federal personal income and capital gains tax
rates) before redemption of fund shares.

36
<PAGE> 178
This proportion may be compared to that of other mutual funds with similar
investment objectives as reported by independent sources.

The fund also may advertise its cumulative total return since inception. This
number is calculated using the same formula that is used for average annual
total return except that, rather than calculating the total return based on a
one-year period, cumulative total return is calculated from commencement of
operations to the end of the fiscal year.

37
<PAGE> 179

Nonstandardized Cumulative Total Return

Cumulative Total Return from commencement
of operations to August 31, 2000*

<TABLE>
<CAPTION>
Schwab YieldPlus Fund
<S> <C>
Investor Shares 5.44%
Select Shares 5.58%
</TABLE>

* October 1, 1999 for Schwab YieldPlus Fund.

A 30-day yield is calculated by dividing the net investment per share earned
during a 30-day period by the income per share earned during the 30-day period
by the fund's share price on the last day of the period.

30-Day Yield

30-day period ended August 31, 2000

<TABLE>
<CAPTION>
Schwab YieldPlus Fund
<S> <C>
Investor Shares 6.91%
Select Shares 7.07%
</TABLE>

The performance of the fund may be compared with the performance of other mutual
funds by comparing the ratings of mutual fund rating services, various indices,
U.S. government obligations, bank certificates of deposit, the consumer price
index and other investments and measures for which reliable data is available.
An index's performance data assumes the reinvestment of dividends but does not
reflect deductions for administrative, management and trading expenses. The fund
will be subject to these costs and expenses, while an index does not have these
expenses. In addition, various factors, such as holding a cash balance, may
cause the fund's performance to be higher or lower than that of an index.

38
<PAGE> 180
APPENDIX - RATINGS OF INVESTMENT SECURITIES

From time to time, the fund may report the percentage of its assets that fall
into the rating categories set forth below.

BONDS

MOODY'S INVESTORS SERVICE

STANDARD & POOR'S CORPORATION

INVESTMENT GRADE

AAA Debt rated 'AAA' has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.

AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated debt only in small degree.

39
<PAGE> 181
A Debt rated 'A' has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.

SPECULATIVE GRADE

FITCH, INC.

INVESTMENT GRADE BOND

AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.

AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated 'AAA'. Because
bonds rated in the 'AAA' and 'AA' categories are not significantly
vulnerable to foreseeable future developments, short-term debt of these
issuers is generally rated 'F-1+'.

A Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to
be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.

40
<PAGE> 182
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.

SPECULATIVE GRADE BOND

B Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the
obligor's limited margin of safety and the need for reasonable business
and economic activity throughout the life of the issue.

DESCRIPTION OF THOMSON BANKWATCH'S LONG-TERM DEBT RATINGS

INVESTMENT GRADE

AAA The highest category; indicates that the ability to repay principal and
interest on a timely basis is very high.

AA The second-highest category; indicates a superior ability to repay
principal and interest on a timely basis, with limited incremental risk
compared to issues rated in the highest category.

A The third-highest category; indicates the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to
adverse developments (both internal and external) than obligations with
higher ratings.

BBB The lowest investment-grade category; indicates an acceptable capacity
to repay principal and interest. Issues rated "BBB" are, however, more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.

NON-INVESTMENT GRADE

BB While not investment grade, the "BB" rating suggests that the
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the
ability to adequately service debt obligations.

41
<PAGE> 183
SHORT-TERM NOTES AND VARIABLE RATE DEMAND OBLIGATIONS

MOODY'S INVESTORS SERVICE

STANDARD & POOR'S CORPORATION

An S&P SP-1 rating indicates that the subject securities issuer has a strong
capacity to pay principal and interest. Issues determined to possess very strong
safety characteristics are given a plus (+) designation. S&P's determination
that an issuer has a satisfactory capacity to pay principal and interest is
denoted by an SP-2 rating.

FITCH, INC.

COMMERCIAL PAPER

MOODY'S INVESTORS SERVICE

STANDARD & POOR'S CORPORATION

An S&P A-1 commercial paper rating indicates a strong degree of safety regarding
timely payment of principal and interest. Issues determined to possess
overwhelming safety characteristics are denoted A-1+. Capacity for timely
payment on commercial paper rated A-2 is satisfactory, but the relative degree
of safety is not as high as for issues designated A-1.

FITCH, INC.

42
<PAGE> 184
COMMERCIAL PAPER, SHORT-TERM OBLIGATIONS
AND DEPOSIT OBLIGATIONS ISSUED BY BANKS

THOMSON BANKWATCH

43
<PAGE> 185
PART C
OTHER INFORMATION
SCHWAB INVESTMENTS

Item 23. Exhibits.
---------
<TABLE>
<S> <C> <C> <C>
(a) Articles of Incorporation
Agreement and Declaration of
Trust, dated October 26, 1990, was
electronically filed and is
incorporated by reference to
Exhibit 1 of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1997.

(b) By-Laws Amended and Restated By-Laws were
electronically filed and are
incorporated by reference to
Exhibit 2 of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1997.

(c) Instruments Defining (i) Article III, Section 5, Article V,
Rights of Security Article VI, Article VIII, Section
Holders 4 and Article IX, Sections 1, 5
and 7 of the Agreement and
Declaration of Trust were filed
and are incorporated by reference
to Exhibit 1 of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1997.

(ii) Article 9, Article 10, Section 6,
and Article 11 of the Amended and
Restated By-Laws were filed and
are incorporated by reference to
Exhibit 2 of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A filed on December 30, 1997.

(d) Investment Advisory (i) Investment Advisory and
Contracts Administration Agreement between
Registrant and Charles Schwab
Investment Management, Inc. (the
"Investment Manager") and
Schedules B and C were
electronically filed and are
incorporated by reference to
Exhibit 5(a) of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1997.

(ii) Amended Schedules A and D to
Investment Advisory and
Administration Agreement referred
to at Exhibit (d)(i) above was
electronically filed and is
incorporated by reference to
Exhibit (d) (ii) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A, filed on July 21, 1999.

(e) Underwriting Contracts (i) Distribution Agreement between
Registrant and Charles Schwab &
Co., Inc. ("Schwab") was
electronically filed and is
incorporated by reference to
Exhibit 6 of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1997.
</TABLE>

<PAGE> 186

<TABLE>
<S> <C> <C> <C>
(ii) Amended Schedule A to the
Distribution Agreement was
electronically filed and is
incorporated by reference to
Exhibit (e) (ii) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A, on July 21, 1999.

(f) Bonus or Profit Sharing Inapplicable.
Contracts

(g) Custodian Agreements (i) Custodian Services Agreement
between Registrant and PNC Bank,
Nation al Association (formerly
Provident National Bank) was
electronically filed and is
incorporated by reference to
Exhibit 8(a) of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1997.

(ii) Amendment No. 1 to Custodian
Services Agreement referred to at
Exhibit g(i) above was filed and
is incorporated by reference to
Exhibit 8(b) of Post-Effective
Amendment No. 13 to Registrant's
Registration Statement on Form
N-1A, filed on December 29, 1996.

(iii) Amendment No. 2 to Custodian
Services Agreement referred to at
Exhibit (g)(i) above was filed and
is incorporated by reference to
Exhibit 8(c) of Post-Effective
Amendment No.14 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1996.

(iv) Amended Schedule A to the
Custodian Services Agreement
referred to at Exhibit (g)(i)
above was electronically filed and
is incorporated by reference to
Exhibit (g)(iv) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A , filed on July 21, 1999.

(v) Transfer Agency Agreement between
the Registrant and Schwab and
Schedule B were electronically
filed and are incorporated by
reference to Exhibit 8(e) of
Post-Effective Amendment No. 22 to
Registrant's Registration
Statement on Form N-1A, filed on
December 30, 1997.

(vi) Amended Schedules A and C to the
Transfer Agency Agreement referred
to at Exhibit (g)(v) above were
electronically filed and are
incorporated by reference to
Exhibit (g)(vi) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
1-1A, filed on July 21, 1999.
</TABLE>

<PAGE> 187

<TABLE>
<S> <C> <C>
(vii) Shareholder Service Agreement
between the Registrant and Schwab
and Schedule B were electronically
filed and are incorporated by
reference to Exhibit 8(g) of
Post-Effective Amendment No. 22 to
Registrant's Registration
Statement on Form N-1A, filed on
December 30, 1997.

(viii) Schedules A and C to the
Shareholder Service Agreement
between the Registrant and Schwab
referenced at Exhibit (g)(vii)
above were electronically filed
and are incorporated by reference
to Exhibit (g)(viii) of
Post-Effective Amendment No. 29 to
Registrant's Registration
Statement on Form N-1A, filed on
July 21, 1999.

(ix) Accounting Services Agreement
between Registrant and Provident
Financial Processing Corporation
was electronically filed and is
incorporated by reference to
Exhibit 8(i) of Post-Effective
Amendment No. 22 to Registrant's
Registration Statement on Form
N-1A filed on December 30, 1997.

(x) Amendment No. 1 to Accounting
Services Agreement referred to at
Exhibit (g)(ix) above was filed
and is incorporated by reference
to Exhibit 8(j) of Post-Effective
Amendment No. 13 to Registrant's
Registration Statement on Form
N-1A, filed on December 29, 1996.

(xi) Amendment No. 2 to Accounting
Services Agreement referred to at
Exhibit (g)(ix) above was filed
and is incorporated by reference
to Exhibit 8(k) of Post-Effective
Amendment No. 14 to Registrant's
Registration Statement on Form
N-1A, filed on December 30, 1996.

(xii) Amended Custodian Services Fee
Agreement dated November 1, 1998,
by and between the Registrant and
PNC Bank, National Association, is
incorporated herein by reference
to Exhibit (g)(xii) of
Post-Effective Amendment No. 27 to
Registrant's Registration
Statement on Form N-1A,
electronically filed on December
30, 1998.

(xiii) Schedule A to the Custodian
Services Fee Agreement between the
registrant and PNC Bank, National
Association and PFPC, Inc. was
electronically filed and is
incorporated by reference to
Exhibit (g)(xiv) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A, filed on July 21, 1999.
</TABLE>

<PAGE> 188

<TABLE>
<S> <C> <C> <C>
(xiv) Accounting Services Agreement with
SEI Fund Resources dated April 1,
1998, was electronically filed and
is incorporated herein by
reference to Exhibit g(xiii) of
Post-Effective Amendment No. 27 to
Registrant's Registration
Statement on Form N-1A,
electronically filed on December
30, 1998.

(xv) Amended Schedule A of the
Accounting Services Agreement
between the Registrant and SEI
Fund Resources was electronically
filed and is incorporated by
reference to Exhibit (g)(xvi) of
Post-Effective Amendment No. 29 to
Registrant's Registration
Statement on Form N-1A, filed on
July 21, 1999.

(xvi) Amendment No. 1 to the Accounting
Services Agreement dated December
17, 1998, by and between Schwab
Capital Trust, Schwab Annuity
Portfolios, Schwab Investments and
SEI Fund Resources was
electronically filed and is
incorporated by reference to
exhibit (g)(xvii) of
Post-Effective Amendment No. 29 to
Registrant's Registration
Statement on Form N-1A, filed on
July 21, 1999.

(h) Other Material Contracts Inapplicable.

(i) Legal Opinion Opinion of Counsel is
electronically filed herewith as
Exhibit (i).

(j) Other Opinions Auditor's Consent is
electronically filed herewith as
Exhibit (j).

(k) Omitted Financial Inapplicable.
Statements

(l) Initial Capital Agreement (i) Purchase Agreement relating to
shares of the Schwab 1000 Fund was
electronically filed and is
incorporated by reference to
Exhibit (l)(i) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A, filed on July 21, 1999.

(ii) Purchase Agreement relating to
shares of the Schwab Short-Term
Bond Market Index Fund (formerly
Schwab Short/Intermediate
Government Bond Fund) was
electronically filed and
incorporated by reference to
Exhibit (l)(ii) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A, filed on July 21, 1999.

(iii) Purchase Agreement relating to
shares of the Schwab California
Long-Term Tax-Free Bond Fund
(formerly Schwab California Tax
Free Bond Fund) was electronically
filed and is incorporated by
reference to Exhibit (l)(iii) of
Post-Effective Amendment No. 29 to
Registrant's Registration
Statement on Form N-1A, filed on
July 21, 1999.
</TABLE>

<PAGE> 189

<TABLE>
<S> <C> <C> <C>
(iv) Purchase Agreement relating to
shares of the Schwab Long-Term
Tax-Free Bond Fund (formerly
Schwab National Tax Free Bond
Fund) was electronically filed and
is incorporated by reference to
Exhibit (l)(iv) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A, filed on July 21, 1999.

(v) Purchase Agreement relating to
shares of the Schwab
Short/Intermediate Tax-Free Bond
Fund, Schwab California
Short/Intermediate Tax-Free Bond
Fund and Schwab Total Bond Market
Index Fund (formerly, Schwab
Long-Term Government Bond Fund)
was filed and is incorporated by
reference to Exhibit 13 to
Post-Effective Amendment No. 22 to
Registrant's Registration
Statement on Form N-1A filed on
December 30, 1997.

(vi) Purchase Agreement relating to
shares of the Schwab Yield Plus
Fund was electronically filed and
is incorporated by reference to
Exhibit (l)(vi) of Post-Effective
Amendment No. 29 to Registrant's
Registration Statement on Form
N-1A, filed on July 21, 1999.

(m) Rule 12b-1 Plan Inapplicable.

(n) Financial Data Schedule (i) Inapplicable.

(o) Rule 18f-3 Plan Registrant's Amended and Restated
Multiple Class Plan for Investor
and Select Shares of Schwab 1000
Fund(R) and Schwab YieldPlus
Fund (TM) was electronically
filed and is incorporated by
reference to Exhibit (o)(i) of
Post-Effective Amendment No. 29 to
Registrant's Registration
Statement on Form N-1A, filed on
July 21, 1999.

(p) Power of Attorney (i) Power of Attorney for Charles R.
Schwab, William J. Klipp, Tai-Chin
Tung, Steven L. Scheid, Donald F.
Dorward, Robert G. Holmes, Donald
R. Stephens and Michael W. Wilsey
was electronically filed and is
incorporated by reference to
Exhibit (p) to Post-Effective
Amendment No. 37 to the Charles
Schwab Family of Funds
Registration Statement on Form
N-1A filed on April 27, 1999.

(ii) Power of Attorney executed by
Jeremiah H. Chafkin, December 6,
1999, was electronically filed and
is incorporated by reference to
Exhibit (p)(i) of Post-Effective
Amendment No. 32 to Registrant's
Registration Statement on Form
N-1A, filed on February 25, 2000.
</TABLE>

<PAGE> 190

<TABLE>
<S> <C> <C> <C>
(iii) Power of Attorney executed by
Mariann Byerwalter, August 4,
2000, was electronically filed and
is incorporated by reference to
Exhibit (p)(ii) of Post-Effective
Amendment No. 33 to Registrant's
Registration Statement on Form
N-1A, filed on August 28, 2000.

(iv) Power of Attorney executed by
William A. Hasler, August 4, 2000,
was electronically filed and is
incorporated by reference to
Exhibit (p)(iii) of Post-Effective
Amendment No. 33 to Registrant's
Registration Statement on Form
N-1A, filed on August 28, 2000.

(v) Power of Attorney executed by
Gerald B. Smith, August 4, 2000,
was electronically filed and is
incorporated by reference to
Exhibit (p)(iv) of Post-Effective
Amendment No. 33 to Registrant's
Registration Statement on Form
N-1A, filed on August 28, 2000.

(q) Code of Ethics Code of Ethics adopted by
Registrant, Charles Schwab
Investment Management Inc. and
Charles Schwab & Co., Inc. was
electronically filed and is
incorporated by reference to
Exhibit (q) of Post-Effective
Amendment No. 36 to the Schwab
Capital Trust Registration
Statement on Form N-1A filed on
February 25, 2000.
</TABLE>

Item 24. Persons Controlled by or under Common Control with the Registrant.

The Charles Schwab Family of Funds (the "Schwab Fund Family"), Schwab Capital
Trust and Schwab Annuity Portfolios are each Massachusetts business trusts
registered under the Investment Company Act of 1940, as amended (the "1940
Act"). Each is advised by the Investment Manager and employs Schwab as principal
underwriter, transfer agent and shareholder services agent. As a result, the
Schwab Fund Family, Schwab Capital Trust and Schwab Annuity Portfolios may each
be deemed to be under common control with Registrant.

Item 25. Indemnification.

Article VIII of Registrant's Agreement and Declaration of Trust (Exhibit (1)
hereto, which is incorporated herein by reference) provides in effect that
Registrant will indemnify its officers and trustees against all liabilities and
expenses, including but not limited to amounts paid in satisfaction of
judgments, in compromise, or as fines and penalties, and counsel fees reasonably
incurred by any such officer or trustee in connection with the defense or
disposition of any action, suit, or other proceeding. However, in accordance
with Section 17(h) and 17(i) of the 1940 Act and its own terms, said Agreement
and Declaration of Trust does not protect any person against any liability to
Registrant or its shareholders to which he or she would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in the conduct of his or her office. In any
event, Registrant will comply with 1940 Act Releases No. 7221 and 11330
respecting the permissible boundaries of indemnification by an investment
company of its officers and trustees.

Insofar as indemnification for liability arising under the Securities Act of
1933, as amended (the "1933 Act"), may be permitted to trustees, officers and
controlling persons of the Registrant

<PAGE> 191

pursuant to the foregoing provisions, or otherwise, Registrant has been advised
that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the 1933 Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by Registrant of expenses incurred or
paid by a trustee, officer or controlling person of Registrant in the successful
defense of any action, suit or proceeding) is asserted by such trustee, officer
or controlling person in connection with the securities being registered,
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the 1933 Act and will be governed by the final adjudication of such
issue.

Item 26. Business and Other Connections of Investment Adviser

Registrant's investment adviser, Charles Schwab Investment Management, Inc., a
Delaware corporation, organized in October 1989 to serve as investment manager
to Registrant, also serves as the investment manager to The Charles Schwab
Family of Funds, Schwab Investments, Schwab Capital Trust, and Schwab Annuity
Portfolios, each an open-end, management investment company. The principal place
of business of the investment adviser is 101 Montgomery Street, San Francisco,
California 94104. The only business in which the investment adviser engages is
that of investment adviser and administrator to Registrant, The Charles Schwab
Family of Funds, Schwab Investments, Schwab Capital Trust, Schwab Annuity
Portfolios and any other investment companies that Schwab may sponsor in the
future as well as provider of advisory services to the Schwab Fund for
Charitable Giving and to Charles Schwab Asset Management (Ireland) Limited.

The business, profession, vocation or employment of a substantial nature in
which each director and/or senior or executive officer of the investment adviser
(CSIM) is or has been engaged during the past two fiscal years is listed below.
The name of any company for which any director and/or senior or executive
officer of the investment adviser serves as director, officer, employee, partner
or trustee is also listed below. In addition, the name and position of each
director and/or senior or executive officer of the Registrant's principal
underwriter Schwab & Co. Inc. is listed below.

<TABLE>
<CAPTION>
Name and Position
with Registrant Name of Company Capacity
-------------------------------- ------------------------------------------------- ----------------------------------
<S> <C> <C>
Charles R. Schwab, Charles Schwab & Co., Inc. Chairman, Director
Chairman, Chief Executive
Officer and Trustee
The Charles Schwab Corporation Chairman and Co-Chief Executive
Officer, Director

Charles Schwab Investment Management, Inc. Chairman, Director

The Charles Schwab Trust Company Director

Schwab Holdings, Inc. Chief Executive Officer, Director
</TABLE>

<PAGE> 192

Schwab International Holdings, Inc. Chairman and Chief Executive
Officer

Schwab (SIS) Holdings, Inc. I Chairman and Chief Executive
Officer

The Gap, Inc. Director

Audiobase, Inc. Director

Vodaphone AirTouch PLC Director

Siebel Systems Director

Mayer & Schweitzer, Inc. Chairman and Director until
January 1999

Schwab Retirement Plan Services, Inc. Chairman, Director until January
1999

Performance Technologies, Inc. Chairman, Director until January
1999

TrustMark, Inc. Chairman and Director until
January 1999

David S. Pottruck Charles Schwab & Co., Inc. Chief Executive Officer, Director

The Charles Schwab Corporation President and Co-Chief Executive
Officer, Director

Charles Schwab Investment Management, Inc. Director

Schwab Retirement Plan Services, Inc. Director until January 1999

Charles Schwab Limited (U.K.) Director until January 1999

Mayer & Schweitzer, Inc. Director until January 1999

Performance Technologies, Inc. Director until January 1999

TrustMark, Inc. Director until January 1999
</TABLE>

<PAGE> 193

<TABLE>
<CAPTION>
Name and Position
with Registrant Name of Company Capacity
-------------------------------- ------------------------------------------------- ----------------------------------
<S> <C> <C>
Steven L. Scheid Charles Schwab & Co., Inc. Vice Chairman and President of
President and Trustee the Schwab Retail Group

The Charles Schwab Corporation Vice Chairman and Executive Vice
President

Charles Schwab Investment Management, Inc. Chief Executive Officer and
Chief Financial Officer, Director

Charles Schwab Limited (U.K.) Finance Officer

Depository Trust Company Director

Requisite Technology Director

The Charles Schwab Trust Company Director until July 1998

Schwab Retirement Plan Services, Inc. Director until January 1999

Performance Technologies, Inc. Director until January 1999

Mayer & Schweitzer, Inc. Director until January 1999

Willie C. Bogan The Charles Schwab Corporation Assistant Corporate Secretary

Charles Schwab & Co., Inc. Vice President and Assistant
Corporate Secretary

Charles Schwab Investment Management, Inc. Assistant Corporate Secretary

The Charles Schwab Trust Company Assistant Corporate Secretary

Jeremiah H. Chafkin, Executive Charles Schwab & Co., Inc. Executive Vice President, Asset
Vice President, Chief Management Products and
Operating Officer and Trustee Services. Prior to September
1999, Mr. Chafkin was Senior
Managing Director, Bankers Trust
Company.

Charles Schwab Investment Management, Inc. President and Chief Operating
Officer

Karen W. Chang Charles Schwab & Co., Inc. Enterprise President - General
Investor Services
</TABLE>

<PAGE> 194

<TABLE>
<CAPTION>
Name and Position
with Registrant Name of Company Capacity
-------------------------------- ------------------------------------------------- ----------------------------------
<S> <C> <C>
John P. Coghlan Charles Schwab & Co., Inc. Vice Chairman and Enterprise
President - Retirement Plan
Services and Services for
Investment Managers

Koji E. Felton, Charles Schwab Investment Management, Inc. Vice President, Chief Counsel
Secretary and Assistant Corporate Secretary

Christopher V. Dodds Charles Schwab & Co., Inc. Executive Vice President and
Chief Financial Officer

Carrie Dwyer Charles Schwab & Co., Inc. Executive Vice President -
Corporate Oversight and
Corporate Secretary

Wayne W. Fieldsa Charles Schwab & Co., Inc. Enterprise President - Brokerage
Operations

Lon Gorman Charles Schwab & Co., Inc. Vice Chairman and Enterprise
President - Capital Markets and
Trading

James M. Hackley Charles Schwab & Co., Inc. Executive Vice President -
Retail Client Services

Colleen M. Hummer Charles Schwab & Co., Inc. Senior Vice President - Mutual
Funds Operations

Daniel O. Leemon The Charles Schwab Corporation Executive Vice President and
Chief Strategy Officer

Dawn G. Lepore Charles Schwab & Co., Inc. Vice Chairman, Executive Vice
President and Chief Information
Officer

Susanne D. Lyons Charles Schwab & Co., Inc. Executive Vice President and
Chief Marketing Officer

Frederick E. Matteson Charles Schwab & Co., Inc. Executive Vice President -
Schwab Technology Services

John P. McGonigle Charles Schwab & Co., Inc. Executive Vice President -
Mutual Funds
</TABLE>

<PAGE> 195

<TABLE>
<CAPTION>
Name and Position
with Registrant Name of Company Capacity
-------------------------------- ------------------------------------------------- ----------------------------------
<S> <C> <C>
Geoffrey Penney Charles Schwab & Co., Inc. Executive Vice President -
Financial Products and
International Technology

George A. Rich Charles Schwab & Co., Inc. Executive Vice President - Human
Resources

Gideon Sasson Charles Schwab & Co., Inc. Enterprise President -
Electronic Brokerage

Elizabeth G. Sawi Charles Schwab & Co., Inc. Executive Vice President and
Chief Administrative Officer

Tai-Chin Tung, Charles Schwab Investment Management, Inc. Senior Vice President, Treasurer
Treasurer and Principal and Controller
Financial Officer

Stephen B. Ward, Charles Schwab Investment Management, Inc. Senior Vice President and Chief
Senior Vice President and Investment Officer
Chief Investment Officer
</TABLE>

Item 27. Principal Underwriters.

(a) Schwab acts as principal underwriter and distributor of
Registrant's shares. Schwab also acts as principal underwriter for the The
Charles Schwab Family of Funds, Schwab Capital Trust, Schwab Annuity Portfolios
and intends to act as such for any other investment company which Schwab may
sponsor in the future.

(b) See Item 26(b) for information on each director and/or senior or
executive officer of Schwab. The principal business address of Schwab is 101
Montgomery Street, San Francisco, California 94104.

Item 28. Location of Accounts and Records.

All accounts, books and other documents required to be maintained
pursuant to Section 31(a) of the 1940 Act and the Rules thereunder are
maintained at the offices of: Registrant; Registrant's investment manager and
administrator, Charles Schwab Investment Management, Inc., 101 Montgomery
Street, San Francisco, California 94104; Registrant's principal underwriter,
Charles Schwab & Co., Inc., 101 Montgomery Street, San Francisco, California
94104; Registrant's Custodian, PFPC Trust Company, 8800 Tinicum Blvd., Third
Floor Suite 200, Philadelphia, Pennsylvania 19153; Registrant's fund
accountants, PFPC, Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809 or SEI
Fund Resources, Oaks,

<PAGE> 196

Pennsylvania; or Ropes & Gray, 1301 K Street, N.W., Suite 800 East, Washington,
District of Columbia, 20005.

Item 29. Management Services.

Not applicable.

Item 30. Undertakings.

Not applicable.

<PAGE> 197
SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, as amended
(the "1933 Act"), and the Investment Company Act of 1940, as amended, Registrant
certifies that it meets all of the requirements for the effectiveness of this
Registration Statement pursuant to Rule 485(b) under the 1933 Act and has duly
caused this Post Effective Amendment No. 34 to be signed on its behalf by the
undersigned, thereto duly authorized, in the City of Philadelphia, Commonwealth
of Pennsylvania, on the 9th day of November, 2000.

SCHWAB INVESTMENTS
Registrant

Charles R. Schwab*
Charles R. Schwab, Chairman

Pursuant to the requirements of the 1933 Act, this Post-Effective
Amendment No. 34 to Registrant's Registration Statement on Form N-1A has been
signed below by the following persons in the capacities indicated this 9th day
of November, 2000.

<TABLE>
<CAPTION>
Signature Title
--------- ------
<S> <C>
Charles R. Schwab* Chairman, Chief Executive Officer and Trustee
Charles R. Schwab

Steve Scheid* President and Trustee
Steve Scheid

Jeremiah H. Chafkin* Executive Vice President, Chief Operating Officer and Trustee
Jeremiah H. Chafkin

Mariann Byerwalter* Trustee
Mariann Byerwalter

Donald F. Dorward* Trustee
Donald F. Dorward

William A. Hasler* Trustee
William A. Hasler

Robert G. Holmes* Trustee
Robert G. Holmes

Gerald B. Smith* Trustee
Gerald B. Smith

Donald R. Stephens* Trustee
Donald R. Stephens

Michael W. Wilsey* Trustee
Michael W. Wilsey

Tai-Chin Tung* Treasurer and Principal Financial Officer
Tai-Chin Tung
</TABLE>

*By: /s/John H. Grady, Jr.
---------------------------------
John H. Grady, Jr., Attorney-in-Fact
pursuant to Powers of Attorney
<PAGE> 198
EXHIBIT INDEX

<TABLE>
<CAPTION>
EXH. NO. DOCUMENT
-------- --------
<S> <C>
(i) Opinion of Counsel

(j) Auditor's Consent
</TABLE>